Global Glance: October 17, 2016
A quick look at intriguing international stories
By John Bostwick, Managing Editor, Radius
Brexit and the Fall of the British Pound
A few weeks ago I mentioned that the Mexican peso and the UK pound have been the two worst-performing major currencies so far in 2016. Since then, the UK pound has been back in the news for its continued, indeed historic fall. The Wall Street Journal reported last Monday that the pound suffered a “flash crash” the previous business day, losing six percent of its value in minutes. The article explains that the abrupt crash “has been attributed to a trading error,” but the glitch only served to heighten awareness about the currency’s ongoing decline. A related Journal article last Wednesday notes that the pound “has likely never been weaker when measured against those of Britain’s trading partners.”
The pound is slipping amid concerns that the UK will make a so-called “hard Brexit,” which would see new, far more limiting UK immigration laws that could alienate EU authorities and in turn remove the UK from Europe’s single market. These concerns were stoked earlier this month when British prime minister Theresa May hinted at a hard Brexit, saying, according to The New York Times, “We have voted to leave the European Union and become a fully independent, sovereign country. … We will do what independent, sovereign countries do. We will decide for ourselves how we control immigration.”
The Financial Times reports that May has engendered further concern among investors by refusing to reveal her government’s negotiating plans, and “has not promised to allow MPs a formal vote on the government’s negotiating strategy.” Last week, she mitigated these concerns somewhat — and helped buoy UK currency — by “agreeing to demands for ‘a full and transparent’ Commons debate before the Article 50 exit clause is activated.” May, however, still “does not want to put her negotiating demands into the public domain” before triggering Article 50, the formal means of announcing a departure from the EU.
Neil Irwin of The New York Times writes that the pound is falling “most immediately because of comments from French and German leaders suggesting they will take a tough line in negotiating Brexit.” He adds, however, that there are other, more fundamental reasons for the decline. He notes that in the immediate aftermath of the Brexit vote, May became prime minister and offered, or seemed to offer, the prospect of a soft break with the EU, in which UK exporters “would retain access to European markets” and London would “remain the de facto banking capital of Europe.” In addition to May’s perceived conciliatory stance, Irwin writes, the Bank of England took palliative steps just after the vote, including cutting interest rates.
Irwin reminds us that since those early mollifying measures, May and other British authorities have taken a tougher stance. This “shift in tenor” could simply be a bargaining ploy in advance of Brexit negotiations. He warns, however, that “staking out that ground means risking the very economic damage that a conciliatory tone and easy money helped avoid over the summer.”
The pound was in the news last week in part because of the flash crash, but its value has fallen steadily since the Brexit referendum and is down 17 percent since the day of the vote. Monday’s Journal article explains that the currency situation has led many UK companies to change their hedging strategies and consider other currency risks. Leslie Holstrom, the global head of products at Eurofinance in London, is quoted as saying related uncertainty is “paralyzing financial decision-making on everything from investment decisions to tax and earnings plans.”
Greg Ip’s “How Sterling’s Crash Paves a New Path for British Growth” provides an excellent summary of the reasons for the pound’s recent weakness and how its fall both helps and hurts Britons. He writes that “the decline in sterling and an uptick in British government yields are a completely logical adjustment to the changed environment in which Britain will soon find itself.” He adds that the deflated pound and higher interest rates will mean that the UK will “henceforth have to consume less and export more of what it makes.” Moreover, the currency’s fall will increase inflation, thereby lowering UK citizens’ standard of living.
Ip also addresses the benefits of a lower pound, including an increase in British exports and an increase in the value of UK investments abroad. “And,” Ip adds, “by reassuring foreign investors that future appreciation is more likely, a cheap pound eases the financing of the deficit.”
Like so many others, Ip sees the fall of the pound as a direct result of Brexit-related uncertainties. And he asserts that Brexit itself is “turning out to be a useful test case for deglobalization.” He anticipates that the likely effects of Brexit will be a neat balance of pros and cons: “Britons may be a bit poorer than if they’d stayed, but more self-reliant and more in control of their own borders.”
A response to Ip’s column by Ryan Avent was published a few days later in The Economist. Avent doesn’t dispute Ip’s reading of the reasons for the pound’s fall. He does, however, question two of Ip’s assumptions. First, Avent is dubious that British industry can, as Ip puts it, “find buyers in other markets that transportation and trade barriers had previously made unappealing.” Avent maintains that “in the trade of goods, distance matters,” and British “firms will find it difficult to turn and embed themselves in the production chains of Asia or North America; such places are simply too far away.”
Finally, Avent wonders about the assumptions behind Ip’s idea that Brexit may lead to increased British “self-reliance.” Exactly who or what is the “self” in this context? Avent writes that “Mr. Ip seems to intend the self, in this case, to be Britain.” Avent, by contrast, believes that “the self” referred to by Ip represents something narrower than the whole of the nation. The self here is the impulse behind the Brexit movement, and according to Avent: “It is a conservative sort of Englishness, which entails the rejection of London as well as of Brussels. … It is a vote against cosmopolitanism and multiculturalism.”
Ip’s article on the UK’s currency situation, and Avent’s response, are short, well-reasoned takes on a complicated economic situation. They’re also reminders that our political beliefs tend to insinuate themselves into virtually any analysis, no matter how hard we may try to be dispassionate.