Hamish McRae: Sterling's in better shape than we give it credit for


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The Independent Online

It may not be much of a beauty parade but currently the pound is voted by the markets to be, well, the least ugly. It is not particularly strong by past standards, for its value as measured by the sterling index is now 83. That is 83 per cent of the level in January 2005 when the index, which is weighted by our trading patterns, was rebased. Still, it is the highest since the summer of 2009. Against the dollar, at $1.62, it is the highest since last August, and it is the highest against the euro for nearly two years.

So why should sterling appear to be a little less ugly? Well, it would be hard to claim that it is the result of any surge in admiration for our economic performance or governance. Even if you allow for the flaws in the official data, this is still a lacklustre recovery, and while the broad thrust of the Government's deficit-cutting programme does have widespread support, everyone who digs into the figures will see how slowly the deficit is coming down and how far we have to go to get back to any sort of balance.

If we are no prettier, the others must have become uglier. The euro, for obvious reasons, has seen something of an exodus, with even some overseas central banks cutting their holdings. But the eurozone is now seen so clearly as two different zones, it is misleading to generalise about this. Investors are perfectly willing to hold German euros but they have been somewhat less keen on holding Spanish ones. So foreign flows into German bunds and foreign deposits in German banks have been strong, driving the interest rate on 10-year bunds – German government bonds – down as low as 1.7 per cent. Meanwhile, as Spanish banks used the injection of funds from the European Central Bank to buy Spanish government debt, foreigners took that opportunity to get their money out. They have also pulled deposits out of Spanish banks, many of which are now seen to be in a parlous state and will probably need to be rescued.

The net effect of all this has been to depress the euro but not as dramatically as one might have expected, for the weakness of the fringe has been partially offset by the strength of the core. But at the margin, sterling has been a winner. The move of the pound against the dollar has been more modest. What is happening is the start of a reassessment of US financial policy, with niggling worries nudging their way to the front. The basic point is that the US has been able to continue borrowing very cheaply notwithstanding its inability to cut its fiscal deficit.

As Société Générale pointed out in a new note to clients: "During the current fiscal year, the US Treasury is expected to borrow $1,058bn. This is only slightly lower than the $1,076bn of net new paper sold in the fiscal year 2011." I had not quite grasped that about a third of US Federal debt was held by the Fed. Once interest rates rise and the Fed has to start selling its pile of debt, the favourable mechanics that have enabled the US to finance this huge pile of debt go into reverse.

So there will be huge pressure on the Fed to find some way of reducing the burden of debt repayment and one way would be to reduce its real value by allowing higher inflation. That is already evident.

Just this week, Paul Krugman, who is a Nobel prize-winning economist, has been attacking the Federal Reserve for not having even looser monetary policies. He called for the Fed to permit inflation at 3 per cent or 4 per cent on the grounds that this would boost employment. That won't happen – celebrity economists have zero influence on either side of the Atlantic – but it is enough to make dollar holders feel a little twitchy. At any rate, you can see, amid all turmoil, why suddenly sterling does not look such a crummy currency after all.

What's wrong with making people wait before giving them mortgages?

Banking in Britain is going back to the 1960s – or at least some of the way back – when banks collected their deposits through their branches and lent only to people they knew. Then they increasingly bid for large deposits on the money markets and finally started to sell off their loans in bundles to other institutions.

That model duly collapsed, and now Lloyds, under its new chief executive António Horta-Osório, is back in profit. But behind its recovery is that it is relying less on money market funds and more on retail deposits. We as taxpayers and part-owners are getting a better-balanced bank.

A more secure banking system is one that is more cautious. Lloyds is our largest mortgage lender. People find it harder to get loans and have to put up larger deposits on their mortgages, hence a run of stories about a mortgage famine. But that was life in the 1950s and 1960s. People had to save for years with a building society before they could get a mortgage. It was a great system and it worked. If you want that, don't bleat about a mortgage famine.