Is the U.K. the Next Greece?

Includes: EWU, FXB, FXE
by: Cullen Roche

There has been a lot of fear mongering in recent months about the potential default of several larger developed nations such as Japan, the U.K. or the U.S.A. As regular readers know, we’ve attempted to quell these fears, but they persist. The fear mongering deficit hawks who can’t understand the very important differences in monetary systems simply refuse to be rattled. This is unfortunate for those who actually listen and even more unfortunate for the governments who succumb to such fear mongering. We’re beginning to see signs of this now and it risks any shred of recovery we might be seeing.

I was able to watch the latest British electoral debates last night and a disturbing topic was raised – Britain joining the EMU (European Monetary Union). WHAT!?!?! They actually bounced this idea around as if it might one day become a feasible or even a good idea. It doesn’t really surprise me that these lifelong politicians don’t understand how the monetary system works, but someone needs to wake them up. The U.K. is NOT, I repeat, NOT the next Greece. But their debt levels are so massive, right? Yes. So are they actually different? Yes. Why? It’s the currency system, of course!

The problem in the EMU is that differing economies and nations are bound by one central currency. This means that no country is its own banker. They do not have a printing press. No country has true control over its fiscal or monetary policy. This means they effectively beggar they neighbor every time they want to fund some new government expenditure (and yes, some level of government expenditure is REQUIRED as government spending is equal, to the penny, to private sector savings). Without government spending the private sector literally has less cash. The system in the EMU is actually a lot like being a state government in the USA. Except there are all sorts of exogenous historical, economic and political dealings that make them far from being unified like the states in the USA.

Imagine it like this – you discover this great little island in the South Pacific and everyone wants to live there with you. Also, being a former Office Depot (OD) employee you have access to this awesome printer that produces shiny little notes that look a lot like money. So you take a planeload of people and your awesome printer and move to this island. When you get there you begin circulating currency for people to spend. You also impose a tax on your friends. Your people are quite productive, innovative, etc and times are good. However, Adolf doesn’t like your tax and tries to overtake you. That is thwarted quickly when you hire Mariusz, Magnus and Maximus, pay them handsomely and give them the only guns on the island. Call it the National Guard. So, you’ve established a functioning economy, created a currency, created demand for that currency (via taxation) and you’ve given people a reason not to question its integrity (the 3 M’s). Everything is good for now.

Over time you discover that there are several neighboring islands who are all running the same racket. One of the island owners named Llloyd (a banker) convinces everyone to meet to discuss some form of “union”. This sounds great. We’ll all be partners under the same economic system which will make us unified and powerful like the motherland, right? In theory, yes.

Interestingly, your buddy Gordon won’t join the union. He thinks his economy is just fine on its own and refuses to hand over control of his printer (he worked at Staples, what a snob) to anyone else. This confounds you, but you move on. Gordon’s loss, right? Wrong.

Unfortunately, joining this unified currency system means that your awesome Office Depot printer is defunct. You also have differing economies, differing social needs, differing monetary needs and vastly different political systems. You can’t use your printer now because it only prints your old currency unit. But don’t worry, Lloyd worked at OfficeMax and he also has a sweet printer which prints our very shiny pretty notes.

So what’s the problem here? No one is their own banker anymore. The only person who controls the currency issuance is Lloyd. And Lloyd is very anal about new issuance because his island is a huge trade surplus nation that requires a great deal of price stability. Over time your island inherits his surplus as deficit. There is a trade imbalance. But you have no control over the currency. No control over the monetary policy. And your fiscal policy is essentially a beggar they neighbor policy. You have no ability to ease the strains on your people via monetary or fiscal policy. You’re handcuffed. This is the time where you hide under your desk and pray that a deep recession never hits because you know there is nothing you can do to save your country from the inevitable and painful austerity. It’s only a matter of time before Mariusz, Magnus and Maximus are hanging you upside down from your toes. You’re beholden to another foreign central bank. How did this happen? Is this beginning to sound familiar? It should….

The moral of the story here is that the U.K. made a remarkably brilliant decision to stay out of the EMU. They are their own banker. They control their currency and their monetary policy. This is obviously not the situation for our island friends above (or the people of Greece). They are not their own banker and have therefore imposed a great injustice on their people (in my opinion).

But the real moral is that the U.K. is the equivalent of our original island community with that awesome Office Depot printer. Can that island default? No. Not unless they somehow decide to. By definition, they always have money readily accessible as long as there is a functioning plug to which the Office Depot printer can be attached. They are their own banker. Of course, the controller of this awesome printer must be a wise man (or preferably a woman not from San Francisco). He/she must be a careful steward of the printer and ensure that money is spent wisely and in proportion to overall receipts so as to avoid leaving the private sector in deficit or massive surplus which could lead to inflation. But that is a different story altogether. The moral here is that the U.K. cannot default on its debts unless it chooses to do so (which would be silly) – almost as silly as joining the EMU.