The pound is heading for a big fall

The British economy is in a mess.

Most of us know it isn’t growing much. We also know that the government’s finances resemble those of a credit card junkie.

But you wouldn’t know it to look at the pound.

Yes, it had a big slump after the financial crisis. But for the last three to four years or so, sterling has been a very uneventful – even boring – currency. Its value hasn’t changed much at all. It has moved around in a pretty narrow range.

Don’t let that lull you into a false sense of security though. We think there’s big trouble ahead…

The pound has gone nowhere for nearly four years

Sterling index

Sterling index

Have a look at the chart above. The sterling index shows the effective value of the pound against a basket of currencies.

As you can see, the banking crisis and the deep recession that followed saw the pound plummet in value during 2008. People sold the pound as Britain teetered on the brink of financial meltdown. It lost nearly 30% of its value against both the US dollar and the euro (see charts below).

Euros to pounds

Euros to pounds

US dollars to pounds

US dollars to pounds

But since then not much has happened.

Unfortunately, this isn’t because the outlook for the British economy has improved. Instead it’s due to the fact that there are lots of games being played with the world’s exchange rates.

Lots of countries want a weak exchange rate right now. Economies that are struggling to grow want to export their way back to prosperity. One way they hope to do this is by devaluing their currencies. This will make their exports cheaper in foreign markets.

The trouble with this policy is that if everyone devalues at the same time, nothing really happens. The relative exchange rates don’t change that much and no-one ends up better off. And that’s exactly what’s been happening.

A lot of exchange rates are at similar levels to four years ago. It’s not just the UK, the US and Japan who are printing money. Switzerland has also been printing to stop the high value of the franc from crippling its exporters. So currency devaluation hasn’t really helped anyone that much.

Strange as it may seem, Britain has also acquired a kind of safe haven status as people fret about the eurozone. Other countries are using the pound to diversify their foreign exchange holdings, and so reduce their exposure to the euro. This has helped prop up the pound too.

Weak economies create weak currencies

So what’s the ‘fair value’ of the pound, if you will? Trying to work out what the value of currency should be is not easy.

The Economist’s Big Mac index tries to do this by working out what exchange rates would be, if the price of a Big Mac were the same everywhere. This is a nice way to explain the economic theory known as ‘purchasing power parity’. And on this basis, the pound looks fairly valued against the US dollar.

But we’re not convinced.

Broadly speaking, weak economies lead to weak currencies. Britain is unquestionably a fragile economy. And it’s only going to get worse.

The UK is stuck in a debt trap. A large chunk of growth in the boom years was phony. It was created by excess credit, and borrowing by governments and households. This borrowed money was spent on increasing the size of the state and trading overpriced houses with one another.

The money was consumed – it’s gone. But the debt has not.

Had the borrowed money been invested in productive assets then it would now be producing cash flows to pay it back. The economy would be in a far better state. With households and banks paying down debt instead, there is no more phony growth or indeed any growth at all.

More money printing is on the way

The only thing that has stopped the economy collapsing is the Bank of England’s printing press. But creating £375bn of money out of fresh air has to eventually make a currency fall in value.

We expect the bank to go on printing money. The government’s deficit cutting plan is based on forecasts of economic growth that are not remotely realistic. So the overall debt will continue to rise. And standing by will be the Bank of England as a convenient source of cheap – even free – money.

But while the bank might be able to carry on rigging the bond market, money printing can’t be good for the value of sterling in the longer term. And raising interest rates to defend the pound – by giving holders a decent return on their money – is a non-starter. Our debt-laden households and banks simply couldn’t cope.

We don’t produce enough stuff

As if a weak economy and a money-printing central bank weren’t bad enough, the other main reason why the pound could go a lot lower is that we don’t sell enough to the rest of the world.

UK current account as % of GDP

UK current account as %of GDP

Even although the pound is a good deal weaker than it was five years ago, the UK continues to suck in far more imports than exports. It has not had a trade surplus (where exports are higher than imports) since 1983.

These persistent trade deficits mean that we have to keep on selling pounds in order to get our hands on the foreign currencies to buy other people’s goods. This puts downwards pressure on the pound.

This is only going to get worse. Our North Sea oil and gas reserves are running out, meaning we will have to buy more of our energy from abroad. The City is also shrinking and can no longer be counted on to bring in lots of foreign income.

Get your money out of the pound

In short, the outlook for the pound is grim. So it makes sense to protect yourself. You can do this by putting some of your savings into foreign assets. As the pound falls in value, they will be worth more to UK residents.

There are many ways to do this. You could buy shares in UK companies that earn lots of its money abroad. Or you could buy foreign stocks or bonds, which is quite easy to do through most online stockbrokers these days. Or you could buy a cheap tracker fund or investment trust that invests abroad.

But where are the best countries for your money?

You need to look for countries that have trade surpluses and strong government finances. These countries should have stronger currencies than the pound. In Europe, countries such as Norway, Switzerland and Sweden fit the bill. Singapore in Asia may also be worth a look.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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20 Responses

  1. 23/11/2012, Humphrey wrote

    All the commentary on money printing leading to devaluation and inflation seems to be based on the assumption that the Bank has no credible plans to reduce the money supply. how would the Bank respond to this criticism?

  2. 23/11/2012, Drake wrote

    I had understood that Switzerland had capped its currency?

  3. 23/11/2012, PJM wrote

    ……..and with Britain huffing and puffing about leaving EU (where 50 % of trade is conducted)…….the future for Sterling is indeed grim.

  4. 23/11/2012, Mark Acklunde wrote

    Now probably is the last time to buy gold before an awful currency plunge in sterling ?

  5. 23/11/2012, armada wrote

    I agree with all your comments about the pound. However on the subject of safe havens you do not mention Poland.
    For the last 3 years Poland has been the economic success story of Europe. A GDP of over 2.5% is something the UK can only dream about. Poland achieves this easily. You predict, probably quite correctly the likely demise of the Pound. However Polands currency, the zloty is likely to appreciate significantly for reasons “Moneyweek” would do well to explore in an article.

  6. 23/11/2012, Anthony wrote

    The western world is in a mess.Its not only the pound.As for the Zolty forget it.That an out and out speculation.Poland is an emerging market & too poor.These articles tend to scaremonger to lure people into buying subscriptions. Sterling collapsed in 1974 & boy that was a collapse.But at the end of the day it eated away our debt.The lira collapsed in the early 70s & the French Franc in the early 80s.The Swedish Kroner ,Finnish Mark & Irish punt in the 90s. Economics is cylical.Anyone of my age of 70 who has been around a long time will see the ups & downs. No matter how qualified writers of these articles are if they are young they dont have wisdom & perhaps thats the problem today.We dont have old wise heads in government.Nobody knows what the future holds but if ones worried about the currency just follow the old simple rule buy shares & Far East ones at that. They are relatively cheap on a 15 year view,aligned to the US$ & far away from Europe

  7. 23/11/2012, FrostyA1 wrote

    What a bunch of `Doom & Gloom` merchants our so-called financial `Experts` are! Every new warning predicts calamity for Britain no matter which way she turns. Get a Life! Britain sits pretty to weather the storm far better than most because she is Trusted, bless the dear old Quid & the FTSE, not the best performers in adversity, but the Safest. We`re now exalted to throw our savings into the marshmallow economies of Italy or the Far East…Cobblers!. I still remember Brit Investors being advised to lob their funds wholesale into Japan around 18 years ago, what`s that worth now?…about the same on paper but minus inflation, i.e. precious Buggerall!…F.

  8. 23/11/2012, Elvis Presley wrote

    And what happens to GBP:EUR when the ECB starts to print (Big Time) to sort out the basket cases in the Eurozone (every country except Germany I mean)?

  9. 23/11/2012, Chas wrote

    I suspect engineering the pounds fall is the governments number 1 growth strategy. How else do you re-balance the economy back towards manufacturing?

    The huff and puff over leaving the EU may give us an indication over foreign investors real intentions. So far nobody seems to be quitting over the risk of British exit.

  10. 23/11/2012, HL wrote

    Why is it that every time a British exit from the EU is mentioned we hear about our trade with Europe being 50% of the total ? (Or as I read the other day, 70% !) How come almost nobody mentions that we have a DEFICIT trade with Europe ?

    They earn more from us than we earn from them, so stop worrying and think about developing trade links with the fast growing economies of Asia and not the sclerotic, stodgy EU.

  11. 24/11/2012, NeutronWarp9 wrote

    5-armada, noting that this year Poland received approximately 9 billion euros more than it put into the EU pot it is no wonder that the place is booming; it would be hard not to be.
    So the secret seems to be to weasel your way into a club where year-on-year you get a lot more out than you put in – and if others are big enough saps to put up with this state of affairs one has to say more fool them.
    Alas, easy money corrupts and, like Greece, once it is withdrawn I expect the boom in Poland will be followed by a Gordon Brown-type spesh.

  12. 24/11/2012, shortchanged wrote

    I am with HL, the EU buys 50% of our goods because they are cheaper, not because they like us, its good business. If the UK leaves the EU they will still buy from us, where else will they go?. As for the banking houses leaving , well, they won’t be missed, except by Boris Johnson of course. I do suspect there will be more scandal’s to come.

  13. 24/11/2012, Ellen wrote

    If the BoE’s primary objective is to protect the bank’s – keeping asset prices high to firm up their balance sheet and giving the appearance of being solvent and government objectives are to be able to carry on funding public spending at current levels, indefinitely – then neither will have any plans to reduce the money supply. The opposite is more likely and the wider economy will be sacrificed to public spending and banking shortfalls. So the outlook for sterling looks bad.

    The only thing sterling has in its favour right now is that the US are also money printing debt junkies and the Eurozone are indecisive debt junkies.

    We desperately need political and economic leaders who are prepared to put the interests of the whole economy at the top of their ‘to do’ list, instead of cowards who are only interested in repaying political favours and the next election.

  14. 24/11/2012, Boris MacDonut wrote

    #11. Wow. I make that £360 a year per person. Boom time indeed. I’m sure no Pole needs to come looking for work in the UK with that level of largesse strewn at their feet.

  15. 25/11/2012, COMMONSALT wrote

    Humphrey: If you reduce the money supply how can you spend it? Money has no value until you spend it

    I repeat my previous comment:
    One probably could not print enough money to represent the value of existing world assets and work in progress – not even for the created value in the last financial year.

    Money supply should never be a problem – finding someone to spend it properly, is our greatest challenge.

    Even in Lydia [Anatolia] the first money was minted by the
    local baron to pay for goods and services – later it was returned in lieu of fictitious taxes. Nothing has changed – if the baron thinks the goods and services are available and of value then he can print and mint.
    commonsalt: http://www.salt.org.il/frame_econ.html

  16. 25/11/2012, Boris MacDonut wrote

    #14 Even better ,it is £360 per working adult. It is only £182 per person.

  17. 26/11/2012, Nick Fury wrote

    We may not be as bad off as we think, we have a finger in many pies; Europe, USA and the old common wealth (as well as the middle east), which puts us at an advantage of many other nations that are similarly in the mire to us. Iagree the Pound could drop in value if all the other major nations were not also still printing money, so in effect nothing really happens as proportionately they are all still roughly equal. The first one to really go for it will get an initial advantage over the others, but it will only drop back as the others do the same.

  18. 26/11/2012, Critic Al Rick wrote

    I would imagine that a lot of our imports, indeed the West’s imports, come from places such as China.

    Of more concern than GBP: Euro and GBP: USD is GBP:Renminbi.

    It’s such as China the West’s stiffest competition is coming from, not so much from within itself.

    To compete with China the currencies of the West ARE heading for a big fall; spear-headed by QE. Prepare to tighten your belts.

  19. 27/11/2012, EJB wrote

    It’s totally wrong to say ‘nothing much happens’ when all the majors print paper and devalue currency: the cross rates might not change but the prices of gold, energy, food, and other essential commodities all rise. The resultant inflation is then hidden by fiddling with the cpi. As a result we are all currently suffering a hidden wealth tax running at up to 10% p.a. (on top of all the other taxes, of course).

  20. 06/12/2012, F.R. wrote

    @EJB – Yep a hidden wealth tax – but NOT on the super-rich who keep their wealth in the form of value-preserving asset. It’s only a wealth tax on the poor and middle classes who keep it in cash equivalents.
    Now, a real wealth tax, levied across the board.. THAT would be an idea to think about… 2% of the wealth of the likes of Gates, Buffet etc would knock a serious hole in any governments budget deficits. Then maybe we could abolish income tax altogether..

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