Photo by Tolga Akmen/AFP via Getty Images)
Artillery Row

Sterling’s last stand

War enthusiasm is endangering the British economy

As summer began in 1984, coal miner strikes were rocking Britain. Amidst the chaos, National Union of Miners president Arthur Scargill sat down with Alaistair Burnet to discuss the situation on television. Scargill’s tone was measured but firm. Gone was the gruff Yorkshire accent that he used to address his fellow miners on the picket lines. Instead, he spoke with a soft, television-friendly pronunciation. Scargill came across as a man assured that he would win. He spoke out against the government’s attempt to “steamroll the mining industry into a pit closure program”. 

When faced with a question of some pits being more costly than others, Scargill pushed back hard. “You can’t take an industry and say that one unit is cheaper than another so we’re closing one down,” he said, “We’ve got a mining industry as a whole. And you can’t destroy communities. If we give the farmers of Britain very substantial subsidies there’s no reason why we, in common with other countries, cannot give our miners the same help.” Many at the time saw this as a purely self-interested plea — but examined in the light of the looming energy crisis this winter, Scargill’s statement makes quite a bit of sense indeed.

War has been the ruination of Britain throughout the 20th century

In the 1980s, when Scargill’s influence was at its peak, there were 327,000 people employed in the British mining industry. By the mid-2000s this had fallen to a measly 6,000. But Scargill continued to argue the case for British coal. In 2008 he attended the climate camp at Kingsnorth and by all accounts met with a frosty reception. In an article he wrote for The Guardian after the event, he made the case that coal was compatible with the movement against climate change. Arch-climatista George Monbiot wrote a scathing and condescending response, saying that Scargill was a “brave man” for attending the climate camp. The gulf between the working-class left of the 1980s and the Oxford-educated left of the 2000s could not have been made clearer. In accepting the terms of the debate, Scargill had set himself up to fail — a political fossil making the case for fossil fuels.

From Making Things to Making Money

As the mining industry collapsed in the 1980s, British industry more generally went with it. In 1980, British manufacturing made up around 23 per cent of gross value added. By 2010 it had bottomed out at around 10 per cent. Because the country ceased to produce goods on a meaningful scale, it began to run enormous and ever-increasing trade deficits. In the first half of the 1980s, Britain ran an average current account surplus of around 1.3 per cent of GDP. By the 1990s this had deteriorated into an average current account deficit of around 1.4 per cent of GDP, and by the 2010s things had deteriorated further still with Britain registering an average current account deficit of 3.7 per cent of GDP. In the first quarter of 2022 the current account deficit hit a record: an eye-watering 7.1 per cent of GDP.

How has Britain been able to afford this? Unlike the United States, Britain does not have the global reserve currency. Even the United States has never flirted with a current account deficit of 7.1 per cent. Once again, we can trace the origins back to the 1980s. In 1983, the Thatcher government and the London Stock Exchange moved to settle a wide-ranging antitrust case that had been launched by the previous government. The case imposed on the City of London various onerous financial regulations that stymied the City’s capacity to become a serious international financial centre. The Thatcher government moved to demolish these restrictions. The day they finally changed, on 27 October 1986, became known as the Big Bang.

Quite a bang it was. By 2021, Britain had a financial services sector the same size as that of the United States. At eight per cent of total economic activity, only Switzerland and Luxembourg had larger financial sectors. Whilst Britain may run enormous trade deficits in manufactured products, it runs large surpluses in the market for financial services. In 2021, Britain exported £61.3bn worth of financial services and imported only £16.6bn — a trade surplus in the market for financial services of £44.7bn and an enormous increase from 1997 when the surplus was just above £10bn.

These statistics capture how important the financial sector in Britain has become for high-paid jobs. They do not capture how important the City of London has become in financing Britain’s enormous trade deficits. When a country imports more than it exports, this results in the rest of the world holding an excess of that nation’s currency. In the case of Britain that means an excess of sterling. The country that holds this excess has three choices: it can hold onto the currency as reserves; it can recycle the currency back into the deficit country’s financial markets; or it can sell the currency in the foreign exchange markets. The first two options mean that the currency in question retains its value; the third means that it declines in value.

The City of London allows foreigners to recycle their currency back into Britain. To put it succinctly: Britain is allowed to run large trade deficits because its trade partners are keen to hold British-domiciled financial assets. This in turn allows Britons to live beyond their means. Foreigners send Britain goods they would otherwise be unable to afford, Britain sends sterling in return and instead of dumping sterling onto foreign exchange markets — thereby driving down its value and rendering the goods less affordable for Britons — the foreigners buy British financial assets. Britain is a potentially rather low-income country living the life of a high-income country, and the whole show is kept on the road by the financiers in the City. A clever arrangement — but clearly an unstable one.

War Enthusiasms

Britain is a country that is enthusiastic about war. Perhaps too enthusiastic. War has been the ruination of Britain throughout the 20th century. Yet Britain seems stubbornly unwilling to learn the lessons that history is trying to teach it. It all started with the First World War. The causes of the war are endlessly debated, but what is clear is that the war emerged out of a changing world. Until the war, Britain was undoubtedly the most important country in the world. The British Empire was enormous, impressive and imposing. It made other countries — most notably Germany — want a piece of the action.

Sanctions policies threaten a collapse of the European economies this winter

By the end of the war the British Treasury was bare. The gold standard that had stood unbroken behind sterling for almost a century was abandoned at the outset of the war. The paper sterling remained in effect until 1925 when Chancellor of the Exchequer Winston Churchill introduced the Gold Standard Act. In his accompanying speech, Churchill made the case that the return to the gold standard was necessary to maintain the financial linkages that underlay the British Empire. But it did not last long. Britain was no longer the country it was before the war, and the gold standard brought with it a depression and a highly unsettling general strike in 1926. The gold standard was once again abandoned in 1931, and sterling would remain purely paper for the next fifteen years.

The Second World War was embraced more cautiously by Britons than the first. When Hitler invaded Poland in 1939, the British people still remembered the privations and loss of life the previous war had brought with it. Chamberlain’s attempts to maintain the peace are routinely subject to derision today, but at the time they were perfectly reasonable. If it was not clear in 1914 what global war meant for the future of Britain, it was crystal clear in 1939. Another global war, even if won, would destroy what was left of British global influence and turn the country into a financial vassal of the United States. That is precisely what happened.

In 1944 a conference took place in Bretton Woods, New Hampshire where the post-war economic order was sketched out. Britain’s delegate was the famed economist John Maynard Keynes. Keynes wanted a global monetary system that was in effect multilateral. His “bancor” scheme would establish a neutral international reserve currency that would recycle trade surpluses back into deficit countries in the form of investment. But the Americans would have none of it. They realised the awesome power that they could accrue if the new system were based on the US dollar standard and so they insisted. Britain, owing America huge amounts of money borrowed to finance the war, was in no position to push back. So sterling, along with all the other currencies of the free world, was pegged to the US dollar which in turn was pegged to gold.

The British chafed under this arrangement. The shortages and continued rationing after the war were demoralising. The British people were told that they had achieved a great victory, yet here they were still carrying their ration cards to the bakers — meanwhile the American economy boomed. British leaders were shocked at how quickly the Empire started to unravel — and how nonchalant the Americans, their allies, were about its collapse. The humiliations came to a head in the autumn of 1956 when Egyptian president Gamal Abdel Nasser moved to nationalise the British-owned Suez Canal. The canal was an extremely important trade route and one of Britain’s last key strategic economic assets. Britain concocted a plan with the French and the Israelis and invaded Egypt with the goal of retaking the canal. But the Americans would have none of it. They told British prime minister Anthony Eden that if he did not back down, the Americans would sell its sterling-denominated bonds and throw the country into an economic crisis. Britain backed down.

War precipitates change, of course. Countries that are in decline suffer worst from wars, as Britain has learned time and again throughout the 20th century. Yet today Britain is, together with the United States and a few Baltic states, the key backer of the Ukrainians in the Russo-Ukrainian that broke out in February of this year. War enthusiasm in Britain is running high and many people — including Britain’s leaders — seem to think that they can win. Win what exactly? That is unclear. But they believe that they can win something. Yet the sanctions and counter-sanctions that the war has unleashed now threaten to finish off the British economy and its reliance on financial inflows into the City of London.

Sterling Eschatology

At the end of the summer of 2022 the Russians announced that they were halting gas shipments to Europe. This followed weeks of ever-falling gas flows to Europe that Gazprom, Russia’s key gas producer, said were due to technical faults. When President Putin announced the complete cessation of gas shipments, he exposed this obvious lie. What did the Russians want? They demanded that the Western nations completely remove the sanctions policies that they had put in place when Russia invaded Ukraine that previous winter.

It does not look like the Western nations are going to back down. They appear completely locked into the sanctions policies even though Russia is not suffering under them. Instead, they threaten a collapse of the European economies this winter. Yet European leaders dig in regardless. Future historians will no doubt try to understand why Europe committed suicide in the winter of 2022–23. All this writer has to offer as an explanation is a combat of war enthusiasm, a series of grossly inaccurate economic assessments and general political inertia. 

British policy response looks like a poorly managed emerging economy

Britain is arguably the worst-placed country to weather what looks like is coming this winter. The country relies on foreign gas imports to heat its homes and power its electricity grid. Scargill lost the battle for coal — and nuclear power was never allowed to replace it. Britain has long been coasting on a sort of postmodern mélange when it comes to energy policy; an energy policy not geared toward the national interest, but rather constructed so that Oxford-educated champagne socialists can feel good about themselves. We have already seen too how Britain, which demolished its manufacturing sector together with its mining sector, relies for its prosperity on financial inflows into the City of London. These inflows in turn rely on investors having confidence in British economic and political stability. Yet with a winter of hell looming on the horizon, the situation looks anything but stable. 

The chatter has already started in financial markets that foreign investment will no longer fund Britain’s trade deficits. Deutsche Bank analysts have pointed out that, with rising energy costs, Britain’s current account deficit will likely hit 10 per cent this winter. This would be unsustainable at the best of times, but Goldman Sachs additionally points out that inflation will hit 22 per cent. Foreign investors hate nothing more than very high inflation, which drives down the value of the currency and hence the value of their assets. Meanwhile, the British government appears completely disoriented and has no other solution than to shovel printed money at the problem. On paper, the British economic position and policy response look like something from a poorly managed emerging economy. Serious economic problems spring up like mushrooms after rain whilst policy descends into clownish fantasy.

The best-case scenario of such an event would be a sharp — very sharp — drop in living standards. Being an island economy, Britain is unusually reliant on external trade. Around one-in-three goods and services purchased in Britain are imported. If sterling falls, these goods become more expensive — and not just for the end consumer but also for the manufacturers that use them as inputs. Wages will not keep up with these price hikes, and the average Briton will simply be unable to afford the basket of goods that he previously purchased. The worst-case scenario of external financing drying up is truly scary. If sterling’s decline precipitates very high inflation that gets “stuck”, this inflation could build on itself and push sterling down further and further. This would be a currency doom spiral of the sort we see in economic basket cases like Argentina and Turkey. The only way for an economy to survive such a spiral is to impose capital controls that prevent money freely flowing in and out of the country. But this would mean the effective death of the City of London which, as we have seen, is what ensures Britons their high standard of living. Such a development would be a catastrophe from which Britain might never recover.

Perhaps cooler heads will prevail in Europe, and the Europeans will remove the sanctions imposed on Russia. At the time of writing, this seems unlikely. If the sanctions remain and the gas supply remains low, Britain will once again take a step down the ladder of prosperity after a war. The enthusiasms of war will fade but the privations it brought about will remain. Another lesson, piled on top of a century of examples, that war does not benefit declining powers — and Britain is a declining power.

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