Nothing to cheer about for sterling

The pound is a basket case. The only reason it hasn’t completely collapsed, says Merryn Somerset Webb, is because the world’s central banks are playing a zero sum game.

A colleague sent me a chart this week that would warm the heart of anyone with even a tiny holding in gold. It shows the extent to which all of the world's major currencies have fallen against the gold price since 2001. Pretty much everyone comes out badly. Take a look at it here.

The currencies we all think of as being the strongest out there the Singapore dollar and the Norwegian krone, for example are all down over 70% and even the Australian dollar is down 69%. And knocking around the bottom of the chart, just as you might expect, is sterling down 83% against gold in a mere 12 years.

Some of you will say this is a point devoid of information because gold isn't a currency. But nothing is a currency unless it is accepted by a critical mass of people as one. And gold is. If it wasn't, why would there have been such a fuss in the press this week about Germany insisting on moving the gold it holds in France back to Germany?

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Why would Germany hold gold as part of its currency reserves at all why not some other relatively easy to transport and valuable thing? Diamonds, perhaps. Tradition, you will say. Nothing but tradition. I'd say that's the point. All money is an odd mixture of tradition and faith. We have convinced ourselves that little seven-sided coins made out of a copper and nickel alloy (20p pieces) are money; that bits of paper are money; and that numbers on a computer screen are money. But their value, just like that of gold, is simply a function of our faith in them. I've got a pile of bank notes on my desk that aren't money any more. They look much the same as the ones in my wallet. It is just that being in a variety of defunct African and European currencies, I can't get anyone to treat them in the same way.

This brings me back to sterling and the 83%. The dollar has done a little worse than us. So has the Mexican peso. But overall there is no escaping our dismal performance. Sadly, I have a feeling we are going to have to get used to it. Markets only have faith in currencies to the extent that they have faith in the countries backing those currencies. Keep that in mind and take a look at the UK. We have a vast national debt we have no good way of paying down. We have a huge deficit (the amount by which the debt rises every year) too. So we are adding £600bn to our debt in five years (2010-15). We should have lost our triple-A credit rating years ago and this year we probably will.

The truth is that in the UK we have kept ourselves going for decades now by doing little more than expanding our banking system and welfare state beyond reason and selling houses to each other on the side. But now the tide is out, to adapt one of Warren Buffett's favourite phrases, we can see who is swimming naked. And it is almost all of us.

You can see this most clearly in our nasty current account deficit (the extent to which we import more goods than we export). It is now about 3.5% of gross domestic product. That's one of the worst in the world. Finally, in the roll call of our inadequacies, we must not forget the quantitative easing we are using to cover for our failing economy clearly the more new money we create, the less, over the long term each unit of that money will be worth. That doesn't exactly encourage people to want to hold it.

You might be wondering why sterling hasn't already completely collapsed. You can put it down to the fact that currencies are what economists like to call a zero sum game they move relative to each other so they can't all go down at once. When all countries are in trouble the ones that look worst fall against the ones that look less bad. Sterling fell 20% at the start of the crisis. But before slide turned to crash, Europe took up its position as the worst of the bad and the UK began to look like a port in a storm.

Sterling, says Halkin Services' Peter Warburton "was the beneficiary of massive cash inflows last year". That made up for the money we had to pay out for our imports, plus a bit. But if the European crisis is as it seems to be "on ice" for the time being; if our new Bank of England governor Mark Carney abandons our inflation target and keeps going with the quantitative easing (which he probably will); and if it is clear interest rates are not going to rise as inflation does, it is, says Warburton, hard to see what can keep this "hot money happy."

An awful lot of analysts have started this year feeling bearish on the pound. They might not be right immediately most other countries are having a go at devaluing their currencies too (in the hope that this will make their exports cheaper and boost their economies) so who can know who will win the race to the bottom in the short term? However in the relative world of currencies, sterling if you think of it as simply a paper representative of the UK economy looks more likely than most to win in the medium term.

What do you do? Insure yourself by holding gold and a spread of shares in companies that operate outside the UK. And perhaps also do what I am doing this weekend: if you are planning on going on holiday anywhere with an even vaguely decent economy relative to ours this year, book it sooner rather than later.

This article was first published in the Financial Times

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.