The Parallax Brief

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Unrepentant Subjectivity on Economics, Politics, Defence, Foreign Policy, and Russia

Currency Update: the Pound and the Ruble

Pound Sterling

No sooner had the Parallax Brief written to defend a weak pound as counter-intuitively desirable for the UK economy, than sterling took a savage mauling on the forex markets. The pound plunged today (Wednesday, January 21) to as low as USD1.3713, only a whisker above the 23-year low of USD1.3682 of June 2001.

Ambrose Evans-Pritchard, in his now regularly terrifying blog, argues:

“For the first time since this crisis began eighteen months ago, I am seriously worried that [the] British government is losing control. The danger is blindingly obvious. The $4.4 trillion of foreign liabilities accumulated by UK banks are twice the size of the British economy. UK foreign reserves are virtually nothing at $60.6bn…

If the Government is forced to nationalise RBS and perhaps Barclays with their vast exposure in dollars, euros, and yen, it risks being submerged… Yes, the banks have foreign assets as well to match the debts. But how much are these assets really worth?”

Yikes!

Prichard points out soberingly that sterling is now teetering on its twenty-year support line, and another fall could send it crashing through the line toward dollar parity. Should this happen, Britain would very likely be faced with a full blown financial crisis, and perhaps even the first British default in modern history.

If omens are anything to go by, the presence of Jim Rogers does not bode well. The Bank of England must have groaned when it read his interview in the Financial Times, arguing that the euro is a far better bet than sterling. Some of you may remember that it was the Quantum Fund, then co-owned by Rogers and George Soros, which broke the Bank of England on Black Wednesday in 1992.

For what it’s worth, I’m not sure I agree with Rogers. First, he only seems to ever talk these days about how truly wonderful Asia is as an investment opportunity, and again in his interview today he appears to making a point not against the British economy, but against the British economy compared to Asia: “The City of London is finished, the financial centre of the world is moving east. All the money is in Asia. Why would it go back to the west?” 

Second, his argument regarding the euro is debatable. If Britain is compared to the euro’s strongest member, Germany, Rogers has a point, but what about Britain compared with Greece, Italy, Spain, or Ireland? There are many who would argue that a currency is only as strong as its weakest link.

Finally, Britain isn’t the only country in dire states at the moment. European banks are just as heavily indebted and leveraged as American or British banks, and the eurozone economy isn’t exactly moving along at warp factor eight at the moment. Sooner rather than later, the hawkish ECB is going to have to face facts, swallow its pride, put a pommander under its nose, get down to the zero rate lower bound and crank up those printing presses.

The equally parlous state of the rest of the world might just be sterling’s saving grace.

The Ruble

Yesterday, the Parallax Brief argued that the step-by-step, managed devaluation of the ruble was approaching its endgame, and today we received further confirmation. First, the ruble held steady against the basket for the third straight day, and second, according to Russian business daily Kommersant, the Central Bank of Russia (CBR) yesterday hosted a meeting in which it informed bankers that the devaluation process was over.

The more wonkish among you can read this article from Bloomberg, in which MDM Bank’s Nikolai Kashcheev argues the CBR may now employ a dirty float.

CORRECTION: I mistakenly wrote that “the Quantum Fund, then co-owned by Rogers and George Soros, which broke the Bank of England on Black Wednesday in 1992.”

It has been pointed out to me that Rogers was long gone from Quantum by the time it broke the BofE. Shame on me. 

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Redwood Supporter in Sense of Humour Shocker; the Pound

So coldly logical is John Redwood’s delivery that he has been dubbed “Mr Spock” in his time, but for one of his supporters at least, wit is not “a difficult, alien concept, captain.”

Responding to Redwood’s short blog on the pound’s latest fall, one poster drolly asked, “I wonder if we can persuade Obama to invade us in the name of ‘regime change’?”

Of course, he then went on to spoil it with a paragraph of right-wing invective about the UK going bust, his sterling savings being devalued along with the pound and me-me-me, but at least his opening gambit managed to raise a cackle from here in Moscow.

On this matter, I’ve been rather irritated by the right’s response to sterling’s drop. Although the phrase “strong pound” sounds very nice, in a chest out, chin up patriotic kind of way, it really wouldn’t be very beneficial in current times.  

A weak pound lowers the relative cost of British goods and raises the relative cost of foreign goods. This has three, extremely beneficial effects: First, British goods become cheaper in both the home market and export markets, materially aiding British companies. Second, encouagement to buy British will help rebalance the UK’s current account deficit. Finally, making foreign goods more expensive will bring at least a small amount of inflationary pressure to bear on the British economy. The Bank of England’s precipitous interest rate reductions, and the current yields on British gilts, give a pretty terrifying indication of just how very close we are to slipping into full blown debt deflation. Anything to encourage inflationary expectations in this environment can be considered A Good Thing.

In boom times, these factors might be negative, as they would likely fan the flames of inflation and discourage saving. And of course, much more of a drop, and investors may get frightened off British investments, and especially our gilts, making financing our current, essential-for-survival budget deficit more expensive — or perhaps impossible — which would be an outright Russia 98-style disaster.

But so far so good.

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