15 April 2004 21:33
Football, fuel and funk money: overseas capital is helping keep the pound afloat
IN FOOTBALL Chelsea is kept running on Russian money. In housing the top end of the London market is supported by
foreign money, including the purchase last week of the world's most expensive home. And, to judge by the recent
recovery of the pound despite the widening current account deficit, the whole economy must be relying on more than the
Russians and the Saudis to keep the currency afloat.
Up to now the main focus on UK financial imbalances has been on the domestic account: the extent to which the country
has relied on personal and government borrowing to keep growing through this economic cycle. We have heard a lot about
the dangers of a collapse of house prices and the plight of the first-time buyer and, on the government side, that the
next chancellor will have to increase taxes or cut spending.
But the external deficit is the dog that has yet to bark. In the past few months the widening US current account
deficit has hit the dollar, but the pound has remained pretty stable.
Indeed the pound is now comfortably back into the trading range that it established at the beginning of 1997 at
between 100 and 108 on the Bank of England's trade-weighted index (first graph). The long decline that occurred
since the devaluation of 1949 now seems ancient history and the post-ERM dip of the early 1990s appears a bit of an
aberration.
So should we worry about the current account deficit at all? It is stuck at about 2 per cent of GDP, half that of the
US. Given the fact that faster growth is forecast for this year for the UK vis-a-vis the eurozone, it is very hard to
see the current account narrowing much. On a long view a 2 per cent deficit may be acceptable - it is certainly much
smaller than at many periods in the past, including the latter 1990s (see next graph). Nevertheless there are at least
three features of our balance of payments position that should make us twitchy.
One is the deterioration of the goods account. The third graph shows we are back almost to the levels of the early
1970s and late 1980s. The gap is to a large extent covered by the surplus on services and as you can see, our services
account is vastly more stable than our goods account. But it is hard not to feel a little uneasy to see the gap widening
so much.
Next, while the surplus on services appears solid enough, there have been changes in its composition over the years
that may make it less secure in the future. On the earnings side we have become more dependent on interest and dividends
from abroad and more dependent on income from the financial services industry. There has been an improvement in the
terms of trade: imported goods have become cheaper, while the services we export have become more expensive. But while
it is great to buy cheap and sell dear, there must be a limit to the amount our bankers, insurance people and lawyers
can charge for their services.
And on the payments side we are spending more on interest payments to support our overseas investments. In essence we
have borrowed short-term and invested long-term. Since we have been able to get higher returns on our investments than
we pay in interest, this appears a good deal. But as anyone who has financed buy-to-let properties on a mortgage will
attest, you become vulnerable to any rise in interest rates or fall in rental income.
Next, we may have to increase our net contributions to the European Union. Membership at the moment costs us about
one-third of a percentage point of GDP, which has to be paid across the exchanges. This subsidy to other EU countries is
deemed to be an acceptable burden, even if the money to which the subsidy is put - European farmers - is not. But the
burden would be even larger were it not for the UK's rebate, and with the enlargement of the EU that is under
threat.
Then there is oil. The UK is still - just - a net exporter of oil but soon we shall become a net importer again. That
puts us in the same position as all other European countries with the exception of Norway. In terms of the impact on
overall living standards the shift is not that important but it will affect the current account. In three years'
time, depending of course on the price of oil, it could add another one percentage point to the deficit.
We seem able to attract a sufficiently large inflow of capital to cover a deficit equivalent to 2 per cent of GDP. It
is, however, quite hard to pin down quite why the money is coming here. To some extent you can say that this is foreign
direct investment, used to build plants here, and in the past this has been big: nearly 40 per cent of our manufacturing
capacity is foreign-owned. Some is portfolio investment, buying shares in UK-listed companies. Big takeovers affect the
flows too - so when the Russians come to buy a football club, that creates a flow of money into sterling.
But it is hard to pin down exactly what is happening, for there is so much random noise in the statistics it is hard
to hear the signals. My guess is that at the moment the UK is attracting a lot of funk money: money that comes here
because if there is a revolution in, most obviously, Saudi Arabia, the elite will choose London and Geneva as the two
main safe havens for their future. The US is out, for obvious reasons, and Monaco is too small.
There is only anecdotal evidence - reports from London estate agents and the like - but I get the feeling that right
now a lot of funk money is arriving in Britain, and not just from the Middle East. The UK has become a beneficiary of
global turmoil, increasing its relative attractiveness vis-a-vis the US.
What might change this? A calmer global political outlook would help, but sadly that does not seem a realistic
expectation. Were the Treasury to misplay its hand in negotiations on the residence/domicile of foreigners, it could
certainly manage to drive money away. But the pitfalls are so obvious that it surely could not make such an error. If it
started losing revenue it would pretty soon mend its ways.
Sadly, we have these days to acknowledge that a serious terrorist attack would be financially damaging as well, of
course, as disastrous in human and political terms. London managed to cope with the IRA attacks with a competent
damage-limitation exercise but a new attack might well be of a different order of magnitude. One of the prime reasons
why the foreign communities come to London is that they feel it is a welcoming as well as a secure place. There is an
obvious danger that mood might change.
None of this is cause for immediate alarm about the value of the pound. The fact that the dollar should have
recovered in recent weeks suggests that investors are more persuaded by growth prospects as by the formal current
account numbers. A capital inflow is a sign of a healthy economy and as a general principle it is impossible to have a
capital inflow if you don't also have a current account deficit. The balance of payments has to balance.
So no immediate panic is in order; just a nagging concern that the current account needs to be watched carefully. If
the Russians (and Saudis and Indians and Chinese) stop coming, there may be a problem for the pound.
[The Independent] |
RUSSIA IN FACTS
