Yen collapse and UK mini-budget debacle show it’s better to work with markets than fight them

Being stubborn on a matter of principle can be costly for politicians and policymakers. They need to remember the wisdom of crowds rather than ignoring the markets, as Liz Truss and the Bank of Japan have

Richard Harris

Published: 10:00pm, 3 Nov 2022

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Swarm intelligence is where natural organisms make collaborative decisions. A flock of birds or a school of fish confounding a predator make better defensive decisions as a group than an individual. Such decisions adapt and change in real time to suit the prevailing conditions and near-term expectations.

Another example is the jelly bean experiment in psychology where a crowd is asked how many jelly beans are in a jar. Individuals are unlikely to get anywhere close, but the wisdom of the crowd makes the average guess very accurate. It sounds like the money markets.

I remember in late 1988 walking near Ginza and an apple on a fruit stall was US$40. At the same time, a small pizza cost US$30. Japan was booming, and it seemed as if it would go on forever. Everything was highly expensive as the yen had strengthened in the 1980s from around 280 to the US dollar to a high of around 120.

The Japanese economy at the time boasted three merits – low inflation, low interest rates and high growth, around 6.7 per cent in 1988. More than three decades later, the first two are still there but growth in the last 20 years has averaged just 0.53 per cent.

Until now, the Japanese yen has been one of the strongest currencies in the world, hitting an all-time high of around 73 in January 2012. It is now 147, having fallen 28 per cent in 2022 alone.

Admittedly, the US dollar index has moved up 16 per cent this year and performed well against almost every currency. However, the yen has especially suffered because the Japanese authorities have been committed to a policy of low interest rates.

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Japanese yen plunges to 32-year low as government steps in to prop currency

The problem is that everybody else is increasing rates with the same domestic pressures, so it is really a matter of principle. What they believe is right and they will not change their mind, come hell or high water. Matters of principle can be expensive.

Modern politicians are a domestic breed with a decreasing understanding of the wider world. It is the same attitude that a fellow fund manager had some years ago, saying to a client after yet another quarter of poor performance that “the market got it wrong”.

However, policymakers also need to be psychologists and bear in mind that others do not think the same as you do. You might be able to get everyone on your side one on one or in a policy forum, but when the crowd is talking you cannot persuade them all of your correctness.

It is dangerous to stick your head above the parapet on a matter of principle, but politicians keep on doing it. Consider the short-lived administration of former British prime minister Liz Truss. She had developed a form of low-tax voodoo economics despite her obvious lack of education in the dismal science.

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Outgoing UK prime minister Liz Truss joins ranks of shortest-serving world leaders

Her surprise and that of her cabinet at the market’s shocked reaction to her unfunded tax cuts was only matched by the surprise in the money markets that she was surprised. It was not a stretch to know that if you are going to pile billions of unfunded borrowing on top of trillions in quantitative easing since 2008 – and remember the annual GDP of the UK is only about £3.2 trillion – then the camel was going to collapse if you waved another straw in front of its face.

That the pound lost 7 per cent in two weeks after the “mini-budget” says that even if you think you have the answers, the uncountable millions making market decisions might disagree with your judgment.

Rather less publicly, the Chinese yuan has seen a sharp fall against the US dollar from its highs, bringing it back close to 2008 levels. This has been a surprise as the yuan has held its own comfortably against a rising dollar in the last two years.

It is still not entirely clear why China has taken such a hard line on Covid-19, or against the commanding heights of the technological sector, when the economy is one of China’s greatest strengths. Not only has the currency weakened sharply, worry has been reflected in the Hong Kong stock market with a fall of more than 33 per cent in 2022 alongside an economy shrinking by 4.5 per cent in the third quarter.

These metrics are likely to recover early next year because of revenge spending, but it is still lost value. Although China does not have to worry unduly about global markets, it remains an indicator of the uncertainty about future policy and growth.

Adam Smith’s “invisible hand” describes willing buyers and sellers meeting and making millions of jelly bean-like decisions through the wisdom of the crowd. The money markets are a good bellwether or benchmark of future expectations because they are neutral. It is better to work with them than against them.

Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, banker, writer and broadcaster and financial expert witness