Over the past six months the value of the British Pound has fallen substantially against many of its trading partners, and thanks to significant economic headwinds and a coalition government that appears to be out of ideas, the outlook for sterling remains negative.
The decline of the British Pound
Over the past six months the value of the British Pound has fallen substantially against many of its trading partners. Sterling is down 8.4% versus the euro, 7.4% versus the US dollar, 9.2% versus the Indian rupee, 6.2% versus the Australian dollar, and 6.5% versus the Swiss franc.
The longer-term picture is just as bad. The table below shows the value of the British Pound versus 24 different currencies including gold and silver. The table reveals that over a five year period the pound lost value against every currency apart from the Argentine Peso, a nation which is experiencing an annual inflation rate of 26%.
British Pound vs. 24 different currencies
Where next for the British Pound?
There are a number of factors weighing on the pound. These include:
- The loss of our triple-A credit rating
- A deficit-reduction plan that has already slipped by two years & may slip again
- Inflation that is set to remain above the Bank of England’s target until at least 2015
- A current account deficit which is still close to the June 2012 record of -£20767 million
- Structurally high unemployment (which for 15 to 24 year olds is the third highest among the 34 OECD nations)
- Net public debt of £1.1628* trillion (which is much higher than before the financial crisis)
- Disappointing tax revenues
- Higher social benefit spending
- Talk of negative nominal interest rates (in addition to the negative real interest rates we already have)
- And the fact that Britain faces the threat of a triple-dip recession
*figure does not include the cost of bailing out Britain’s banks.
Adding to these woes is the fact that the coalition government appears to be out of ideas. As a result, more and more industry groups are calling for the Chancellor to implement radical growth-promoting policies at next week’s budget. However, all the signs indicate that he will stick to his current plan.
Finally we come to money supply. For the most part, the value of a currency is determined by supply and demand. When the supply of a given currency is increased it becomes less valuable, and as the chart of Britain’s M2 money supply below shows, that is exactly what is happening.
United Kingdom M2 Money Supply
Source: tradingeconomics.com | Bank of England. Note: M2 is a measure of total money supply which includes coins and notes in circulation together with other money equivalents that are easily convertible into cash. M2 also includes savings and other time deposits.
Between 1982 and 2013 M2 money supply in the UK averaged £587,339 million, however in January 2013 it reached an all-time high of £1,345,814 million.
The bottom line
Britain is not the only country that is dramatically increasing its money supply. In fact, the British Pound is taking part in a global “race to debase”, as nations compete for export advantage (the so-called currency war). In addition many western nations are pursuing a policy of financial repression which involves deliberately creating inflation in order to lessen their debt burden.
The Japanese Yen and the British Pound are currently leading the race to the bottom among fiat currencies, and it looks as though they will continue to do so.
With stock markets at record highs, sentiment among stock investors is understandably bullish. However, there are an increasing number of signs that equity markets are becoming overextended. One area that should be watched closely is NYSE margin debt, which in absolute terms is now only fractionally below the all-time highs it reached in 2007/ 08.
In this environment holding some level of cash certainly seems like a good idea, however if there is one currency you don’t want to hold it is the British Pound. Investors should consider either diversifying the cash in their portfolio among several major currencies, or (for more sophisticated investors) hedging downside risk via puts or a spread bet.