It may come as a shock to people in Britain but the Bank of England (BoE) wants a weaker pound.
Why would that be true?
Well, as I’m sure you know only too well: the BoE wants inflation – it has an inflation goal that it has not been able to reach for years. That’s publicly known.
What’s less understood is how central banks actually get inflation…
They used to believe that by printing money they would get inflation. But what they discovered is that printing money alone doesn’t do it – as well as printing the money, people need to spend it.
But that’s not happening
The money is being printed, but it’s just sitting undeposited at the BoE as excess reserves.
So the BoE has to try another technique… which is to cheapen the pound.
Sure, if you cheapen the pound it means every time you buy imported goods, or you travel abroad, take a Swiss vacation, enjoy French wine, or Chinese technology… it’s more expensive.
In fact, whatever you buy is going to cost more if your currency is worth less. It’s a disadvantage to you but it does cause inflation…
And that’s what Mark Carney and the BoE want.
They won’t ever say it in so many words. But they know that a weaker pound leads to higher prices, and that is what they want. Inflation is currently below the BoE’s 2% target, so rising prices are a priority.
There’s also the impact on exports…
Britain’s trade deficit will get a boost if a weaker pound leads to more exports. Britain has wonderful technology, competing with Germany and other countries around the world. And the fact is, you can sell more if your currency is worth less.
Oh, and then there’s the gold problem: the UK only has 310 tonnes of the stuff. If you look at what I call the “gold to GDP ratio” – ie, the amount of gold a country has in its reserves relative to its GDP – you find:
- The US gold to GDP ratio is about 2%.
- Russia’s is about the same, also about 2%.
- The European Central Bank, taking the eurozone as a whole, including all of its members, is closer to 4%. It’s the biggest gold power in the world.
The UK?
It’s pathetic… way below 1%.
This means the UK is missing the same monetary insurance policy that other countries have in terms of their gold holdings.
It all adds up to a very fragile situation for the UK and specifically the pound.
So, if you’re invested in UK assets… that could be a real threat.
What can you do about it?
Well, you should start by watching this video I recorded specifically for UK readers recently. In it I expand on why I’m so worried for the pound and what you can do to protect yourself:
Hit this link to watch my video briefing in full.
Dinner with the second most powerful central banker in the world
Meanwhile, as central bankers in England wished for the pound to fall further, last Wednesday I was at a private dinner in New York City with William Dudley – president and CEO of the Federal Reserve Bank of New York and arguably the second most powerful central banker in the world after Janet Yellen.
The atmosphere was relaxed, and Dudley was generous with his time in discussing Fed monetary policy with me and our fellow dinner companions.
Of course, he was circumspect and made it clear (as he always does) that his views were personal and not the “official” views of the Federal Reserve System. Despite the disclaimer, there was no doubt in anyone’s mind that we were getting a privileged view inside the mind of one of the key monetary policymakers on the planet.
The most important view Dudley expressed was his belief that the Fed will raise interest rates “before the end of the year.” There are only two Federal Open Market Committee meetings between now and the end of the year: 2 November and 14 December.
No one expects any policy decision on 2 November, since it’s just six days before the US presidential election
The Fed may or may not be political, but it is definitely not stupid. The Fed does not want to be blamed by either side for the outcome of the presidential election, so it will take a pass.
That leaves December, and the Fed will definitely raise rates then – as I advised readers weeks ago and as Dudley confirmed the other night.
Once the rate hike discussion was out of the way, the dinner conversation turned to two other equally important topics. I reminded Dudley that after the last rate hike (16 December 2015, the famous “liftoff”), the stockmarket fell over 11% in the following eight weeks.
That would equate to a 2,000-point drop in the Dow Jones Industrial Average from today’s level.
I asked if the Fed was mindful of that history and if the Fed considered it important to put a floor under the stockmarket.
Dudley disagreed with the implication and said that he saw the early 2016 stockmarket drop as “unconnected” to the December 2015 rate hike.
My view is the opposite
The early January 2016 stock collapse was directly related to the Fed’s December 2015 rate hike and the devaluation of the Chinese yuan caused by that hike.
Dudley then suggested that the Fed is not worried at all about any damage that might be done to stockmarkets from the next rate hike. Dudley said it is “not our job” to put a floor under stock prices.
Taken together, these remarks told me that the status of the stockmarket is not an impediment to a December rate hike by the Fed, and that the Fed is unprepared for the market damage that will arise when it does hike rates.
Some Fed voices are more important than others
The last topic of dinner conversation concerned the relationship between Fed rate policy and the markets, particularly when it comes to Fed communications. Dudley defended the Fed’s communications policy against criticism that there were too many Fed voices giving too many speeches.
He said that “some Fed voices are more important than others.”
That drew laughter around the dinner table because he obviously includes himself among the “important” voices. But on a serious note, it confirmed what I’ve been telling readers for a long time – that the only communications worth listening to come from Yellen, Fischer, Brainard and Dudley. Most other voices can be safely ignored.
Dudley expanded his views on the communications policy by saying that far from confusing markets, the Fed is giving markets a chance to “think along with the Fed” when it comes to financial conditions, economic data and future policy.
That’s a pleasant perspective, but in reality, the Fed and markets are not moving down a path together. They are going around in a feedback loop of offsetting initiatives and reaction functions that leave markets fatigued and confused – and leave the Fed impotent to achieve its goals.
Dudley was considerate in joining our dinner, and my group was appreciative of his time. The conversation was long, cordial and substantive. Despite the pleasantries, I was disturbed by what I heard…
The Fed is on track to raise rates in December in the face of weak growth data
The Fed seems unaware or unconcerned about the potential impact of a rate hike on asset valuations and investor portfolios.
Finally, the Fed seems to believe that the markets understand what the Fed is doing, when in fact markets believe the Fed barely understands what it is doing. The result is confusion rather than concert.
The systemic dangers are clear. The world is moving towards a sovereign debt crisis because of too much debt and not enough growth. Declining productivity is the last nail in the coffin in terms of countries’ ability to deal with the debt.
Inflation would help diminish the real value of the debt, but central banks have proved impotent at generating inflation. Now central banks face the prospect of recession and more deflation without any real policy options to fight it.
This raises the prospect of a new liquidity crisis and financial panic worse than 2008. Persistent low rates have not caused inflation, but they have caused asset bubbles which threaten to pop and unleash a financial panic on their own – independent of tight financial conditions.
When this new panic hits (either from a liquidity shortage or bursting asset bubbles), investors will have no confidence in the ability of central banks to limit the panic.
Unlike 1998 and 2008, the next panic will be unstoppable without extreme measures – including International Monetary Fund money printing, lockdowns of banks and money market funds, and possible martial law in response to money riots.
To find out how to prepare now, make sure you watch the video recording I mentioned.
Well, you should start by watching this video I recorded specifically for UK readers recently. In it I expand on why I’m so worried for the pound and what you can do to protect yourself:
You can click on this link to watch it in full.
Best wishes,
Jim Rickards
Capital & Conflict
Category: Central Banks