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Down with the Pound! (And Gilts)

From London, England

The streets of London are sparse this week, as most people remain on holiday and schools are closed until next Monday.

Taxis, the best and the most spacious in the world, complain about the few rides despite the bitter cold. It’s about minus 3 degrees here this morning and Londoners are complaining; where I come from in Montreal, minus 3 is almost a day at the beach.

Back in November while visiting the United Kingdom, I commented on the state of her bungled finances.

England is essentially a mini version of the United States – over-leveraged and heavily in debt. But unlike America, it doesn’t have the Chinese to bail them out or harbor the reserve currency status that is enjoyed and manipulated by the United States. England is on her own.

Probably one of the greatest speculations in 2010 and beyond is betting against the British pound and the government bond market, or gilts. The cost to finance this crisis will exceed more than $1.1 trillion dollars over the next five years, according to The Financial Times.

At some point, as debt grows to almost 100% of GDP or higher, credit markets will demand higher interest rates to finance England’s debt burden. The same challenge confronts other countries like the United States, Japan, Ireland, Greece – and many others.

Pound Settling in Much Lower After the Crash…

There’s no doubt in my mind that the United Kingdom along with other heavily indebted nations in the industrialized economies will face higher rates over the next several years. Too much debt-financing is chasing too many lenders and, at some point, these creditors will demand much higher risk premiums to finance bludgeoned state balance sheets.

In Britain’s case, the government must keep the pound competitive.

The last thing this country needs is a surging currency amid debt deflation and a big drop in exports. The pound must stay weak. The endgame, of course, is inflation. And bonds don’t like inflation.

Though there isn’t an exchange-traded fund available yet to play this theme, investors can place these trades pretty easily through most options-based brokers or European private banks. I would short the British pound and/or the long-term gilt market.

Both trades should be profitable as the year unfolds…

Eric Roseman, Editor of Commodity Trend Alert

Disclosure: none