UK pound heading towards dollar and euro parity

Foreign exchange dealers have decided to slaughter the UK pound. This morning’s press attacks appear the start of a sustained campaign to drive sterling much lower and profit from the process. And who can blame the forex guys for backing a one-way bet, and probably one the British Government secretly endorses.

For in this world of competitive currency devaluations who wants to be left with the embarrassing hot potato of an overvalued currency. Better to have one that is cheap and cheerful and good for exports. That is the theory but this hand can be overplayed.

Double dip recession

The problem is that the new UK government’s enthusiasm for public spending cuts and the resulting 490,000 more unemployed are almost a slam dunk for a double dip recession. And there is no secret that the Bank of England will print money in these circumstances just like the Fed.

More money in circulation devalues the unit concerned. It is a very old trick by governments in trouble, as old as clipping edges off silver coinage. Exit the pound if you still have any money in sterling and all UK currency denominated assets, whether stocks or bonds.

And while a gradual devaluation can help a country restore its economy, a sudden rush to the exit will make an already bad outlook even worse by crushing investor confidence.

The great trade is surely to convert UK assets into another currency now and buy back those assets in a couple of years when the pound is on the floor. With debts on the scale of the US, a banking system way too big for the national balance sheet and house prices still far too high, the implosion of the British pound is to be expected.

This is what happened in the 1970s under circumstances that were not as bad. The pound reached parity with the US dollar. But first will come parity with the more valuable euro, and then the euro will overtake the pound in value.

FX positions

Foreign exchange positions are very important to any investor but sometimes the wood is overlooked for the trees. Holding good stocks in a declining currency makes no sense. All UK investments are also bets on the pound.

Foreign exchange traders will likely make a lot of money on this but amateurs should beware as currency markets are the most difficult to forecast. That said avoiding a toxic currency is obvious good sense. This can hardly be good news for London as a financial centre either.