Is the Pound Doomed to Follow the Dollar's Decline?

Rob Mackrill - Fri 11 Jan, 2008

Ben Bernankes Fed is ready for aggressive cuts. Mmm, more cheap money. US stocks liked what they heard...so did gold. The Dow which has been pretty much in freefall for the year to date went up 117 points yesterday and gold homed in on $900. The news has done little for European bourses, though. Well, whats to celebrate for European business from a yet weaker dollar? Here in London its raining and the skies are leaden grey. The FTSE 100 index looks something similar. Its sunk below 6,200 as it continues its down trend for the year...

The tone has changed.

Ben Bernanke’s Fed is ready for “aggressive cuts”.

Mmm, more cheap money. US stocks liked what they heard...so did gold. The Dow which has been pretty much in freefall for the year to date went up 117 points yesterday and gold homed in on $900.

The news has done little for European bourses, though. Well, what’s to celebrate for European business from a yet weaker dollar? Here in London it’s raining and the skies are leaden grey. The FTSE 100 index looks something similar. It’s sunk below 6,200 as it continues its down trend for the year.

What’s this? The money’s coming out of hedge funds... Man Group report private clients have been doing what investors in unit trusts have been doing - getting their money out. This sounds a bit of a sea change. Aren’t investors flocking to them anymore? Aren’t hedge funds supposed to keep making money in the bad times? Or at least hold on to it.

“It was not our strongest period. Assets didn’t go up as much as we had hoped,” says Chief Executive Stanley Fink ‘fessing up to betting the wrong way on the dollar/euro for a $600m bruising.

Man Group is the blue chip of hedge fund managers, being a listed company on the London Stock Exchange. Most hedge funds fly below the radar of course and domicile themselves in sunnier climes with easy going ways – the Caymans, Bermuda. You don’t hear much about them until the day they make a thumping amount of money, like in 1992 when Soros made $1bn betting against the pound in the Exchange Rate Mechanism. Or when it all ends in tears and they lose a large amount of money. In 2006, Brian Hunter, a Canadian trader, lost Amaranth’s investors $6bn betting the wrong way on gas prices.

It’s worth remembering that Alfred Jones, who first came up with the idea of a hedge fund in the 1940s, thought it a conservative investment strategy. It’s worth remembering too that the average hedge fund has a short shelf life...around two years if memory serves. And upheavals in the credit markets will have done nothing to decrease their mortality risk.

Sell the pound buy gold? Maybe. Even at these elevated levels of £457/oz, it might make sense if, as Martin Wolfe says in today’s FT, the pound sterling is indeed the next dollar. Judging from its past year’s performance the call is looking a little overdue. But it won’t come soon enough to save UK workers at Rolls Royce. They’re set to be laid off on account of the weak dollar and higher input costs. Even though the pound is now sinking fast from the once flattering 2:1 level. It’s now $1.95.

It’s already sunk against the euro...to a new low. A pound was worth more than 1.5 euros a year ago against 1.31 today. Or put the other way, the euro’s broken
through 75p for the first time. Looking around, you could have bought a wide range of currencies a year ago, from the Thai Baht and Indian Rupee to the Brazilian Real, and come out on top against the pound.

The reasons the pound is doomed to follow the dollar are the reasons common to Anglo-Saxon economies. Namely, debt-fuelled spending featuring rapid credit growth, a meagre savings rate, rampant house price growth, indebted consumers and a current account deficit nearing 6%... on a par with the US.

Household mortgage debt in the UK is even more acute than the US. 126% of GDP against 104%. Still, it could have been worse, notes Wolfe. We could have been in the euro. And where would we be today if we had had even lower interest rates handed down to us from the one size fits all European Central Bank? An Ireland? A Spain? Our interest rate today would be that of the ECB at 4% (and in 2003 as low as 2%) rather than one set by the Bank of England 150 basis points higher at 5.5%.

For staying out of the euro we have Gordon Brown to thank...particularly given he ignored the wishes of JP Morgan’s latest high-priced adviser, Tony Blair. The ex-
PM will now be able to lobby the government he once led on behalf of the US bank. The ultimate gamekeeper turned poacher.

Latest news on house prices from the FT House Price Index today, which takes its info from the Land Registry itself. House prices went...up. Well, a bit anyway. 0.1% in December and almost 8% on the year. Strip out the bonkers London market and it’s flat around the rest of the country. According to Dr Peter Williams who puts it together:

“The (housing) market has been slowing since August...and the FT index is trending downwards...we would expect this downward trend to continue even though the fundamentals of demand and supply, employment and interest rates remain favourable.”

There you go. A brief update to look informed on the subject at a dinner party this week-end. 

This article is from The Daily Reckoning. With over 500,000 readers every day The Daily Reckoning has become essential reading for anyone who’s interested in their money. If you think you'd enjoy witty, irreverent and often hilarious commentary on economics and investment - for FREE - then sign up today.