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ABSTRACT
The Brexit referendum marks a critical juncture in Britain’s political economy. Benjamin Cohen argues that a nation’s monetary sovereignty lies in its balance of payments (BoP) flexibility (2008, 2015). I argue that a country’s position in the global financial régime must also be accounted for when explaining its BoP dynamics. This allows us to understand why, while sterling has long lost its ‘world currency’ status, Britain’s BoP exhibits some of the same features associated with American ‘exorbitant privilege’. To appreciate the UK’s own BoP flexibilities as well as to flesh out the Anglo-American axis in the international financial order, I compare the UK’s external balance sheets with those of the US. Given the complexities and uncertainties inherent in BoP analyses, I advise against micro-analyses of the BoP in favour of a broader approach that takes into account macro-dynamics as well as the International Political Economy (IPE) concerns outlined above. Elaborating such an analysis for the UK BoP, I explore the potential implications of Brexit for Britain’s external balance sheets and its political-economic future. While Britain’s financial power has helped insulate its balance sheets from external shocks, Britain’s impending departure from the European Union heralds a period of considerable uncertainty.
Acknowledgement
Many thanks to Tony Norfield for advice on researching the UK’s balance of payments, lessons from British economic history and invaluable commentary on an earlier version of this article.
Disclosure statement
No potential conflict of interest was reported by the author.
Notes
1. The BoP accounts measure a nation’s trade and financial transactions with the rest of the world. The current and financial accounts record the flows of goods, services, incomes and financial transactions. The stocks of the country’s foreign assets and liabilities are also recorded.
3. Geographically, the City refers to the financial district situated in the square mile of the City of London but like others – including Norfield (Citation2017) and Shaxson (Citation2012) – I use the term more broadly to signify the UK’s financial sector as a whole. This not only includes Canary Wharf in London but also other financial hubs including Edinburgh.
4. McCloskey (Citation2017) recently noted how BoP measurements ‘besides hard to get right … [are] meaningless’. Her remarks echo those of the former US Treasury Secretary, Paul O Neil. http://www.economist.com/node/1325394.
5. The latter refer to the large trade and financial imbalances of the major economies including the US and China – striking contours of the global economic landscape over the last few decades (Ali Citation2016b).
6. Chin and Frankel (Citation2008), for instance, employed central bank reserve-holdings to (incorrectly) predict that the Euro would surpass the dollar by 2015.
7. If the country cannot borrow more or if it is forced to sell its assets to foreigners.
8. The official settlements balance measures ‘the financing of the current account deficit by the central bank and foreign central banks’ (Krugman et al., Citation2012 313).
9. I owe this point to an anonymous referee.
10. i.e. financial outflows.
11. Even after Britain’s retreat from the Suez – which some commentators mark as the transition of the world’s hegemonic power from Britain to the US – in 1957, sterling was still financing almost half of world trade (Norfield Citation2017; 37; Cain and Hopkins Citation2001; 631).
12. Before WWI, the City had been the largest hub for loans, bonds and other securities (Norfield, 34).
13. Helleiner (Citation1994) argues that the Euromarkets led to the reconstruction of the 1920s ‘London-New York financial axis’ (89). Ironically, these unregulated Euromarkets also ruptured the incipient Bretton Woods régime (Palan Citation2015).
14. The bon mot employed by Norfield (Citation2017 232) to describe the UK’s political-economic role in relation to the US and other leading powers. By ‘consigliere’, Norfield (Citation2017 232) argues that the UK’s role is more than that of a major hub in global finance. It is also as an advisor to ‘imperialist powers’ such as the US.
15. Measuring GDP at purchasing power parity, the UK ranks as the world’s 9th largest economy (World Bank, Citation2017).
16. These include ‘visibles’ (manufacturing) and ‘other visibles’ (non-manufactured goods) such as oil and other commodities.
17. Incomes on foreign assets minus incomes earned by foreigners in the home country.
18. Known as ‘secondary income’ in Britain’s BoP, these are primarily composed of non-market transactions such as international aid and transfer payments to the EU (Coutts and Rowthorn Citation2013).
19. The danger in this, of course, is that raising interest rates to attract overseas financial inflows may promote unproductive investment (ibid).
20. As Thatcher’s Chancellor of the Exchequer, Nigel Lawson was instrumental in pushing the ‘Big Bang’ reforms.
21. Obstfeld (Citation2012) also argues that in a BoP crisis, the distinctions between ‘public’ and ‘private’ become irrelevant.
22. Deputy Governor for Monetary Policy (2014–) and External Member of the Monetary Policy Committee of the Bank(2014–2017) respectively.
23. This was later revised by the Office for National Statistics to −4.3% of GDP.
24. Forbes refers to Suez while Broadbent points out that the present deficit is ‘significantly larger than at the time of the UK’s post-war currency crises’ (Broadbent 10).
25. Foreign assets – Foreign liabilities.
26. Forbes (Citation2016) notes the relatively faster growth of the UK relative to its trading partners.
27. Half of foreign portfolio inflows included gilts – HM Treasury bonds which tend to have long-term maturities – while a quarter included equity which isn’t subject to refinancing risk (Office for National Statistics Citation2016a).
28. I thank Tony Norfield for pointing this out.
29. Obstfeld (Citation2012) notes that the literature hasn’t drawn a causality between current account imbalances and financial crises, while Borio (Citation2015) maintains that current account surpluses are no guarantee for macro-stability. Both Obstfeld and Borio argue that credit booms rather than current account deficits precipitate crises.
30. Indicative of this turn away from the traditional/Keynesian focus on the trade account in favour of the financial account was the provocative title of Obstfeld’s Ely Lecture at the ASSA meetings in 2012: ‘Does the current account still matter?’ (His lecture, however, affirmed the importance of the current account as a policy variable.)
31. Based as they are on a residency basis, Britain’s external balance sheets do not capture the full extent of the City’s offshore operations.
32. the main component of net primary income (Office for National Statistics Citation2016a).
33. Especially in the FDI category (Ali, Citation2016b).
34. Forbes notes that in 2014, ‘the investment income deficit (−1.8% of GDP) was almost as large as [the] trade deficit (−1.9% of GDP)’ (13).
35. These include reclassifications and write-offs. Reclassifications might involve change in a firm’s residency status or write-offs from bankruptcy (Office for National Statistics, personal correspondence, September 2016; Gourinchas, Rey, and Truempler Citation2011, 3).
36. Net valuation effects may be affected by compositional differences between assets and liabilities as well as the initial size of gross stocks.
37. Because of BoP accounting conventions, negative numbers indicate capital inflows.
38. Given limited space, I do not show these figures but am happy to provide them.
39. Evidence of the UK’s sensitivity to US monetary conditions is provided by Passari and Rey (Citation2015) who find mortgage spreads in the UK highly responsive to US monetary policy shocks. This monetary shock transmission undermines the Mundell-Fleming trilemma: even the UK, a liberalised floating exchange-rate régime, is vulnerable to external monetary shocks from the US (Passari and Rey, Citation2015). This is yet another aspect of the Anglo-American axis in international finance.
40. These are primarily loans and deposits (Bank of England Citation2016a). Less than a quarter of these are the assets of UK-owned banks (ibid, 6): in short, they are largely held by foreign institutions.
41. Derivatives owned by foreigners (liabilities) closely track foreign derivatives assets as these are off-setting deals. Showing derivatives liabilities alone risks exaggerating their importance. I owe this point to Tony Norfield.
42. bolstering the value of non-sterling foreign assets.
43. Gagnon argues that while positive income balances might lessen some of the negative impact of the US NIIP, income balances themselves may, in part, be a statistical artefact of MNC tax avoidance strategies. This is also the view of Gohrband and Howell (Citation2015). Gagnon neglects to mention that the NIIP may also be mismeasured as argued by Hausmann and Sturzenegger (Citation2006). In terms of policies to bolster the NIIP by reducing the current account deficit, Gagnon recommends dollar devaluation and increasing national savings.
44. Exchange rate changes were especially powerful: they drove almost half of the annual changes in valuation (Forbes 12).
45. However differential economic growth is but one measure of economic power.
46. I thank an anonymous referee for this insight.
47. Obstfeld cites Gohrband and Howell (Citation2015) who argue that the rate of return differential between foreign assets and liabilities may be driven by tax avoidance.
48. An artificially lower stock of assets, in turn, artificially enhances the rate of return on UK FDI (Office for National Statistics Citation2016a; Whittard Citation2012).
49. Both FDI and portfolio investment are affected by this (Gourinchas, Rey, and Truempler Citation2011, 15).
50. This is because the retained earnings of the overseas subsidiaries of UK firms may, in part, accrue to foreigners rather than Britons, while the earnings of foreign subsidiaries in the UK may also accrue to foreigners.
51. When firms shift their headquarters overseas post cross-border mergers.
52. The ONS bypasses making adjustments for transfer pricing, downplaying its possibility on grounds of its illegality: ‘[t]ransfer pricing to avoid tax is illegal in the UK so the distortions in the international accounts caused by transfer pricing are not considered widespread. For both reasons, adjustments to account for transfer pricing are rarely made in practice’. (Office for National Statistics Citation2015, 7). Lane notes that transfer pricing impacts the trade balance and the NIIP but not the current account balance as changes in net exports are offset by changes in investment income (Lane Citation2015, F71).
53. Broadbent’s analysis predates the 2016 uptick in the NIIP.
54. Campos and Coricelli (Citation2017) assert that the post-war renewal of British economic growth began around 1970 when the UK acceded to the European Economic Community. This pre-dates Thatcher’s structural reforms which many attribute as the cause of Britain’s modern growth revival.
55. Passporting rights allow companies to sell services throughout the single European market from one location in the EU. More than 5,500 UK registered companies use this provisioning (Arnold Citation2016).
56. Over the last five years, gold (in whose trade London is a global centre) has been the UK’s second-largest export after cars http://news.sky.com/story/how-gold-takes-the-shine-off-britains-trade-balance-11056152.
57. The City’s FRPS export surplus is greater than the combined financial services export surpluses for the US, Switzerland, Luxembourg and Singapore (TheCityUK Citation2017).
58. London is the predominant global clearing house for euro-denominated derivatives.
59. Relatively more restrictive US laws long compelled American banks to rely on their less regulated UK operations – in fact, the 2008 financial crisis partly originated in the London operations of New York investment banks.
60. More than 90% of UK foreign assets are denominated in foreign currency (Bank of England Citation2016, 6).
61. For monetary authorities, this poses a dilemma between higher interest rates (to prevent financial out-flows in the face of devaluation) and declining aggregate spending which requires monetary easing.