08 September 2016
The Bounce-Back In Activity
A revival, or just maths?
By John Watson
Supporters of the England cricket team are entitled to celebrate its triumph over Pakistan in the Fifty Over version of the game. Records have fallen; the numbers are terrific; open the champagne!
Despite the self-satisfied smiles on the faces of the Brexit supporters, no similar comfort can be drawn from the rebound in activity in the manufacturing, construction and services sectors. Of course it is better to have good figures than bad ones. Of course it would be worse if the pound had continued to tumble, but the strong recovery in activity was very predictable. Reflect on the numbers. The pound now stands at $1.3422 as against a pre-Brexit record of $1.559. Against the euro, it is 1.19370 against a high of 1.42950. Those are big drops, and they have the effect of making British goods and services cheaper. To be more precise about it, that is some 14% cheaper against the dollar and some 16% cheaper against the euro.
It can be no surprise that that has increased activity. If you assume the prices were already in some sort of equilibrium so that, say, a car made in England would have cost broadly the same as the equivalent car made in Germany, the English car is now much cheaper and a rational purchasing manager will buy it rather than a German one. The improvements in activity are not, then, the result of “a vote of confidence in Britain”, “a desire to forge new relationships” or even “the Boris Johnson effect”. No, it is nothing like that. They simply follow, as night follows day, from the decline in the pound.
The same logic applies to the recent rally in the stock market. The FTSE index was down to around 6000 at about the time of the Brexit vote. Now it is over 6800, more than 10% up. Isn’t that a sign that the market has confidence in Britain? No, I am afraid not. It’s the maths again. Yes, it does look good but you have to bear in mind that although the FTSE is an index of shares listed in London, the companies are international with international revenue streams. Sometimes those streams will be sterling earnings from UK activities but, if you take the market as a whole, a very considerable proportion will be in euros, in dollars, in rand or in any number of different currencies, and will be earned by trading in places many thousands of miles from the UK. If the pound declines, those revenue streams become more valuable in sterling terms. So, surprise, surprise, the market rallies. Again this is not primarily because of some recovery of confidence but because that is the way in which the figures work.
In the days before Brexit there was a particularly irritating description of the UK which one could hear used in the bars of the City of London. “A first class city linked to a third class country” some sharp-suited broker would say, with the self-satisfied smirk which presumably meant that he associated himself with the London end of the union. In a politer version people would say that London was more European than British – meaning that they were at the financial heart of Europe and that the rest of Britain could be dismissed as a minor embarrassment. Neither statement was ever really true, of course, but below the surface there lurked a different truth, that one of the factors driving the decline of British manufacturing was a currency which stood high because of the predominance of the City. In that sense London did oppress other parts of the UK and the drop in the currency, surely a prediction of the City’s post-Brexit decline, will naturally tend to revive them.
Mrs May has, since coming to office, made much of the importance she attaches to ensuring that the financial system works for all. Oddly, the decline in sterling may help to achieve a more economically balanced country although one suspects that overall it will be a rather poorer one.
There are echoes here of a similar imbalance in the EU itself, with the workshop of Germany in the north keeping the euro at a level which makes it impossible to sustain full employment in the south. There, of course, no one is suggesting that Germany should be less successful and, short of a degree of integration which looks unlikely at the moment, it will remain reluctant to transfer sufficient of its profit to its southern friends to revive their economies.
Although we and the EU face a similar problem there is a fundamental difference. Politics and state aid rules within the EU make substantial transfers of funds a highly intractable problem. Here we will be a single country free from regulation concerning state aid and the like. It will be the perfect laboratory in which to explore different ways of moving funds from one area to another. We would, I think, prefer to achieve more uniformity through substantial transfers of revenue round the country rather than relying on further declines in sterling as a result of less business flowing through the City of London. It will be interesting to see how the new Prime Minister and her new Chancellor of the Exchequer decide to tackle it.
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