Sterling remains one of our least favourite currencies. We have frequently highlighted the terrible state of the UK economy, and the baleful effects the heavy private and public debt loads are having on its long-term health. This places the burden on the external sector, eg exports and earnings from overseas investments, to revitalize the UK economy. A weaker currency is the easiest and quickest way to increase the competitiveness of the external sector.
In the aftermath of the Lehman bankruptcy, the Bank of England helped engineer a 25% weakening of sterling. But this was not enough, and the current account and trade deficit have shown no signs of a sustainable pick-up.
The UK has usually had a strong services surplus, helping to offset a long-standing deficit in goods. However, the goods trade deficit has been on a long-term decline, and recently the services surplus has shown signs of rolling over. Furthermore, the income balance – the income earned on UK-owned foreign assets, which has historically been in surplus – is showing signs of a permanent lurch downwards. A recent news story about the energy company Iberdrola – domiciled in Spain, a country with its own severe economic problems – extracting a £900m dividend from UK subsidiary Scottish Power is emblematic of the problem.
This is not good for the UK. If a 25% cut in the currency – virtually all of whose effects have now passed through – was not enough to revive the external sector, it is clear another devaluation will be required. We are seeing the seeds of this now. The Bank of England minutes released on Tuesday showed a shift in outlook, with Governor King being joined by two other MPC members in a vote for a fresh injection of bond-buying money.
GBPUSD subsequently sold off sharply and, over the last month, GBP has sold off against all G10 currencies, except Japan’s (which has been aggressively encouraging the devaluation of its own currency).
However, as we can see in the chart below of trade-weighted sterling, the recent move down has been insignificant from a longer-term perspective, and it is likely much more will need to be done. A “creative” and “innovative” central banker such as Mark Carney – the incoming Governor at the Bank of England with no ties to the ‘old guard’ – is quite possibly just the man to accomplish the task. Nominal GDP targeting, discussed in a recent HindeSight Letter is just one of the ideas in play to justify easier monetary policy and thus a weaker currency.
Due to its manifold and profound problems, the UK is only a little further along the road to economic catatonia than other developed nations, who will soon also have to devalue as aggressively as the UK. However, one currency is acting precisely as it should in such an environment: gold. Gold, for a sterling investor, is up slightly since the beginning of 2013, despite declining 5.5% against the dollar and the euro. Indeed, gold in pounds has risen 117%* since the Lehman crisis, when the last, failed, devaluation of sterling took place.
* We feel we should add, this being a Hinde Capital blog after all, that an investment in the sterling share class of Hinde Gold Fund over the same period (October 1st 2008 to January 31st 2013) would have returned 151% (23.7% annualized).