The UK spends more on imports than it earns from exports and has been doing so for the last fifteen years. This means that sterling must be sold to buy the foreign currency needed to buy the excess imports. Now, importantly, the foreign exchange (forex) dealers who buy sterling and sell foreign currency have to maintain a balance at all times because their stocks of foreign currency are limited, so, unless there are as many buyers as sellers of sterling they very soon take action to encourage foreigners to buy sterling and sell their own currencies. They do that by offering sterling for sale at a lower price - they become willing to sell more pounds per dollar or per euro than they were before, in order to make them more attractive to foreigners. In these circumstances the pound depreciates against other currencies. A depreciated currency means that the UK as a whole is worse off with respect to other countries - UK wealth is worth less on world markets. For the UK, which is far from self-sufficient, this carries significant dangers. When the depreciation becomes significant, imports, and everything that depends on them become much dearer, threatening a recession or worse, when life becomes harder for everyone.
What do the foreign buyers do with the sterling that they buy? That is a key question. They aren't buying our exports because those buyers are already accounted for; we're only talking here about the buyers that take the sterling that is sold to buy the excess imports. They invest, in bonds, equities, derivatives, even building entirely new factories (foreign direct investment - FDI); anything that is available in sterling that provides an ongoing return or a likely price rise, and they will only do that if the return or price rise is equal to or preferably better than they can get with their own or other currencies. To pay for our excess imports therefore we must:
i. rely on foreign investors to buy our debts (lend us money);
ii. sell our ability to produce future wealth (FDI); or
iii. sell some of our accumulated wealth (shares in UK companies, commodities, antiques etc.).
Borrowing money (i) and allowing foreign investors to buy UK wealth production (ii) carry very painful penalties. They make money available immediately but remove continuing streams of money thereafter. Indeed that is why foreigners invest - because they believe that they will reap more than they sow. The UK does the work that earns the income, but the benefits go to foreign investors. Selling accumulated wealth (iii) to buy essential consumables (which is what the bulk of our imports are) diminishes the country, just as a family that sells its furniture to buy food diminishes the family. (ii) and (iii) represent the export of wealth, but (i) is borrowing, where the obligation is to repay the foreign investor in domestic currency because the investor has bought domestic currency debts, which may be public (government bonds) or private (commercial bonds or other forms of private debt). The important point, which follows on from the discussion in chapter 65 section 65.5, is that since the obligation is to pay domestic currency it is the UK's currency that will be sold by the investor to buy the foreign currency that he or she wants, both for the interest and the principal. Therefore, regardless of whether the debt obligation is public or private, it is the UK that is affected by having its currency sold when the foreign lender exchanges it. This point will come up again when we discuss the Lawson doctrine later in the chapter.
A normal transaction is usually beneficial to both parties, where the use value of the things traded to each party exceeds their exchange value, as discussed in chapter 2. However foreign investments aren't transactions of that sort, they are intended to make a profit, and if the investment is profitable for the buyer then that profit is paid by the seller - we are worse off with the investment than without. The neoliberal policy of selling wealth-creating assets to anyone who wants to buy them, regardless of nationality, is particularly dangerous for the domestic economy. Continual borrowing and selling either accumulated wealth or wealth producing capacity are unsustainable. The more that profit from industry and interest on debts flow abroad, the less that is available for recycling in the domestic economy, and the more the economy declines.
The unpalatable fact is that as a single country trading with other countries we can only buy foreign wealth by selling our own wealth abroad or by borrowing, just as an individual trading with others can only buy wealth by selling wealth (usually labour) or by borrowing.
The UK never needs foreign direct investment. As a country in control of its own economy we can generate the necessary money (which is only lubrication after all - see chapter 10) for whatever investments we require (Werner 2005 p217). The government says it wants foreign direct investment because it creates jobs, but we can more easily create our own jobs, and create them in order to produce things that we want produced, not whatever foreign investors choose to produce. All it needs is for the government to take proper control of the economy instead of leaving everything to the unfettered market. We should ensure that our imports are paid for by selling exports, not by borrowing or selling wealth because both are harmful to the domestic economy.
Attracting foreign investment to pay for excess imports is like an individual paying for today's basic consumption by borrowing or by contracting future labour - there's no happy outcome. We can only pay for today's imports without future penalty by selling today's exports, just as an individual can only buy today's basic consumption without future penalty by selling today's labour.
The UK is on a dangerous and slippery slope. Depending on foreign investors to offset our excess spending is very hazardous. Investors will only invest if they have confidence that the exchange rate won't move too far against them, because of all the risks they take that relating to adverse exchange rate movement is one of the biggest. The more we continue to overspend on imports the less confidence that foreign investors will have, and when they abandon sterling in significant enough numbers then the exchange rate will plummet. Forex dealers will have to discount sterling very heavily to attract investors, and the only investors they will attract are those willing to take big risks - high-stakes speculators. If the exchange rate falls heavily then the UK economy will go down with it because all the essential imports that we depend on, and most of our essentials have at least some imported component, will rise rapidly in price.
Surprisingly, trade deficits seem to worry governments less than budget deficits (excessive government borrowing), yet the UK has control over budget deficits - if it chooses to exercise that control (see chapter 100 section 100.5). With trade deficits it is at the mercy of nervous foreign investors who, like all investors, care only about benefiting themselves and operate with a herd mentality. In the relatively recent past foreign investors have devastated weak countries when an event has triggered a stampede for the exits, and with the cruellest of ironies the very organisations that were set up to help countries in distress - the IMF and World Bank - made the situation for them far worse (see chapter 73). It is a dangerous mistake to think that the UK is immune from similar treatment.
If the worst happened and we were left with a very weak pound there would be no quick fix. In effect UK wealth would have become worth very much less than foreign wealth. Keynes was well aware of this and pointed it out in his submission to the government setting out his proposals for the Bretton Woods conference in 1942[273]:
If, indeed, we lack the productive capacity to maintain our standard of life, then a reduction in this standard is not avoidable.
Keynes was well aware of the implications of a drop in wealth-creating capacity as happens when essential import prices rise. In fact Keynes foresaw the problems that would arise by the adoption of floating exchange rates and his Bretton Woods proposal would have avoided them. No-one would have been at the mercy of foreign investors. There would have been an international agreement in force administered by an organisation charged with overseeing and managing international trade for the benefit of the whole world. There would have been a single international currency together with guaranteed overdraft facilities for all countries that needed them. More than that, there would have been measures in place to help any country in difficulties, where creditor countries as well as debtor countries shared responsibility for correcting imbalances. Every country would have known exactly where it stood and have had increasingly forceful warnings about movements out of line with sustainable development. Instead we have a system where any country in difficulties is ruthlessly attacked for private gain with little warning - see chapter 73.
The current drive to outsource jobs abroad also weakens the UK position internationally. Although the main damage is to domestic jobs, outsourced worker pay represents spending diverted abroad to buy the imported labour, and it stays abroad because those workers spend their earnings in their own country
There is a strong school of thought, especially amongst neoliberals, that trade deficits don't matter or are even a good thing. This belief is strongly supported by the Efficient Markets Hypothesis (see chapter 29) which sees international markets in the same way as domestic markets - best left solely to market participants because they have already taken all relevant information into account. Quiggin states in his book - Quiggin 2010 p49 - "In the United Kingdom, this view became known as the Lawson doctrine, after Chancellor of the Exchequer Nigel Lawson. Lawson argued in 1988 that current account deficits[274] that result from a shift in private sector behaviour should not be a public policy issue." However recall the discussion earlier in the chapter about currency being sold when foreign lenders and investors take home debt interest, principal and profits. Doing so means that trade deficits directly affect the value of the national currency and are therefore very much a public policy issue, or should be.
The line of reasoning is that floating exchange rates compensate for trade imbalances. However the only compensation they offer is to keep borrowing and investment from abroad in step with excessive importing - for as long as the currency remains internationally viable. What they don't compensate for are the penalties involved in excessive importing. Floating rates continuously balance money flows in and out of a country, but they don't continuously balance trade. The main country with this view is the US, which has massive foreign debts of over $4.5 trillion[275], of which China holds over $1.2 trillion. It isn't a good thing even for the US, but the US is a special case in that its currency is the world's major reserve currency. China has been stockpiling dollars and using its own stock of yuan from its own population's savings to pay its own workers to produce exports. It uses the dollars to buy US bonds, on which the US pays interest. The US is like a credit card holder who has a massive outstanding balance but is content just to pay the interest on it every month. For the US though, being in debt to China isn't the same as any other country being in debt to another, because the debt is more China's problem than the US's, as was discussed earlier in chapter 65 section 65.5. This is because depreciation of the dollar would hurt China's economy more than the US's by reducing the value of the debt.
Nevertheless the imbalance has hit US employment hard, and contributed to keeping domestic wages and living standards low for most of its population for the last thirty years. Also it gives foreign powers the ability to depreciate the dollar if they wished to do so. For example if China wanted to create economic problems for the US it could spark a major dollar depreciation by selling its dollar holdings. That would panic the markets and the dollar would plummet. Its own economy would suffer but hostile political reasons might make that less important than damaging the US economy. The US is probably prepared to take this risk because it is largely self-sufficient in most things, and could cope with some painful but manageable re-adjustment. Oil usage would have to be cut back, but it is predicted to be self-sufficient even in oil by the 2030s.[276] Also it is by far the most heavily armed country, so other countries are wise to think very long and hard before incurring the wrath of the US.
The UK, as most other countries, is in a very different position to the US. Sterling is not a significant reserve currency so we have to buy practically all our imports by exchanging it for other currencies, and we are far from self-sufficient. Yet we continue to ignore or play down our trade deficit.
However, in our case we have a different reason for complacency - our liabilities to foreigners are largely balanced by foreign assets owned by the UK. In 2014 the UK's liabilities to foreigners (debts, equities, derivatives and direct investments) was 587% of GDP, or £10.7 trillion, whereas the UK's holdings of foreign investments was 569% of GDP, or £10.37 trillion.[277] These figures are massive by any standards but the difference is much smaller at only 18% of GDP or £328 billion. The difference is known as the Net International Investment Position (NIIP), and it is only this difference that concerns the complacent. But complacency isn't appropriate. It's like being trapped between two enormous forces that balance each other for now, but may become unbalanced at any moment. Imagine my owing someone £1.5 million and being owed by someone else £1.6 million. I have a net worth of £100,000 - happy days! But not so fast, this is a very different situation to my having £100,000 in the bank and no debt. At any moment the person owing me £1.6 million might default, leaving me with an unpayable debt of £1.5 million - happy days no longer!
There's an additional and significant worry with international assets and liabilities, they are all investments of various sorts and all denominated in different currencies. Investments vary in value continuously and foreign currencies fluctuate, often quite wildly, relative to sterling. Changes in investment and currency values operate on the gross investment positions, so the difference - the NIIP - can easily be squashed between the gross changes, and at over £10 trillion the gross values are formidable.
One heartening factor is that if sterling were to depreciate significantly against other currencies the UK's foreign investments would rise in value in sterling terms, so if foreign investors do take fright and abandon sterling then we have a cushion to soften the blow. Nevertheless the UK is in a very uncomfortable position, and relying on such a cushion might well prove ineffective in a world that starts to suffer severe consequences from political or environmental changes. In these circumstances our foreign investments might vanish in a haze of debt defaults and unilateral investment repatriations. We could retaliate in kind in cases where there are foreign investments in the UK from the same countries, but not otherwise, except perhaps by going to war, but let's not contemplate that.
It is better to plan for a pessimistic turn of events than to rely on optimism. Hope for the best but prepare for the worst!
We would therefore be wise to reduce both our holdings of foreign investments and foreigners' holdings of ours - by buying them out and repaying the debts. The effect on the value of sterling will relate to the net investment, so should be relatively small compared to the gross position. This of course means restricting capital flows which goes directly against neoliberal orthodoxy, but there are other good reasons for capital flow restriction as well as this, as discussed in chapter 74. At the same time we should take urgent action to expand our export industries and reduce our imports. The sooner we establish a proper trade balance the more secure we shall be.