The Euro and the U.K.

May 18, 2010

The Euro continues to come under speculative short selling   pressure because of the fallout from the Greek debt crisis and the hyper panic behaviour of twenty something traders with virtually no historical knowledge of sovereign debt and monetary policy. The European central bank recently quite sensibly acquired some 16.5 billion dollars worth of sovereign debt bonds to ease the situation. It held on to them for about a week and then began reselling them to the market thereby unwinding the positive impact they had had on rates and panic. They need to continue to intervene where appropriate and hang on to the debt before sterilizing its monetary impact for a longer period of time than simply a few days.But at least they are moving in the right direction.

The panic artists have begun to talk about Britain where the change in government has permitted the new 39 year old Tory coalition chancellor to muse aloud foolishly about the Greek situation and its implications for the U.K. The truth is there are none, except among panicky twenty and thirty year olds who don't know their history nor understand that British debt levels are at   historically quite low levels in comparison to the GDP.

As I have said many times before, the current ratio is about one fifth of where it was at the end of the Second world war and about a third or less than it was in the 1920s and thirties.If it were affordable and manageable then when the U.K. was a much poorer country in terms of its GDP per capita it is certainly manageable now when the U.K is much richer. Deficits as a proportion of the GDP were also much higher during the war years.

Furthermore , less than thirty percent of the debt is financed by foreigners.The F.T. has just pointed out that in the first quarter of 2010 foreigners bought a record amount of British gilts because they see it as a safe haven for their money.They bought a total of 20.4 billion pounds worth of gilts.this is quite contrary to what the new Chancellor was claiming in his press conference.

Since the debt exclusive of the monies advanced by the central bank to bail out the British banks is about 55 % of the GDP then 30 % of that is about 16.5 % of the GDP. So about 270 billion British pounds worth of debt is really in play and subject to speculative buying and selling by foreigners.Assume at worst 30 % of that , say 81 billion is subject to short time horizons.

Given the power of the Bank of England to offset speculative short selling through the buying and selling of debt and through quantitative easing there is no danger of a crisis.Traders should calm themselves and recognize short of blundering fiscal policy by the new Government obsessed with deficit reduction, the recovery will proceed and the UK pound is still a good bet for the future.