"Am I missing anything here?" -- asks our reader about GBP/USD

Tuesday, 17 February 2009 14:53

On Friday, February 12, 2009, a reader sent us the following question:

Can you or anyone please explain why the British Pound is doing so badly against the Yankee Dollar? All we here on US television is doom and gloom on the US economy and huge "Bail outs" to save the US economy but I do not here of the same problems in the UK...........am I missing anything here?

In general we try to stay away from macroeconomics per se, regarding it  a subject too far off in the "liberal arts" area for the hard quantitative nature of this site, but since you're asking specifically -- here goes our opinion.

No matter how you view the nature of the present crisis, UK is not spared by it. Similarly to the US, it entered the crisis having a current account deficit, a budget deficit, an overheated real-estate market, and is home to some of the world's largest and most influential financial operators. Unlike the US, the UK does not enjoy the "extraordinary privilege" of emitting global reserve currency regarded as the universal equivalent of exchage, the "world money".

UK entered the eventful October 2008 having short-range interest rates about 400 points higher than those in the US, which made the Pound Sterling victim of carry-trade unwinding caused by risk aversion (for a well articulated and informative opinion on the role of leverage in the modern financial system and the mechanics of the crisis, see Peter Gowan's "Crisis in the Heartland"). Other high yield currencies such as the Australian Dollar, not to mention the Icelandic Krona, shared the same fate. Europe 2020 notes that "Financially speaking, Iceland thought of itself as UK, in the same way as, financially speaking, UK thought of itself as the US and the US thought of themselves as the entire world." This sounded puzzling to me initially but if I take it in Gowan's "New Left" context, I take this to mean that the US is a "shadow bank" to the world while the UK is a "shadow bank" to the US and Iceland -- to the UK. (Here, "shadow banking" is almost synonymous  with  "financial innovation".) The collapse started in reverse order with Iceland.

Going back to the UK, there hasn't been lack of bad news related to it lately. Among the recent issues, you can find speculations weighing the likelihood of UK's sovereign credit rating being downgraded. Bank nationalization (and re-capitalization) seems to be the British English equivalent of the US bail-outs you mention (recall the Northern Rock story).

On February 11, BOE Governor Mervyn King had this to say at a press conference: "The UK economy is in a deep recession. At home, the MPC has cut Bank Rate from 5% to just 1% in the space of five months. At its February meeting the Committee judged that an immediate reduction in Bank Rate of 0.5 percentage points to 1% was warranted. Given its remit to keep inflation on track to meet the 2% target in the medium term, the projections published by the Committee today imply that further easing in monetary policy may well be required. That is likely to include actions aimed at increasing the supply of money in order to stimulate nominal spending." The market anticipation of this statement might have been playing a role in the short-term GBP dynamics which could make you wonder what was going on.

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