World Economic News

'Elite' U.S. Banks Expect Sterling To 'Plummet' in 2007

The pound sterling is now close to twice the value of the U.S. dollar, Ambrose Evans-Pritchard wrote in the Daily Telegraph Dec. 12. Analysts of both Goldman Sachs and Lehman Brothers are warning that the pound will fall. Goldman Sachs has told some investors to take out a "short" position against the pound on derivatives markets: a client note stated that the "UK remains the largest current account deficit country in Western Europe, with a substantially overvalued currency—about 13% on a trade-weighted basis." Lehman Brothers' UK economist Alan Castle is saying that the pound would fall to $1.82 in 2007 and to $1.68 by the end of 2008, amidst concerns about the property market and Britain's current account deficit, which "could widen to 4% of GDP in 2008."

While central bankers had been making sterling "a favourite choice for global central banks switching reserves out of dollars over the last two years," now, the UK Office for National Statistics shows, private investors are the main foreign sterling buyers.

In 2006, the Bank of Italy switched 20% of its reserves into sterling, and Russia and Switzerland had each raised their share to 10%. (See InDepth for more coverage of sterling/dollar crisis.)

Secondary Market for British Mortgage Debt Soars

The amount of British mortgage debt being sold on capital markets has soared to more than 90 billion pounds, almost double the amount of a year ago, the Daily Telegraph reported Jan. 8, citing Citigroup figures. Between 15%-25% of the 1 trillion pounds in outstanding mortgage debt in Britain is being sold on capital markets at this time. This "securitization process ... is one of the fringe factors helping to keep mortgage rates low in Britain, fanning the flames of the housing market," according to the Telegraph. "As a result of these deals, Britain's banks are no longer the only institutions directly exposed to any collapse in Britain's housing market."

Such mortgage bonds were introduced in Britain in 1987, but only became a sizable part of the financial situation in recent years. In 1999, some 4.9 billion pounds of mortgages were sold as bonds; in 2006, it was almost 90 billion pounds, one-third of all the securitizations completed in Europe last year. The bubble will grow when the new Basel II European capital rules come into effect later this year, which will make mortgage paper a more attractive investment, the Telegraph wrote.

Of course, the hedge funds are getting involved, buying higher-risk mortgages. Such hedge funds as CQS and Cheyne Capital are involved, and hedge fund "demand" is "fueling growth in the so-called 'sub-prime' sector of the mortgage market," the Telegraph noted.

World Economic Forum: World Faces Major Economic Risks

The Davos World Economic Forum released a report on global risk which includes economic, environmental, geopolitical, societal, and technological risks, the Daily Telegraph reported Jan. 11.

The economic risks include an oil price shock, the U.S. current account deficit/fall in the U.S. dollar, a Chinese hard economic landing, a fiscal crisis caused by demographic shifts, and a blow-up in asset prices and excessive indebtedness. All of this, they fear, will lead to a retrenchment of globalization—which is itself a risk. The debt and housing bubble which has built up around the world could burst, causing more than $1 trillion in damage.

In a commenting on the report, the Telegraph quotes the chief executive of Marsh and McLennan, Michael Cherkasy, as saying, "The world has certainly become a riskier place to live, thanks partly to globalization."

People's Bank To Reduce Liquidity—'If Necessary'

The People's Bank of China will take further measures to reduce liquidity in the country, if necessary, stated PBOC governor Zhou Xiaochuan at central bankers' meetings at the Bank for International Settlements in Basel. Zhou said that policy changes are designed to cope with the excess liquidity in the market. "We are not ruling out the possibility of using more measures, but we have to see the effectiveness of the current policies," Zhou said.

The PBOC has just announced that banks, as of Jan. 15, will have to raise their reserve ratio by 0.5%, which will keep some 150 billion yuan from flooding the stock market, the Hong Kong Standard reported Jan. 9.

In addition to its huge trade surplus, China also has been receiving a big flow of foreign direct investment, which is also pushing up its foreign exchange reserves.

"We don't know what the trend of the market demand and supply will be for this year," Zhou said. "So far, there is more supply of foreign exchange than demand for it."

Bloomberg quoted Zhou Xiaochuan also saying that, "The data from 2006 show that China's trade surplus has been increasing, and if this situation continues, then I think the flexibility of the exchange rate will be increased." The RMB has risen 5.7% against the dollar since July 2005, and the national Xinhua Economic Analysis report of Jan. 2 said it could rise by another 5% in 2007.

Zhou had told visiting U.S. Treasury Secretary Henry Paulson in December, that he wants to increase the flexibility of the yuan at a "gradual" pace.