Some Ironic Possibilities for the British Pound

The following are some musings on the U.K. economy, prompted by an adage that seems quite appropriate for our times of thinking the unthinkable.

1. The U.K. public finances are in dire straits with a likely deficit this year well in excess of £200 billion and with red ink as far as the eye can see. It seems highly likely that within the next three or four years outstanding public debt will exceed 100% of GDP.
2. The U.K. is still in recession with a -0.4% GDP reading for Q3, 2009
3. The fact that the U.K. faces a national election within the next nine months means that there is no immediate political will to address the problem or even to spell it out to the electorate.
4. The markets are expected to fund the deficit through the continued purchase of gilts despite the fact that the Bank of England has indicated that it is winding down its Quantitative Easing program.
5. Sterling recently has exhibited as its default mode a tendency for sudden plunges against other major currencies.
6. A recent posting here reveals that the price of gold as expressed in terms of a variety of currencies showed that holders of the U.K. currency had lost the most purchasing power vis a vis the precious metal over the last five years. The real point of this is to highlight that the U.K. economy has historically been more inflation prone than many others.
7. Could the U.K. government - whatever flavor it takes after June 2010 - be faced with the awkward choice of having to approach the IMF for an emergency loan to bail out the gilts market and prevent a collapse in sterling, or to adopt the euro to seek some safety under the umbrella of a more globally acceptable currency?
8. Will Tony Blair, as the possible new President of the European Union, find that he has been provided with the unique destiny of rescuing the U.K. economy by facilitating the early adoption of the euro in place of sterling?

Comments

[Dave Wrixon]

Come on at least try to be objective. I read yesterday that part of the Northern Rock is now to be sold off and has already repaid most of the money lent to it by the Government. Other banks to follow suit.

The acid test will come when the Fed and the Bank of England actually try to sell the assets they took in exchange for debt back onto the markets. I think the Bank of England will come out the clear winner.

2009 Oct 29 06:54 AM

[Dave Wrixon]

You also need to get a grip on the difference between one off events and ongoing structural deficits.

2009 Oct 29 06:55 AM

[Clive Corcoran]

Thanks for the great comments Dave.
What exactly do I need to get a grip on?
What is one-off about a series of budget deficits which are themselves based on very dubious forecasts as to future GDP growth, and where there is no clear direction from policy makers as to how the widening gap between outlays and tax receipts is going to be funded?
As for Northern Rock you should read the articles more carefully such as the one in today's Daily Telegraph. This suggested that the taxpayer will be obliged to Northern Rock until 2020 as the bad bank's mortgage book is wound down, and that the "good" bank might be worth as much as £200 million (no, that's not a typo). Hardly what might be called a bonanza payout for the UK taxpayer!

2009 Oct 29 07:34 AM

[chap08]

The UK debt position seems dire, but no worse than many other nations. Its official debt and unfunded liabilities are in line with the EU average. US unfunded liabilities are much worse. It may have a debt crisis, but if it does, other countries will too.

One thing that will not help in any way is membership of the Euro. There is no "safety under the umbrella". That is what the likes of Ireland and Spain are finding out the hard way. They may not suffer a currency devaluation in the same way that, say, Iceland did, but that just means that their recovery is more difficult.

The last time the UK pulled out of a crisis and went in to an economic boom, it was because they devalued their currency (or rather the market did). That was when they left the ERM. If they joined the Euro, they would simply lose that flexibility. Being stuck with an over valued currency is a heavy burden to bear. I fear that Ireland, Spain and others are in the process of learning that painful lesson for themselves.

2009 Oct 29 08:23 AM

[Steve in Greensboro]

How would converting to the EUR "rescue the U.K. economy"?

The U.K.'s core problem is that its government continues to run massive deficits. If the government foregoes the ability to print GBP, this just puts more pressure on gilts. They can't print GBP to fund the deficits so they must borrow more. They can't reduce the value of the debt through debasing the GBP.

I suppose converting to EUR would hasten the day when the U.K. government will have to stop deficit spending. And that would eventually be a very good thing for the U.K.

2009 Oct 29 10:41 AM

[Dave Wrixon]

Before this crisis struck the overall debt of the British Government was in reasonably good shape, and the deficits were under control. This was turned on it head by the need to rescue British Banks and a slump in global demand. It would seem likely that when normal conditions return that situation would largely reverse itself.

This situation is quite different from the US where the current huge deficits have been piled high on at least a decade of profligate waste. Indeed the US Government seems to have no concept of fiscal discipline.


On Oct 29 07:34 AM Clive Corcoran wrote:

> Thanks for the great comments Dave.
> What exactly do I need to get a grip on?
> What is one-off about a series of budget deficits which are themselves
> based on very dubious forecasts as to future GDP growth, and where
> there is no clear direction from policy makers as to how the widening
> gap between outlays and tax receipts is going to be funded?
> As for Northern Rock you should read the articles more carefully
> such as the one in today's Daily Telegraph. This suggested that the
> taxpayer will be obliged to Northern Rock until 2020 as the bad bank's
> mortgage book is wound down, and that the "good" bank might be worth
> as much as £200 million (no, that's not a typo). Hardly what might
> be called a bonanza payout for the UK taxpayer!

2009 Oct 29 12:41 PM

[Dave Wrixon]

The main benefit would be that the UK would greatly benefit from the exchange cost that it incurs to participate in it own market. It is also somewhat incongruous for the UK to be the financial centre of Europe when it does not use the Euro. The discipline imposed by the Euro would be an additional fringe benefit, although I do not believe that the British Government has been excessively profligate. Yes, it might mean short-term pain, but unlike most Americans that is something that the British can generally relate to.


On Oct 29 10:41 AM Steve in Greensboro wrote:

> How would converting to the EUR "rescue the U.K. economy"?
>
> The U.K.'s core problem is that its government continues to run massive
> deficits. If the government foregoes the ability to print GBP, this
> just puts more pressure on gilts. They can't print GBP to fund the
> deficits so they must borrow more. They can't reduce the value of
> the debt through debasing the GBP.
>
> I suppose converting to EUR would hasten the day when the U.K. government
> will have to stop deficit spending. And that would eventually be
> a very good thing for the U.K.

2009 Oct 29 02:01 PM

[Dave Wrixon]

www.telegraph.co.uk/fi...

Here it says £1.5 Billion. Clearly the telegraphs is plucking figures out of the air.


On Oct 29 12:41 PM Dave Wrixon wrote:

> Before this crisis struck the overall debt of the British Government
> was in reasonably good shape, and the deficits were under control.
> This was turned on it head by the need to rescue British Banks and
> a slump in global demand. It would seem likely that when normal conditions
> return that situation would largely reverse itself.
>
> This situation is quite different from the US where the current huge
> deficits have been piled high on at least a decade of profligate
> waste. Indeed the US Government seems to have no concept of fiscal
> discipline.

2009 Oct 29 02:13 PM

[Nathaniel C]

The only thing that has saved the UK from complete collapse is that they still have their own currency the sterling. Sterling has weakened over the last year which has boosted exports and reduced imports. Tourism is up and foreigners are picking up cheap UK assets which has led to some stabilization in the economy. If the UK was on the Euro they would end up like Spain, Portugal, Greece, and Ireland which are suffering depressions. Spain in particular has 22% unemployment and the economy is in a coma which is expected to continue until 2012 at the earliest. Beacuse of the Euro, spain cannot let their currency depreciate which would give a boost to the economy. This one size fits all Euro does not work. Every country has its different monetary needs.

2009 Oct 29 04:53 PM

[cyclingscholar]

Britain IS, where the Anointed One is leading us. A pathetic, helpless former superpower embarassed by its cultural, economic, and military superiority, overrun by illegal immigrants who detest its very soul and play on liberal guilt.

2009 Oct 30 01:39 PM

[Clive Corcoran]

Nathaniel

I can agree with a lot of what you say about how the UK has benefited over the last year from being allowed to "debase" its currency more than its eurozone neighbors have been able to. My point is that, if the financing of the public debt -which is going to be problematic to put it politely - runs into serious resistance from foreigners - esp Chinese - because of concerns that sterling is not as "safe" as the euro (and don't forget there has been some discussion about a possible downgrade to the AAA status on the UK government debt) then lenders may precisely require the discipline that would be imposed on the UK by having to adopt the euro.
Complacency runs pretty high at present about the manner in which all of this debt is going to be sold. I would maintain that any disruptions in the sovereign debt market from another bout of financial instability could, especially given the US's need to fund massive deficits as well, lead to a shakeout of the more marginal national currencies - of which sterling is certainly one.

2009 Oct 31 10:58 AM