Money is pouring out of the UK - here's how to protect yourself
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Associate Editor
David Stevenson Mar 08, 2010
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You may have heard that scientists are hunting for a new word to describe figures bigger than 1,000,000,000,000,000,
000,000,000,000 (that's 27 zeros, by the way). The likes of 'kila' and 'giga' just aren't cutting the mustard anymore.
And it's not just the scientific community that's having problems with gigantic numbers. Financial market students have been blown away by the sheer size of the sums of money sloshing around. Only a few years ago, you rarely encountered the word 'trillion' on the business pages. Now it crops up in almost every edition.
It's enough to give you number blindness. So it's perhaps little wonder that yet another huge number which came out on Friday was largely ignored by the press. But it contains a huge threat to Britain's well-being - here's why...
It matters if the pound falls
As you may have noticed, sterling has been slumping. We've covered the short-term reasons in Money Morning, so I'll not repeat them here. But there's another, longer-term, problem brewing that's likely to prove a lot more dangerous.
Many pundits have said it doesn't matter if the pound drops sharply. It's best to get sterling's slide 'out of the way now', as if this is just a nasty dose of medicine that Britain must take before it can get better again.
They say that our trade deficit will be sorted out because a weak pound will make Britain's exports cheaper. But the trouble is, apart from the likes of electronics and precision engineering, which we've spotlighted in the current issue of MoneyWeek magazine: Profit from the return of British manufacturing (if you're not already a subscriber, claim your first three issues free here), our falling currency isn't making a serious dent here.
That's as maybe, say the pundits. But at least a sterling plunge would force the government - whatever the hue - to tackle our near-£1 trillion public debt. That's partly true. There's no doubt the deficit needs tackling fast.
But currency slumps have a knack of getting out of control and turning into dangerous crashes. And the trouble is, there are far bigger perils in a plunging pound.
I'm talking about UK banks' external liabilities (what they owe foreign investors) and claims (what foreign investors owe them). Yes, I know - discussing these sounds like a handy way of dealing with insomnia. But please bear with me for a moment. They matter - almost more than any other mega-number.
Bad news - foreign investors have lost confidence in the City
Banks' external liabilities are the cash that's held in the UK on behalf of foreign investors – foreign investors' deposit accounts if you like. On Friday, we learned that the money in these had dropped by $29bn to just under $6 trillion (that's a mere 12 zeros this time). On the surface, this isn't an obvious cause for concern.
Trouble is, the flip side of these deposits is the pile of assets they're funding. These are investments worldwide, and are known as 'external claims' – effectively, what Britain's banks are investing in on behalf of these foreign investors. Broadly they move in line with the deposits, and in the last quarter they declined in value by $74bn (when you're dealing in trillions, a difference of $45bn is small beer!)
In short, these figures measure the amount of money going in and out of our financial industry. And what they show, is that foreign investors are giving our financial industry less business. And given that finance is still such a vital part of our economy that could prove to be a major confidence problem for the UK.
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Over the last two years, the decline in foreign money rushing through our banks amounts to almost $2 trillion.
In a nutshell, we're now seeing a major 'capital flight'. It's a dramatic reversal of the long-term uptrend since Bank of England stats began in 1986, as this chart points out…
Source: Bank of England
The fall in external liabilities coincides pretty well with sterling's fall from more than $2 to the pound, to the sub-$1.40 levels seen during the credit crunch.
But the latest Bank figures only cover until the end of 2009. The real damage to sterling has happened since then. That suggests there's been another vast outflow during the current quarter.
To repeat, we're talking about some massive numbers here. And as the pound weakens, foreign investors will become ever less keen to hold their money in the UK. Colin Ellis at Daiwa Securities cautioned a year ago that "foreign investors will be smarting from the sharp fall in the exchange rate – raising the question of what could possibly tempt overseas investors to return to the UK".
Money is pouring out of the UK
Jump forward 12 months, and it seems he was right to be concerned. Everything points to the 'run on London' gathering pace in 2010. Even worse, the "slide in sterling is seemingly becoming a self-fulfilling phenomenon", according to Sean O'Grady in The Independent. "The danger is that the heavy depreciation of the pound could become a rout if confidence completely evaporates".
In other words, the latest sterling slide really matters. International investors have had enough. Money is already pouring out of the country. Unless the government slashes the budget deficit and takes some action to defend the pound - don't hold your breath - before sterling collapses, there's big trouble ahead.
As the pound keeps dropping, it'll get a great deal tougher persuading foreigners to buy the UK government bonds - gilts - needed to plug the gap between taxes and spending. Much higher long-term interest rates - i.e. higher bond yields - will be the only working weapon left in the Treasury's armoury. That will push up borrowing costs across the economy.
How to profit despite sterling's problems
This sort of downward spiral doesn't make a very pretty picture at all. So how do you avoid getting caught up in it? As John Stepek pointed out last week, 'shorting' sterling - selling with the intention of buying back lower down - via the likes of spread betting can be risky. But holding UK shares that do well when the pound is weak, is one idea (Five stocks to profit from a weak pound).
Buying international stocks that pay decent dividends is another. That way you get both a good starting yield, and the value of your investment climbs as sterling drops. We tipped four US shares last week. And we'll be looking for other ways to protect your portfolio in the coming weeks.
Our recommended article for today
For cash-rich investors who don't want to risk it all, there are very few options that offer much of a return, says Merryn Somerset Webb. Here, she picks two of the best savings accounts around at the moment, and, for the more adventurous, two cheap ways to get into in China.
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