10 Nov 2018
When I wrote recently about financial contagion I pointed out that holding cash is an investment. It is effectively a bet against inflation and for political and economic stability. Moreover, holding any currency involves a potential hidden opportunity cost – that of not holding a different currency. On a couple of occasions in my lifetime, the British government has had to abandon a policy of maintaining the level of sterling against another currency; in 1967 against the dollar and in 1992 against the deutschmark.
GREAT STERLING DEVALUATIONS OF OUR TIME
On the first occasion, following a 14% devaluation, the PM Harold Wilson attracted a certain amount of ridicule for addressing the nation in the following terms. He acknowledged that sterling was worth less “abroad” but said:
“That doesn’t mean, of course, that the pound here in Britain, in your pocket or purse or bank, has been devalued”.
Essentially he said that the pound hadn’t been devalued against the pound. In truth, it wasn’t much of an argument but it relied on the fact that currency losses are largely invisible until people are obliged to make some kind of foreign transaction.
I don’t remember the devaluation of 1967 but in 1992, on (Black) Wednesday 16th September I was sitting in a dealing room listening to an open line from the Bank of England’s dealer who repetitively intoned the price at which he was prepared to buy sterling. One of my colleagues told me that the Bank of England dealer always closed for the day at 4.30pm (presumably to catch the 5.07 to Sevenoaks) and wondered what would happen then.
What happened is that he did indeed bid everyone a good afternoon and no doubt picked up his briefcase and headed for the door. In the time the world’s only buyer of sterling could have walked to the station, the dam had burst and he had pissed away £3.3 billion, which was real money in 1992.
If that sounds like a story of pinstriped establishment incompetence from ancient British history, I must mention that the Bank of England is sitting on paper losses of some £49 billion (my estimate) from the gilts that it has bought above par since 2009 as a result of QE, assuming it holds them to maturity (which it shows every sign of doing).
It is possible, if inconvenient, to invest in the currency of another country or economic area (in the case of the eurozone). On the plus side, you have a 50% chance, on average, of being right. Most national governments a) prefer their citizens to invest in domestic assets and b) somewhat hypocritically want to attract foreign money as well. In sophisticated modern economies governments are more relaxed about these things.
In the UK, from 1939 to 1979, there were quite severe exchange controls restricting people who wanted to take money out of the country, even to go on holiday. I blame this for family camping holidays in the 1970s when we took three weeks’ worth of canned food with us, thus cruelly delaying my exposure to French, Italian and Spanish food. I try to forgive but I can’t forget.
WHAT MAKES A CURRENCY APPEALING?
Far too much is written about what makes currencies fluctuate against each other. But Alan Greenspan, in a famous speech in 1996 in which he temporarily spooked the markets by using the phrase “irrational exuberance”, had something much more interesting to say about the responsibility that the Fed carries for the soundness of the dollar.
“For, at root, money–serving as a store of value and medium of exchange–is the lubricant that enables a society to organize itself to achieve economic progress. The ability to store the fruits of one’s labor for future consumption is necessary for the accumulation of capital, the spread of technological advances and, as a consequence, rising standards of living.”
Money: “serving as a store of value and a medium of exchange” – we require currency that we own to hold its value over time (not to be devalued by inflation or explicit government policy) and to be readily acceptable in transactions. This is pretty basic and might sound simple but all around us, (both historical and contemporary) are examples of currencies gone wrong.
In distant history, the French National Assembly in the wake of the 1789 revolution sold Assignats, paper money backed by the word of the state. The National Assembly, having confiscated the property of the nobility and the church, was hardly in the position to start taxing the newly liberated peasants, so it carried on issuing more and more paper until, by 1795, the whole lot was effectively worthless. Note that totalitarian governments tend to behave as if money will obey their commands.
Move forward to today and look at Bitcoin. If it is either a store of value or a widely accepted medium of exchange, I have missed something.
Of course, a currency can be a store of value and a medium of exchange until it suddenly isn’t. So the international trading and investing community will always take a broad view, (not readily available to a country’s own nationals) and judge the economic and political trends of the issuing nation of a currency.
HOW THE WORLD MIGHT VIEW STERLING
In 2015, the exchange rate of sterling to the euro traded mostly in a range of 70-75 pence i.e. it cost between 70p and 75p to buy one euro. When PM David Cameron, honouring the promise in his successful election manifesto, announced that there would be a referendum on the UK’s continued membership of the EU, sterling broke its range and was standing at 78p to the euro (i.e. sterling had weakened) the day that the electorate went to the polls in June 2016.
We all know what happened next but I think it is important to step back and think about that fall in the value of sterling in advance of the result. Yes, it was pricing a risk but what was the risk? I suggest that while it was generally considered unlikely that the UK would vote to leave, the fact of the referendum itself had pretty much killed any possibility that the UK would join the euro.
If you are an investor in Asia, for example, you are naturally inclined to see Europe and particularly the EU as a single market for trade and investment. You may well find it baffling and irritating that the UK is not part of the euro. You know what happened in 1992 (Black Wednesday) but whereas most people in Britain saw that as proof that sterling should not merge with the euro, you, the Asian investor may well have seen it as proof that it should, (arguably because you are more logical and less emotional than the British public).
So the fact that the British electorate voted for a referendum at all pretty much stamped out the last embers of hope that the pound would ever become the euro.
After 24th June 2016, when it was announced that the UK had decided to leave the EU, sterling fell by c.10% to 85p per euro and has largely traded within the range of 85-90p since then. In three years it has devalued from 70-75 to 85-90, a pasting over the whole Brexit period of around 20%.
The current received wisdom of currency experts and assorted talking heads is that sterling will fall again (i.e. it might break up through 90) if the UK leaves the EU “without a deal”. It is hard to imagine otherwise in the midst of the inevitable doomsday panic that will result.
IT’S NEVER A ONE WAY BET – MIND THE RALLY?
But as they used to stay on the floor of the London stock market, “mind the rally!”
It seems to me that the demand for currency havens is a little above average at present. Currency havens are sought by citizens of certain nations wanting to park their money legitimately abroad. I am thinking primarily of China at present. According to Bloomberg there are 50 million unoccupied apartments in China owned by speculators, sorry, investors. By definition, an asset that yields no rent is only worth holding if its price rises and a capital gain results. Good luck with that, everyone.
In the light of that it makes some sense that Chinese investors are known to have been buying apartments rising above glamorous Lewisham, South East London, off plan. Historically, the UK is a stable democracy that values property rights very highly. You don’t have to take my word for it. Here is an index of European property rights which rates the UK at number one. (Ireland is #9, France #12, Italy #18, Portugal #19, Spain #22 and Turkey #30 but I’m sure your holiday home will be absolutely fine).
The Swiss franc is a haven currency despite the fact that you have to pay to hold it. This may have something to do with the historic ask-no-questions policy of Swiss banks (I think that’s supposed to be over, isn’t it?) but it surely also reflects the view that the Swiss government is about as exciting as a manufacturer of cuckoo clocks but less well known. Havens are not supposed to be exciting and popular.
I may be missing the point but a refreshed and independent UK state, free of EU supervision/interference, and with property rights guaranteed by centuries of legal precedent, seems like it could be quite an attractive proposition, regardless of whether it is more difficult than it used to be to import smelly cheese.