Is The Sterling Dangerously Overvalued?

The captains and kings of Europe have resolved to preserve the euro with history’s biggest bazooka of fiscal and monetary largesse. Sterling trades at 1.62 against the US dollar as it is positively correlated to euro strength, as well as to the reduction of systemic risk in international banking. After all, despite Barclays, Northern Rock, Barings, BCCI, Johnson Matthey, AIG, Robert Maxwell, RBS and the J.P. Morgan Whale, Londontown is still Ground Zero in global finance.

The credibility of the Square Mile has been devalued in Westminster, Whitehall and the boardrooms of the sceptred isle. The Square Mile, where the Warburg, Rothschild, Baring, Hambros and Fleming clans invented the alchemy of merchant banking, has been the jewel in Brittania’s financial crown in the two millennia since Roman Londonium. Yet the sterling’s role as a global reserve currency is under grave threat.

Since 2010, existential euro risk forced central banks to buy the tsunami of gilt debt printed in Threadneedle Street. As euro kaput risk plummets, so does the
safe haven bid in sterling. This means a fall in sterling against the euro is inevitable as offshore safe haven flows into UK gilts unwind. Sterling is also
headed lower against the dollar and the Swiss franc if risk aversion returns.

The Bank of England’s MPC has now opted for another £50 billion of gilt purchases to stimulate bank lending at a time of High Street distress. Since David
Cameron did not drop fellow Old Etonian/ Bullingdon Club mate George Osborne in the latest Cabinet reshuffle, 10 Downing Street will not repudiate the Chancellor’s fiscal austerity diktat even though Britain is in recession and CPI inflation fell below three per cent in July.

Moreover, the current account deficit is now minus 2.7 per cent, the BOE will dare not increase the bank rate until late 2013 and UK exports to a Europe in recession will only decline. The 2012 Budget mandates the most draconian public spending cuts since the opening months of the Thatcher era. I also expect another £50 billion quantitive easing move by the Bank of England this winter. Monetary easing and fiscal tightening is a classic macro argument for a lower currency and sterling will be no exception in 2012 or 20 years after Maastricht and Black Wednesday.

In 2008-09, sterling lost one third of its value on its trade weighted index.

This was the biggest de facto sterling devaluation in history, more traumatic than John Major’s (Soros midwifed!) humiliating exit from the ERM in 1992, Harold Wilson’s (gnomes of Zurich) pound in your pocket devaluation in 1968 and even Ramsey MacDonald’s fateful decision to take the British Empire off the gold standard in 1931.

In the past century, sterling has punched above its weight in the world currency leagues. This was due to London’s historic rule as the world’s banker during the British Empire, the North Sea oil boom and epic privatisations under Mrs Thatcher, the epic credit bubble that transformed the City’s dealing rooms in the past decades, its role as the safe haven gilt hedge during the euro’s death rattle since 2010.

Britain’s recession will deepen this winter, the reason I expect Mervyn King to panic and print another 50 billion quid. UK PLC faces a protracted balance sheet recession with a broken banking system, savage public spending cuts and social unrest. Tory politics unnerve me as the Conservative Party has regicide in its DNA – ask Edward Heath, Sir Anthony Eden and Mrs Thatcher, also William Hague, IDS and Michael Howard. If a “man or mouse” Prime Minister holds a referendum on the EU as Tory backbencher MPs demand, the Coalition is a goner.

Scottish devolution is another political risk. The ghosts of Culloden still linger in the SNP’s debating halls in Edinburgh. Sterling is dangerously overvalued, as is high-end London property. Gulf investors hoping to mint gold in the streets of London, like Dick Whittington, are doomed for disappointment in sterling’s winter of discontent.