Belfast Telegraph

Thursday 31 July 2014

Is it now time for the death of sterling?

Both the dollar and the euro have made gains while sterling falls

Watching the pound slump in value over the last few months has been a chastening experience for many investors.

We are haunted by images of our European neighbours running amok in our shops and supermarkets as sterling flirts dangerously close to parity with the euro.

The once mighty pound slumped to a 24 year low against the US dollar in January. It has lost a third of its value since the end of 2007 when it hit a high of $2.11.

It now stands at $1.41 and €1.07 respectively.

This dramatic fall from grace has prompted one fund manager with Quantum, set up by George Soros, to declare the death of sterling; whereby he is, basically, urging his investors not to have anything to do with it.

What has happened? You hardly need ask. Our economy is in the grip of the worst recession since the thirties, brought about by mind-boggling amounts of debt at both government and personal levels.

Then there is a general lack of confidence in the present government, not to mention the failure of the first billion pound bail out and successive interest rate cuts to breathe life back into the economy.

Follow this with bank nationalisation — or something pretty close — and the printing of money (or quantitative easing if you want to be technical) and you have a picture that tends to back up the comments made by that Quantum fund manager.

But the question as to ‘why’ still needs analysing.

One leading economist has argued that, despite the fact that the US shares many of the same problems as the UK, sterling has to be put into perspective.

He argues that sterling has been overvalued on the back of years of sustained economic growth and high interest rates and was due a correction.

In other words, when the pound was at $2.11, it was overvalued because the imbalance of the UK economy mirrored those of the US — high levels of debt, problems in the housing market and a massive trading deficit.

The natural ‘purchasing power parity’ of sterling (i.e. its natural buying power) is around $1.55. Clearly it has fallen below this.

The other main factor is that, as the US dollar is still the main reserve currency of the world, it would be the last straw for markets to lose confidence in that. Others have argued that despite the fact that the US itself is in bad shape, the world is short of US dollars.

While equities are falling, fund managers are looking for safe havens such as cash and because most are denominated in US dollars this is creating demand and sterling therefore suffers as a result.

So what’s the bottom line? What are the prospects for sterling?

Despite the cheap pound and the hope that this will help exports, the problem is that in a recession demand will fall away globally.

So we will have to wait much longer than the government might like to see any good effects.

There is also a risk of a run on the pound although, on the other hand, this might be the one thing to get us back into normal economic activity.

The truth is that no one really knows what the immediate future holds. There are too many unpredictable factors to allow anyone to make that call.

For investors, the danger is going down a specific path now and then finding, when the climate changes, that they are in the wrong place after all and thus losing yet again on the deal.

The best bet may well be to stick with your original plan rather than vacillate.

Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk.

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