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’.


14 Responses

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  1. hopisen said, on March 12, 2009 at 11:56 am

    You know, i think a “Fraser nelson talks nonsense” feature might be both timely and useful. As far as can tell, Fraser frequently recycles economic nightmare scenarios he’s had fed to him by some friendly right wing source – scenarios that I suspect he doesn’t really understand but thinks are politically useful for his over-riding project of making Gordon brown look bad. See for example his piece on gilts today.

  2. newmania said, on March 12, 2009 at 12:35 pm

    We have no such target now.

    The fall of Sterling shows a lack of confidence in this country as compared to others when we are told by the cure of boom and bust , we are better prepared than those same others .In fact we are told that it is all their fault ( although not at the joint congress chat…fancy).. You keep alluding to a Conservative Policy to intervene where there is none so that entire section is incomprehensible to me . You finally seem to be concluding that the fact we are considered a basket case is actually a good thing because we enjoy the inestimable advantages of a leper currency. Well thanks for that its good for exports but it makes imports expensive and we import a lot ( I expect that a good thing as well as it will stop deflation ! )
    .This supposed lack of Opposition Policies does not prevent Labour stealing the welfare to work policy the IHT Policy and the border control Policy and that’s off the top of my head.( and I am not as hired spinner for the Labour Party like Hopi Sen)

    I don`t understand , to be honest why it is so important that private indebtedness is in Sterling , the indebtedness is mostly mortgages I take it which , it appears are now going into negative equity in many cases(report out today saying there may be as much as 50% to go and I can believe it )
    The Security behind the entire thing then is illusory in any currency which means this county is facing uncharted disaster and no-one want there money invested in us ?That’s the way I saw it anyway.

    • duncanseconomicblog said, on March 12, 2009 at 1:06 pm


      Whether or not debt is denominated in Sterling matters, if people ae arguing that falling Sterling = crisis.

      I agree households are over indebted. I am thankful that the debt is in Sterling.

    • Andreas Paterson said, on March 12, 2009 at 5:03 pm

      Locational mismatch, as an example, if you live in the UK and are paid in sterling but owed a debt of €100,000 it would have been around £70,000 back when the pound was strong, now it would be about €93,000.

  3. The Common Humanist said, on March 12, 2009 at 1:23 pm

    Osbourne has a political purpose – to try to talk the economy down for his partys gain – irrespective of the damage it does in the mean time. Nice fella. Not.

    I work in infrastructure consultancy and the fall of Sterling is a gift for competativeness – we can bid lower and/or squeeze in more added value for clients – which they appreciate.

  4. Richard T said, on March 12, 2009 at 2:13 pm

    Are these wee chaps – especially Fraser Nelson – not the sort of economic experts that a previous Tory Chancellor called teenage scribblers? His name for the moment escapes me but I believe he has a more famous daughter who cooks.

  5. Riz Din said, on March 12, 2009 at 5:14 pm

    One interesting thing about the collapse is that, in text book fashion, sterling was stretched by almost all measures of PPP on the upside and now it has significantly overshot on the downside, at least against the euro and dollar. It’s somewhat reassuring that we weren’t stupid enough to issue to much debt with longer maturities in foreign currencies, falling for the illusion of cheaper pricing.

    In terms of a crisis and going to the IMF, this time around I would say that sterling’s fall will not be the cause but there is a relationship in that the currency could instead be a partial indicator of the country’s creditworthiness, and so we could still see a good correlation between the weaker pound and going cap in hand to the IMF, even if the direction of causality runs in the other direction.

  6. ad said, on March 12, 2009 at 8:05 pm

    I should think that Osbourne’s “political purpose” is to find another stick to bash the government with.

    It’s his job, after all.

  7. charliemarks said, on March 13, 2009 at 1:25 am

    Great post, comrade, very informative and well written. I have just found your blog – can tell it is worth reading what you write – keep up the good work!

    For years manufacturers complained that the pound was over-valued, that it made exports less competitive. The politicians weren’t bothered, as financial services were supposedly going to replace old fashioned exports and a strong pound didn’t damage them.. Now with the faltering of financial services some are seeing sense (not Osborne or Nelson, alas!)

    Hopefully, we’ll be able to export our way out of recession and the trade deficit if global demand pick up – if that fails we might do well from tourists from Eurozone countries…

    This “cap in hand” thing is an attempt to pick up on people’s anger at what Labour did in the crisis of the 70s – turn on the people with an IMF bailout and resulting public sector cuts. The Tories want to cut public spending – a disastrous thing to do when demand is weak in the economy, never mind the morality of making cuts to vital public services.

    Ironically for Brown, the devaluation of the pound – something the government has been assisting with quantitative easing (killing two birds with one stone) – is a protectionist measure, although not in the direct sense of subsidies or tariffs. A lower pound against the Euro is a good move, especially if it gets us buying local produce – it’s effectively assuring import substitution takes place, which will be good for UK farming and manufacturing – as well as the environment.

  8. tory boys never grow up said, on March 13, 2009 at 10:56 am

    I take your points about £ being overvalued and the Tories not having a clue about their own economic policy stance. I do however think you are missing a point about there being some need to manage foreign exchange (and other) markets so as to avoid the damaging volatility that has occurred over the past two years. How can any exporter/importer can do any sensible planning in the current environment? The recent fluctuations in FX rates are hardly a function of what is going on in the real world (they bear no relation to what is happening in terms of overall capital flows) but are being driven by large amounts of speculative transactions – we have seen the same speculative flows go into and out of commodities, shorting financial stocks and destablilising countless other markets. Something has to be done to stop the speculators and perhaps more importantly their ability to leverage their risk positions – proper taxation and capital requirements for hedge funds might be a good start.

  9. […] recession which have cut inflation expectations.  For this reason, I share Duncan’s relaxed view of sterling’s fall. It’s a symptom of a global problem, not a UK one.  There’s a simple […]

  10. yorksranter said, on March 14, 2009 at 6:46 pm

    Mmm, content.

    I have to say, I suspect there are more than a few people on one side of the Despatch Box who would be delighted to have an IMF crisis as a pretext/excuse to implement a spot of structural adjustment to things like the NHS, the education system.

  11. Richard Laming said, on March 26, 2009 at 3:43 pm

    There is a crisis, and the pound has fallen as a result. It makes no sense to argue that fears about the crisis imply that the pound ought to be pushed back up again. We now have the biggest government deficit we’ve ever had in peacetime. The banking system can only be saved by being nationalised. That’s a crisis.

    • duncanseconomicblog said, on March 26, 2009 at 3:54 pm

      There is a banking crisis and a demand crisis which are causing an economic crisis.

      I don’t think we have a sterling crisis.

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