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Ajouter un commentaireThe UK banks have had generous credit policies. In other words, they lend too much money to borrowers, especially in the manufacturing and real estate industry, on the assumption that prices will continue to rise. This lending policy was successful, at least in the short term, thanks to trust and confidence based on indicators, such as economic growth, stable prices especially in the real estate sector. However in the long run, these economic indicators turned out to be not as solid as once thought. As a result, this lack of confidence was also translated into the British currency sector where the sterling has lost substantially in value.
Why is the Sterling so weak at the moment ?
- Source : Wikipedia
The reason behind the current sterling’s weakness is devaluation. However the latter was agreed upon by the Bank of England to improve the situation in the UK. Its intention was to both correct an anomaly and render the British economy more competitive and boost its exports. Instead, the rapid weakening of the sterling created new problems. For instance, if the sterling continues to be depreciated it will boost inflation, at least temporarily, through the cost of imported consumer goods and services and through the cost of imported raw materials and intermediate inputs, which in turn will lead to the rise of unemployment.
Recently, Prime Minister Gordon Brown warned against any policies directed at managing the sterling’s exchange rate. He said that last attempts at targeting exchange rates had failed and that the Bank of England was currently to target inflation : « That is the best way to bring about recovery in the economy and I would caution him [David Cameron, Conservative leader] and his party against any policies that would target sterling », he said.
Gordon Brown has called for the government to do more to support the pound. As a matter of fact, the pound has fallen by around 20 percent against the Euro and has reached its lowest level against the dollar over the past 20 years. But still policymakers continue to think that the decline in sterling has a positive impact on the economy.
What could the British government do to struggle against the weak sterling ?
The British government can struggle against the weak sterling through two main kinds of measures. Firstly, the British government should reduce the exposure of the state to the private banking sector. This could be done through a capital injection.
- Source : modified from ECB
However, by injecting money into the banking sector, the state is still exposed to the banks which could mean a nationalisation. The British government has already followed this route with Northern Rock and Bradford and Bingley. Consequently, the British government has guaranteed new medium term debt issuance by UK banks and therefore, guaranteed all deposits, retail and wholesale. Nevertheless, the main problem of nationalising a bank occurs when the bank goes bankrupt because the state has to reimburse all the bank debt. If the state does not make all creditors in full, the bank default becomes a sovereign default.
Secondly, the British government should reduce the threat of exchange rate crunch by (a) announcing that the UK is actively pursuing EMU (Economic and Monetary Union) membership at the earliest possible date and (b) ’adopting a peg with the Euro’ (Buiter, 2008). It would be very helpful for the British economy to have access to the resources of the Euro system. But to enter in the Euro zone, the UK must meet the so-called five convergence criteria. However, today’s British economy does not meet the debt criterion for EMU membership (gross general government debt less than 60 percent of annual GDP). Moreover, the UK does not meet the Maastricht deficit criterion either (general government financial deficit less than 3 percent of GDP). Yet, the inflation criterion will probably be met considering UK inflation and EU inflation seem to be well synchronised.
But what does the term ‘financial crisis’ mean ? In the broad sense of the term, it is when demand cannot meet the market. According to Willem Buiter a ‘financial crisis is a situation where quantity rationing of would-be borrowers and would-be sellers of securities suddenly replaces normal market clearing through variations in interest rates or market prices of securities’.
Moreover a sterling crisis does not require a fixed or managed exchange rate regime for sterling. It can occur even when sterling floats, which means, when its external value is market-determined, as it is today.
Should the UK adopt the euro ?
The UK has always been very independent from the rest of the EU. Sterling constitutes a consequent part of the British identity that is why British people appear to be quite to reluctant to adopt the euro money and to abandon the sterling. Over the past years, sterling has nearly always been very strong. However from the beginning of the financial crisis the sterling has lost substantially in value. That is why ; nowadays the British government start to think about adopting the euro. Nevertheless, the UK has to face to major difficulties such as public opinion and criteria set by the Maastricht Treaty.
Five economic tests for the introduction of the Euro
The five economic tests are the criteria defined by the UK Government that are to be used to assess if the UK is ready to join the Euro Area readiness to join the Economic and Monetary Union of the European Union and therefore to adopt the euro as its official currency. The five tests are as follows :
1. Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis ?
2. If problems emerge is there sufficient flexibility to deal with them ?
3. Would joining EMU create better conditions for firms making long-term decisions to invest in Britain ?
4. What impact would entry into EMU have on the competitive position of the UK’s financial services industry ?
5. In summary, will joining EMU promote higher growth, stability and a lasting increase in jobs ?
Definition : Exchange rate mechanism (ERM)
Process by which member countries of an economic community (such as the European Union) maintain exchange rate parity among their currencies. The currencies are allowed to fluctuate with respect to one another within a specified limit. If the exchange rate between any two currencies reaches the limit, the central banks of both countries intervene to bring it back within the limit. Source : Business Dictionnary
Even if some bookmakers were retending at the end of 2008 that the UK was about to join the Euro zone, it is hard to believe in the foreseeable future. On the one hand, euro sceptics see the single currency as the stepping stone to a unified European Union, which is by definition the idea that they have always strongly rejected. Moreover, the UK benefits from a particular position with its transatlantic relationship and it has always proclaimed itself to be independent from the rest of the EU. On the other hand, Gordon Brown has always rejected the idea to enter in the Euro zone ‘the decision not to join had been right for Britain and for Europe’. Moreover Tony Blair’s government had underlined that to enter in the Euro zone it was absolutely necessary to meet the ’five economic tests’. Nevertheless, only one of these criteria passed. Similarly, the government promised to hold a referendum on membership of the Euro zone once the five criteria were passed. In any case, it is absolutely necessary for the UK to meet the criteria (as described before) highlighted by the Treaty of Maastricht before applying for membership.
Considering the EMU criteria are not fully achieved by the UK, the UK is likely to set a fixed peg for sterling vis-à-vis the Euro or a central parity with a very narrow fluctuation margin with no more than 1 per cent on both sides. In doing so, the UK should begin the two year process so as to enter in the Euro zone. The European Council could eventually waive the Maastricht criteria for the UK because of the exceptional circumstances. A currency peg of the sterling against the Euro could make sense only if it is done with the full agreement of the European Central Bank and every member of the euro zone. The sterling would probably be a little bit less depreciated than it is currently which could avoid the UK to benefit from a competitive advantage.
The sterling crisis could be partially solved if the UK government would reduce the exposure of its banks by making new policies and legislation. Nevertheless, privatisation could create a high risk of a sovereign debt crisis and sterling crisis. What’s more, pegging the sterling vis-à-vis the Euro would be not only a sign of the formal entry of the UK into the Euro zone but also a sign of a stabilisation of the UK’s financial and macro economy. Both measures would remove the sovereign insolvency and exchange rate risks faced by the British economy.
The five convergence criteria (according to the European Commission)
What is measured :
Price stability, Sound public finances, Sustainable public finances, Durability of convergence, Exchange rate stability
How it is measured : Consumer price inflation rate : Not more than 1.5 percentage points above the rate of the three best performing Member States
Government deficit as % of GDP : Reference value : not more than 3%
Government debt as % of GDP : Reference value : not more than 60%
Long-term interest rate : Not more than 2 percentage points above the rate of the three best performing Member States in terms of price stability
Deviation from a central rate : Participation in ERM II for at least 2 years without severe tensions
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Gran Bretagna : riuscirà la Sterlina a salvare l’economia inglese ?
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