Even Wall Street agrees the Pound Sterling must tumble.
So why have central bankers been buying all they can get...?
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,
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
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 balancesheet"
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
Now add 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
During the 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.
"There are 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
is always a question mark," he shrugged again. "At least the
British economy is humming along okay and UK bonds offer a decent
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 Euro.
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.
Lehman Brothers 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?
"In the 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
All central 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.
Japanese 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 Franc 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
Central bankers in gold buying shock? You read it here first...
By : Adrian Ash
Head of Research
correspondent for The Daily Reckoning in London,
Adrian Ash is
head of research at www.BullionVault.com
– giving you direct access to investment gold, vaulted in Zurich, on $3 spreads
and 0.8% dealing fees.
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