Edward Price is a former British economics official and currently Professor of Political Economy at the Center for Global Affairs at New York University.
A third British Prime Minister in three years. Inflation is apparently heading towards 20%. Investors are hovering around the pound like flies, each wondering if the British currency is burnt toast or sweet jam.
Some think of toast. Earlier this week, Deutsche Bank hinted that the UK was at risk of an emerging markets-style balance of payments crisis that could cause the pound to implode. Thanks
the german government German Bank.
But, again, maybe not so fast. Others believe the pound is still attractive, or at least secure enough to avoid a true EM-style meltdown, thanks to a floating exchange rate and no foreign debt. However, that only holds as long as the UK labor market is ready to STFU and take the hit for the GBP. This is what it means to “absorb the necessary external adjustment”.
How can such different views of the pound coexist?
It all boils down to stories. For a long time, the UK had a pretty good history. Attached to the EU but not subsumed, it offered continental market size (large) and British permissiveness (loose). Thus, the City and Canary Wharf have become breathtaking nirvanas of investment bliss. The story was almost perfect: the English language, a promiscuous time zone, common law. Etc.
Now, however, there are two competing stories – two competing books if you will.
The first story is simple. The city is screwed. And the book too. Assessing the UK post-Brexit, investors will only see the size of the UK market (small). Meanwhile, the continent’s regulatory permissiveness (shrinkage) suggests that the UK will see reduced access to the EU over time. Capital markets will not want to play with this.
Add to that a bullied central bank, runaway inflation, a cost of living crisis, strikes, reasonable balance of payments questions and, well, the pound sterling is the easiest left shift of all. time. The dollar parity, and below, must surely be beckoning.
The other tale? London can now strengthen its original position. The size of the global market (big again) and the Anglo-Saxon permissiveness (unleashed baby) will result in bacchanalian investment madness. A pro-growth government will trigger the Big Bang 2.0, harnessing fiscal policy and central banking to boost domestic activity. Energy prices will be brought under control, domestic inflation will fall, GDP will rise, investors will invest and later, with the defeat of Russia, UK public finances will be in order. Britannia will fly the waves. No need to think. Just swipe right.
Rationally, the pound is not finite. And neither does the UK. The world is a very long game of great power, and all countries are going through tricky times. But here is the immediate point. When were capital markets entirely rational?
A cheeky little assassination somewhere, a messy tank battle, an unexpected debt crisis and a whole new story will emerge. Some currencies will benefit from events. Other currencies will fall. That’s the whole point of the absolutely crazy FX market. It is a game of calculation, not firm but of fleeting convictions.
And based on this, any currency could very quickly catch fire.