How Safe Is Britain's Proud Pound?

How Safe Is Britain's Proud Pound?

By Carsten Volkery in London

First the euro, now the pound. Britain's currency is coming under massive pressure as speculators bet that the UK's national debt will soon get out of hand. Like Athens, London has its share of problems -- and the Brits don't have any euro zone partners to back them up.

Schadenfreude may be a German word, but it has never been a foreign concept in Great Britain -- particularly in recent months as the British watch the trials and tribulations of the European common currency, the euro. The budgetary and debt problems facing Greece, Portugal, Italy, Ireland and Spain have merely reinforced their conviction that staying out of the euro zone was the right decision. Unlike Berlin, London is not under pressure to come to the aid of Athens.

But speculators have not just taken aim at the euro in recent days. The British pound, too, has become a favored target -- showing Brits how vulnerable their own currency may actually be. At the beginning of the week, the pound slid to a 10-month low of just $1.4781. Since then, the pound has staged a mini-recovery, moving back above $1.50 on Wednesday. But market pressure on the British currency is not likely to disappear overnight.

Alarm on the Markets

The most immediate trigger for the recent currency swoon came in the form of political surveys which indicated that a Conservative victory in general elections (which will likely be held in early May) may not be a foregone conclusion. Markets were alarmed out of fear that a close election could make it difficult for parliament to pass a strict package of savings measures.

Such political concerns are temporary. Given the British electoral system, a Conservative victory remains likely -- nor is it clear that a minority government would be unable to cap spending.

More permanent, however, are the fundamental economic indicators that are becoming the pound's Achilles heels -- debt and budgetary problems that have fuelled the British currency's downward trend since October 2008.

The problems start with the size of the country's budget deficit. With a budget deficit of 13 percent of GDP this year -- Greece's is 12.7 percent -- Britain is by far the deficit champion of the G-20 states. Britain has so far avoided an Athens-style crisis primarily by virtue of the fact that its economy is much more flexible and competitive than Greece's. Furthermore, most still believe that the country is capable of shrinking its debt without outside help. Also, unlike Greece, which is facing the need to immediately refinance €20 billion in debt, most British debt won't come due until 14 years from now.

Losing their Patience

But international financiers are beginning to lose their patience. Since the beginning of the year, the share of foreign investors in British bonds has dropped from 35 percent to 29 percent. Returns on 10-year bonds, one measure of the risk associated with them, have climbed to above 4 percent -- almost a percentage point above the German benchmark. The number of short positions on the Chicago Mercantile Exchange betting on a further loss of pound value has spiked upwards recently. The numbers reflect the market's growing skepticism.

In recent months, the British have proudly pointed out the advantages of having their own currency in the midst of the crisis. Through the devaluation of the pound, exports have been made cheaper and investments in the country more attractive. The domestic economy has profited, too. Growth of around 1 percent is predicted for the first quarter of 2010 -- the first since 2008.

It has also enabled the Bank of England to intervene in grand style, holding down interest rates so that money is available cheaply to both the government and consumers. Attractive mortgage interest rates have also helped to revive the real estate market, which has in turn buoyed the general mood of the British.

Whitewashing the Crisis

The downside of these monetary policies, though, is that they conceal the true scope of the crisis. The most recent bonds issued by the British government were fully subscribed because the Bank of England purchased the majority of them. That may enable the government to finance its deficit under favorable conditions, but the move risks jeopardizing the trust of the markets.

Mass consumer debt in Britain is whitewashed in a similar manner. With an average personal debt of 170 percent of annual income, British households are even further indebted than the Americans. And interest rates kept artificially low by the Bank of England are still feeding this bubble. Sooner or later, a rise in interest rates is inevitable -- at which point domestic demand could take a nose dive.

If Britain had joined the euro zone when it was established, at least some of these excesses could have been prevented. The fiscal policy guidelines of the common currency would have ensured that. The average annual deficit of the euro-zone countries is currently only 6 percent. Great Britain also could have hid behind the reputation of more solid euro-zone members, just as the Greeks are now doing. As a relatively small country with its own currency, however, Britain is more vulnerable.

Currency Remains Weak

But in Britain, the opinion still prevails that the country is better off staying alone. Hope for a upswing is being nourished by a series of positive economic indicators. On Wednesday, the Markit Service Index, which measures the mood of British service providers, rose to its highest level in two years. It also helped to rally the pound again.

Still, the currency remains weak. And though it is unlikely at this point that the rating agencies will downgrade Britain's creditworthiness, the possibility cannot be ruled out. In May 2009, Standard and Poor's cut its view of British bonds from stable to "outlook negative." If Britain were to actually lose its AAA rating, it could have disastrous consequences for the pound. And there would be no holding the speculators back.

Looks like everything is taking a sh!t.... worldwide.

At the moment I'm thinking it is worse to be in the Euro as Greece is on the brink of bankruptcy. I'm currently listening to an article on the radio that the weak pound seems to have increased tourism in the last few weeks, particularly from abroad.

Swings and roundabouts.

Maybe my response was too generic.

As it is, the tanking of Greece doesn't sound good for thew EU. Who's going to fix that? All of the EU? Is the UK getting involved?

This is what i wouldn't like about a 'North American Union'.... what people have talked about -- making Mexico, the USA and Canada into one unit like you all have in the EU. I'd hate to have to bail out Mexico (for instance) for their lousy lack of government.

The good thing about having Economic unities is that you have some stability. While Greece collapses, EU members are likely to help it back on its feet. If Greece wasn't part of the EU, people would suffer a lot heavier than they are now in Greece.

Fine for you people. But most Americans of all stripes don't want to be responsible for Mexico's bullshit. They haven't gotten it right in decades to start with. It's a corrupt gov't there. Always has been.

TexasBlue wrote:Fine for you people. But most Americans of all stripes don't want to be responsible for Mexico's bullshit. They haven't gotten it right in decades to start with. It's a corrupt gov't there. Always has been.

It isn't as though just anybody can join the EU. Simply being geographically in Europe isn't enough. There are economic and legal requirements in order to become a member. Under the conditions the EU has, Mexico probably wouldn't be permitted to join if it were in Europe. And yes, all of Europe would foot part of the bill for helping Greece get back on its feet, whether they are in the single currency or not.

Exactly, Matt.
You have to meet certain qualifications before being admitted into the EU. Turkey for example is trying to join the EU but Germany and other countries keep vetoing that due to human rights abuses that take place almost daily in Turkey.

That changes everything. In that case, the USA and Canada would be mutual almost from the get-go.

I don't see the point of a N. American union just for that reason. NAFTA is enough, IMO.

NAFTA is a piece of sh!t. It's one thing i agree with the Democrats on. Obama hates it. I hate it. Ross Perot was right when he said (in 1991). "the giant sucking sound" of job going south. He was wrong on the jobs going to Mexico. But all the jobs have gone to China and India.

Well they did go to Mexico first. Now they're either farther down in Latin America or in China, India, Bangladesh, etc.

Some people are actually advocating to include countries like El Salvador or Nicaragua in NAFTA.

Bad idea there.

NAFTA was what destroyed this economy as far as outsourcing goes.

Yup.