Even Wall Street agrees the
Pound Sterling must tumble. So why have central bankers been buying all they
Everyone wants a piece of the UK today. Bill Bryson
just got himself an honorary gong. Monty Python's 'Spamalot' musical will
soon hit Las Vegas (it's a hoot, by the way). And half-a-million Polish
citizens are now living in Britain to earn Sterling, not Zloty.
Should US investors hail a black cab to Britain? Hold
the Pound up to the light before you hedge your Dollars this Christmas.
Check the watermark. Make sure the metallic strip is
intact. Then read the "promise to pay" signed by Mervyn King,
Governor of the Bank of England. It's just as empty as the promise on US
Treasury notes. Nothing but more fiat promises back it up - which will work
fine so long as everyone accepts Sterling in payment of debt.
But the Pound is set to fall hard, according to two
big US investment banks. Goldman Sachs says the Pound is 13% over-valued on a
trade-weighted basis. Lehman Brothers are gloomier still. "I'm not
saying that things will be terrible, but they will feel much worse,"
warns their chief UK economist, Alan Castle. He sees Sterling falling to
$1.82 next year, before sinking to $1.68 by Christmas 2008.
Wall Street's reasons are simple. They might give
you déja vu, too. For Great Britain and the United States have much
more in common than merely the mess in Iraq.
Just like America, Britain is currently running a
huge trade deficit with the rest of the world. The largest shortfall in
Western Europe, it reached a near 18-year record this fall. And just like
America, Britain also has a mountain of government debt.
Officially, public sector net debt stands at
£486.7bn. That's equal to US$953.9bn and represents a little under 38%
of annual GDP. Add the state's "off balance sheet" debt, however -
including its pension promises to state-paid employees - and the total shoots
nearly three times higher. Research by the Centre for Policy Studies in
London says it would put UK government deficits at a staggering 103% of GDP. The
debt burden per household would be over $103,880.
Then there's consumer debt - only here, Britain is
way ahead of the States. Total consumer liabilities now run to an entire
year's worth of GDP, thanks to house prices tripling since 1996. That's when the last wipeout troughed. It started
in late '89 and knocked average home prices, adjusted for inflation, down by
35% and beyond. Fast forward to Dec.'06, and the British now owe $2 trillion
in housing debt, much of it held as a naked call - otherwise known as
interest-only home loans with no money down.
unsecured debt per household of $16,840 on average...plus personal
bankruptcies doubling to an all-time record since 2004...and "the
surprise is that the Pound has been so strong," gasp Lehman Brothers.
"Current account deficits matter over time," the suits in the City
remind us, "and we're worried that Britain's [trade] deficit could widen
to 4% of GDP in 2008."
But c'mon! What
took Lehmans so long? None of this trouble is new. And other US investment
banks have called the Pound lower before. Trouble is, they were wrong.
"As a top
trade for 2005, we recommend going short AUD, GBP and NZD," said Morgan
Stanley in January last year. By their expert math, these three Anglo-Saxon
currencies were all "overvalued [and] no longer trading on
fundamentals." That bit was right, but the trading idea was not. If you
had sold the Aussie, Kiwi and Sterling against Euros and Dollars in 2005 it
would have cost you dear long before now. As 2006 draws to a close, the
trade's barely back in the money.
And all this
while, the Pound has grown weaker on all fundamentals. Britain's broad money
supply has exploded 25% since the start of '05. That's the fastest growth by
far amongst the G7 economies, and nearly twice the rate of world money growth
judging by the Bank of England's own data. Worse still, in early April this
year, Dollar interest rates overtook Pound rates for the first time since
2001. This didn't bode well for Sterling, as a research note from HSBC said.
previous three decades, the GBP/USD pairing - known as "cable" by
traders - had lost 12% per year on average whenever Dollar rates were higher.
Yet this time the Pound shot higher against the Greenback as the
yield-premium went Stateside. In fact, it leapt 15 cents higher to $1.90
within only five weeks!
So who's been
filling their boots? It's a good job that Sterling broad money has risen so
fast. Because the Pound has become the "anti-Dollar" of choice for
the world's central bankers.
not many places to go once you decide to get out of the Dollar,"
shrugged an official from the Banca d'Italia in August. Italy's monetary
wonks had just said that Sterling accounted for 24% of their foreign currency
reserves. They didn't hold any in 2004.
always a question mark," he shrugged again. "At least the British
economy is humming along okay and UK bonds offer a decent yield..."
In other words,
Sterling is better than a poke in the eye. And it's thanks to that logic,
says a report from the Bank for International Settlement (BIS), that the
Pound now accounts for 12% of all foreign reserves held by governments
worldwide. In fact, the UK currency - underpinned by record inflation of the
money supply...record house-price inflation...and near-record trade deficits
- is now the world's third reserve currency, second only to the Dollar and
What's to love
about Sterling in this beauty contest of misshapen half-wits? Put simply, it
isn't the Dollar or Euro. Nor are buttons or whale's teeth, of course. But a
government vault full of cowrie shells would be tough to explain next time
the wonks met for dinner in Paris. And the same sorry logic is at work on
Wall Street, remember.
say Sterling will drop to $1.68. Goldman Sachs forecast a 13% drop or more
versus the Dollar. Morgan Stanley this summer set "fair value" at
$1.63. But what if the Dollar keeps falling...and Sterling falls too? Where
will central banks turn next as they try to spread their currency risk from
one fiat money to another?
1980s," the BIS says, "the Yen had begun to erode the US Dollar's
share [of central bank currency reserves]. At its peak the Yen accounted for
over 10% of reserves. By 2006, it accounted for less than 5%. The decline in
Japanese asset prices and the subsequent long period of low relative returns
on yen assets appear to have contributed to the shift out of Yen
reserves...The pound sterling has replaced the yen as the third largest
currency in reserve portfolios. According to the BIS data, the share of
sterling doubled between 1995 and 2006."
Funny, but the
UK economy looks uncannily like late '80s Japan Inc today...only in miniature
and minus the trade surplus. Yet central bankers have piled in regardless.
Even the Swiss have bought Sterling, pushing it to 10% of their foreign
exchange reserves! The BIS can't be sure what China, Japan and Russia have
done. The three largest owners of foreign exchange reserves now deal secretly
- through private bank transfers - to avoid telling the market what they're
selling or buying. But Russia collects some $12bn per month thanks to its oil
and gas sales. Sterling's strength in the currency market says it can't all
have been destined for Dollars or Euros.
bankers now share this headache. The BIS puts total worldwide currency
reserves at $4.8 trillion...a full 11% of world GDP. When the Pound hits the
skids - which even Wall Street knows it must, soon - the stampede out of
Sterling will send the next-best-thing soaring. In fact, the glut of central
bank Pound buying may in fact have already ended.
In October, the
official data report, the largest buyers of British government bonds were
private foreign investors rather than central banks. Okay, furtive officials
in Beijing, Tokyo or the Kremlin may have placed those orders "off
book". But if they have chosen to stop buying Sterling, they'll find the
four other major currencies in a race to the bottom.
inter-bank lending pays less than 0.4% today. Eurozone bankers have got all
the Euros they want; the "Esperanto Experiment" now yields two
percentage points less than the Dollar. The Swiss France pays even less, and
the Dollar itself...well, you already know how ugly the Dollar now looks.
What about the
commodity currencies, Korean Won, or the newly convertible Russian Rouble?
"The BIS data suggest," says the Bank's September Review,
"that at the margin [central bank] reserve managers have increased their
holdings of Australian and Hong Kong dollars, Danish kroner and other
currencies in recent years. The share of currencies other than the major five
rose to 4% of deposits in 2005-06."
But there's a snag. For while cash deposits of
non-major currencies are easy enough to snap up, there aren't enough
non-major bonds to go round. The Dollar, Euro, Yen, Sterling and Swiss Franc account for 83% of
the world's debt issuance in total. Most likely that leaves non-major
securities too tight. The big central banks can't seriously increase their
holdings without freaking the market, most of all at the long-dated end where
supply is tightest.
Finally, of course, there's gold. Since it pays no
interest in a world always seeking out yield, it now accounts for just 0.5%
of all government reserves by value. But now the 5 major currencies all look
as bad as each other, then who knows? Gold might just find favor...most especially in Asia.
"It is unfortunate how much [India] has lost
by...holding on to the antiquated belief that gold transactions in the market
by the Reserve Bank of India are bad, while frequent transactions in USD,
Euro, Yen and Sterling are good," said former RBI Deputy Governor
S.S.Tarapore late in November. "Gold is unique, in the sense it is both
a commodity and a store of value...
"More importantly," he went on,
"gold invariably moves inversely with the US dollar and also rises in
value when international inflation gathers momentum. Thus, there are strong
reasons for holding a reasonable proportion of Indian foreign reserve
exchange reserves in gold."
Central bankers in gold buying shock? You
read it here first...
By : Adrian Ash
Head of Research
Ash is head of research at BullionVault.com,
the world's fastest growing gold bullion service online. Formerly head of
editorial at Fleet Street Publications Ltd – the UK's leading publishers of investment advice
for private investors – he is also City correspondent for The Daily
Reckoning in London,
and a regular contributor to MoneyWeek magazine.