Whither the great British pound?

on January 24, 2022

Pound Sterling, pound, currency

Whither the great British pound?: Nigel Farage has been eager to discuss currencies since the inception of Fortune & Freedom. Changing currency rates are an excellent opportunity for investors to profit. However, trading them is notoriously tricky.

Even if you don’t wish to bet on the pound, the pound’s value in the currency market may be the single most essential element influencing your investment results, although being the least appreciated. The movements of the pound have an impact on everything.

Consider the current hot topic: inflation. The intrepid Ambrose Evans-Pritchard writes in the Telegraph that the pound’s exchange rate mainly drives the most significant upheaval in financial markets right now. The headline says it all:

The next inflationary shock will be a declining pound.

This winter’s strong pound has kept the worst of post-pandemic inflation at bay.

You have to like a journalist who predicts while simultaneously pointing out that economics works both ways.

Now, I’m sure it doesn’t feel like inflation in the UK has been subdued, with prices skyrocketing. However, it is higher in several locations, including the United States, the Netherlands, Spain, and Eastern Europe. And the majority of those locations are also saddled with lower interest rates.

However, the point is that the pound has a significant impact on inflation and that the pound may be on the rise. We’ll go back to that shortly. But first, let’s talk about why our currency is so important.

The FTSE 100’s share of revenue denominated in pounds is relatively little in the stock market. From 2007 to 2015, around 76 per cent of sales came from outside the country rather than the local market. Compared to Japan’s export powerhouse stock market index, only 32% of its sales are not denominated in yen.

As a result, movements in the pound have a significant impact on the earnings of FTSE 100 companies. When measured in pounds, the higher it rises, the less money those corporations get. That is, of course, how you and I evaluate them, given that we are UK stockholders.

Although many companies hedge the currency rate to ensure the effect spreads over time, it still matters.

My interest is in gold. Gold, you see, is denominated in US dollars before being translated into local currencies. As a result, changes in exchange rates play a significant role in determining the returns from gold in those local currencies.

Because of this, I believe that gold investors in the United Kingdom and Australia are in a good position. In a crisis, the pound and the Australian dollar tend to fall, raising the local gold price when you want it to — when your other assets are in jeopardy.

You could argue that the same is true for bitcoins, another worldwide investment.

The same currency rate effect applies to all foreign investments. Investing abroad is an excellent idea for a number of reasons, including this.

Because retirees enjoy travelling, the pound has a significant impact on them. And a lot of investment is geared toward retirement planning. Maybe even a foreign retirement? These are the subjects I just covered with cryptocurrency specialist Sam Volkering on the Exponential Investor podcast.

The pound has recently been on a rip. According to Bloomberg, “the Pound Is Approaching Its Strongest Level Against the Euro Since 2016,” which is somewhat embarrassing now that Brexit has occurred.

Indeed, Bloomberg headlined in December, “Funds Bet Against Pound at Levels Last Seen Before Brexit Vote.” At the very least, the City put its money where its mouth was. And then I lost it.

Of course, Brexit has resulted in a significant deterioration in the UK’s trade balance… oh… wait… that’s the eurozone? That’s true, and they have a trade imbalance!

The headlines on Reuters make for an amusing progression: “Eurozone trade surplus lower than expected in August” to “Eurozone trade surplus smaller than predicted in October” to “Eurozone swings to trade deficit in November.” Is this despite Brexit?

But let’s get back to money. Brexit isn’t the reason for the pound’s increase, at least not immediately.

With its tepid rate hike, the Bank of England was the first to act on inflation. However, in a world of 0% interest rates, a minuscule rate is greater than the rest.

However, the rest of the globe is about to catch up, with the threat of interest rate hikes already sparking panic in financial markets.

As a result, the pound could be on its way back down. According to Ambrose Evans-Pritchard and the banker he quotes, “the party’s over” for our money.

Is the pound rolling over a good or a negative thing?

Investors should be pleased to hold foreign currency-denominated assets like gold and cryptocurrencies, as well as UK stocks with foreign earnings, as we will receive more pounds for our investments.

But what if the country’s fate?

It depends on who you ask. And also, when.

Not long ago, the concept of floating exchange rates was regarded as extremely risky. We now recognise that they play a crucial role in maintaining economic balance.

Devaluation was feared during the days of fixed exchange rate regimes, leading to legends of vigilantes breaking the backs of entire nations. Consider George Soros’ 1992 bet against the pound.

Meanwhile, strong currencies were thought to be a good thing. Consider the yen and Japan during its extended economic boom in the 1980s

However, governments now engage in currency wars, aiming to depreciate their currency to obtain a competitive edge.

Isn’t it interesting how economic theory, or the political perception of it, evolves?

Indeed, looking back deeper in history reveals another reversal in conventional wisdom, with today’s concept of currency conflicts being popular in the 1920s and 1930s. And before that – and after that well, you know the rest.

Currencies tend to be the element of the economic equation that works as a release valve in the fate of nations. A country with excessive inflation sees its currency plummet, forcing it to get its act together. People in that country also try to save in foreign currencies.

Countries with prudent economic policies are more prudent than their neighbours, likely to see their currencies rise. As a result, they get to fight over deckchairs in Spain with each other. (My German and English parents’ families most likely did this before my parents married.)

So, whether the pound’s movements are positive or negative depends on which specific elements your politicians wish to emphasise. The depreciation of foreign goods, the increasing stock market, more expensive vacations, more robust export prospects, inflation, or other factors.

One thing is sure. None of the politicians debating these issues will bring up gold or cryptocurrency to escape the manipulations.

So, as the argument over the pound’s future trajectory continues, keep in mind that we’d never be able to agree on whether it’s good or bad for the country in the first place.

I’d say the pundits have the whole thing entirely backwards. The currency’s value is not a policy tool or a cause that has an effect. It’s a repercussion.

The pound’s value does not change to cause other things to alter. Instead, those other factors alter, causing the pound to shift.

Countries that manipulate their currency’s exchange rate almost always face difficulty because they misunderstand this relationship. They transform a result into a policy instrument. However, this has the unintended consequence of causing odd consequences. That is why we abandoned fixed exchange rates – they are easily manipulated.

Unfortunately, we only received less evident manipulation.