Sterling: the 85p in your pocket

No one compiles lists of wealth destruction, but if they did this year’s fall in the pound should rank high. UK household net worth of £11tn was valued at $16.5tn in January and just $14tn today. In dollar terms, value equivalent to the market capitalisation of the FTSE 100 has been destroyed.

Yet the complete implosion forecast by some did not materialise, and even the declines to date may be too melodramatic. Most Britons’ wealth is for paying sterling-denominated bills. These did not leap 15 per cent in 2016. This fact only highlights a faultline at the heart of finance: everything is valued in terms of a currency, yet what is currency really worth?

One answer is “what it will buy” — what a former prime minister meant when talking of “the pound in your pocket”. The theory that this should not change when currencies are converted is known as purchasing power parity. A facile example: in November a pound suddenly bought less Toblerone than before. But price indices generally move slowly. In PPP terms, the OECD valued sterling at $1.44-$1.60 for years (one reason S&P Global said it was too cheap at $1.21).

PPP struggles with foreign exchange movements, which are more volatile than underlying prices. So instead, look at supply and demand. Measured by nominal GDP, 2016 clearly did not see a 15 per cent leap in the supply of pounds. But the prospect of Brexit suggests lower demand for sterling, which non-Brits mainly use for buying UK exports and assets. Both are at risk from loss of access to the single market.

More than this, sterling’s allure has rested on London’s deep and liquid financial markets that provide a home for trillions of pounds. For years, Britons could afford fuel, foreign trips and Toblerone only because the City kept sterling high. Brexit threatens this. While it is true that some sectors may gain from a weaker currency, it is also the case that if a strong pound is no longer sustainable, then previous living standards cannot be, either.

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