Start with substituting the country’s leaders for company management. The president or prime minister is the CEO, the finance minister is the CFO, and so on. A country’s accounts become its income statement and balance sheet. Broadly, revenue (tax) is the royalty the government collects from all participants to use its infrastructure and resources. Expenses are the costs of running the government and public services. Provided there is no change in the tax rate, a country’s revenue grows with gross domestic product, which the government uses to increase public services or allocate to infrastructure the same way a company can provide more employee benefits or expand its plant, property and equipment, or PP&E. The publicly traded stock of the country is its currency and it can fund itself through excess cash (revenue>expenses), issuing debt or selling stock (printing money).
If we apply this model to the latest currency debacle in the U.K., it becomes apparent why investors sold the currency (stock). The original fiscal plan of “CEO” Liz Truss, who just announced her resignation, and her now ex-“CFO” Kwasi Kwarteng, was going to reduce the royalty (tax) rate, decreasing revenue in hopes that by giving consumers more money they will spend more, eventually boosting revenue (taxes). This is analogous to a company cutting the price of its products in hopes that people will buy more (trading price for volume). As Ms. Truss and Mr. Kwarteng hadn’t detailed any cost cuts, the country would have needed to borrow or sell stock (print money) to fund their initiative. If they decided to borrow, the interest expense would have been an additional increase to their overall cost base.
Let’s pause for a moment and reflect on how a lender in the business world would react to a small business owner asking to borrow money so it could reduce the cost of the product, betting that customers would buy more and eventually increase sales. Or how the stock market would react to a CEO who announces at the quarterly call that the plan to increase sales is to initially cut them without a reduction in costs. Borrowing costs would soar and the stock price would collapse. Surprises and uncertainty scare investors, and this is exactly what happened in the U.K. In the past three decades, the only event comparable to a credit crisis is a loss of investor confidence (for example, the U.S. corporate scandals involving Enron and Arthur Andersen). Ms. Truss severely dented investor confidence, causing her stock (currency) to drop and lenders to ask for higher rates. It’s a timely reminder that one should never count on the goodwill of others to meet obligations.
