Currency Conundrums

So the Dollar is doomed? Despite the recent rally, if you were to believe by far and away the majority of commentaries one could easily assume that the great greenback is doomed to yet further falls. Well against certain currencies that in fact might be the case, and research from Goldman Sachs especially highlights the currencies of Singapore, Malaysia and China as such candidates. This seems to relate to inflationary pressures being translated into currency strength. The report differentiates between “good”
inflation and “bad”.

“Good” inflation stories come about where central banks have kept currencies undervalued for an extended period of time. This typically leads to the growth of both a significant current account and balance of payments surplus, a build up of reserves and a high increase in money supply. When inflation pressures do arise therefore, as we are seeing especially in relation to food prices, one easier way of releasing such pressure is to allow the currency to strengthen.

On the other side of the coin, “bad” inflation occurs when a currency is already overvalued and then there are options for economic planners. Under these circumstances, consumers could be sucking in further goods and both the current account deficit and balance of payments could widen - so the imbalances could worsen. The choices for the policy makers could then be to fight this bad inflation with tighter fiscal and monetary policies in order to slow domestic demand - thus such actions could be both painful and
unpopular.

However, there may be one currency which may in fact show weakness against the Dollar, namely Sterling. The recent comments from Governor of the Bank of England were painful and honest - probably too painful for the Chancellor to listen to. A decade of growth based on cheap money and easy debt is coming to an end. The consumer, which as I have mentioned before is 50% of our economy, is being severely squeezed with an appalling figure of 30% of salaries going on servicing overall debt (mortgages, loans, credit cards etc.) During the last recession in 1992 the figure for servicing mortgage repayments reached 26.7%.

Equally, government debt has been rising and must surely break through the 40% (as a percentage of GDP) measure of control as set by the Prime Minister in his days as Chancellor. What I don’t understand is that in all the interviews I have yet to hear anyone ask him about his famed “cycle” and that this is the time when he should have the extra reserves being built up ready to help us through the downturn. Well he hasn’t and there aren’t any reserves! I think the rhyming slang is “pants on fire”.

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I was asked by the BBC to do a very short broadcast for the World Service on the confusing world and history of short selling. I thought that this might make a good opportunity to add such an explanation here.

Despite the jargon the definition of short selling is in fact quite simple - all you are doing is borrowing a share or commodity from a broker with the aim of profiting from its hoped-for price movement. This is effected by immediately selling it, on the understanding that it will be bought back at hopefully at a lower price and returned to the broker. So if you sold it at £100 and bought it back at £80 - you have just made £20 profit.

However, not unexpectedly, this practice has caused a lot of ire and frustration as for some as it was just seen to encourage speculation. This grew to such an extent that it was even banned for a while in London in the 18th century.

Going back even earlier the practice was often cited as being one of the causes of the great Tulip Disaster in the Netherlands 1637. Astonishingly at that time there was a huge demand for the rare and precious tulip bulb that had recently been imported from Turkey. A speculative frenzy developed throughout 1636 and the prices for tulip bulbs rocketed until finally the bubble burst the following year, ruining many.

What made the bubble burst may never be fully known, but the speculative practice of selling what you did not own effectively forced the price down and was blamed as a key contributory factor.

However, not all is so negative about the practice. In 1949 Alfred Winslow Jones adopted it to help him run his portfolios, where he would hedge or protect his investments - this was the birth of the first hedge funds that we are now so familiar with, where short selling is so important.

More recently there have been examples of investors making large sums out of shorting Northern Rock shares and, more controversially, some have alleged that short selling raids may recently have taken place on banks including HBOS in the UK.

So whether you approve or not they certainly can be vital tool for the professional investor - but like all tools they can be used for both good and ill.

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And finally……….just to ensure that we are all focussed on the equality of the roles of our partners, I note that it has been recorded that women carry out on average over 215 miles of ironing in their lifetime.

Men apparently can only manage 73 miles. This can either mean that us males have become increasingly lazy – or, more worryingly, our anticipated lifespan has just been dramatically reduced.

Have a good weekend,

Justin A. Urquhart Stewart
Director
Seven Investment Management Limited

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This article represents a personal and lighthearted view from Director, Justin Urquhart Stewart of Seven Investment Management Limited, and is based on current financial news and events around the world. Its content should not be used for investment purposes and you should contact an independent financial adviser before making any investment or financial decision. Seven Investment Management Limited is authorised and regulated by the Financial Services Authority. Member of the London Stock Exchange. Head office: 23 Austin Friars, London EC2N 2QP. Telephone 020 7760 8777. Registered in England and Wales number 4092911. Registered office: 3 More London Riverside, London SE1 2AQ.