Wednesday, January 21, 2009

The British Pound: Not So Sterling

In November, Willem Buiter warned that the UK could follow Iceland into default:

With the pound sterling dropping like a stone against most other currencies and credit default swap rates on long-term UK sovereign debt beginning to edge up, this is a good time to revisit a suggestion I made earlier on a number of occasions (e.g. here, here and here), that there is a non-trivial risk of the UK becoming the next Iceland.

The risk of a triple crisis - a banking crisis, a currency crisis and a sovereign debt default crisis - is always there for countries that are afflicted with the inconsistent quartet identified by Anne Sibert and myself in our work on Iceland: (1) a small country with (2) a large internationally exposed banking sector, (3) a currency that is not a global reserve currency and (4) limited fiscal capacity.

All of this seems to be coming true.

UK banks are technically insolvent.

The risk of a sovereign debt default is real. As John Higgins, of Capital Economics, points out:

"The 5-year credit default swap for the UK government has widened by 25bp since early January."

And the Sterling is tanking. Indeed, Jim Rogers is saying:

"Sell any sterling you might have. It's finished"
For further analysis on the sterling, see this roundup from Nouriel Roubini, and this one from Mish.

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1 comment:

  1. TamasJanuary 27, 2009 at 3:27 AM

    1. Iceland is a small emerging economy. The UK is a large mature economy. There hardly anything in common.

    2. The UK banking sector is internationally exposed, indeed. But in a much less straightforward, and - crucially - much less one-directional way. The comparison to Iceland is a gross simplification.

    3. The UK pound, unlike the Icelandic krona, does play some global reserve functions, although not on the level of the USD, for sure. If you look at past incidents of flight to quality, the sterling was usually on the winning side, for instance.

    4. Yes, every fiscal capacity is limited by definition. But there is limited and there is limited.

    Any emerging markets analyst will have trouble with these ideas. They come across as entirely surreal.

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