Pound Sterling Crisis - Will A Run On The Pound Prompt An IMF Bail-Out?

It’s late autumn, 1976. Britain is facing yet another sterling crisis. In less than two years the pound has fallen from $2.40 to $1.60. Investors have no faith in the British economy, or the government that runs it. The Budget is a mess — vital public spending will have to be cut.

Investors punish Britain by ditching its currency.

The plummeting pound pushes the economy to breaking point. Prime Minister Callaghan is told that unless a solution is found, Britain can no longer afford to be a nuclear power. In desperation, the government finally acts. In December, Labour Chancellor Denis Healey takes a drastic step. He borrows £2.3 billion — the maximum allowed — from the International Monetary Fund (IMF).

The above was a nightmare scenario for Britain. But it happened. The question is, could it happen again?

Look at how the pound has fared against the dollar in the last two years and there seems little cause for alarm. But, as we all know, the dollar is facing its own crisis. A far more meaningful comparison is with the euro — which, of course, was not around in 1976.

Two years ago the pound was hovering around the €1.47 mark. Today the exchange rate is €1.26. Most of our imports are priced in euros — so this is cause for more than a little concern.

But what really matters isn’t what’s gone before. It’s what happens next. And the portents are not good.

Yesterday I mentioned three factors which spell further inflation for the UK. They were the rising cost of living, the impotence of monetary policy, and the rising power of the unions.

On the last point, I think it’s fair to point out that business leaders have actually praised the government for not making too many concessions to the unions. One demand resisted was the repeal of the law against secondary picketing. To its credit, the government also resisted calls to reopen public sector pay negotiations.

Sadly, however, I don’t expect this peace will hold. Firstly, this is a government that is on its last legs. So the unions — Labour’s paymasters — will want to grab any opportunity they can between now and the next election. Rising prices will give them plenty of scope to reiterate their demands.

But rising prices are only one half of the story. What we certainly don’t have in Britain is an overheating economy. Our inflation is exogenous (created abroad) rather than endogenous (created by domestic factors).

As the economy stalls, deflation is as real a threat as inflation. Many businesses will see revenues fall. But at the same time their costs will rise.

It’s a classic stagflation squeeze. Mix in a weak government, and you have the perfect recipe for uncertainty. Uncertainty is the one thing investors hate most. British investments look less attractive right now than they have in nearly thirty years.

It may seem melodramatic, but a run on the pound is a genuine possibility. We might not see an IMF bail-out, but that’ll be cold comfort for sterling holders (that’s you, me and most of the people we know). Over at the Fleet Street Letter we’re taking this threat seriously. We’re looking at a number of investments, and expect to make a recommendation soon.

I’ll keep you posted.

[NB As well as writing Fleet Street Daily, I also edit our sister publication the Fleet Street Letter. Our latest report is about an investment opportunity that, despite the current malaise, offers excellent long term potential. Find out more about The Fleet Street Letter here.]

That oil company windfall tax debate

"Should there be a windfall tax on the oil industry?" asks Tom Bulford in the Penny Sleuth.

I can see why the government must be tempted. BP’s profits, announced today, have soared on the back of record oil prices. Our strapped-for-cash government needs all the tax revenues it can get. If Treasury officials see a cash cow, pound signs appear in their eyes.

As Tom points out, it wasn’t long ago they wanted to impose a similar tax on the banks. And look at the state banks are in now!

There is, Tom says, a good argument for such a tax. But he’s not sure it applies in this case...

Profiting from the New Silk Road

For over a thousand years, the so-called Silk Road carried trade between Europe and Asia. Merchants made fortunes transporting luxuries like diamonds... pearls... exotic foodstuffs... and, well, silk.

It’s no controversy to say that Asia will be the big winner of the 21st century. That’s why we’re seeing the construction of a ‘New Silk Road’. Only, there’s a twist. This ‘road’ is not a road at all...

It’s a railway. It starts in eastern Turkey, and proceeds through Georgia, Azerbaijan and on into resource-rich Central Asia.

Our emerging markets watcher Manraaj Singh is licking his lips at the investment opportunities this will throw up.

Indeed, his readers have already made a tidy little profit from this region. And Manraaj thinks the time may soon be right to go in again...

Until tomorrow

Ben Traynor

The Daily Reckoning - Private Equity: one of the biggest humbugs in capitalism

Yesterday, the Dow dropped 239 points. Oil rose $1.46. Gold remains at $927. And the yield on a 10-year Treasury note is barely above 4%.

It’s that last item that puzzles us.

People are buying Treasuries for safety. Money markets, which hold short-term Treasury bills, are at record levels. We understand why you might want to have money in a money market fund...but where’s the margin of safety in a 10-year note paying less than the rate of consumer price inflation? Even in the money market funds, you’ll lose money when the dollar goes down — whether it goes down against other currencies or against consumer items. And what do you get in exchange for the risk? Not much. The 91-day T-bill rate is only 1.66%.

You can read the Daily Reckoning in full here.

P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.

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