The Sterling crisis – again

I drew attention to the 12% devaluation of the pound from $2 earlier this year to around $1.75 as that occurred. In recent weeks the pound has been hovering around $1.71-$1.75 for much of the time. Suddenly, in the last two days, it collapsed to $1.62.

Market reports ascribe the sharp fall yesterday in part to the Governor of the Bank of England’s remarks. He told us the UK banking system had been on the edge of collapse before the government offered extra share capital to three banks. This was certainly not a helpful remark, and I think it was too pessimistic a view as well. It is true the banks were strapped for cash, but the Bank of England could have solved that problem earlier by offering the large amounts of cash they subsequently made available when they were first needed. It is true they did not trust each other’s paper, and a government guarantee for a price should help resolve that. That, after all, is a prime duty of a Central bank.

It is also true that confidence in banks can be increased by persuading them to raise more capital and hold more reserves. However, the authorities unilateral decision to demand more capital for a given volume of lending, and then the decision by someone to leak details of the negotiations to Stock markets, was a move which undermined confidence further and weakened the position of the banks needlessly. The Governor also shared with us his belief that the UK will go into recession, the first time someone in an official position has made such a forecast.

The Governor – and others in authority – have to recognise how the UK is viewed by external investors. To some overseas analysts the UK is a large international financial services industry and centre married to a medium size slow growth economy which has borrowed too much. Once doubts are placed on the performance and strength of the most vibrant lead sector, financial services, which has fuelled the respectable overall growth of recent years, it puts some overseas investors off holding sterling.

My critics on this website have argued against a UK interest rate cut because they say it will lead to a fall in the pound. What we now can see is we are getting a fall in the pound with much higher interest rates than the USA, whilst the dollar with low interest rates is powering ahead. Why should this be?

Investors today would rather put their money into an economy where the authorities are using every weapon including interest rates to fight recession. They see this in the USA. They are worried that the failure of the UK authorities to take enough action to fight recession early enough will produce yet more bad debts and loan loasses in the banking system, eating up the new capital that is being provided. They worry that the very rapid debt reduction the authorities are wanting to bring about will bring further tensions within other parts of the financial system which will cause more losses. The long shadow of the Lehman collapse hangs over current proceedings. There are other non bank institutions which could cause problems ahead.

Yesterday also saw the debt Management Office in active mode, as they need to be to fund the mushrooming government deficit. They announced a £4.75 billion 2011 issue, a £1 billion 2032 issue and a £4billion 2016 issue of debt, and made up to £47.8 billion of government debt available at the Bank’s dicsount window for banks to borrow. There will be concerns about the size of public borrowing, reflecting the worries expressed recently about difficulty the Debt Management Office might start to experience at getting each issue away at the chosen price.

The National Institute has also come out with a forecast of recession next year. They sensibly re ran their forecast to see what would happen if interest rates were cut by 2.5% (250 basis points) immediately. Their model, similar to the Treasury one, predicts that we would have 0.25% more growth or an extra £4 billion of income and activity. That would be helpful. The only thing that seems to be stopping the cut in interest rates is the Monetary Policy Committee. Having resolutely got it wrong on the way up, with interest rates that were too low, they are clearly determined to get it wrong on the way down with interest rates that are far too high for too long.

In a democracy comment and criticism of the monetary authorites has to be part of the debate, especially when their actions are so important to our economic future and have had such an impact on our immediate economic past. Why doesn’t the MPC meet more often during the crisis? They clearly were not predicting all the extraordinary events we have seen in the last few weeks, so shouldn’t they earn their salaries by turning up for a few extraordinary meetings to get up to speed in the new circumstances? (Amended text after minutes of MPC published) We learn from the minutes that the MPC was summoned to a short extraordinary meeting instead of the usual two day affair. They were given a briefing by the Governor of the plan to have co-ordinated interest rate cuts, and given an update on the state of the eocnomy by the Bank in much more gloomy terms than their previous judgement. They then voted for the cut which the authorities clearly wished to co-ordinate with other governments. Whilst the government can claim the “independence” of the MPC has been shielded, this does not sound like a truly independent body coming to its own conclusions. Rather, it sounds like a body which had got it badly wrong was asked to start to make amends to fall into line with intergovernmental and inter Central bank thinking. If they were independent they would have stuck to their original timetable, or asked for a special meeting themselves and presented their own views on the economy.
Lower sterling makes us all worse off. It means higher prices of imports, which in current conditions means we buy less of them. Fortunately for commodities and energy the fall in the dollar prices still means prices are dropping in sterling terms. In order to rebuild confidence in our currency the government has to take more action to limit the downturn and to improve its own financial position. Yesterday’s debate on the troubles facing bsuienss going into the downturn was long on analysis but short on action commensurate with the problem. The Minister on duty talked about the odd million here and the odd million there on public spending. As the authorities seem to be seeking to withdraw more than £100 billion from private sector borrowing through their revised views on capital and prudence, these sums are tiny in comparison. The Credit Crunch began by troubling the banks. They will now pass the problem on to their customers, running down the lending and demanding repayment in some cases.


  1. figurewizard
    October 22, 2008

    Today's opening pound / dollar rate of around $1.62 represents a drop of 20% on the rate (£2.02) exactly a year ago. However this year-on-year devaluation stood at 18% the day before, so what is yet another potential economic crisis cannot be entirely the result of the Governor of the Bank of England failing to keep his counsel. The problem is that foreign markets have shown that they do not feel confident in this government's ability to restore the UK's financial stability as against other economies.

    This is a far greater indictment than any opinion poll and the problem for all of us is that it will carry a serious cost because devaluation of this order represents a tax on the value of our money. Deep cuts in interest rates by the Bank of England at the moment will only serve to make holding the pound even less attractive than it already is; if anything further falls will inevitably force rates up from their present levels. You can't buck the market.

  2. Stuart Fairney
    October 22, 2008

    With government borrowing at record levels, and the overall national debt pushing us close to bankruptcy, unemployment heading toward two million, public sector workers threatening strikes, widespread nationalisation and the more or less unreported news that we are entering a recession, combined with a loss of one fifth of sterling’s value in 2008, it is obvious that the BBC think that this is the time to focus almost exclusively on ill-founded political gossip to try to harm the Tories. A new low for a dire, amateurish, wholly partisan organisation of pathetic middle-aged, increasingly rotund, erstwhile student-revolutionaries that can’t get real jobs, let alone at the salaries they seem to pay themselves. I am very, very sick of being forced to pay for this circus.

    1. APL
      October 22, 2008

      Stuart Fairney: "A new low for a dire, amateurish, wholly partisan organisation of pathetic middle-aged, increasingly rotund, erstwhile student-revolutionaries that can’t get real jobs, .."

      For a moment Stuart, I thought you were talking about Gordon Browns cabinet.

      Stuart Fairney: "I am very, very sick of being forced to pay for this circus."

      So am I! If the Tories are to have a reasonable crack of the whip in what are going to be increasingly difficult circumstances, the BBC must be cut down to size and privitized and it must be done with in a very short timeframe of winning the next election. Should the Tories manage that feat.

      Digital TV & the cut over to Terrestrial TV tarting now, will permit the BBC to go to a subscription only basis. Those that want it can pay, just like SKY. For the rest of us, we can buy or hire our DVD's 'dirt cheap' these days, or [GASP] there is always ITV.

      The fact is, for the last 25 years the BBC has been a schill for the Labour party. In the interests of Democracy, its got to be reformed.

      1. Stuart Fairney
        October 23, 2008

        I don't honestly see the vested interests changing the BBC anytime soon, and in truth, I'm not sure Mr Cameron has the stomach for the fight, but actually, technology will blow away the BBC licence fee, not politicians. When my current TV goes pop and I buy the inevitable plasma screen, I shall connect it to the internet and take a SKY 'on-demand' subscription. As I read TV licence legislation, you can't watch any TV as it is broadcast without a licence, but you can watch i-player etc without one. Now on demand SKY (which will surely increase exponentially in the coming years) means you can simply select a program at the time you want, so there is no broadcast time per se. Combine that with a blu-ray DVD and youtube and I don't think I will ever need terrestial TV again. As more people do that, they won't want BBC subscription TV as people might actually question the partisan dross they are served up. We will of course hear nonsense about 'great' BBC shows like costume dramas (how much more Jane Austen can anyone want?) and David Attenborough type programs (Discovery does it better) and how the Beeb must be funded from general taxation, best in the world etc.

        Note: SF does not give legal advice, make your own mind up etc.

  3. adam
    October 22, 2008

    Is this sterling collapse possibly due to signs of future interest rate cuts.
    If rates are cut then maybe the drop in consumer spending wont be as pronounced as commentators are predicting.
    People have much less confidence in the stock market, money has been withdrawn but little of it has gone into gold.
    I withdrew money from stocks july 07 and started spending heavily june 08.

    My spending has gone up as i am worried about inflation and falling sterling. Real inflation that is not temporary oil driven inflation.

    1. figurewizard
      October 22, 2008

      Even if Bank of England rate cuts were to be passed on then the lessening in the drop in consumer could only take place if the pound was to remain stable. The evidence of the last twelve months is that this is not the case. In any case the liklihood that the banks would lower their rates is given the lie by their conduct since the last cut whereby both mortgage and business lending rates have actually risen. At present the reason given is that they need wider margins to repair their capital base. This is the hidden financial support that we are all forced to give to them over and above the official taxpayers' 'rescue package' while this government looks the other way.

  4. Mark Wadsworth
    October 22, 2008

    Lower sterling makes us all worse off?

    Not all! Some of us had the good sense to move out of overpriced UK property and overvalued GBP into foreign currencies, just about anything would be showing a handsome profit over the last year (except AUD).

    I've also done some workings on putting that £37 billion that the banks are being given into perspective (Click link above), to sum up:

    £40 billion is barely 1% of total bank sterling assets
    £40 billion is a 3.3% write-down on mortgage advances
    £40 billion is three-and-a-half months' worth of gross cash receipts from existing mortgage borrowers.
    £40 billion is seven-and-a-quarter months' worth of pre-tax, pre-bonus profits.
    £40 billion is 1.7% of total bank bonds, mortgage backed securities (should you agree with me that the best way to solve the 'banking crisis' is debt-for-equity-swaps).

    Crisis? What crisis?

  5. Tony Makara
    October 22, 2008

    In these recessionary times there has to be a co-ordinated global policy on cutting interest rates and in fixing currency exchange rates. This could happen for, say, six months and then be reviewed, to measure the overall effects. If the worlds major currency exhange values are fixed, and lending rates are cut in unison, each nation can enjoy a greater level of liquidity without having to worry about importing inflation. There is of course a danger that in the initial stages smart money might flood into commodities, but once it is established that economies are on the up and that fiat is sound, commodities will be less attractive. The worlds major powers must now co-ordinate their efforts to establish financial security. We should not start slashing rates in splendid isolation.

  6. Monoi
    October 22, 2008

    You forget to mention that the euro is not doing very well either…

    So it is not only a case of the sterling against the dollar, but the dollar against everything else.

    Funnily enough, as I have agreed with you all the time, relation between interest rates and currency valuation is not all that is cracked up to be, and never has been. The markets are a step ahead, and they see that the US is doing what it needs to get out of their recession whilst the UK and ECB are just sitting on their hands.

  7. Tim Worstall
    October 22, 2008

    "We should not start slashing rates in splendid isolation."

    Erm, Tony, we're cutting rates in isolation because we want the pound to fall against other currencies. This will make exports more attractive to foreigners (and of course imports to us more expensive and less attractive), thus increasing the demand for goods and labour in the UK. This will make the recession shorter/less bad.

    1. Tony Makara
      October 23, 2008

      Tim, what you say is very true. However the fact that we now import 40% of our food, most of that being staple foods, means that we don't currently have the productive capacity that allows consumers to switch from imported to domestic food overnight. For this reason we need to ensure that we don't get hit by imported food inflation when cutting rates leads to a weaker Pound. A trip around any supermarket will demonstrate just how dependent we have become on imported food.

      The question of food security is one that senior Politicians like John Redwood must address, our agricultural sector must be encouraged to grow and supply our domestic market. Cutting rates is certainly going to make most imports cost more and the danger is that because our economy is now 76% service based we are not now producing the wares needed to offer consumers an alternative. David Cameron has talked about the need to re-balance the economy and he raises a very important point, one that is often overlooked. There can be no consumer choice without import substitues.

      1. Tim Worstall
        October 23, 2008

        Of course we can't switch overnight. Food does take time to grow you know.
        But what is it that we would want to do to encourage domestic production? We'd want to make imported food more expensive than domestically produced, wouldn't we?
        And Sterling falling does exactly that. So we've already solved the problem by cutting interest rates. Nothing else needs to be done.

        1. Tony Makara
          October 23, 2008

          What can we do to encourage domestic production? In the long-term this can be achieved through a package of initiatives from government to support farming, including special-tax-status, so that those who produce in certain key areas of the economy such as agriculture and manufacturing are allowed to make huge profits so that they are able to compete against cheap imports. In the short-term we should try to maintain price stability so that we don't end up with inflation, to ensure that our economy is in shape to make the shift away from services. Once the newly developed agricultural and manufacturing infrastructure is in place, then we will be in a position to lower rates, shutting the door on imports and boosting our exports. There is already a problem with food inflation of around 15% in the UK and sustained rate cutting at this time will create severe problems because we are importing 40% of our food, much of which is basic foodstuffs such as milk and meat. We have to rebalance the economy, but we have to do so at a pace that maintains price stability. Adding to food inflation now will lead to much higher interest rates later on. The balance has to be right.

  8. not an economist
    October 22, 2008

    One of the concerns I have about a falling pound is that it will be used by supporters of the Euro that it proves we should the Euro.

    Most intelligent criticism of Euro membership has always stressed that the pros and cons of the Euro do not rest on the transient strength of the pound at any particular time. Unfortunately such a distinction will be spinned away by Euro-Fanatics as they re-launch their assualt on the pound.

  9. mikestallard
    October 22, 2008

    "The Minister on duty talked about the odd million here and the odd million there on public spending. As the authorities seem to be seeking to withdraw more than £100 billion from private sector borrowing through their revised views on capital and prudence, these sums are tiny in comparison. "
    I am sorry, but I just do not understand this bit at all.
    I understand the profligacy of the government all too well. I also understand the fact that many pundits, here and abroad, have seen through them.
    I also understand the fact that the members of the government, having been professional politicians all their lives, do not rate industry or manufacture that highly.
    But are you saying that they are now trying to destroy them?

    Reply: I assume they are not trying to – I guess they do not understand the consequences of their actions on banking capital and interets rates. They are about to find out.

  10. Lola
    October 22, 2008

    If you expand the supply of Sterling at 10% p.a. greater than we grow UK GDP Sterling will devalue. End of story.

    1. Stuart Fairney
      October 23, 2008

      All other things being equal, you are entirely correct and it is very likely story of the next few years. My only hope is that I don't get a Wiemar republic style letter from the bank in a couple of years time saying that my savings of 10,000 marks can no longer be guaranteed, with the stamp on the letter worth a million marks.

      Much as I dislike Mr Brown and his crew, I dislike Mr Griffin and his associates very much more, (as I am sure you do). And it's not like such a scenario, albeit unlikely, is without historical precedent.

  11. Tim Skinner
    October 23, 2008

    Let us have honest money – money which holds its value and is not manipulated by governments hoping to "boost growth", or spend without taxing.

    Money is the means of exchange and the means of financial calculation in a free market. It is time governments stopped interfering with and corrupting it. Inflation introduces uncertainty, miscalculation, dishonesty, and a lack of integrity.

    So abandon the 2% inflation target (which is anyway a joke).

    Come on – 0% inflation: it is not rocket science.

  12. Tapestry
    October 23, 2008

    I don't agree. Sterling in a slump is ideal right now. It gets British business back into the competitive zone. Imports will not rise as Oil is tumbling, as are all commodities, far faster than sterling is falling.

    Manufactured goods might rise somewhat but pricing in Britain has been outrageous for a decade. Hopefully now imported goods will find they have to be sold at lower margin to compete with local and keep people buying. Price rises will be muted to say the least.

    Thank God we are not in the Euro which is stuck at too high a rate. Sterling is doing exactly what it's meant to do at times of economic crisis – bomb and get us back into business.

    This is the correction of the overvalued economy Britain has been suffering from for a decade with excess borrowing holding it up. Thank God it's now over.

  13. Aatif Ahmad
    November 19, 2008

    The reason why investors are nervous about putting money in sterling assets is the parlous state of the UK economy and the fact that it is one of the most overindebted economies among the industrialised countries.

    When investors put money in sterling assets, they are not relying upon the City's status as the largest financial market in the world or its financial genius. The backing for sterling assets (be in equities, corporate bonds or government stock) does not arise from the City only, but from the entire UK economy, Flushing and Loo included.

    Investors must surely see the UK's housing bubble, which is worse than America's, its excessive leverage and its stretched-out consumers. They know that there has to be an adjustment in consumption, an increase in saving and a develeraging to sustainable levels. That is why there is investor flight from sterling assets.

  14. Aatif Ahmad
    November 19, 2008

    Furthermore, the City could have maintained its international reputation as a financial centre without the rest of the UK having to borrow up to the hilt.

    A wise government would have regulated finance in the rest of the UK, whilst treating the City as a 'special economic zone' where light regulation applied.

    Instead, the government has applied the same, light regulatory approach to everything: from the eurobond market to the consumer mortgages market.

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