So that begs the question: would a "hard" Brexit really be worse than Napoleon?


In a post immediately after the referendum, Willem looked at various models of sterling valuations based on effective exchange rates. They argued sterling was unlikely to trade sustainably below $1.20. With the currency now trading at those levels, we have closed our longstanding sterling underweight (and have even moved to an overweight in more tactical portfolios).


The recent bout of weakness has been driven by tough talk at the Conservative Party conference on "hard Brexit". However, putting those issues to one side, I want to take a (much) longer-term perspective to think about the prospects for sterling. 

Personally, I think the first chart is quite cool. In the middle of the American Civil War you could get $10 for your pound. Today you can only get $1.2. The vast majority of that change is due to inflation differentials. UK inflation has run persistently higher than US inflation for (literally) centuries. That implies that the secular fall in the exchange rate has simply kept the relative price of goods and services in the UK static relative to the US.


The second chart adjusts for those inflation differentials to give us the real exchange rate.  The GBPUSD real exchange rate is now 25% below the average of the last two hundred years. Over that period, we have seen our fair share of currency crises, but sterling has only traded weaker versus the US dollar during the middle of the Napoleonic War. 


It has become increasingly common for currency strategists to talk about GBPUSD trading at parity (i.e. another 20% below current levels). That would put the real exchange rate into totally uncharted territory. At that point, the pound would be even weaker than just before the Battle of Waterloo.


In 1814, the pound was on the floor due to fears that the UK would get swallowed up by a European empire. Ironically, in 2016, the pound is on the floor due to fears that the UK will get pushed out of the European single market.


So that begs the question: would a "hard" Brexit really be worse than Napoleon?