STERLING UNDER THE COSH
Some months have now elapsed since the warning here about the very real risk of a run on the pound sterling (GBP). Though – thus far, anyway – the currency’s value has eroded rather than crashed, the relentless, almost daily setting of new lows is starting to look ominous.
This process has an importance reaching far beyond Britain itself. As will be explained in a forthcoming discussion, the next financial crash is likely to differ from the 2008 global financial crisis (GFC) in at least one crucial respect – this time, it’s likely to be currencies, rather than banks, which are hit by a traumatic haemorrhaging of trust.
And, if you’re looking for the likeliest candidate for a crisis, sterling stands out from all other major traded currencies.
The real problem, frightening in its implications, is that there are almost no fundamental grounds for holding the pound. The economy is weak, depending entirely on the spending of borrowed money to deliver any growth at all. The current administration has been left in office, but stripped of power, by an electoral debacle which could hardly have been worse-timed, given the immediacy of post-“Brexit” trade talks.
Even before this setback, the United Kingdom was suffering the consequences of two decades of poor leadership. Not just in economic policy, but in other areas too – ranging across the gamut from defence and foreign policy to energy, public administration and civil liberties – it’s impossible to fathom what the British people could have done to deserve such woeful governments.
In economics, where it matters most, the leadership of the UK has, time and again, proved itself almost wholly detached from reality. To a greater extent even than the United States, successive administrations have turned Britain into a poster-child for extreme ‘laissez-faire’ economics, championing the very same mistakes (such as “light touch” regulatory negligence) that led directly to the 2008 crash.
Successive promises to “rebalance” have come to nothing, leaving the economy dangerously skewed towards speculation rather than innovation. Reflecting this, productivity is dire, and vulnerabilities now include an unsustainable deficit on the current account. Hitherto, inward investment has kept the wolf from the door, but reasons for keeping capital in the UK, let alone adding to it, have become very hard to find.
After severe forex losses since the June 2016 “Brexit” vote, overseas investors must now be wondering whether putting yet more capital into the UK amounts to pouring good money after bad. If that logic becomes a consensus view, sterling could crash, in a panic dash for the exit.
A sterling slump could easily turn into a self-fulfilling prophecy, most notably through the escalating local level of debt denominated in foreign currencies. Further sharp falls in the value of the pound could push debt up to unsustainable levels.
In such situations, the standard response is to raise interest rates, in order both to defend the currency and to attract foreign capital. But there are at least two reasons why this might not be workable.
First, the sheer scale of debt might make a meaningful rise in rates unaffordable.
Second, markets might interpret rate increases as a panic measure, confirming some of their doubts about the health of the economy.
The best hope for sterling in the short term is that the authorities show at least a preparedness to consider rate rises, and – above all – that foreign investors keep putting in more capital.
The trouble with this is that incentives to invest are few and far between. Most seriously, the long-standing deterioration in average earnings, with wage rises remaining adrift of inflation, doesn’t point to vibrant customer demand. This makes it hard for an investor to expect growth in sales and profits.
Moreover, there has to be a very real danger that the British will fail to secure a worthwhile post-“Brexit” trade deal with Europe. Additionally, the fractured nature of British politics makes the election of a left-leaning, pro-nationalization Labour administration a possibility too plausible to be discounted.
When negatives outweigh positives to this extent, a relentless downwards momentum can set in. If the pound continues to deteriorate, and unless government gets a grip and puts pragmatism ahead of ideology, the risk of a sterling crisis could quickly become very real indeed.