Pound tumbles as UK’s debt worries sink in

Pound tumbles as UK’s debt worries sink in
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First Published: Thu, Dec 11 2008. 09 18 PM IST

Updated: Thu, Dec 11 2008. 09 18 PM IST
The pound sterling has had a miserable month. The UK currency has fallen 12% on the Bank of England’s trade-weighted index. Meanwhile, the spread on UK government credit default swaps has almost doubled—to 110 basis points.
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One basis point is one-hundredth of a percentage point.
Peer Steinbrück has a plausible explanation for why. The German finance minister told Newsweek magazine that there had been a “breathtaking” shift “from decades of supply-side politics all the way to a crass Keynesianism”.
That Britain has willingly rediscovered Keynesianism is undeniable. But whether the new approach is “crass” is open to debate. Steinbrück’s accusation has some force to it. There is something simplistic about the government’s claim that an economy which is overleveraged, shrinking and runs a big trade deficit can borrow its way out of trouble.
Borrow less: British Prime Minister Gordon Brown. Carl De Souza / AFP
The pound’s troubles haven’t yet hurt the government in the cost of borrowing. The 10-year bond yields a modest 3.6%. Gilts, along with most government debt, have benefited from investors’ panic. But a tumbling currency brings many sorts of pain: higher prices for imported goods, costly losses at any banks which have net foreign currency liabilities and foreboding over the ability to finance the burgeoning deficit.
Like any heavily indebted family or company with a negative cash flow, the UK relies on the continuing willingness of its creditors to stay supportive. If they go away, the pound could drop to ridiculously low levels. A dirt-cheap currency would eventually stabilize, as exporters seize opportunities. But the transition would be agony. No government wants to go through that. To keep foreign creditors sweet, Prime Minister Gordon Brown and Alistair Darling, chancellor of the exchequer, need to explain clearly how they will cut the country’s new debts. If they can’t come up with a plan, they should do something crass but constructive: borrow less.
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First Published: Thu, Dec 11 2008. 09 18 PM IST