Pound Sterling

With the concerns about the fiscal integrity of Greece and several other Eurozone members, the Euro has been under the most significant pressure since it was introduced as a common currency more than 8 years ago. There has been much speculation that it could fall to parity with the US dollar. Few recall that when it was introduced in 2002 and replaced national currencies, for example the German Mark, the Euro fell by approximately 15% vs. the US dollar in the first half of the year. It reached its peak of $1.599 vs. the US dollar in July of 2008. but since the global financial crisis began it has been under pressure. The Euro is the second largest reserve currency after the US dollar and the UK's sterling is the third largest reserve currency. (Wikipedia: Euro)

In February, the world's best-known bond trader, Bill Gross of Pimco, wrote in his monthly report: "...the UK is a must to avoid. Its Gilts are resting on a bed of nitroglycerin. High debt with the potential to devalue its currency present high risks for bond investors. In addition, its interest rates are already artificially influenced by accounting standards that at one point last year produced long-term real interest rates of 1/2% and lower." For the developed countries, Gross favors fixed-income investments in Canada — its conservative banks did not participate in the housing crisis — followed by Germany. (Pimco: Investment Outlook,Ring of Fire: Red Zone Countries,February 2010) While Pimco runs the world's largest fund, Total Return Fund, and I hold Bill Gross in high regard, I do not believe that the United Kingdom is the next Greece or that we will repeat 1992. (The Wall Street Journal reported that the "bets against the pound are the highest since 1992. and credited Camilla Sutton, currency strategist at Scotia in Toronto. [WSJ 3/6/2010])

The Bank of England, founded in 1694, and its Governor, Mervyn King, along with Chancellor of the Exchequer Alistair Darling, understand what the sterling represents on the world stage and how important it is to defend. During the dark days of the global finance crisis they introduced quantitative easing as one tool to support their banks. I have been reading Hank Paulson's book, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System". In it he relates a call he received from Darling during the search for an acquirer for Lehman Brothers, before its collapse into bankruptcy:

"I understand one of your possible buyers is a British bank," I remember him saying. "I want you to know that we have some concern, because our banks are already under a lot of stress. We don't want them to become overextended and further weakened."

"Afterward I commented to Jim Wilkinson that Alistair seemed to be telling me that the British didn't want their banks to catch the American disease. But because he couched this as a general concern, I didn't see his words as the red flag that in retrospect they appear to have been."

Barclays management team could not get the approval they needed to acquire Lehman Brothers, but did end up buying Lehman's best assets after the bankruptcy filing. I find this supportive of my view that the Bank of England will not let the pound weaken further. (It did bounce back towards the end of this week from below $1.50 to close the week on an uptick at $1.5145.)

There is concern that the spring election between Labour & the Tories, which once seemed like a sure bet for the Tories, now appears too close to call. The Tories have squandered a 20+ point lead in the polls over the past year. They are going to have to become proactive & let the British electorate know where they stand on the issues of the day. In the final analysis, I believe that the British pound will withstand this storm better than the Euro and will reinforce the sentiment in the U.K. that they made the right decision not to join in the Eurozone common currency, which allowed them to avoid the budget restrictions imposed upon Eurozone members. I sense that both the U.S. and the U.K., with an assist by their respective deficit stimulus plans, will recover faster from the Great Recession than their Eurozone counterparts.

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