Duncan’s Economic Blog

Crisis? What Crisis?

Posted in Uncategorized by duncanseconomicblog on March 12, 2009

I am becoming tediously bored of the ‘debate’ on Sterling weakness, which has somehow became muddled into a ‘debate’ of ‘Britain needing to go cap in hand to the IMF’.

Personally I always find evidence and facts useful in a debate, so let’s start with some numbers. Yes, Sterling is weak – it is down 34% against the dollar over the past 16 months. So does this constitute a currency crisis? George Osborne seems to think it does.

Well I think it depends on how one defines crisis. We had a ‘Sterling crisis’ in 1931, 1947, 1967 and 1992 as in each case an explicit aim of monetary policy was to maintain the value of the pound against variously gold, the dollar or a basket of European currencies. Hence as Sterling fell, an explicit policy aim was not being met. We have no such target now.

The opposition seems very keen on pointing out that Sterling has now fallen by more than it did in the 1992 ERM debacle. No one seems to be noting that between October 1980 and February 1985, the pound dropped from $2.40 to $1.10 – a fall of 54%. That would be the ‘Thatcher Sterling Crisis of the 1980s’. Which we don’t hear about. Because it wasn’t a crisis.

In the same way, I would argue that Sterling’s fall is simply the unwinding of Sterling having been overvalued. The arguments as to why this is helpful are well rehearsed and don’t need to be repeated here (but for the sake of it: it makes imports more expense and exports cheaper, it combats deflation, it aids the manufacturing sector, it reduces the balance of payments deficit).
It is certainly annoying our European neighbors who seem to be under the impression that weakening Sterling is a deliberate act of public policy aimed at boosting the economy rather than a result of a crisis. But what do they know? Mr Osborne thinks it’s a crisis.

I do wonder what the actual Tory policy is, but then like so many Tory policies it is somewhat elusive. Would they order the Bank of England to intervene to boost Sterling? Would they raise interest rates to make it a more attractive international currency? What would be the effect of this on Bank of England independence? Do they think stronger Sterling would be helpful?

Curious is it not how the party of free markets is complaining that the government is letting the currency markets move freely and calling for more intervention?

Somehow the argument that Sterling is having a ‘crisis’ has become conflated into a ‘Britain might need to go to the IMF’ crisis. Or so says Dave.

I suspect the source for this argument can be traced back to Fraser Nelson. The argument here is perfectly logical: the currency is falling and we owe a lot of money to foreigners in foreign currencies, i.e. Britain faces the same issue that Asia did in 1997 and Iceland in 2008. If this was the case then, yes a fall in Sterling would be a catalyst for crisis. Thankfully it isn’t.

There is no doubt that consumers are heavily indebted. But there is equally no doubt that this debt, no matter who the ultimate lender is, is almost entirely Sterling denominated. How many people do you know with a credit card, auto loan or mortgage denominated in dollars, Swiss francs, yen or euros? I’m guessing not many. This is in contrast to Eastern Europe, where most recent mortgages have been made in Swiss francs or euros. So the zloty/forint/ koruna falling heavily might cause a crisis, Sterling falling doesn’t.

Equally most corporate debt is Sterling denominated. Sure, some corporations have issues dollar or euro bonds – but mainly companies such as Shell, Pearson, BAe etc that earn their revenues in those currencies anyway.

Government debt too is Sterling denominated. Unlike Latin America in the 1980s the UK government does not issue bonds in dollars.
So, given consumers, corporate and government don’t have much foreign currency debt how does Fraser come up with?

“Britain’s external debt is a sickening 400 per cent of GDP — by some margin the highest of any major economy.”

I scratched my head about this one for a while. Then using having eliminated the consumers, corporate and government – realised there was only one sector left – the banks. But again, before panicking, it is worth looking at the actual data in more detail. It can be found here.

‘Bank operating in the UK’ owe the rest of the world $5.3 trillion dollars in foreign currencies. That’s a lot. (They also owe $0.8 trillion in Sterling, which matters less). However there are two very important caveast to this, neither of which Fraser stresses.
First they also have claims on the rest of the world outside of the UK, in foreign currencies, worth $4.9 trillion. So the net difference is more like $400bn, a big number but less scary.

But this is not the key point, the key point is what is meant by a ‘bank operating in the UK’. This means exactly what it says on the tin – not ’British banks’, but nay bank with an office in London. The BOE provides a full list here. So the foreign debts of UBS London, Deutsche Bank London, are all included in these figures. Hhhhmmm, this is looking a lot less scary.

As Fraser says:

“Britain’s total ‘external debt’ — what the country owes the world — is more than twice the next highest G7 country (France, at 187 per cent of GDP). Italy’s is 110 per cent.”

Yes, indeed. But neither France nor Italy are major centres of financial intermediation. London was the centre of the global shadow banking system. It is no surprise that liabilities stacked up here. But ultimately they are not debts owned by the UK. So falling a falling pound is hardly a crisis and we are extremely unlikely to ‘go cap in hand to the IMF’.