December 2, 2008 | posted by Michael Baxter in Sterling | comments (0) |

It was the biggest fall in sterling against the dollar since 1992.

Sterling plummeted again yesterday, falling five cents against the dollar and three cents against the euro.

At the time of writing, there are 1.4799 dollars to the pound and just 1.176 euros to the pound.

The pound is falling as the economic woe grows. With yesterday’s Purchasing Managers Index from the Chartered Institute of Purchasing Supply falling to the lowest level ever recorded, and with news on job losses mounting – HSBC and Aston Martin are the latest – expectations are growing for a big cut in the UK rate of interest.

The view expressed here a couple of months ago that rates would hit zero, seems to be gaining traction – with more and more economists warning this is a real possibility.

Yet it is not time to panic.

At current levels the pound–dollar ratio was even lower in 2002 and 1993.

If you believe the fundamental problem with the UK is that it was spending more money than it was earning, then it seems that an overvalued pound was a part of that problem. (For heaven’s sake, at one point in 2007, the UK actually enjoyed a higher GDP per capita than the US, measured at exchange rates.)

The UK needs a cheaper pound before the economy can be restructured – and we can export more.

Sure, it is not easy relying on exports at the time of a worldwide economic slowdown, but bear in mind the pound is now more than 25 per cent down on its dollar price seen a few months ago.

As for the euro, the pound has been steadily falling for years. At one point earlier this decade there were more than 1.7 euros to the pound; 12 months ago, there were 1.4 euros to the pound.

Sure, global demand is falling, but it has not fallen out of sight. An economy that suddenly finds it can sell its products abroad for 25 per cent less, measured in dollars, than it could a few months ago, will surely benefit.

It will help when our main trading partners in the Eurozone recover, which is why the French and Germany economies may recover before the UK does.

Just bear in mind, the global economy was in dire straights in 1931, the year the UK left the gold standard and allowed the pound to sink – yet economic recovery in the UK did follow.

But the danger lies in the possibility of even steeper falls in sterling. Should sterling collapse by another 25 per cent against the dollar and the euro – then we will be in trouble. If that happened, the UK government may not be able to fund its spending, and the Bank of England may have to up interest rates.

If the UK is going to export its way out of trouble, then entrepreneurial Britain needs invigorating. We need to innovate ourselves out of trouble, not spend our way forward. That is why Alistair Darling missed a trick when he announced a £16bn cut in VAT, which we will barely notice, and only much more modest plans to lend to business.

It is business that needs money – not old mature business that is past its sale by date, but new dynamic business with bold ideas.

August 15, 2008 | posted by Michael Baxter in Sterling | comments (0) |

The pound closed in on its lowest value against the dollar in almost two years yesterday; meanwhile, in the US, inflation hit a 17-year high. The two are connected, and their connection throws light on what may well happen next as Stage 2 in the credit crunch unfolds.

Economists once coined the phrase Dutch Disease to describe what happens when an economy’s currency is driven so high by one particular sector – in the case of Holland it was oil – that the rest of the economy is rendered uncompetitive. Well, in the UK too, oil drove up the price of the pound. Such was the jump in sterling and the resulting loss of competitiveness for UK manufacturing that some have argued North Sea oil was a mixed blessing for the UK.

The pound surely stopped being a petro currency two or three years ago now, yet it stayed high. It stayed high despite surging consumer spending, and the resulting massive deficit in the UK’s current account. Many have argued, including this publication, that sterling is due a sharp correction.

For the last few years, though, it seems that the pound ceased being a petro currency and became a kind of bankers’ currency instead. Money surged into the UK, and was lent to British banks and business at low interest rates. The UK was considered low risk, so money lent to the UK carried a low premium.

The UK, on the other hand, enjoyed much higher returns on assets its citizens held abroad.

But during the credit crunch, this changed. Post credit crunch, presumably it will change some more. Less money is flowing into the UK, and much of the money that is coming in is being invested via sovereign wealth funds into buying assets on the cheap. The result will be a much greater flow of dividends leaving the UK in future years.

It seems then there are good reasons to think the pound has been due a correction, and that once corrected the change will stay in place for the foreseeable future.

It may be this correction is what we are witnessing, right now.

The pound has of course been falling against the euro for some time, but until recently actually rose against the dollar. Now even this has gone into sharp reverse.

It seems likely that the main reason why the pound initially gained against the dollar, even though the two economies have similar structural problems, is that the US economic cycle is 18 months to 2 years ahead of the UK. Maybe we are now simply seeing the UK experience the kind of falls the US suffered from earlier in 2007.

It is both good and bad news. It is bad news for Brits travelling abroad, and it is bad news for inflation. As the pound falls, foreign goods become more expensive, pushing up prices yet again. This will in turn make it much harder for the Bank of England to lower interest rates.

On the other hand, our exporters should experience a healthy boost as a result. It won’t happen straight away, for as long as the Eurozone is contracting, it is difficult to see how the UK can enjoy export-led expansion. But if the Eurozone recovers, as was predicted in the article above, the result will then be surging exports.

The pressure a falling pound will exert on the Bank of England to up interest rates may be a good thing in the long-run too. The savings ratio in the UK is too low. It may be that this can only be corrected through higher interest rates – well, that and a shortage of credit. So a weaker pound will at least help in that respect.

But it is difficult to see how the UK economy can continue to expand if its high-spending consumers turn to thrifty savers.

That is why exports are so important. And that is why the telling point will be how rapidly the Eurozone can recover, in an environment where its two main external customers are losing steam.

As for the dollar, this has of course risen sharply in recent days, not just against the pound, but against the euro. This has largely been caused by the bad economic news from the Eurozone and Japan.

But, if the analysis above on an imminent Eurozone recovery is right, the dollar’s resurgence may be short-lived, at least against the euro – maybe not against the pound.

US inflation hit a 17-year high in July. The annual US consumer price index was 5.6 per cent higher than a year ago last month. Prices surged by 0.8 per cent in July alone. Even if you strip out food and energy, prices rose by 0.3 per cent in the month.

Then again, with oil and food falling in price, there are good reasons for thinking the index will fall soon. For that reason, it seems unlikely the Fed will tighten interest rates.

The US is simply seeing the same inflation picture that the rest of us are experiencing. The fight against inflation is in full flow. It is being fought in the form of falling real income levels, meaning the resulting fall in demand will lead to lower prices in the future.

The US has avoided recession so far, and the Eurozone experienced recession for two simple reasons. The US government gave out a huge tax credit – something that most Eurozone governments are unable to do because the EU Stability Pact does not allow them the scope to up their borrowing by the amount required to fund this credit. Secondly, the ECB has been much firmer with inflation.

There is one of two possible outcomes. Either the ECB has been foolishly tough on inflation and the Stability Pact is unnecessarily restrictive with its rules. Or rather, this tighter approach will pay dividends in the longer-term.

Right now, it seems the odds are with the latter possibility; this suggests the Eurozone will recover while the US and UK remain in the doldrums. If that is right, then presumably the dollar will fall back against the euro.

August 13, 2008 | posted by Michael Baxter in Sterling | comments (0) |

So the world re-aligns. The US and UK see the consequences of all those years of borrowing. And the rest of the world look on, and thank their lucky stars their own economies were based on producing things. But all of a sudden, it looks different. France joins Germany, Italy and Spain in the recession-fears club; Japan stutters; China changes; and we wait and see whether the recent trend seen of falling oil prices continues, and if it does continue, what this means for Russia.

And as all this happens, the dollar turns from being yesterday’s whipping boy, to the big buying opportunity.

The dollar is now at its highest price relative to the euro since February; relative to sterling it is at its highest price since November 2006. And the change really is like clockwork.

If you believe that the UK economy lags around 18 months behind the US, then the timing is about right – maybe a touch late, but the right ballpark.

In some ways the recent falls in the dollar against sterling seemed a touch odd. After all, the UK has suffered from similar problems to the US – massive current account deficit, over-indebted consumers. It is just that the US suffered first.

But what we are really seeing now, though, is something quite curious.

The dollar has fallen because the US economy needs to export its way out of trouble. This has gone into reverse, partially because the rest of the world can’t afford to let the US export its way out of trouble.

So, if the dollar continues to rise, US exports will fall, and the US economy will weaken again.

The world needs to see two things happen. It needs to see oil, food and other commodities fall in price – and it needs to see the Chinese consumer continue to spend more. If neither of these things happens, then it is difficult to see how the current economic crisis can improve any time soon.

August 11, 2008 | posted by Michael Baxter in Sterling | comments (1) |

Which way next for the currency markets. Everything seemed to flip on Friday – with the dollar the star of the moment, talk that the euro has had its day, and sterling left somewhere in between. So, what next for the pound?

If there is a word for 2008, then that word may well be schadenfreude – to take pleasure at others’ misfortune. Barely a day goes by without at least one newspaper article mentioning this ‘s’ word. But Friday saw schadenfreude hit a new level of absurdity, as markets in the US celebrated over news that the Erozone could be heading for recession.

The Dow soared by 302 points, taking the index to its highest level in about 6 weeks, and yet there has been no improvement in the economic outlook for the US. On the contrary, losses incurred by US banks show no sign of going into reverse. Consumer confidence is diving faster than any athlete in the Chinese Olympic diving pool could manage, the economic benefit from the US tax credit is slowly ebbing away now, and many economists believe 2009 will be the worst year yet for the US in this sorry tale of economic crisis we are seeing at the present.

And yet the Dow soars. And it soars because the news from Europe is so bad.

Jean-Claude Trichet, president of the European Central Bank said on Friday that Eurozone growth in the third quarter would be “particularly weak,” and as a result traders in the US couldn’t buy stock fast enough.

Why is that? All of a sudden, the euro is losing its attraction. While all the bad news was being restricted to the US and UK, currency traders jumped on the euro. Speculation grew that the euro was set to replace the dollar as the world’s premier currency, and the foreign reserve of choice. It was easy to see why; with the exception of countries such as Spain and Ireland, the Eurozone has stayed clear of an unsustainable debt bubble. Not for the Eurozone, growth based on borrowing. Instead, it was doing things the old-fashioned way, through producing goods and services the world wanted. But then a slow trickle of news that the region was not doing quite as well as expected turned into a raging torrent. Italy appears to be in recession now. The house price crash in Spain makes the UK housing market downturn more akin to a walk in the park, and now we hear that Germany may have seen a contraction in the quarter just gone.

And the deteriorating conditions in the Eurozone spelled crisis for the euro. The dollar saw its biggest one-day rise against the euro in eight years.

All of a sudden the view emerged that the Eurozone bull run was over. That it was time for the greenback to make a comeback. And that is good news for US stocks. Okay, the prognosis for US corporate earnings is not especially rosy, but, if the dollar is rising, then at least US company profits valued in euros may be improving, or at least not falling so fast.

Mind you, the big dollar buying spree on the back of Mr Trichet’s comments was a tad slow. It has been becoming more and more obvious that the economic outlook for the Eurozone was worsening for some time. See, for example, the falling Economic Sentiment Indicator, first shown here over a week ago.

As for sterling, it gained slightly against the euro too, but didn’t do as well as the dollar. In fact, at the time of writing, there are 1.92 dollars to the pound; that is the cheapest the pound has been relative to the greenback for many months.

It does seem that the currency markets may have quite an interesting time ahead.

At the moment, rising inflation in the developing world would suggest that the authorities in countries such as China should appreciate their currencies fast. On the other hand, if inflation in these countries sets in, there will be pressure on the currencies to fall.

This was the experience of the pound, of course, from 1967 onwards, when the Harold Wilson government devalued sterling. The UK suffered more severe inflation than its economic rivals, making British goods more expensive, forcing the pound to fall even further.

As for today, sterling is sitting in an intriguing position.

It has been argued here many times that the pound will fall eventually – and the recent falls in sterling against the euro have helped support this view. But the appalling news from the US seen this year has meant that, against the dollar, the pound has remained very strong.

But one of the issues that has protected sterling over the last few years, despite the massive deficit on the balance of payments current account, has been the massive flow of money into Britain. At the same time, Britain has benefited from a curiosity.

For some time now, the value of assets held by British investors abroad has been lower than British assets held by foreigners. Given this, you would have expected a negative flow of interest and dividend payments. But, in fact, the opposite has happened. It seems the reason for this is that foreigners were investing in low risk British bonds – especially government bonds, while the British were investing in higher risk overseas assets, which yielded a better return.

But, the credit crunch does of course mean big chunks of UK PLC are being sold off on the cheap. In the longer-term, this will surely lead to a big rise in dividend flow out of the UK, which will surely lead to massive pressure on sterling to fall.

The dollar has seen massive falls over the last 18 months or so. There are reasons to believe these falls could be near an end. But the UK and US economies are similar in so many ways, yet the pound has not risen anywhere near as fast as the greenback. Maybe the pound is about to play catch up.