British Pound in the Hand of Speculators

I warned that sovereign debt problems posed a major threat to global currency especially the EU-related currencies as early as December 2009. And this threat could represent a catalyst for a return of global risk aversion as it has the ability to be contagious. Such fears can destroy investor confidence in the capital markets of troubled countries.

Despite the European leadership’s attempt to lessen the sense of urgency in the euro zone and the despite the ambitious plans rolling out to shave outsized deficits, the problems with government finances’ finances in the Eurozone and Britian are not finding a resolution.

In late November, the Dubai government created a hiccup in the rosy plans that many market participants were increasingly hitching their wagons and it is a wake-up call. Dubai World’s debt holders now are getting only 60 cents on the dollar for their government bond investment.

Now, Greece is the next in line – the weakest of the 16 members of European monetary union, and is running a budget deficit more than 4 times the limits set forth in the euro-zone’s fiscal constraint guidelines. The ratings agencies took the alert from Dubai.

The next hot spots – Portugal, Ireland and Spain all have severely bloated deficits and debt levels and the spill-over of Greece issue have created an irreparable moral hazard. As for the euro, this total breakdown in the foundation of the currency union has it on a path for destruction or at best, an extended period of uncertainty.

With all this development, I am becoming more worried about the United Kingdom. Among G-7 economies, the UK has the weakest performing economy, the largest deficit and the worst deterioration of its debt position. As conditions get worse in the euro-zone and it becomes increasingly evident that there are no clean fixes, the UK is the most likely candidate to come under the gun.

The British pound plunged to its lowest level in 24 years against the dollar at the height of the financial crisis, and now just a year later it appears another test of that level is in the cards.

While the uncertainty about the UK government’s finances continues to build, I expect the pound to be the next victim of currency speculators.