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What the Sterling Crisis Means for You

Currencies / British Pound Dec 12, 2008 - 07:23 AM GMT

By: MoneyWeek


Best Financial Markets Analysis ArticleIf this isn't a sterling crisis, what is? Not content with plunging 25% against the dollar over the last six months, the pound is now fast heading for parity with the euro.

Our so-called government may think it can solve Britain 's economic problems via borrowing like crazy, and letting sterling collapse into the bargain.

But it's quite wrong. As the Germans are now telling Gordon Brown, his mistaken approach is actually storing up a lot more trouble for the future...

We have a full-blown sterling slide on our hands

If you want to gauge a country's financial wellbeing, the best health check barometer around is the strength of its currency.

And the way the pound is ailing, it looks like Britain is fast heading for the emergency ward. Our economy is collapsing, and the government's rather pathetic response has been to promise to run up the national deficit to more than £1 trillion by 2012. Now we have a full-blown sterling slide on our hands.

On Tuesday this week, my colleague John Stepek wrote about ' Why sterling is set to fall even further '. Within three days, the pound has dropped yet another 3% against the euro, and the headlines are full of stories of 'parity' by Christmas.

Now Peer Steinbruck, the German finance minister, is telling Gordon Brown where he's made such huge mistakes. Describing the UK government's recent actions as "depressing", Mr Steinbruck warned that it will take Britain a generation to pay for the huge financial stimulus introduced by our government: "The same people who would never touch deficit spending are now tossing around billions. The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking".

Steinbruck points out how madcap borrowing will result in disaster

Now we could be forgiven for feeling a bit tetchy about being corrected by the Germans. After all, the eurozone economy doesn't look too hot right now either, and anyway, isn't the French president urging European governments to "do everything we can to move the economy forward" with a €200bn EU-wide stimulus package?

But of course, Germany very sensibly doesn't want to join in – it's actually managed to balance its budget for the first time in 39 years in 2008.

And three cheers for Mr Steinbruck. Politicians worldwide are fast developing a taste for splashing out oodles of our, i.e. taxpayers', cash on their own pet projects, led by their cheerleader, US president-elect Barack 'deficit doesn't matter' Obama (although to be fair to Mr Obama, his predecessor was no better at balancing the books).

Now, at last, a national government figure has actually been brave enough to shatter the ghastly Keynesian "spend, spend, spend" consensus that's creeping in, and to point out what a disaster all the resulting madcap borrowing will become.

And sadly for us, he's 100% right. That means that the pound will fall even further.

So what will that all mean for us here in Britain ?

The main beneficiaries will be exporters, as well as those firms who derive most of their income from abroad. With at least 50% of the earnings of FTSE 100 companies coming from outside Britain , the 'translation effect' will see profits at those businesses increased in sterling terms. Though, of course, if losses are being stacked up abroad – quite likely in these days of global recession - that would mean a bigger shortfall measured in pounds.

But for the rest of us, it's bad news. As the pound buys less, everything we purchase from abroad will cost more. So even if local prices are falling in the countries from which we're importing, the cost to someone in Britain , either a retailer or the consumer, is bound to rise.

Just look at fuel. The oil price is down by over 70% but the cost of a litre of petrol has dropped by just 25%.

And as for holidays outside the UK - forget them!

There's a very nasty sting in the sliding sterling tale, too, for British banks. "It's now clear that for years, British banks have been borrowing off foreign banks to lend to UK retail customers", says the Evening Standard's Anthony Hilton , "an economic model pioneered by Argentina and banana republics down the years. It ended in tears for them… just as it now is for us".

Shades of Iceland ? Certainly.

For the government too, there's a big downside to the plunging pound. Much of that £1 trillion of borrowing is going to have to come from outside the UK . The more sterling slides, the less willing overseas investors will be to lend the British government the money it's spending. Already the bond market is getting spooked, with the cost of insuring against a default by UK gilts rising almost six times within the last three months.

Nor would so-called 'quantitative easing' - effectively printing money, with the Bank of England buying up either government or commercial debt to try to kick-start the economy – do anything other than cause yet more problems. The Americans may be able to get away with doing this – for a while at least - because they operate the world's reserve currency. But for the UK , more pounds in circulation would make matters even worse for sterling.

In short, our currency is now in crisis. Apart from those shareholders in those overseas earners, there's no silver lining for investors – or indeed for any of us.

Sadly, that's very unlikely to stop Gordon Brown digging us into an even worse hole than we're in already. How long will it be before Alistair Darling is forced to turn the clock back to 1976, and has to phone the IMF for an emergency loan?

By David Stevenson for Money Morning , the free daily investment email from MoneyWeek Magazine .

© 2008 Copyright Money Week - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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