It's quite remarkable that the 2 countries who dominate the world's financial mechanisms are in the same dire straits. Both followed almost identical policies of financial oligarchy - while both countries have countless regulation on the books, obviously they were mostly useless in retrospect. When real regulation and supervision was introduced anytime in the past 10, 15 years the cries of don't stifle financial innovation! rang out. Then that was followed by if you regulate us, all our bankers will move to New York (if you were in the UK) or if you regulate us, all our bankers will move to London! (if you were in the US). Personally I would of been thrilled if most of our bankers had moved to London 10-15 years... and instead we had a non innovative financial system ala Canada. Just imagine how much more money we'd have in our pockets, and how much less debt our future generations would have to deal with. But I don't run our country - our oligarchs do.
So now both countries are in a steaming mess and the central bankers in both countries have done unprecedented things to keep the mirage going. And they will continue to do these things... both countries now run huge deficits and are attempting to inflate their way out of their debts. Just from reading the UK papers online, the citizens across the pond seem much more engaged and worried about their fiscal disaster - while Americans have been sated with Dancing with the Stars and the return of the NFL. The core difference between the 2 countries right now is the US has a magnificent advantage of holding the world's reserve currency... hence being the global bully it can persist in bad behavior since there is no real alternative (yet) and long held perceptions of safety are hard to kill. The UK used to hold this prestige many decades ago... until it did all the things the US is doing now.
We'll be keeping a very close eye on the UK in the coming decade - much like I said in 2007 that Las Vegas would be the canary in the coal mine for the conspicious consumption culture of America, I believe the UK will be the fiscal canary in the coal mine for the United States. Our fate will be met at a longer term date since we will be allowed much more rope to hang ourselves than the UK... that's the benefit of being the reserve currency. The UK thus will be forced into making more harsh decisions much sooner and we'll see (based on these decisions) how things turn out in 6-8 years. There seems to be far more political will to return to fiscal sanity in the UK than in the US, but the central bank in the UK seems as out of control as the United States version. An interesting push - pull...
For now while almost every asset on Earth (including the pound sterling) is beating the US dollar into submission, the sterling is itself facing hard times versus almost all other currencies not named US peso. Again, what readers need to understand is we have solved nothing despite what political (and central bank) leaders have done. All we've done is moved the toxic debt (you never hear about it anymore do you?) from our oligarchs to the taxpayers. Since we have printing presses we believe we can hide them on central bank balance sheet, and print them away (into the ether) over time. The effect of this solution will be seen in the currency - both for reasons of sovereign risk, and devaluation by quantitative easing. Over and above that, the US has some massive unfunded liabilities in our entitlement programs that are not even part of the current discussion but will make this crisis look like a walk in the park. But let's focus on the UK for today since as I said above, they will be first into the frying pan.
Via WSJ - UK Sterling Takes a Beating
- While currency experts focus on the plight of the dollar, it is clear the outlook for the British pound could be just as bad, if not worse. The dollar sank to its weakest levels of the year on Monday against most major currencies, but the pound also took a beating, hitting a four-month low against the dollar and a six-month low against the euro.
- It fell to fresh 24-year lows against the Australian and New Zealand dollars.
- Speculators are selling the British currency more heavily than at any point since records began in 1972, according to widely watched data issued last week by the U.S.'s Commodity Futures Trading Commission.
- Sterling's weakness stems from several factors, many of them similar to the challenges facing the dollar. Short-term interest rates in the U.K. are very low and are expected to remain that way. The fiscal situation is challenging, and a looming election campaign will make hard choices to address what ails the British economy and the pound more difficult until after the vote.
- The U.K. budget deficit is set to exceed 12% of gross domestic product in the financial year ending in March, one of the highest budget gaps in the developed world. (U.S. is almost identical)
- With tax income ravaged by the recession and welfare bills rising, the treasury expects net debt to reach 80% of GDP by the middle of the next decade, more than double what it was before the downturn started. (the U.S. is ahead here, we should be at 100% of GDP within 2 years)
- Moreover, following the financial crisis, Britain's dependence on the financial sector is undercutting prospects for recovery. Even after the sector rebounds, many analysts believe, it will be smaller than it was before the crisis. Investment funds and bank analysts have grown increasingly gloomy about the pound's prospects, and many think its weakness could last for several years.
- Contributing to the pound's fall is the resurgence of the so-called carry trade in foreign-exchange markets. The pound, usually linked to high interest rates, has historically been a beneficiary of this trend, where investors borrow in currencies with low interest rates to invest in those with high rates. [Sep 18, 2009: US Dollar Replaces Japanese Yen as Carry Trade Currency]
- But the ingredients of the carry trade have flipped, with the pound now being borrowed and sold to fund trades in regions with higher interest rates. (used to be the yen, now it's the dollar and pound taking the role as the world's peso) That selling pressure is further undercutting the pound and shows little sign of letting up since the Bank of England has made it increasingly clear that rates are set to stay low for a long time. (as has I'm not Alan Greenspan, I'm Greenspan on steroids Ben Bernanke)
- Fresh news from the U.K. government on Monday of plans to sell a range of state-owned assets to fill the nation's coffers did little to stem the tide. Currency traders fear it will take years for the U.K. to shake off its debt burden and return to robust growth and rising interest rates, and that is being reflected now in the pound's value.
- This may not necessarily mean sterling is set for a slide against the dollar, as the greenback is weighed down by its own debt problems and by long-term concerns over its status as a reserve currency. The so-called race to the bottom between the two currencies has become a dark obsession among traders. (ooh, a race! I'm sure we'll win!)