Sterling on the Rocks

October 11, 2016

From a high of $1.5019 on the day of the June Brexit referendum to a low of $1.1807 last Friday, sterling fell over 21% in less than four months. Concern about Brexit’s short- and long-term possible damage to the British economy and political stability were the cause of this still on-going correction. It remains to be seen if 2016 will join other periods of sterling infamy.

In the wake of World War I, sterling’s dollar value averaged $4.23 in 1919-1924, some 13% below the narrow range surrounding $4.87 that prevailed through most of the 130 years from the start of the nineteenth century until 1929. The pound lost significant value during and after the Depression, averaging $4.63 in the 1930s, $3.98 in the 1940s, $2.80 in the 1950s, and $2.43 in 1968-72 after a 14.3% devaluation in November 1967.

The mid-1970s brought more difficulties to this former hegemon of world currencies. The period was marked by runaway wage and price inflation with the CPI advancing on-year between 12% and 27% without interruption in 1974-77. Foreign exchange controls were gradually removed in the 1970s, and the current account was deeply in deficit. From $2.40 in the winter of 1975 to $2.00 in March 1976 to $1.5550 in October of 1976, sterling lost 35% in a year and a half. Things got so bad for Britain that government submitted a Letter of Intent to the IMF in as the year came to a close.

When the Thatcher years began in May 1979, Britain was already transitioning into becoming an oil exporter. 1977-80 was not a good time for the dollar generally, and the pound averaged $2.3833 in the second half of 1980. The reprieve did not last long, however, and by February 1985 sterling had depreciated all the way to $1.0345, a drop of 56% in just 4-1/2 years.  The ignominy of slipping under dollar parity didn’t happen then nor ever since.

Sterling’s next grand trauma occurred in 1992. It had recovered to just over $2.00 by early September of that year, helped by the Plaza Accord and the U.K. tying its fortunes to the European Exchange Rate Mechanism with a central parity against the Deutsche mark of 2.95. Speculation drove the government to withdraw the pound from the ERM on Black Wednesday, September 16, and it fell almost 30% to as low as $1.42 by early February 1993.

In spite of these swings, sterling recorded very similar decade averages of $1.68 in the 1980s and $1.64 in the 1990s. The 2000s, moreover, produced yet another similar big picture when the pound averaged $1.70. In November 2007, just three months after the U.S. subprime mortgage crisis surfaced, sterling peaked at $2.1160. This merely set the stage for yet another compressed dive in the currency, which fell to a low of $1.3505 in 2009.

The six years thereafter was a period of relative stability in contrast, with successive annual mean values of $1.5454 in 2010, $$1.6038 in 2011, $1.5849 in 2012, $1.5646 in 2013, $1.6473 in 2014, and $1.5184 in 2015. In those years, sterling was no stronger than $1.7191 and no weaker than $1.4232. But 2016 has marked a departure from that calm, lower period lows and highs ($1.1807 and $1.5019) than seen in the prior six years and also a weaker year-to-date average of $1.3885.

These are low inflation/slow growth times for much of the world, including Britain. Currency depreciation in such an environment is very different from earlier times when sterling depreciation and excessive inflation fed each other in a toxic vicious cycle. There’s little reward in promoting a strong currency.

Copyright 2016, Larry Greenberg. All rights reserved. No secondary distribution without express permission.




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