Today I published an article on The Guardian’s website entitled The left needs a deft touch in tackling the financial sector’s dominance. In the article I made the case that the value of the sterling is inherently tied up with inflows of foreign capital. These are due to the enormous financial center that exists in the UK and if they ever dried up the sterling would likely collapse and a sustained inflation would result.
In the article I had to greatly simplify the dynamics. In doing so I wrote the following,
Today, British consumers and producers send sterling abroad to buy imports, and this sterling then comes washing back into Britain in search of investment opportunities in the City. If investors ever found that they had nowhere lucrative to put their sterling, they would likely dump it on the foreign exchange markets. Such massive sales of the currency would drive its value into the ground.
This is not, of course, how the process actually works. Rather bank accounts in various countries are credited and debited. But in order to explain the process to lay people who are not too familiar with the monetary system I thought that the above parable was a rather good one.
Here I would like to lay out the details of these capital inflows. In doing so I will draw on the Financial Account in the ONS’s Pink Book — the statistics can be found here.
First off, some accounting. The British trade deficit — i.e. the deficit on the current account — should be matched by a surplus on the capital and financial accounts. Here are the surpluses on the capital and financial accounts in the years 2002-2012.
As we can see it is the financial account that is dominant in most of these years. This is actually quite handy because, while the breakdown of the financial account provides us with useful information on what is going on with regards to where these capital inflows are going, the breakdown of the capital account does not.
So, let’s break down the financial account into its various components. You might want to click on the following chart to enlarge it.
Here we see some interesting trends emerge. For example, debt securities were a key component of the financial account surplus up until 2008. Presumably investors lost confidence in these after the crash. Or perhaps the central bank bought them up during the QE programs.
Financial derivatives, rather unsurprisingly, became rather unpopular in 2008. But since then they have regained in popularity for foreign investors.
Equity securities became very popular in 2008. Frankly, I’m not altogether sure how to interpret this.
In 2012 the bulk of inflows was due to ‘Other Investments’. This is rather annoying because we have no idea what there ‘Other Investments’ are. Whatever they are they see to be very important in 2012.