Runs on countries and currencies

Yesterday the BBC’s business correspondent Robert Peston drew attention to runs on countries that have borrowed too much. He pointed out that Iceland, Ukraine, Belarus, Hungary and Pakistan are already experiencing this, and wondered if South Korea might also fall into such a plight. He told us the first five countries have gone to the IMF to borrow because they can no longer borrow on the scale they would like on overseas markets at a sensible price. Just as media attention to a number of stories about British banks talking to the Treasury helped undermine confidence, so now there are media hints at problems ahead for the UK in raising all the money it needs to borrow.

None of this is very helpful when there is already a run on our currency. I have drawn attention before to the sharp falls in sterling that have etched themselves into the last three months. In the last few days sterling has fallen especially heavily against the yen, as well as falling against the dollar. Of course international investors are getting worried about heavily overborrowed countries, especially when their lead or dominant sector like the UK is going to go through a rough period of decline. The UK government is about to discover how dependent for revenue it has been on property, oil and financial services. All of them will yield far less in current conditions than they did in the heady days of the credit boom. This is one of the reasons why I have been suggesting to the authorities in the UK that they might like to reduce the amount of money the taxpayer needs to borrow to buy bank shares, finding other ways of buttressing bank balance sheets.

There has to be a limit to how much it is realistic for any government to borrow. The government does have to take into account how much the private sector has already borrowed in its country, as the overseas investor will look at the total debt and interest burden. It is the same people having to pay off both lots of debt. At the moment there is the danger in the UK that the taxpayer will borrow money to buy bank shares. The banks will then reinvest the money they receive for their new shares in government debt, creating a money go round. Overseas investors will not see it as a self cancelling transaction, as it puts the taxpayers on risk for all the difficult debts owned by the banks, and exposes taxpayers to more potential losses which means more borrowings to meet them.

Just as there has been a flight to quality in bond markets, with people fleeing from risky private sector paper in companies that might get into trouble in the financial crash or in the subsequent recession, so there could now be a flight into quality in the world of government paper. Investors will look to buy into the safest, most politically secure, least borrowed countries. Divorcing Prudence could prove an expensive option at such a time.

The big debt issues have started as the Treasury attempts to raise the huge sums needed to feed the banks and the public sector’s appetite for spending at a time of sharply reduced revenues in crucial areas. Oil taxes will be well down, Stamp duty and other property taxes will be badly hit, and tax on financial service and banking profits will fall sharply. Given this, the government needs to be careful with its overall spending, and needs to find ways to get its loans to banks back as quickly as possible. Nationalising banks was always going to be the dearest and longest term way of rescuing banks at risk. It was also always the way to damage the government’s own credit rating the fastest.


  1. Tony Makara
    October 24, 2008

    All this just goes to show the need for fixed exchange rates and a a world central bank with a world currency to run alongside existing national and regional currencies. Floating currencies invite arbitrage and invite boom and bust as nations consciously decide to scupper their currency when their trade deficit grows too large or as a short cut to growth.

    Can anyone realistically say that floating exchange rates have brought more economic stability? Of course people can point to spurts of growth after effective devaluations, but these are only transient and are eventually paid for in terms of economic crash accompanied by inflation. Conversely
    those like Gordon Brown who thought it better to have an overvalued currency with credit to supply the demand suffer an equal fate when the credit cash-flow dries up.

    The lesson the world needs to learn is that floating exchange rates benefit no-one except those that engaged in speculation. A world central bank, a world currency running alongside local currecies, with fixed exchange rates that can be upgraded periodically depending on the national need balanced against the global situation, has to be the way forward. A new economic world order has to happen, otherwise nations will continue to lurch from boom to bust. We must value economic stability over quick-fix attempts to achieve growth.

    1. Blank Xavier
      October 24, 2008

      A fixed exchange rate?

      I may be wrong, but I understand this to mean that you select a target currency (say the dollar), set an exchange rate between your currency and the target currency (for simplicity, lets assume 1:1 and that we accordingly reprice everything – the real cost of course remaining the same). We then ensure we have one dollar in the central bank reserves for every pound.

      E.g. we adopt the dollar. Or the euro. Or the yen, whatever it is. We cannot print money as such, since every pound we print (which is worth one dollar) requires us to obtain one dollar in reserves.

      How does adopting the euro or the dollar help us?

      1. Tony Makara
        October 25, 2008

        I refer to keeping current exchange values fixed for a given period, say six months, so that nation states are able to increase liquidity by cutting rates without seeing the value of their currency decline because of arbitrage. In the long run the solution should be international agreement on a new world currency to run alongside existing currencies with, naturally, foreign reserves held in the new currency. This would be overseen by a world central bank, which in turn would have the power to upgrade or downgrade the rate of exchange periodically for each nation state depending on national need and global consequence. This of course could only work by international consensus and there should be common agreement that those who are members of such a global currency system do not trade with non-members, thereby forcing intransigents to join up. Its clear that the era of using the Dollar as a base currency must end. The Dollar has proven to be unstable. People should not be fooled by the recent rise of the Dollar, which cannot be maintained without impacting on America's severe trade deficits. This rally will prove to be short-lived.

        1. Blank Xavier
          October 25, 2008

          Tony wrote:
          > I refer to keeping current exchange values fixed for a given
          > period, say six months

          I'm confused. You mean *all* exchange rates? but what happens if the *other* currency fails? do we continue to convert at the fixed rate?

          > so that nation states are able to increase liquidity by cutting
          > rates without seeing the value of their currency decline
          > because of arbitrage.

          Do you mean *all* nations should fix *all* their exchange rates?

          If this was so, consider the recent Icelandic failure. Their banking system has imploded under massive external debt. Consequentially, their currency is valueless – because it *is*.

          If other countries agreed to assign an arbitrary value to the krona, it would be a lie.

          Indeed, what would actually happen, if the State forced people, by law, to trade at the rate the State specified, is that the rates would be fixed and *no one would lend to them*.

          That is, unless the State *also* then forced people to perform lending – which is of course a full violation of individual liberty and private property rights.

          You can either have lending at the correct rate, or no lending at all.

        2. mikestallard
          October 26, 2008

          Who will fix the currency exchange rates though?
          Isn't it best to leave this to the experts (money markets) who have years of experience? They are betting their money on which currencies are over exposed (the pound, the dollar?) and which are solid as a rock (the yen?).
          I can see a LOT of politics going on round a huge table. And, of course, the politicians, while they are expert at a lot of things, are in no sense financial wizards, are they?
          If the politicians make a hash, then there will be lots of legal/illegal "hedge funds" springing up all over the place offering a "real exchange rate". (Honestly, what does, say, Mr Sarkozy know about the money markets?)
          (I do not include, of course, our host on this blog, who has shown his expertise today on page 13 of the Telegraph).

      2. mikestallard
        October 25, 2008

        This, surely, is what the Argentinians did? They pegged their peso to the American dollar. Prices then went up until nobody could afford anything and then – crash! – the whole house of cards came tumbling down.
        A better example, perhaps, within living memory, is the crash that happened when the wise George Soros brought us out of the ERM on Black Wednesday – to the whoops of joy from the Left.

        1. Blank Xavier
          October 25, 2008

          In Argentina, the State pegged the peso to the dollar, which meant – in theory – they were enforcing full convertability; for every peso, the State held the equivelent value in dollars. The peso effectively became the dollar.

          This works fine as long as you don't then mess about with monetry policy – printing your own pesos, for example – which amongst a range of other behaviours which weakened the convertability of pesos to dollars is exactly what the Argentine State did (because they're a State and that's what States do – economy idiocy for political reasons – and this is why it's so crucial the free market exists, which is to say, the State does not meddle, or you get what you see today where for example Wal-Mart in the US are see pay-day related spikes in *baby formula* sales 🙁 ).

          The peso was then pegged to the dollar, without the necessary reserves, speculation occurred (because obviously in this situation the peg is not a realistic measure of value) and speculative pressure forced the peg to be dropped and the peso devalued to its correct value (representing the extent to which it was actually backed up, rather than the extent to which the Government would have liked people to imagine it was backed up, which would have let them continue to spend more money than they had).

          This rapid devaluation caused considerable economic hardship.

          Of course, the longer this farce continued, the more it was going to hurt when it ended and the market saved a lot of people a lot of suffering by preventing the Argentine State from continuing with its madness. If only it had done so earlier, for the earlier this had occurred, the less harm would have been done.

        2. Tony Makara
          October 25, 2008

          If current exchange values are fixed for a given time it will allow national central banks to lower rates, increase liquidity, without inviting currency speculation. This isn't a question of all-follow-the-dollar but rather is an effective freeze on currency speculation while liquidity is increased. The alternative scenario of nations trying to cut rates in isolation will invite arbitrage and will lead to nations importing inflation as their currencies lose value.

  2. figurewizard
    October 24, 2008

    Today (24 October 2008) the pound is 11% down on the US$ since the beginning of the month. Against the Japanese Yen it is down by 16% and 9% against the Swiss Franc. The fact that these currencies, which are always regarded as safe havens have risen so sharply in so short a time, is a stunning indictment of our government's economic policy of relying on a debt fueled boom based on wildly inflated house prices to increase equally unsustainable growth in both consumption and public spending. The effects of the present value of our money are going to be bad enough as it is, let alone what they might become as the pound sinks lower still. Like it or not the Bank of England will have no option but to increase rates and soon, otherwise what has gone before will come to be seen as a walk in the park.

  3. Thatcher-right
    October 24, 2008

    GB is borrowing at the moment happy in the knowledge that the bill will be picked up when the Tories come into power.

    What would the consequence of a statement by DC along the lines of "we regard lending to the government beyond level X to be irresponsible and will therefore not feel obliged to repay it. Requests for repayment of the excess will be forwarded to GB c/o the Labour Party"?

  4. APL
    October 24, 2008

    According to the FT, Alistair Darling seems to have deliberatly mislead the british public on the substance of his discussion with the Icelandic finance minister.

    Did Darling make a similar statement to the Commons?

    Reply: needs checking

  5. Lola
    October 24, 2008

    The government, this government, is not borrowing money to 'help the banks' (they could be recapitalised in other ways), or to 'help unemployment' or for any other preudo economic management reason. It's borrowing money to, putting it bluntly, save its arse and the arses of its client state. No common sense will be applied. No logic will deployed. Cut spending? Are you bonkers? They are not even capable of thinking that. The fiscal consequences will be ignored. It will do whatever it takes to (a) Make Gordon look good, so (b) it gets re-elected, or (c) leaves a hopeless legacy for the Tories. Normally you would assume that the government would at least act reasonably responsibly, but this one, having been found out, and knowing that its philosophy (hah!) is shot full of holes has absolutely no intention of doing anything except that which serves its own purposes. A run on the pound? So what? Will Gordon and the government resign when (and I mean, when) that happens. Don't bet on it. It will try the 'national Emergency' tack and seek to stay in power a la Mugabe. In a nutshell, we're screwed.

  6. Johnny Norfolk
    October 24, 2008

    Dont worry John. When Labour have to go cap in hand to the IMF for a loan, The IMF will insist on a big cut in government spending.

    Its just like last time they they were in power.

  7. mikestallard
    October 24, 2008

    As our mood tightens, I want to paint an idealistic picture.

    The government, for whatever reason, stops spending and reins in the State hard. Yup, there will be lots of hardship and lots of good stories for the media. Weeping people on TV etc etc.
    Say PFIs were got rid of (dream on!)
    Say pensions were cut back for the Public Sector just as they have been for the private sector (by Gordon Brown, remember?)
    Miles of strikes from "bin men", "teachers", "nurses", "police". All waving placards. Excellent for TV!
    Say the government then went on to reduce taxation in a spectacular way. At the moment it is prohibitive – 42%? Say it came down hard to the Polish 18%?
    Wouldn't the people who lived here shake themselves and say – hey! we can go out and make some money! Mightn't the brighter sparks form new companies, which actually met the real needs of the people. Mightn't they see where the world needed things like the carrying trade, like raw materials, like African food?
    Being desperate, they would take sensible chances (and ridiculous risks). But our country would then rest on a sensible economic footing.

    "Then I woke up……."
    Actually, according to First Post, that is exactly what happened in Argentina when it withdrew its peso from linkage with the US dollar.

  8. adam
    October 26, 2008

    But the economy is based on debt. The money has no intrinsic value. Sterling falls against the dollar yet the US has a ridiculous amount of debt.
    The debt will never be repaid it just grows and grows.

  9. Adrian Peirson
    October 26, 2008

    Comparing two plummeting currencies is a bit misleading.
    Supposing Putin came out with a Gold or Silver Backed currency as he has suggested, the Dollar and Sterling would be dumped big time.
    Our currency, just like the Dollar is being destroyed, they want us to use the Euro.

  10. Adrian Peirson
    October 30, 2008

    The Beginning of Hyperinflation.
    See it's not Just Me that thinks Paper money is worthless.
    There is no need for this to happen.

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