Sterling Crisis Distorting Scottish GDP

Here is my latest piece for the excellent Newsnet Scotland:

Sterling Crisis Distorting Scottish GDP

The plunging value of the British pound (GBP) is making it difficult for Scottish firms to plan for the future.

Mervyn King hinted today that UK base rates would remain at their all time low of 0.5%. Making it cheaper for commercial banks to borrow money and lend it out into the economy will cause an increase in the money supply further devaluing sterling.

Quantative easing (QE) also known as money printing dilutes the wealth of the citizens but makes exports cheaper. In the last 3 years the GBP has dropped against the Euro 23%, US$ 26%, Swiss Franc 46% and the Japanese Yen by 61% respectively.

It is difficult to truly compare the drop in the value of the pound against other currencies which are also being devalued and so the best indicator is the price of the pound is in terms of gold. In the last year alone, sterling has fallen 30% against the yellow metal.

By increasing the money supply the British government and the Bank of England (BoE) hope to stimulate the economy but the effect is that business can't tell if orders are temporary and based on short-term stimulus or a real improvement in economic fundamentals. QE now stands at £200 Billion and the BoE have been given the nod by the UK government to print further.

This week CBI Scotland reported (1) that Scottish exports were up in the last quarter to October but that overall manufacturing had stalled and while orders had risen, businesses were not increasing staff. This picture indicates that Westminster policy is causing volatility and uncertainty for Scottish businesses.

As the tax-take shrinks Britain's budget deficit is spiralling out of control. Government borrowing now stands at £15 Billion per month.

When that £15 Billion is spent by the government it goes into the economy and used for consumption. It is therefore calculated as part of the GDP figure. If you take the borrowings out of the GDP figures it is clear that the British economy is contracting rapidly as debt is being used to drive the economy instead of organic growth.

With an injection of money into the system there is the illusion of wealth but it is actually debt. This distorts economic planning as sales often go up as a result of 'stimulus' but decline when the 'stimulus' is withdrawn. To make matters worse repaying what the government borrows will come from productive companies who will suffer by subsidising the temporary 'stimulated' economy. The net effect could be hundreds of thousands more unemployed at a time when public sector jobs are to face an austerity cull.

Holding interest rates down artificially renders most economic data meaningless. Not only is GDP misleading but the market loses its vital price discovery mechanism. Flooding the system with more money creates artificial demand for products and so prices do not reflect their true economic value to the economy.

By increasing the money supply, Westminster and the Bank of England distorts the economy by re-inflating bubbles caused by too much credit in the first place and so prevents a market-led correction. The economy wants to correct itself but that process is suspended while the currency is being debased. Another downside is that the money the government is borrowing will have to be paid back at interest meaning increased deficits.

The only beneficiary of this monetary policy are the high street banks who borrow money almost zero cost and lend it out at commercial interest rates which on credit cards can be as much as 50% APR. Some commentators argue that this policy of low interest rates is simply to help the banks pretend that they are solvent.

Banks' debts are being transferred to the British taxpayer so that what was a financial sector crisis is now becoming a sovereign debt crisis.

Bankrupt Britain
As more international investors like Jim Rogers warn of Britain becoming bankrupt the debate in Scotland will focus on whether to accept David Cameron's austerity cuts or move towards economic independence.

With receipts from North Sea oil set to account for 20% of all the UK's corporation tax, the SNP will argue that the Labour and Conservative parties in Scotland will have to defend a British state with a worsening crisis in its public finances.

Recent polls show that over 80% of Scots believe that the current coalition and the previous Labour governments are to blame for the crisis.

As the race to enter Bute House heats up, the nationalists will hope to exploit these findings by comparing Westminster's economic competence to Holyrood's.

The agreement last week of the former World Bank chief economist and key aid to President Clinton, Joseph Stiglitz, to advise Scotland's First Minister Alex Salmond, will be calculated by SNP strategists to underline that case.

Notes1) http://www.cbi.org.uk/ndbs/press.nsf/939bc8c78700388480256886003bbeac/740853d4a9508674802577c100326916?OpenDocument