Wednesday, 7 January 2009

New year, new problems

Happy New Year, folks! I’m back from my hols and I see the UK situation has not improved in my absence. Today we have 27 store closures and 1200 redundancies from Marks & Spencer, Woolworths closed for good yesterday, Viyella is in administration and sterling has just pulled back from parity with the euro. (At launch one euro was worth 72p.)

The government has a plan for the economy though. They are going to drip-feed in £18bn of new (borrowed) money. This will be going into apprenticeships, infrastructure projects and anti-jobloss measures. I’m afraid that’s chickenfeed – the economy has a £50bn-a-year MEW habit to sustain. Or put less ‘street’, the economy is currently configured to benefit from people increasing their mortgages and spending the house price ‘gain’ on consumer items and services. That £50bn-a-year cash injection has gone away now and isn’t coming back any time soon. The economy will need to adjust to a business environment where discretionary spending doesn’t happen to anywhere near the same extent.

But the real problem is the pound sterling. A few days ago it came close to parity with the euro. It now struggles to buy one and a half US dollars. It has lost 30 percent of its value in Swiss Francs over the last three months. This loss of confidence in our currency is not surprising. Does anyone really believe the government has the fortitude required to defend its value? That would require restraining public sector spending, running a budget surplus in fact, and raising interest rates to lure in foreign investors. I can’t see any of that happening in the near term. The government will turn a blind eye to the problem until it feeds through into the inflation numbers; and that won’t be until the current deflation caused by the economic collapse has bottomed out. (I say deflation; the inflationary pressure of all the government’s borrowing is so high we may never actually see real deflation, ie negative RPI or CPI, just lower numbers than we’d have otherwise.)

So sterling is going to drop like a stone and the government will ignore that for a while. Then inflation will take off with a vengeance and the government will either fight it, or let it rip. Given the level of sterling-denominated debt, both public and private, it seems almost inevitable that the government will opt to surrender to, rather than fight, inflation.

When that happens, it will actually be quite beneficial to have an inflation-proof asset such as a house, and a large sterling debt to fund it. The real value of the debt will evaporate but the house will largely hold its value. In the meantime cash reserves should probably be kept in a strong foreign currency. I favour the Swiss Franc. There is also gold.

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