Beware of the Currency War

So last week, the Financial Times reported that the UK Exchequer Secretary, David Gauke, held a number of high level meetings with U.S. businesses to assure them that the UK remains a respectable low tax country and that the Government had stuck to its plans in spite of public anger over corporate tax planning.  “Since the controversy about large corporations and tax broke last year, we have twice further announced further cuts in corporation tax,” he said.  He told West Coast businesses that their ideas and intellectual property would be lightly taxed in the UK.  But he said that Britain was not a tax haven and had a “stronger reputation for respectability that some of our competitors” because it did not strike preferential deals with individual taxpayers. American Tax Singapore

In a previous blog I mentioned that the UK was at a crossroad.  Is it in her best interest to get closer to the EU (aka Germany), disengage from the EU and pivot to the Pacific (as Obama is clearly doing in this second administration) or even more closely align herself with the United States.

A radical change is needed as clearly the present direction does not seem to be helping the UK. Business Insider recently noted that the “Biggest Economic Experiment Of The Last 5 Years Has Ended In Disaster”.  It goes on to say that the U.K.’s economic story for the past five years has been bleak.  Since then there have been two recessions.  Last week again saw the labor situation deteriorate.  This week we’ll find out if the U.K. has entered its first ever triple-dip recession.  Economists project the economy will post a tiny 0.1% – 0.2% growth in the first quarter.  Even if the country does manage to grow a little,it would still be clear that the economy is underperforming. 

Contrast this to what appears to be happening in the US.  One particularly optimistic analyst notes that compared with other major powers, America’s future is looking brighter than before the financial crisis.  In a March report, Goldman Sachs found that foreign investors owned a larger percentage of the U.S. equity market than at any time in the 68-year history of the study.  The housing market is picking up, and dependence on foreign energy is falling. Congressional gridlock does not appear to be standing in the way of America’s energy revolution. The Keystone XL pipeline will likely be approved.  The pipeline, along with the Obama administration’s emphasis on energy independence, helps strengthen the domestic economy.

The Ian Bremmer commentary points out that on trade, the US administration has managed to convince Japan to join Trans-Pacific Partnership talks.  Should the trade consortium of countries ranging from the United States and Chile to Canada and Mexico to Singapore and Vietnam get off the ground, it will liberalize trade between members that represent nearly 40 percent of global GDP — and boost American trade and manufacturing.

Reuter’s Bremmer goes on to say another policy positive is the forward movement in Washington on immigration reform.  If that effort is successful, it could entice millions of illegal immigrants to pay U.S. taxes for the first time — and it could provide the labor force, skilled and unskilled, that many companies desperately need to ensure growth.  A recent study by the Center for American Progress found that immigration reform could inject more than a trillion dollars into the U.S. economy.  So at a time when recession-riddled Europe is muddling through, and major developing economies like China have huge looming question marks, the United States is looking pretty good from the top down.

So going back to the above mentioned options facing the UK,the answer probably lies in a policy that combines all 3, but by far the superior choice has to be strengthening the bond with the US.  It is no coincidence that UK economy seems to be further fracturing into two with the decline in regions north of the M25 becoming more pronounced.  The south east is being kept afloat only by the financial services sector. 

To a large extent, London gets to play an “offshore” role to the US.  As financial regulations tighten stateside (welcome to the post Dodd-Frank era), London becomes an even more attractive option for American institutions.  Gordon Brown understood this as Chancellor. Remember his “light touch” with regards to regulation?  Regardless of the actual trade balance,American financial institutions continue to be awash with QE liquidity and petrodollars which benefit London.  The role of the City of London in the 2011 MF Global collapse is an incredible case study for the interested observer (pay special attention to Reg T).

The biggest threat to this cozy financial relationship and therefore the economy of the south east UK, would be the looming currency war.  I am not talking about competitive devaluations but rather the move of certain countries in Latin America, the Pacific rim together with South Africa and Russia to settle bilateral trade deals with gold or currencies other than US dollars.  If this trend continues to the extent that the role of the US as the world’s reserve currency is threatened, then both the US and the UK would be in serious trouble.

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