by Philip Pilkington
Thursday, 8
September 2022
Chart
10:20

Is sterling on the verge of collapse?

As the pound slides, fears of a currency crisis grow
by Philip Pilkington
The pound has fallen to its lowest level against the dollar since 1985. Credit: Google

Things are going from bad to worse in Britain — and at a rapid clip. With the pound falling to its weakest level since 1985, there is talk of a looming currency crisis in Britain. In this scenario, the value of sterling would fall and living standards would follow suit. Currency crises are rare in stable, developed countries and more typically associated with economic basket cases like Argentina and Venezuela. So what is happening?

Discussions surrounding a potential currency crisis started earlier this week when respected Deutsche Bank analyst Shreyas Gopal published a note on the British election. In the letter, Gopal pointed to the fact that, due to inflation and rising energy costs Britain’s current account deficit — that is, the amount of money the country is borrowing from the rest of the world — could hit 10% soon. Current account deficits of 2-4% are standard fare for Britain, but a deficit of 10% would put the country in an extremely precarious position.

Gopal notes that the only reason that Britain has been able to finance this deficit until now is because of “large capital inflows”. This is money sent from other countries into the UK — mostly into the City of London and the London property market — which foreigners believe will yield a good investment return. He adds that this money is being sent because investors believe in “improving investor confidence and falling inflation”.

Yet with the fundamentals deteriorating so rapidly, the analyst highlights the possibility of “investor confidence [eroding] further” and that “this dynamic could become a self-fulfilling balance of payments crisis whereby foreigners would refuse to fund the UK external deficit”. This would mean a decline in the value of sterling of at least 30%.

This is the nightmare scenario that those who worry about the stability of the British economy have been concerned about for some time. Many have noted that sterling responds rapidly to events such as Brexit. Most currencies do not behave in such a volatile way toward referenda and other one-off events. But because sterling’s value depends on financial inflows, its value can change drastically overnight.

What would a true collapse of sterling mean for Britain? Frankly put, it would mean a drastic decline in living standards. Britain is an island nation. It imports large amounts of what it consumes. Imports make up around 32% of GDP in the UK which is enormous when compared with the United States (13%) or even Australia (21%). If the sterling falls by, say, 30%, then the price of these imports rises by 30%. As such, around one-third of the products that Britons buy will immediately increase in price by around 30%.

Then there are the pass-through effects. If something is produced in Britain but uses a large amount of imported inputs to make, this good will rise in price too as the inputs rise in price. In an economy with the import-dependency of the UK, a crash in the currency value would have a detrimental impact on living standards that are not easily reversed. If this were to happen, Britain would be in serious trouble.

Historians may look back on this moment in history and note that Britain, a country that was a leading champion of the sanctions against Russia in 2022, turned out to be their worst victim. Let us hope that cooler heads prevail and we choose a different path.

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Stephen Walsh
Stephen Walsh
19 days ago

This is hysterical attention seeking. The USD has strengthened against most currencies, as it typically does during a crisis. Sterling has been stable vs the EUR, and is expected by most market commentators to stay weak vs USD for the rest of this year, but to strengthen again in 2023. If short term fiscal supports stave off a recession and help reduce inflation by capping energy prices, that will be helpful to GBP.

Sam Brown
Sam Brown
19 days ago
Reply to  Stephen Walsh

Also, never discount the voices of those with an agenda for it to fall for their profit. Remember Soros…? The articles of gloom are being written by financiers who are betting against the currency and trying to talk up their positions. Charlatans the lot of them and they should be publicly ridiculed and exposed.

hayden eastwood
hayden eastwood
19 days ago
Reply to  Stephen Walsh

If it is, indeed, hysterical, can you point out why a deficit of 10% and capital outflows won’t cause a lasting depression of the pound? Why will it strengthen in 2023 in the face of the larger forces the author refers to?

Matt M
Matt M
19 days ago

There is no 10% current acct deficit and no problem with outflows. That is what the author (or rather the DB analyst) is speculating might happen.

As the author says this is a “nightmare scenario” or in other words an hysterical, attention-seeking forecast.

Last edited 19 days ago by Matt M
Aaron James
Aaron James
19 days ago
Reply to  Stephen Walsh

”If short term fiscal supports stave off a recession and help reduce inflation by capping energy prices, that will be helpful to GBP.”

So spending a few hundred Billion £ of printed/borrowed money to reduce inflation will help? That’s like saving a drowning person by holding their head under water.

You must be a Biden voter, and love his ‘Inflation Reduction Act’ which does exactly that.,

Steve Elliott
Steve Elliott
19 days ago

I’m not an economist but both sterling and Euro have been falling steadily against the dollar over the last year. Doesn’t that suggest that it’s more that the dollar is strengthening.

polidori redux
polidori redux
19 days ago
Reply to  Steve Elliott

Against the Yen too, apparently.

Last edited 19 days ago by polidori redux
Stephen Tye
Stephen Tye
19 days ago
Reply to  Steve Elliott

Yes, it’s a strong $ story, not a weak £ story.

Roger Ledodger
Roger Ledodger
19 days ago
Reply to  Stephen Tye

That is the consensus of most of the non-MMT economists and investing platforms I read too. As pointed out elsewhere, all that saves the $ is its a reserve currency and it is a Petro-currency. There has always been an interesting speculation over who exactly has the $ in it sights. The idea being the US would not survive the $ ceasing to be the world’s reserve currency, at least in terms of being the World Hegemon and such a powerful military power – it couldn’t afford it.
China and Russia were the two prime suspects, both of whom appear to have far more gold reserves than they are willing to admit. In China’s case so much gold there was speculation it might announce a gold backed Yuan, and send the fiat $ into a death spiral.
The only thing I do know is, that 3 years or so ago when I would suggest that the EU wasn’t as strong as it appeared, I was ridiculed. When I explained why and what the sources I read said, remoaners in particular, laughed aloud. The worrying thing for me, is that what is occurring is even worse than the doomsayers, who believed Fiat money as printed today was going to be our downfall, were predicting. But then again, though they scoffed at Net Zero and warned of it, I doubt they thought we’d hit that wall quite so soon. Though I’m still waiting for Gold to surge in price, another of the predictions.

Colin McC
Colin McC
19 days ago
Reply to  Steve Elliott

Indeed, the dollar ‘hegemony’ with its reserve-currency status and ‘exorbitant privilege’ usually results in it strengthening in a global crisis. What’s different, going forward, is the rise of alternative reserves in roubles (!) or renminbi, due to geopolitical decoupling of the BRICS from the G7. Other nations may have to choose which bloc to make their ‘home’, currency-wise, which may be driven by their trade and the FDI they have (ie. increasingly favouring China).

Nicky Samengo-Turner
Nicky Samengo-Turner
19 days ago
Reply to  Steve Elliott

Yes, not least because there is a big ” flight” into US Government bonds, and selling of equities during crisis periods which, obviously both escalates the dollar demand and price.

Matt M
Matt M
19 days ago
Reply to  Steve Elliott

Euro and Sterling both down 15-16% against $ YoY. Yen down 30%.
Euro is down 17.2% over last 5 years (i.e. since the referendum)
Sterling is down 12.9% over the same period.
Euro is even down more than the pound so far today!
Main difference between Britain on one hand and Europe and Japan on the other is that those places don’t have bitter, hand-wringing Remoaners infesting their media.

Last edited 19 days ago by Matt M
andrew harman
andrew harman
19 days ago

Unherd has been a Godsend at times these last two years but there are times when it exasperates me. Not for the same reasons as some posters indulge in – that it dares to have pieces which conflict with their own view and they throw their toys out of the pram – but because it descends into sensationalist fear-mongering like this. I lost patience with GB news for this (amongst other reasons). If I want such journalism I will read the Daily Express (ugh)

Last edited 19 days ago by andrew harman
Max Price
Max Price
19 days ago

“ irreversible damage to living standards that are not easily reversed.”

Hmmm.

Last edited 19 days ago by Max Price
Prashant Kotak
Prashant Kotak
19 days ago
Reply to  Max Price

(⁠•⁠‿⁠•⁠)

Last edited 19 days ago by Prashant Kotak
Roger Ledodger
Roger Ledodger
19 days ago
Reply to  Max Price

The Greens will be rejoicing then, that is what Net Zero means, ‘Pre-industrial Revolution’ world. Thanks to the wind not blowing and hydro not flowing and Putin stepping in, we now get a glimpse of the world of Net Zero. Suddenly Lomborg’s solutions to Climate Change seem even more sensible and appealing. However, we have yet to survive the coming winter, come next spring Europe may have embraced a Post-Industrial landscape as bleak as was the pre-industrial one.

Roger Ledodger
Roger Ledodger
19 days ago

I’m always intrigued by the pressure on the pound. IF the economic disaster heading toward the west becomes Economy Crashing, then I suspect the UK Govt will ban gas exports. We supply approximately 40% of our own needs and deals with Norway exist which is fortunate, as Norway hasn’t a big enough population to need all the gas they produce.
Then we have 3 LNG terminals which reports suggest are behind the record UK export surge to the EU. IF we are desperate for gas, I doubt they’ll be exporting to the EU. The irony is the EU has quite a few LNG terminals, but the interconnector pipes don’t flow the right way. So Southern Europe, eg Spain, has 6, but no pipeline pumps North to say Germany, which has plans for 4, but none working. The other interesting fact is the sheer number of planned LNG terminals. Has no one yet figured out that the demand for LNG is going skywards? Yet the Green Agenda is not increasing the supply? This whole crisis comes about because the Green Dream turned nightmare last year when neither wind nor Hydro produced the expected amount of electricity and countries like Brazil and Portugal ‘dashed for gas’. Then add on the need of the rest of Europe to replace wind power with gas and that pre-Xmas gas price spike encouraged Putin to take his chance.
Now the Net Zero crisis is here in spades, to be followed by the lockdown inflation meeting QE etc. It isn’t only Sterling under stress, and any one of Sterling or the Euro goes, then it isn’t going to be a localised issue.
Though I was amused at the reference to Deutsche Bank. The most toxic bank on the planet allegedly. Now in potentially the most toxic energy crisis in the EU. ‘Look behind you!’ We should be shouting because in another Unherd piece on Olaf Scholz and his lack of popularity, it appears that the German leaders think shutting down their industry is a sensible move toward saving gas. I’ve even read a piece that suggest ‘de-industrialising’ Germany as the answer. I’d be interested to know what the question was – it must have been – “How can we completely destroy the Euro and the EU?”
Aluminium, Zinc and Steel production are already significantly affected in the EU. Reducing supply of those metals is going to raise the prices as well. Quite frankly by the time Sterling collapses, I expect the Eurozone will have too.
The bad new is that of the two inflationary storms coming the Net Zero energy one, unexpected by the majority, came first and led to Putin taking the opportunity to make it worse.
The QE/Low interest rate/Lockdown inflation was the one I have been following and its consequences were considered dire by all the economists I read. Add that to this energy one and I fear the Central Bankers & our idiot leaders with their Net Zero insanity have broken the world. We will probably get a great reset whether we want it or not. The only question is, who determines the nature of it? State actors using the likes of the FBI, CIA etc who may be rolled out to control the proles, or will the proles kick out all the incompetent leaders and their useless parties for a democratic ‘great reset’?

Prashant Kotak
Prashant Kotak
19 days ago

This is all fine, but I miss “The Russians are coming, the Russians are coming!!” theme from this author, can we not go back to the old hits?

Last edited 19 days ago by Prashant Kotak
Martin Smith
Martin Smith
19 days ago

Yet value against the Euro is within the range it has been normal since Brexit. The Euro is equally weak against the US$. This is only because of the US reserve currency status in the midst of a crisis. Surely the real question is, can the dollar’s strength be sustained as the overall US situation continues to decline?

Steve Gwynne
Steve Gwynne
19 days ago

Britain’s current account deficit can only get worse as our population grows considering our reducing biocapacity for essentials.

This might be offset somewhat by fracking and an expansion of North Sea gas.

Thus I guess, the volatility of sterling is not only determined by our ability to pay foreign debt repayments but also the attractiveness of foreign direct investment.

Hence the need to u-turn on the corporate tax rises, incentivise investment and productivity growth especially in relation to freeports but also of utmost urgency is sorting out the Northern Ireland Protocol and the deteriorating terms of trade emanating from there as intra UK trade is substituted by imports from Ireland.

Last edited 19 days ago by Steve Gwynne
Roger Ledodger
Roger Ledodger
19 days ago
Reply to  Steve Gwynne

An intriguing situation according to various news items I’ve read recently is
a) The EU has apparently offered Brexit Britain the opportunity to ‘share’ their Energy plan
b) Ireland has a whole Island plan and it is, apparently drive by the EU’s agenda.
Given my understanding that Ireland relies on the UK to supply it, what price Truss telling the EU to get lost over item (a) and re part (b) tell Ireland that IF they want to share in our Energy plan, then the NI protocol is going to have to go.

Mike Michaels
Mike Michaels
19 days ago

Collapse the £. People beg for CDC. Simple.

J Bryant
J Bryant
19 days ago

Philip Pilkington has been consistently very negative about the future of the global economy and has been adamant that the sanctions against Russia are severely hurting the West.
My sense is he may be right but I’m not an economist so, like almost everyone else, I don’t know the truth of the matter. We won’t have to wait long for an answer, though. By the end of the year we should know if Mr. Pilkington is a Cassandra.

Steve Gwynne
Steve Gwynne
19 days ago

The current account deficit in the UK ballooned to GBP 51.7 billion or 18.3% of the GDP in the first quarter of 2022 from GBP 7.3 billion in the prior period and compared to market forecasts of GBP 39.8 billion. It was the largest current account shortfall since comparable data began in 1955, as the total trade gap broadened to GBP 33.4 billion, from GBP 6.2 billion in the prior period, in part due to the soaring cost of fuel imports. Additionally, the total primary income account returned to a deficit position of GBP 12.4 billion, or 2.0% of GDP, after recording a surplus of GBP 4.7 billion, as income from British assets abroad was more than offset by investment-related flows. The total secondary income surplus was little changed at GBP 5.8 billion. The Office for National Statistics issued a warning over the figures, saying there was an impact of changes in post-Brexit data collection on trade in goods imports and foreign direct investment, which it is investigating.

https://tradingeconomics.com/united-kingdom/current-account

Steve Wilson
Steve Wilson
18 days ago

Not a well thought out argument. Exporters benefit from a weak currency. Yes, raw material costs go up, but that’s neutral overall as you can recover that cost when you sell. Along the way you are adding value to those raw materials by turning them into products. That cost is, largely, unchanged with a weak currency, so you can either undercut your competitors without cutting profits, or make more profits in pounds without increasing you selling price in overseas currencies. That played a big part in Germany’s success after adoption of the Euro which was weak that the German economy justified because of the weak southern European economies.

Nicky Samengo-Turner
Nicky Samengo-Turner
19 days ago

Let us not forget that in the then ” old” City, Callaghan was told by the then primary Gilt brokers ( post to them having ” leant on” the main bidding UK institutions) that there would be no Gilt auction bidders, and so he had to go cap in hand to the IMF. Of course, the Gilt brokers had told, correctly, the said institutions, that it was the best way of getting rid of the l***a Government…. the rest, as they say, is history. Times, electronics, and derivatives and the microsecond movement of money and securities have , of course, changed all this, but beware the current mismatch between ” cable” FX , gilt yields/ pricing, and interest rates… having said that, the chronic mismatch between, say Tesla and Toyota does not seem to have even been noticed, let alone reacted to, so perhaps the ” Tesla Universe” in which a USD 1 bill can be valued and sold at USD 50, is the ” new reality”?…. God help us?! …. it cannot last and ” old reality WILL arrive in early October, not least because fund managers will ‘ allow’ a ” downwards correction’ in the hope that they can create an ” upwards correction by end Q4 22, so as to secure their ‘ numbers” and bonus…. My prediction is that they won’t!

Billy Bob
Billy Bob
18 days ago

I knew the author would shoehorn in a criticism of the pushback against Putin at some point, and while he made me wait for it I wasn’t disappointed

Jonathan Price
Jonathan Price
19 days ago

And there it is in the final paragraph for all to see “Historians may look back on this moment in history and note that Britain, a country that was a leading champion of the sanctions against Russia in 2022, turned out to be their worst victim. Let us hope that cooler heads prevail and we choose a different path.
The underlying message is that we should not be sanctioning Putin and his war machine. Which we absolutely MUST be doing. What alternatives does the author propose?

Roger Ledodger
Roger Ledodger
19 days ago
Reply to  Jonathan Price

Leaving 2 of the most corrupt oligarchies and former Soviet Republics to sort out Soviet imposed borders in a post Soviet world, rather than siding with the most corrupt one simply because the US likes to think Russia is the former Soviet Union and is still an enemy super-power?

Aaron James
Aaron James
19 days ago
Reply to  Jonathan Price

”The underlying message is that we should not be sanctioning Putin and his war machine. Which we absolutely MUST be doing.”

WHY??? It is none of our business. All we did by the sanctions and arms and $100 Billion, or whatever mad amount it is up to now by the Neo-Con warmongers…..Is to destroy a golbal economy teetering on the edge from the Insane covid measures which did all harm and no good. And to destroy Ukraine.

Alastair Spate
Alastair Spate
19 days ago

Dream on, you Poms. This bloke’s dinkum: as in Leon Trostsky, 1925 – “America must put Europe on rations.” Which is what’s happening.