Thursday, 28 April 2016

Brexit and The Looming Sterling Crisis

The latest opinion polls continue to show that the Leave and Remain camps are neck and neck in the EU Referendum.  But, as described recently, that means that the chances are that the actual vote will be to leave, by a sizeable majority, because history shows that in low polls it is the fanatical nationalists who will turn out to vote.  Economists have forecast that a Brexit vote would lead to a fall in the value of the Pound by around 20%.  But, if the polls stay as they are, such a sterling crisis is likely to happen long before the actual vote.  For one thing, if you are a foreign holder of sterling or sterling assets, why would you wait until everyone else rushes for the exits before you got rid of a depreciating asset?  But, there are other reasons why such a sterling crisis is likely prior to the vote.

If sterling drops by 20%, and the drop could be more than that, it would have several effects. Proponents of Brexit argue that such a fall could be beneficial, because it would make British exports cheaper, and so help the ever widening trade deficit be reduced.  That is unlikely.  Firstly, a large part of British exports is in the realm of professional services.  Demand for such services tends not to be particularly price sensitive, so low UK prices for such services is not likely to increase demand for them significantly.  If demand only rises by say 10%, whilst the price charged falls by the 20% caused by a lower Pound, then the consequence is actually a reduction in income of around 10%, which would act to increase rather than reduce the deficit.

In terms of other exports, Britain's manufacturing exports have been reduced to a core of more higher value commodities, and again, demand for these tends to be less price sensitive.  As far as other manufactured commodities, the trade deficit can be affected both by the ability to export more, or to substitute for imports with domestic production.  But, the reason British manufacturing production has become concentrated on the high value core output is that economies like China have such a competitive advantage that it is almost impossible to breach.  That is the case with volume steel production, as I set out recently.  British steel production is a tiny fraction that of China.  As with many other types of mass production, China not only has plants using the latest equipment, situated in purpose built industrial zones, providing efficient infrastructure and supply lines for inputs, but also has the benefit of still relatively cheap labour-power compared to an economy like Britain.

Even though wages and living standards in China have risen massively in the last couple of decades, they are still way below those in the UK.  On top of that, it has all these benefits of the economies of scale that come from capital being based in a huge single market, such as that which exists in China, the US or the EU.  A British steel industry is never going to compete for mass produced steel with a Chinese or a US or EU steel industry.  That applies to trying to compete for exports on a global scale with the industries from those economies, or simply trying to compete against imports from those countries. The only way that UK mass produced steel could compete against steel from these other economies would be via the imposition of import controls or tariffs.

But, that would have two consequences.  Firstly, the Brexiters claim that the EU would want free trade with Britain, because they export more to Britain, than Britain exports to the EU.  True, but as I pointed out a while ago, that is exactly why it would be Britain that would need to impose import restrictions on those cheap EU exports that would then flood into Britain!  As soon as Britain imposed these import controls to protect the British steel industry, and all the others that would find themselves incapable of competing against the much larger capitals operating out of these much larger economies,  Britain would find itself facing concerted retaliation, reference to the WTO and so on.

But, also those import controls would raise the cost of inputs for other British production.  That was what the US found some years ago when they imposed import controls on steel.  It meant that US carmakers and other manufacturers, faced much higher costs for the more expensive steel they now had to buy, which meant that either they had to absorb that higher cost from their profits, reducing economic growth, or else they had to pass on those higher costs in their own prices, which then made their production less competitive, and to the extent it went into domestic consumption, acted to raise the cost of living and reduce US living standards.

The same would be true for Britain on an even larger scale, because of the relatively small size of the UK economy.  The Brexiters boast about Britain being the fifth largest economy, but as I set out recently, it is a mirage.  Compared to the US economy, Chinese economy, EU economy, and the other economic blocs developing across the globe in Asia, Latin America and Africa, the UK economy is tiny.  Moreover, the UK economy is in long term relative decline, as it has been for more than a century.  Even compared with individual national economies, Britain could sink from fifth place to fifteenth place within a decade behind economies like Mexico and South Korea.  Outside the EU, that is almost inevitable.

The UK, could compete in the production of the relatively low output, high value, specialist steel production, where what counts is quality, and skilled labour.  But, again in those types of production price is not a decisive factor, so there would be relatively little benefit from lower prices resulting from a sterling devaluation.  In fact, it could mean that actual export earnings fell as a result of a lower pound.

But, the other obvious effect of a sharp fall in the pound is that the cost of imports would go up. There would undoubtedly be some import substitution as a result of that, but again the cost would be that this would raise domestic prices.  If British clothes manufacturers, for example, were then able to compete against Chinese manufacturers, it might mean that they would be able to expand production of suits etc.  But, the effect would be the same as if an import duty had been placed on the imported commodities.  British clothes manufacturers would only be able to compete, because the price of imported suits had been raised by 20%.  But, whilst some people might find employment in clothes production, as a result, the further effect would be that British consumers would face a higher cost of living as the price of suits rose by 20%.  That in turn would cause the value of labour-power to rise, which would mean that either real wages fell, if nominal wages failed to rise, or else all other costs of production would rise, making British made commodities more expensive, once more, and thereby removing any competitive advantage that might have resulted from the devaluation.

In the end, devaluation of the currency, like imposition of import controls can only be beneficial to the domestic capital in terms of gaining competitiveness, if the higher costs are born by falls in real wages by the workers in the importing country.  And, the fact is that Britain has a huge trade deficit, because it is reliant on importing large quantities of commodities, including energy.  The reason for that is not just the long-term relative decline of the UK economy, but the fact that starting from the 1980's, and continued by every government since, the UK has focussed on the creation of a low-wage/high private debt economy.

Although, in the 1980's a section of the economy drew in capital into high value production of services, and some high value products, too little capital was accumulated in those spheres.  Instead, large amounts of capital was sucked into low value service industries, and retailing, as described recently, in relation to BHS.  The blowing up of asset price bubbles, on the back of which the private borrowing was based, effectively destroyed capital - as, for example happened with pension funds, leading to the current pensions black holes - but also, there was in effect a mammoth process of asset stripping, as dividends and capital transfers were paid to shareholders not out of profits, but out of paper capital gains.  It is what lies behind the UK's atrocious levels of productivity.  And without productivity there can be no real competitiveness, no growth in real living standards, and no growth in real profits.  Brexit, will make those problems worse.

Even a 20% devaluation is unlikely to reduce UK imports, because its unlikely to be able to substitute for those imported commodities.  Consequently, a 20% devaluation will simply increase the import bill, and make the trade deficit widen even further.  In the absence of being able to pay for your imports by the export of goods and services of equal value, a country has to export capital, to bridge the gap.  But, a country that sees such a drain of capital, is on a path to destruction, because as Marx, following Adam Smith, realised, the wealth of nations comes from the accumulation of ever increasing amounts of capital, not its consumption.

The effect of that will be that as capital flows out of the country, the price of that capital, the rate of interest will rise, because the price is a consequence of the interaction of supply and demand for it.  As interest rates rise, the process of capitalisation will cause the price of revenue producing assets such as shares, bonds, and property, to fall.  Because interest rates in the UK are at such historically low absolute levels, any rise in rates will have a huge relative effect on those capitalised prices.  If the average rate of interest is 2%, for example, and doubles to 4%, the consequence is to halve the price of revenue bearing assets.

One means of effecting the transfer of capital would be that foreign capital could buy up British assets at knock down prices.  The prices of those assets would have fallen not just because of this process of capitalisation, but also because of the devaluation of the pound.  If an hectare of land produces £1,000 a year in rent, and currently has a price of £50,000, with interest rates at 2%, if interest rates rise to 4%, the capitalised value of the rent is then just £25,000.  But, if the pound falls by 20% against the Euro, the effect is also that Eurozone buyers could pick the land up for the equivalent of just £20,000.

The ironic consequence of Brexit would then be not to bring the greater domestic sovereignty and control that the Brexiters claim, but far greater foreign ownership and control of British assets and capital.  The Brexiters have referred recently to the takeover of the London Stock Exchange by the German Deutsche Bourse, claiming that this shows that EU businesses are keen to invest in the UK. But, again as described recently, in relation to BHS, this is to misunderstand investment.  Deutsche Bourse is not investing in the London Stock Exchange, in terms of advancing capital to buy additional buildings, computers and so on to be used in the Exchange.  That would be actual investment.  But, instead what Deutsche Bourse is doing, rather like Philip Green when he bought BHS, is not to make any such investment, but rather to simply buy a controlling number of shares in the company.  That does not involve any capital going to buy one single additional machine, or employ one additional worker.  It is really just a payment of money from one money-lending capitalist to another, in exchange for the shares they own.  In the process, Deutsche Bourse obtains the ability to drain profits from the London Stock Exchange business, and to use them to actually invest in additional capital in the German Stock Exchange.  It means that if Brexit were to happen, Deutsche Bourse would be in a position to increasingly make Frankfurt the financial centre of Europe, with London playing an increasingly diminished role.

So, its clear why a vote for Brexit would act to seriously devalue the pound, leading to a rise in inflation, an outflow of capital, a sharp drop in asset prices, which could then be bought up on the cheap by foreign capitalists, able to asset strip what they have bought.  But, its precisely for that reason that no sensible capitalist is going to get left holding the baby at the time of a Brexit vote, they will all, as the vote comes closer, want to offload that risk.

But, there is another reason why a sterling crisis is likely if the polls stay as they are.  For the reasons given previously, unless the polls suggest a 2:1 vote in favour of Remain, there is a strong possibility of a vote to leave, as the Brexiters are far more likely to vote than the supporters of remain.  Cameron and his supporters can offer no real positive view of remaining in the EU, because essentially they share all of the same ideological positions as the Brexiters, as his renegotiation showed, and as Theresa May showed in her recent speech.  Only socialists can offer a positive view of a future EU, but that positive view involves not more independence for Britain (and logically, therefore, other economies within the EU) but much further integration of the EU, the creation of a United States of Europe, with all of the centralised state functions, and requirement for democratisation of institutions that go with it.

Logically, a condition of British continued membership of the EU should have been that it joined the Euro when it was established.  As Paul Mason commented in his interview on the Daily Politics recently, the logic of the current position, is that Britain would leave the EU ultimately, however the referendum goes, because the Eurozone must form an ever closer political and fiscal union.  There can be no rational single market without that transformation, as every national economy discovered in previous centuries.  So, Britain outside the Eurozone is ultimately untenable, as is the existence of other EU economies outside the EZ.

In the past, such greater integration often came out of a crisis.  It is not beyond the realms of possibility that if Britain were to vote to leave, and then see its economy fall into a severe crisis following a sharp devaluation of the Pound, crash in UK stock, bond and property markets, as interest rates rose, and inflation soared, it would have to quickly apply for readmission to the EU for safety. That could even happen within the two year period when the negotiations for its separation was occurring.  Under those conditions, the EU would no doubt require the UK to give up its existing concessions, including its continued use of the Pound.  It would provide the basis for the creation of the kind of European state that is required to take the EU forward, and would be consistent with the bureaucratic, behind the scenes methods it has moved forward by in the past.

But, for the same reasons it is quite possible that such a sterling crisis could occur before any referendum vote, if the polls remain as close as they are now.  If all the above scenario were to play out, at the end of May, with the Bank of England having to step in to prop up a collapsing Pound by raising the official interest rates, which caused a collapse in share, bond and property prices, it would be a far more effective "Fear factor" than Cameron and his cronies have been able to muster in words, and it is the kind of manoeuvre that has been used many times in the past to persuade votes to vote vote the right way.

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