Sterling may fall to parity with euro declared a header in the Daily Mail City pages last week[i]. It was one of many stories reporting the warnings of the throng of professional Jeremiahs unleashed by the government-orchestrated IN campaign. Apparently, the gnomes (“strategists”) at UBS had spoken. Other queer fish at Goldman Sachs, HSBC and Citigroup foresee a twenty percent decline in the Pound if the British people commit ritual hara-kiri[ii] (as they see it) on 23 June. Even the MoneyWeek people have clambered onto this bandwagon.
I fear that, once again, the barrow boys on the forex trading floors may be getting their bright red braces in an undignified twist severe enough to damage their manhood. That’s another reason I call them The Sopranos.
This is a typical one-dimensional analysis of a kind that we need to be wary of. You see, the big story in the global currency markets since the Chinese wobble last summer has been the rise of the US Dollar against both Sterling and the Euro given uncertainty about the global economy and the collapse of commodity prices. The mighty greenback always gains when the world begins to contract, regardless of the relative health of the US economy. A vote for Brexit on 23 June would surely send a shock through the markets: but the Euro would be in the frame as well as the Pound. Thereafter, it’s quite possible that a number of fissures in the European “project” might become more apparent – like Greece’s need for a new bailout about that time and inevitable calls for other “copy-cat” referenda. I’ll show another time why the European Budget, minus the net contribution of £10 billion from Britain, will be totally unsustainable (and forty percent of that budget is related to the Common Agricultural Policy (CAP)).
Stepping back from the fray for one moment, I must say that the demise of Sterling has been one of the most oft-predicted economic themes of my lifetime. My grandfather (born in the early 1880s – a South London tram conductor) used to call a pre-decimal[iii] half-crown coin (worth the equivalent of 12.5 new pence) a half a dollar – because, for most of his lifetime the Pound Sterling was worth four dollars. After WWII the US Dollar displaced Sterling as the pre-eminent global reserve currency and the Pound declined to below US$3.00. In Harold Wilson’s famous Pound-in-your-Pocket devaluation of November 1967, the value of the Pound was cut from US$2.80 to US$2.40. During Mrs Thatcher’s time in Downing Street the Pound oscillated between US$2.00 and, for a brief time in the mid-80s, near-parity. As I write Sterling is at US$1.43.
Thus, right now, Sterling is worth 36% of its US Dollar value in the year of my grandfather’s birth 136 years ago. If you prefer, that is a devaluation of just over 64%. That is totally exceptional in the weird world of foreign exchange. The French Franc, by contrast, by the time it was cruelly culled in 1999, was worth 0.03% of its 1880 value – equivalent to a devaluation of 99.7% against the greenback over the same period[iv]. (Most other European currencies, like the Spanish Peseta, suffered even more extreme devaluations.)
So, please admit, barrow boys, the Pound is a racehorse with historical stamina and form. It is a much more resilient currency that is commonly supposed. The perception that the Pound is a “weak currency” is a hangover from the 1980s and 90s when it fell back consistently against the rampant Deutschmark (remember them?) and is not historically representative.
Since the Euro became a real paper currency on 01 January 2002, Sterling has ranged from €1.54 to €1.04 in early 2009. This nadir was about the time that EU President Barroso declared that the Credit Crunch was purely an Anglo-Saxon problem. Note then that the mistake the barrow boys (and their posh bosses) made then was to presume that, because the UK was affected first, it was a uniquely UK problem. They will make the same mistake after Brexit.
The lessons from history about what happens when governments try “to manage” their currency are also instructive. At the fag-end of her premiership, before she was shafted by the knights of the shire, Mrs Thatcher was persuaded by John Major and Douglas Hurd to allow Sterling to enter the Exchange Rate Mechanism (ERM). This was the financial sheep pen that the architects of the Euro (about whom I have written elsewhere) attempted to herd the ovine flock before its migration to the sunlit uplands of the common currency.
It was a catastrophe: for us at least. On 16 September 1992 (Black Wednesday) Sterling fell from around DM 2.90 to around DM 2.35 – despite massive currency purchases by the Bank of England and attempts to raise interest (for a few hours) to fifteen percent. Only George Soros came out smiling. Yet after Sterling’s exit from the ERM the British economy finally rebounded from a stubborn recession. On the British side, the experience left an indelible impression; on the European side the notion grew that Britain was the awkward customer.
Yes, there will be increased volatility in the currency markets in the run-up to Brexit but there are plenty of other potential shocks to the world economy in the months to come. The foreign exchange market always over-reacts to events. If the British people vote OUT on 23 June, there will be some selling of Sterling but, in my view, markets will concentrate on the clarity and plausibility of the exit strategy. There will be plenty of bluster and menace from the Franco-German elites, but well before Christmas I believe it should be clear that there will be a free-trade agreement between the UK and the EU. (Of course, there will be much horse-trading: we shall probably have to pay them something – so we won’t get the full £10 billion back; but if that gives us control of our borders and of our taxes and benefits, it will be worth it.)
Thereafter, things will settle down. In due course it will become apparent that Brexit offers the UK the opportunity to reduce regulation and to pursue more pro-active trade relations with old friends like Australia and Canada and with dynamic up-comers like India. Within a year or two the outlook for the UK could look much brighter than for the Eurozone, whose problems are acute. Our national finances (a weak spot), however, will come under intensive scrutiny and whoever is at the helm will have to address this.
During any pronounced sell-off in Sterling the Bank of England might decide to increase interest rates in anticipation of cost-push inflation. That would stimulate savings and therefore investment (as discussed elsewhere) and would be a step back towards monetary normality. Further, a modestly lower exchange rate would help reduce the current account deficit.
In terms of prices, imported goods will get more expensive, but home-produced food may fall in price given import substitution. There will be a sunny outlook for English wine.
Let’s remember that the main reason for staying out of the Euro was to maintain an independent monetary policy and a flexible exchange rate. But the latter is a double-edged sword: we should be prepared to take the rough with the smooth.
You know what they say. There is pond life; and then there are foreign exchange dealers. Those “strategists” – the people who stuff themselves with canapés in Davos while someone else pays the bill – get most of their insights (and prejudices) from the trading floors.
My best guess is that, one year hence, Sterling-Euro will not be dramatically different from where it is now, trading in the €1.20-€1.30 range – though the US Dollar will have advanced further against both the Pound and the Euro. I may be wrong.
In any case, politicians should not get too worked out about short-term fluctuations in exchange rates, though they always should have a clear notion of the long-term impact of their policies. Remember the Iron Lady in her prime: you can’t buck the market.
[i] Daily Mail, 01/03/2016, City & Finance, page 68 – article by James Salmon.
[ii] Apologies to Japanologists: ritual self-disembowelment by samurai warriors is, of course, correctly called seppuku.
[iii] The UK decimalised its currency in 1972, going from £1 = 20 shillings = 12 pennies to £1 = 100 “new pence”.
[iv] One French Franc was worth US$3.95 in 1880. In 1960 De Gaulle converted Old Francs into New Francs at a rate of 100:1. On 01 January 1999, the Franc was converted into Euros at a rate of €1 = NF 6.55957 while the Euro-Dollar rate on that day was US$1.1686. I therefore calculate that the value of the Old Franc in Dollar terms was US$0.001305, or 0.03% of its 1880 value.