How a Surprising Power Struggle Could Sink the British Pound

Feb 18, 2020 Investor Resources

Bruce Kovner, a retired billionaire currency trader profiled in the book “Market Wizards,” once said he made most of his money from “stupid governments.”

Kovner did not mean individual policymakers are dumb. The idea is that high-IQ people can make collectively dumb decisions as a result of political pressure and groupthink.

When the bad decision is obvious, central banks and treasury departments can help make currency traders rich — or in Kovner’s case, help the rich get richer.

Sometimes a government will telegraph a bad decision or a lavish spending strategy well in advance. When that strategy has direct implications for the currency, things get interesting.

In the United Kingdom, something surprising has happened along those lines.

To briefly summarize, the chancellor of the Exchequer resigned as the result of a power struggle. This concentrates more fiscal power in the hands of the prime minister and his top adviser, which increases the odds of a lavish spending spree.

The shocking nature of the struggle itself — and the chancellor’s replacement with a compliant 39-year-old — sends a signal that the prime minister will not be held back by spending concerns. With the U.K. budget due in a matter of weeks, and big political promises already on the books, perception of this new reality could weaken the British pound. 

To give some background, the chancellor of the Exchequer is considered the second-most-powerful figure in Britain, behind only the prime minister.

The chancellor’s role is comparable to that of the U.S. Treasury secretary. Like the country’s chief financial officer, the chancellor of the Exchequer is in charge of the U.K.’s finances.

Sajid Javid, the chancellor who quit, was a longtime ally of Prime Minister Boris Johnson and a powerful figure in the conservative Tory party. Javid’s strong position within the party, along with his desire to rein in spending at the margins, created inevitable conflict with Johnson’s powerful top adviser, Dominic Cummings.

So, Cummings and Johnson pushed Javid out.

While Johnson didn’t fire the chancellor, he told Javid his top five senior aides would have to resign, and that the Exchequer would have to form a joint economic unit with the prime minister’s office.

Again, to compare with the United States Treasury, this would be akin to the U.S. president telling the Treasury secretary, “You don’t run Treasury, my adviser and I do — so fire your top people, let us replace them with ours, and let Treasury be run jointly by the White House.”

When the U.K. press asked Sajid Javid why he quit, he cited the untenable demands. “I was unable to accept those conditions, and I do not believe any self-respecting minister would,” he said.

The political backdrop here is important to understand.

Thanks to his sweeping victory in the latest election, Boris Johnson is the most powerful conservative prime minister since Margaret Thatcher. The Tory Party won a stunning 80-seat majority because Labour, the U.K.’s left-wing party, ran a horrifically bad campaign and alienated many of its own supporters.

Now that he is prime minister, Johnson wants to cement the newfound power of his party by converting ex-Labour voters into permanent Tory constituents. That means making a lot of political promises to neglected areas of Britain — and spending a lot of money.

That will involve writing some very big checks. Johnson has already begun with approval of a massive $130 billion high-speed rail project, known as “High Speed 2,” that will link prosperous London with the disadvantaged north.

Johnson has also proposed building a bridge between Scotland and Northern Ireland, building at least 40 hospitals, hiring 20,000 new police officers, and more.

Whatever Johnson and Cummings plan to do, it will be easier with their own man running the country’s finances. Rishi Sunak, a rising star with a very thin resume, will be far easier for Johnson and Cummings to control. Whereas Sajid Javid showed signs of pushing back on a wild budget, Sunak is more likely to quietly do Johnson and Cummings’ bidding.

The UK’s annual budget proposal is due to roll out in a few weeks. When Sajid Javid was chancellor, he had announced a publishing date of Wednesday, March 11.

That date is in question now, but at some point relatively soon, the U.K.’s budget will have to be revealed.

If Johnson and Cummings follow through on their power grab — pushing out the chancellor in an unprecedented show of force — their next logical move would be to cement political loyalty among ex-Labour voters and disgruntled Scots via gargantuan spending plans.

The speculative opportunity here would be shorting the British pound, which hit multi-decade lows against the U.S. dollar in mid-2019 and has since seen a six-month bounce. We’ll be watching for signs of price action confirmation in conjunction with more budget news.

When political strategists seize control of the checkbook, forex guys like Kovner start paying attention. 

TradeSmith Research Team

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