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It may be
only a matter of weeks before the Pound's next great decline begins...
Right at the
top of the banking pyramid you have an institution called the Bank for
International Settlements (BIS), writes Paul Tustain
- founder and director of BullionVault.
It acts like a central bank for central banks.
Germany can
draw down currency from the Bank of England and deposit it into the BIS.
Again, it just writes the cheque drawn on the
importer's central bank, and pays it into its BIS account. You could say
Germany has placed its 'Foreign Currency Reserve' at the BIS.
The BIS does
lots of things I don't understand. But I am starting to understand the
Special Drawing Right (SDR). It's a sort of 'compost' currency worth - at the
moment - about the same as a Pound. You can mix it up yourself in the garden
- as a heap of slowly rotting currencies in the following proportions: US
Dollars (0.66) Euros (0.42) Yen (12) and Pounds (0.11). The package gets
acquired by exporters when they flip all sorts of other accumulated foreign
currency.
The BIS's
Special Drawing Right allows countries acquiring - say - too many Rupees
(that would be exporters to India, like Thailand, who don't want to
accumulate the ever inflating Indian Rupee) to flip out of Rupees into this
super-solid mixture of 'top' currencies, packaged as an SDR. But the Rupee
not being in the SDR the BIS looks to dispose of it. So the Rupee stays low,
which in principle makes it easier for India to export.
Our careful
analysis shows that the SDR composition allows the UK and US to be lazy, and
everyone else to turn a blind eye. Few British or American workers have any
intention of doing anything cheaper than a Thai factory worker, so their
negative balances have in the meantime been parked with the Thais - within
SDRs - as a store of wealth. The Thais are assuming that this makes a good
solid base for Thailand's own 'Foreign Currency Reserve'.
For as long
as everyone else is buying Pounds as part of a package labelled
SDRs (or indeed in their own right) this allows the British to run a big
trade deficit for a very, very long time. Lots of the outstanding calls on
the British to get off their collective ass are frozen into those SDRs and
held by the rest of the world as a trusted store of value.
The Pound is
by a long way the most overweight currency in the SDR, being 11% of its value
but less than 3% of the world economy. It's an enormous current privilege for
us British.The world's financial garden mulch could
be legitimately advertised "Now with extra British Pounds!"
I doubt this
will turn out well, either for us, or - frankly - for the Thais.
In a way, I
suppose, it seems that all global trade is always balanced, by
the definition of trade. But whereas we have an appetite for American grain,
Japanese digital cameras, European fridges and cars, and absolutely anything
from China, their manufacturers seem to have an appetite for the security of
a store of value that they can in future draw down from us. They don't want
our products, they appear to want some savings
denominated in our money, which is extra-ordinarily convenient for British
shoppers.
Somehow the
British got to this situation of being a key component of the SDR. But as a
component - and from the point of view of the user of SDRs - you'd have to
say the Pound is now spectacularly unfit for the purpose.
A bit of
thinking about how the SDR is composed, and what it is for, shows that the
SDR can be a stabilising force in world trade when
it works to distribute the currency of strong exporters as a reserve for
everyone else. If that is how it is composed it will force exporters'
currencies up, make their exports more expensive, and generally retain value
for the people who hold it.
This is
exactly how the SDR works with Japan, who are exporters, but who find the
inclusion of the Yen into SDRs causes their currency to be held artificially
high and suppresses their prodigious export power. In the case of Japan the
SDR acts as a force for bringing world trade back toward balance.
The inclusion
of the Pound, a long time ago, was at a time when the British economy may
have merited its inclusion (I really don't know) and, this inclusion being
decided by committee, and in the absence of a crisis, it remains the status
quo today. But it has helped hold our currency high making it still harder
for us to export - even though we run a large trade deficit. It encourages us
to enjoy cheap imports, and works to increase the imbalance in world
trade in goods.
It has also
caused SDR holders to hold a chunk of Pounds which they might reasonably see
as overvalued, which ought to matter to people like the Thais, and the
Chinese, because the whole point of the SDR for them is to store reserves of
international purchasing power.
As it happens
the recipe for the SDR is re-set periodically. The next re-setting is due in
January 2015. Since the last re-set the Chinese have become the world's
biggest exporters, and exporting countries are looking for a secure store of
value. They have been accommodated by ownership of SDRs - and lots of Sterling
held directly too.
As a Brit I
really don't like looking at the way this could play out. Why would all the
voters on the IMF and BIS committees continue to support the Pound being
overweight in the composition of the SDR? Why would the Chinese seek an SDR
that incorporates Sterling? What would happen if there were a move to make an
overdue and substantial reduction in the British weighting or - even - to
replace it with Chinese Renminbi.
When push
comes to shove, if the Americans and the Chinese are arguing over Chinese
suppression of their exchange rate, and the Chinese are offering the Renminbi as a replacement for Sterling within the SDR,
would the British deserve or get any support from America, or anywhere? No,
they would not. The Americans want a more expensive Renminbi,
the Chinese want a bigger slice of the international monetary action for the Renminbi, and the Europeans (the other big voting bloc,
and a major SDR component) could be absolutely relied upon to support the
Pound's marginalisation and a few British financial
chickens coming home to roost. In the Eurozone they are starting to
understand that this is what financial chickens generally do.
It looks
possible that the case everyone will rightly make is that the SDR should be
composed of the currencies of strong exporters - because this
both secures the SDR as a meaningful Foreign Currency Reserve, and helps to
bring world trade into balance. The Pound - I believe - could soon be
isolated, marginalised, and eventually ejected from
the SDR's composition, leading to a big surplus of ex-SDR pounds being
available on international currency markets. I don't think there will be many
takers.
So, with all
the usual provisos about the danger of making predictions, I say that UK
savers should be ready for an escalation in the cost of your favourite imports, starting soon, and expect it to
accelerate as the market prepares for January 2015. It may be only a matter
of weeks before Chinese positioning for a seat at the top financial table
spells a turbulent near term future for the Pound.
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