Why the British pound is getting pounded

FINANCIAL markets usually give wealthy, politically stable nations a lot of fiscal space. In particular, a country like the United States, or for that matter Britain, can normally run quite big budget deficits without creating a run on its currency. This is because investors typically believe that nations like ours will, in the end, get their acts together and pay their bills; they also believe that central banks like the Federal Reserve and the Bank of England (BOE) will do whatever it takes to prevent deficit spending from setting off runaway inflation.

In fact, deficit spending in an advanced economy normally causes the value of that country’s currency in terms of other currencies to rise, because the collision between fiscal stimulus and tight money leads to high interest rates, and these high rates attract an inflow of capital from abroad. When Ronald Reagan cut taxes while increasing military spending during the early 1980s, the dollar surged against other major currencies, like Germany’s Deutsche mark (this was long before the creation of the euro).

But a funny thing (or not so funny, if you’re British) happened over the past week, when Liz Truss, the new prime minister of the United Kingdom, announced a neo-Reaganite “fiscal event”. (She didn’t call it a proper budget, because that would have required issuing fiscal and economic projections, which probably would have been embarrassing.)