The dollar is up, and the pound sterling is down. But only one of these shifts is significant for the world economy. The decline in the value of the pound doesn’t matter much. The United Kingdom no longer has a currency peg to defend, as it did in other times of crisis, such as 1931, 1949, 1967, and 1992. Its floating exchange rate can do what it is designed to do, namely, float. The British government borrows in its own currency, and nearly three-quarters of its debt is held at home. Spiking interest rates are mainly of concern to British homeowners with variable-rate mortgages and aspiring homebuyers who must watch as their banks withdraw from the mortgage market. Rising rates are also of concern to British pension funds that hold bonds issued by the British government to match, at least in part, their long-term liabilities. As their investments lose value, such funds are forced to sell those bonds into a falling market. In response, the Bank of England felt obliged to step in and support the government bond market in the name of financial stability.
The pound’s weakness has undermined confidence in Prime Minister Liz Truss. But at the end of the day, these are just parochial British problems. The United Kingdom accounts for just three percent of global GDP. The pound, notwithstanding its history, accounts for less than five percent of the identified foreign exchange reserves of central banks worldwide. Those central banks may now replace the sterling with more reliable currencies. This pervasive doubt is a problem for the United Kingdom because it augurs a still-weaker currency and even higher borrowing costs. But it is not a problem for the United States and the rest of the world. If the United Kingdom’s financial tribulations provide a timely and important reminder that there may also be financial problems festering in other countries’ pension funds and mortgage markets, then all the better.
