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THE POUND STERLING The fall of the pound ... written by Paola Subacchi in 2020 
The fall of the pound ... HARRIS/PA Archive/PA Images Original article: https://www.thearticle.com/the-fall-of-the-pound Peter Burgess COMMENTARY Peter Burgess | ||
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The fall of the pound
Written by Paola Subacchi @PAOLASUBACCHI Tuesday July 07, 2020 The nineteenth-century Gold Standard revolved around sterling as much as the post-war international monetary system has been revolving around the dollar. But in the twentieth and twenty-first century, sterling has been following the UK’s long-term geopolitical trajectory, and the shift in the international economic order. The world shifted from Britain and sterling to the United States and the dollar, a change that was hastened by the Bretton Woods conference in 1944. Over the last seventy-five years, sterling has epitomised Britain’s economic and political transformation, and its adjustment to the post-war international order. Reflecting the intrinsic weakness of the British economy, sterling has been a currency in distress, moving through financial crises, embarrassing devaluations and political humiliation at regular pace. In 1949, for instance, sterling was devalued by 30.5 per cent on the back of a large balance of payments deficit that Britain had accumulated with the other European countries, and an outstanding sterling debt of £3.7 billion, which had been amassed during the war with countries in the sterling area. In 1967, pressures from the balance of payments led to a 14 per cent devaluation. This was followed, in 1976, by a 25 per cent drop in sterling’s value against the dollar, forcing the government to borrow £2.3 billion from the International Monetary Fund. But the mother of all crises — and humiliations — came in 1992, when a series of speculative attacks resulted in sterling being ejected from the European Monetary System. The crisis sealed the fate of Britain’s future relationship with the EU. In the aftermath of the Brexit referendum in June 2016, sterling lost one fifth of its value against the dollar and hasn’t recovered. It now trades at approximately 80 per cent of its pre-referendum value. In addition, its implied volatility — an indicator of market expectations vis-a-vis the scale of future price moves — has increased. Since the outbreak of the Covid-19 epidemic, volatility has been exacerbated not only by concerns about the state of the UK economy, which is currently projected to shrink by 6.5 per cent in real terms this year , but also by the not implausible prospect of a Brexit deadlock. As a result, sterling has been swinging widely, in a way that is typical of emerging market currencies rather than one belonging to a member of the G7. Indeed only the Brazilian real has been more volatile. Does it mean that sterling is now effectively an emerging market currency? Possibly, but only if we use volatility as the key criterion, which is definitely too narrow. Sterling like all international currencies that are used in international trade and financial transactions and are held as assets, needs to maintain its value and avoid sudden swings. But volatility is a necessary, but not sufficient condition to determine sterling’s future trajectory. Undoubtedly sterling remains vulnerable to the ebb and flow of market risk appetite given the constraints and challenges to the UK economy that can exacerbate such a risk. But there are downside as well as upside risks — sterling is likely to strengthen in the event, for example, of a trade deal agreed with the EU. But rather than looking at sterling as the reflection of the “small and shrinking” UK economy, as a recent report by Bank of America argued, and drawing comparisons with emerging markets, it would be more appropriate to assess sterling and its role in the international monetary system, in terms of being a “safe haven” currency, such as the Swiss franc or non-key international currencies such as the Canadian dollar. The former is the currency of a significant financial centre, while the latter is underpinned by a middle-sized economy (Canada is also a member of the G7). Both features seem apply to Britain. The International Monetary Fund keeps a store of assets called the “SDR basket”, the composition of which reflects the relative prominence of the currencies. Sterling currently has a weight of a bit more than 8 per cent. It is in the same position as the Japanese yen, but below the Chinese renminbi the share of which is almost 11 per cent — the dollar and the euro weight for approximately 42 and 31 per cent. This is likely to change at the forthcoming revision that is undertaken every five years. As it happened to the Swiss franc, sterling, being no longer one of the most heavily traded currencies in the world, may be demoted and no longer deemed suitable for the SDR basket. This will leave in the basket only the currencies that represent the world’s largest trading areas. Bretton Woods marked the end of sterling’s dominance; however, market forces, network externalities and inertia contributed towards keeping it going for quite some time. We may be at the end of this long process of transformation, during which sterling becomes a “normal” currency, and when Britain can move beyond the point where it sees sterling as a projection of its geopolitical influence.
| The text being discussed is available at | https://www.thearticle.com/the-fall-of-the-pound and |