STERLING VS EURO

The long term chart of Sterling vs. Euro confirms the budget proposal that the Government and Bank of England will sell Sterling to build up reserves of currency. Tight fiscal policy will be counterbalanced by weak monetary policy; QE keeping longer term rates artificially low and a weakening exchange rate to boost the export sector.

Unfortunately this policy is typical of a "race to the bottom" where countries try and weaken exchange rates (UK, USA) or impose capital controls (Brazil) to gain competitive advantage. It might be the case that countries that act in this manner quickly will get an advantage over countries that do not, but the sum total of such mercantilist behaviour is usually zero at best. A competitive battle between Coke and Pepsi where bottom line is paramount is quite different to a win-lose battle between countries. Mercantilism does not succeed now and Ricardo's view of comparative advantage means that free trade and cooperation always wins over a nationalistic competitive ethos. We are back to the 1930s.

On top of this, the UK policy of zero rates is understandable in terms of preventing a deflationary nightmare but zero rates distort capital formation. Investment is eschewed for speculation (commodities) hoarding (gold) or simply flees to other currencies that do pay interest.

We live in a world where there is little cooperation between the main players (G20) and if the UK and USA really think they can outwit China they are niave as well as isolationist.

Unfortunately (for students) this is the exception.

Texas University Endowment Storing About $1 Billion in Gold Bars

By David Mildenberg and Pham-Duy Nguyen – Apr 15, 2011 6:13 PM ET

The University of Texas Investment Management Co., the second-largest U.S. academic endowment, took delivery of almost $1 billion in gold bullion as the metal reaches a record, according to the fund’s board.

he fund, whose $19.9 billion in assets ranked it behind Harvard University’s endowment as of August, according to the National Association of College and University Business Officers, last year added about $500 million in gold investments to an existing stake, said Bruce Zimmerman, the endowment’s chief executive officer. The holdings reached about $987 million yesterday, as Comex futures closed at $1,486 an ounce.

The UK Budget 2011

Having promised a budget for growth, Mr. Osbourne gave the country an indication that his stewardship of the economy will lack innovative thinking. Taking from Oil Companies will give concern to other industries that future profits may be expropriated and then giving to the consumer via lowering petrol duty is shamefully populist. Mr. Snow on Channel 4 news skilfully questioned Danny Alexander and pointed out that higher petrol prices would have forced the population to adapt to higher energy prices; a market mechanism for perhaps considering ways to embrace new sources of energy. Unfortunately the coalition are interventionist at heart despite the rhetoric.

Of note was the reference to currencies. Mr. Osbourne made clear that the Bank would be building reserves; a clear statement that Sterling will be sold to complement the low interest rates.

The comment that it was important that G7 buys yen to support the Japanese economy was the highlight of a dull budget. Was that a faux pas or a Freudian Slip?

Upcoming 2011 UK Budget.

Mr. Cameron is trying to prepare the country for a budget that will be the most pro-growth in a generation and one which will encourage the entrepreneur. At the same time there is an emphasis on getting banks to lend to small business.

Mr. Cameron might find British Economic History from the early 1970s interesting. Ted Heath pressed cabinet and the chancellor, Tony Barber, into an expansionary budget; a dash for growth. At the same time the Bank of England had liberalised the high street banks to lend money without credit constraint and the World was embarking on a commodity boom fueled by the break down of the dollar peg.

The result was a classic Keynesian expansion, UK style. Investment into industry actually fell as the banks chose property as the sector to invest in. ( British banks have always favored property with its natural collateral, rather than small business). Billions went into property and when interest rates rose in November 1973 and a rent freeze was imposed, the whole house of cards collapsed. The Bank of England was forced to rescue the secondary banks and property companies collapsed alongside the banks.

In other words, the combination of pushing banks to lend, a reflationary budget with ever increasing commodity prices and low interest rates produced a classic boom and bust. Sounds familiar?

Proposed Pension Reform will encourage Government to inflate the economy

The Pension reform being proposed by Lord Hutton may have dangerous consequences. It is clear that the public sector will have to see a cut in their final salary schemes, but a more transparent solution must be preferable to one which may have dangerous consequences.

What is being proposed is that workers receive a pension in line with their average life-time earnings. What is not being disclosed is that wage inflation will seriously erode that average. If compounded interest is a marvel for savers, it is a nightmare for pension beneficiaries.

Suppose wage inflation is 5% compounded over 40 years. A person starting on £30.000 p.a will receive £201,000 after 40 years with an average salary of £90,600.

If wage inflation is 8% compounded, that same person will receive £603,000 with an average salary of £194,300

In the 1st scenario, the pension will be 45% of leaving salary and in the second just 32%

Once again government is changing to policy that undermines the population through inflation.

The Bank of England is both candid and economic with the truth

Mr. King was one of the few leaders in 2008 to be candid about our economic future. He said that standards of living would fall; i.e. wages would not increase as much as prices. However, his recent comments might suggest that he might raise rates to curb inflation. True, but it is a little economic with the truth. The market's assessment through short sterling futures suggest rates at 1.5% by the end of the year. That is hardly enough to deal with CPI above 4% and RPI above 5%. (RPI is conveniently being dropped by government). Both the Government and the Bank want inflation. It is the only palatable way to reduce our debt in real terms. Don't be fooled.

With all the Economic Doom and Gloom around in the West, it was a real pleasure to become British Gold Cup Bridge Champions in 2010. The team of Zia, Gunnar Hallberg, Robert Sheehan, David Burn, Fredrick Bjornlund all played magnificently for team Gillis. It's also ironic that the Cup is made of the Yellow Metal.