Is Soros Wrong?

Two days ago, none other than the man who "broke the Bank of England" in 1992 when the UK was forced out of the ERM, handing Soros a $1.5 billion payday, penned an Op-Ed titled "The Brexit crash will make all of you poorer – be warned" in which he laid out the "facts" saying that "sterling is almost certain to fall steeply and quickly if there is a vote to leave– even more so after yesterday’s rebound as markets reacted to the shift in opinion polls towards remain. I would expect this devaluation to be bigger and more disruptive than the 15% devaluation that occurred in September 1992, when I was fortunate enough to make a substantial profit for my hedge fund investors, at the expense of the Bank of England and the British government."

Of course, what Soros meant is that in his older and far wealthier years, when his net worth is a function of perpetuating the status quo, he would be "fortunate enough" for nothing to change, for the UK to remain part of the EU, and for the current bout of volatility to pass.

But is he right?

That is the question that Albert Edwards tries to answer today in a note that takes a step back from the scaremongering campaign, and compares the outcome of tomorrow's events with what happened in September 1992.

First, here is his "big picture" view, showing what happened to UK unemployment in 1992 shortly after "Black Wednesday" - it tumbled alongside the pound.

There is an argument that a Brexit might look similar to the aftermath of sterling?s ignominious exit from the ERM on ?Black Wednesday? 16 September 1992. After this much-feared event, the UK economy actually recovered strongly and unemployment fell sharply (see chart below). In a current environment where central banks and governments have failed to generate a strong enough economic recovery to normalise interest rates amid persistent deflationary pressures, one would have thought a substantial decline in one?s currency would be welcomed ?- for that is one way to inject a modicum of inflation back into the economic system. But even in the event of a Remain vote, sterling is in trouble.


What follows is Edwards' critique of Soros. This is what he said.

I was reading George Soros? interesting oped in the UK?s pro-Remain Guardian newspaper, under the banner title “The Brexit crash will make all of you poorer – be warned” with the subtitle “My 60 years of experience tells me the pound will plummet, along with your living standards. The only winners will be speculators”. He believes that sterling will decline some 20% from current levels in the event of a Brexit vote, but that comparisons with sterling?s ejection from the ERM in September 1992, when the economy benefited greatly and ?Black Wednesday? was renamed ?Happy Wednesday?, are wrong. People might forget that back in 1992 we were told by the then Government of the day that leaving the ERM would be disaster as it was the anchor for our economic policy. It was not a disaster ? quite the reverse.



The Soros article makes it clear he believes the UK will not benefit from a substantial sterling decline in the event of Brexit, in the same way it did in the aftermath of the September 1992 ejection of sterling from the ERM ? quite the reverse. Boiling his highly eloquent argument down to its essence, Soros thinks the key is that interest rates fell substantially subsequent to Black Wednesday, from 10% the day before to just 6% only three months later. He does not believe monetary policy will be eased subsequent to a Brexit. Second, the UK has a very large current account deficit (see chart below) and Brexit will cause funding pressure resulting in capital flight. Third, post-Brexit uncertainty will prevent higher investment and jobs growth to take advantage of the weaker sterling, and the UK would be left with a sharp squeeze on household incomes due to higher import prices.



So is Soros wrong? According to Edwards, the predicted 20% devaluation of sterling would be sufficient to offset any other potential negatives.

George Soros may well be right. But thinking about this from the point of view of my Ice Age thesis, where interest rates cannot be normalised because of economic weakness and deflation pressures persisting throughout this recovery, I would have thought a 20% sterling devaluation is exactly the antidote needed in the current circumstances. Yes of course a fall in sterling increases import prices and squeezes household real incomes, but the booming profits companies enjoy from a weaker sterling should generate a virtuous wage price spiral and take us away from the deflationary abyss that awaits all developed economies in the next recession. This is exactly what Abenomics was all about in Japan. Hence I would be much more positive about the immediate post-Brexit economic outlook than Mr Soros.

Incidentally, this is what we have said all along: in a world in which central banks rush to devalue their currency at any means necessary just to gain a modest competitive advantage in global trade wars, a GBP collapse is precisely what the BOE should want, if it means kickstarting the UK economy? To be sure, if given half the chance to devalue the Yen by 20%, we are confident Shinzo Abe would would gladly exit not only the EU but the entire world if possible.  After all, Mark Carney would have a vastly cheaper currency without doing any unorthodox monetary policies that have marked the global arena of the past 7 years in hopes of stimulating not so much growth as inflation.

Edwards does agree with Soros on one thing, however:

Where I do agree is that the UK current account deficit is huge, reaching 5.2% of GDP for 2015 as a whole ? the largest peacetime deficit since 1832 (the deficit incidentally is entirely due to the UK?s imbalance with the rest of the EU). In the final quarter of last year the deficit ballooned out to 7% of GDP ?- wow! And that is not all. There is another key deficit problem. For in sharp contrast to other countries and Chancellor Osborne?s rhetoric, there has been an almost total lack of discretionary fiscal tightening in the UK (see chart below). The UK economy is a mess ?- see "?The UK is a ticking time bomb?". I think sterling will end up falling substantially whether the UK stays or leaves the EU ?- it is just a matter of timing.

In other words, even if it avoids Brexit, the UK economy will only get worse, until it ultimately is forced to engage in precisely the action that will lead to the outcome that Soros is earning against. Only then the scaremongering campaign will be about the terrible world that would result if the BOE is not allowed to devalued the Sterling.

As for whether Soros is right or wrong, or if his warning will be promptly forgotten in case of a Leave vote, we will have the answer shortly.