UK and Iceland: Not So Different

Wednesday, January 21, 2009

"I would urge you to sell any sterling. It's finished. I hate to say it, but I would not put any money in the UK." –Jim Rogers

The British Pound (XBP) broke important support around $140 from the 1993 and 2001 bottoms. The speed and magnitude of the decline should really raise some concerned eyebrows right about now because there is a very real possibility that the Pound could go Krona on us. It really is possible for the UK to be a bigger, badder Iceland.

All the growth in tax receipts linked to real estate and financial services was of course was nothing but an illusion. Those tax receipts are gone now, almost certainly never to return. Most of the financial firms won't record profits for years and when they finally do, they will have years of losses to carry forward. The net result will be a giant, prolonged corporate tax shortfall.

In the meantime, the government is throwing good money after bad. This is of course plunging the country deep into debt. Just like in Iceland, although to a lesser degree relative to GDP, UK banks have liabilities in other currencies. As the pound goes into free fall, these liabilities explode in value crippling the banks. As the UK issues more debt to stabilize the banks, even more pressure is put on the pound. A vicious, debt death spiral could easily be sparked.

Don't dismiss the possibility that even a respectable first world economy could get swept away in this credit crisis. Take it seriously, because the consequences will certainly devastate every financial market in the world.

Calls to nationalize RBS and Lloyds as markets lose faith in bail-outs. Sterling hammered on currency markets as traders take: "Jim Rogers, a veteran US investor, said the UK economy was "finished". He told Bloomberg: "I would urge you to sell any sterling. It's finished. I hate to say it, but I would not put any money in the UK."

Rumors were awash in febrile markets that ratings agencies could downgrade the UK's sovereign debt ratings if the government had to issue tens of billions of pounds of government bonds to finance its latest rescue for the banks. A downgrade would increase the cost of raising debt for Britain, the world's fifth largest economy. The price of insuring British debt against default also rose sharply.

Alistair Darling, the chancellor, was forced in Brussels to dismiss market talk that he, like Denis Healey in 1976, would have to turn to the IMF for a bail-out, saying he had laid out at the pre-budget report in November how he intended to pay for the government's schemes.

But Peer Steinbrück, Germany's finance minister, also at the EU finance ministers meeting in Brussels, said he and others had urged a swift return to sound public finances and expressed fears about the situation in Britain, which is forecast to have a 9.5% budget deficit next year, and Ireland, whose deficit in 2010 is put at 13%.

Saying he did not understand Darling's scheme to insure UK banks' multibillion-pound toxic assets via the Bank of England and a "bad bank", he said: "I am skeptical that a national scheme will work."

Steinbrück echoed market fears about the UK scheme by saying it was unclear how to find the right price for the securities in a bad bank. The bank might have to be capitalized with up to 30% of what was on lenders' balance sheets – up to €200bn.

The bail-out also worries the City. "The market rightly fears the long-term fiscal costs of a collapsing banking system," said Graham Turner, of consultancy GFC Economics. The gilts market was spooked by the potential costs to the public purse. Gilts prices fell sharply on the fear of greater supply, which in turn pushed yields up to 3.55% for a 10-year benchmark gilt. Falling yields recently have helped bring down the price of some corporate borrowing and fixed-rate mortgages."