By Joanna Slater
As the British pound continues to sink, its travails are a cautionary tale for the U.S. dollar.
The U.S. and the U.K. face very similar predicaments, from a deepening recession to a damaged financial system. Both are orchestrating massive bank bailouts and attempting to assist struggling homeowners. Both are ramping up government spending even as they rely on financing from overseas investors. And both countries have central banks that have slashed interest rates and opened the door to unconventional ways of stimulating the economy.
Yet their currencies have headed in opposite directions. On Wednesday, the British pound tumbled to a 23-year low against the dollar, briefly buying just $1.362, down from over $2 only six months ago. The pound also hit a new all-time low versus the Japanese yen. It got a minor boost in late afternoon trading, following a report that finance ministers from major industrialized nations will discuss the currency's weakness when they meet next month.
By contrast, the dollar managed to strengthen against a host of currencies as the financial crisis intensified last fall. It has also surged ahead in recent days, particularly versus the pound and the euro.
Unlike the pound, the dollar is being buttressed by its unique status as the world's reserve currency and the vehicle for transactions in U.S. financial markets, including Treasury bonds. That means investors often seek out the dollar as fears rise, sometimes in spite of their concerns about the U.S. economy.
"The dollar is still benefiting by default" as investors run from riskier bets, says Lisa Scott-Smith of Millennium Global Investments, a London currency manager. "The pound isn't a natural reserve currency in the way that the dollar would be."
The euro also has flagged in recent weeks, as concerns have risen over the creditworthiness of some of the more indebted countries that use the currency. But it has suffered less than the pound, a sign that investors may be gravitating toward the largest, most highly traded currencies as nearly all economies stumble.
Meanwhile, there's little light ahead for the beleaguered pound, say some currency experts. The economic news is "horrendous," says Neil Mellor, a London-based currency strategist at the Bank of New York Mellon. "There is very good reason for panic at the moment."
In one worrisome sign, investors not only dumped the pound earlier this week, but also shed U.K. stocks and government bonds, sending their yields up. Such a combination, if sustained, would raise the fear that investors are exiting from a host of U.K. assets, creating a vicious cycle that is difficult to arrest.
That's also the scenario that some worry might await the dollar and U.S. bond yields, should appetite from overseas investors wane.
These days, policy makers are inclined to let their currencies weaken "until such a time as other asset markets flag that enough is enough," says Alan Ruskin, chief international strategist at RBS Greenwich Capital. Given that the moves in British government bond yields aren't yet extreme by recent standards, "I don't think we've quite reached that point in the U.K."
In a note on Wednesday, Goldman Sachs analysts pointed out that recent moves in the pound and U.K. bond yields were more typical for emerging markets with weak fundamentals. However, they added, the analogy isn't justified over the long term. Indeed, the firm recommended that investors buy the pound as well as U.K. bonds.
While the dollar continues to benefit from its unique position in financial markets for now, it is far from clear that the resilience will last. "Right now the market is beating up on the pound, but at some point it will look for something else to pick on," says Paul Mackel, a currency strategist at HSBC in London.
The fact that the Federal Reserve stands ready to use a host of unconventional measures to flood the economy with liquidity in an effort to stimulate growth "could hurt the dollar quite badly" later this year, he says.
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