In 2004, Labour Chancellor Gordon Brown inaugurated the opening of Lehman Brothers’ London headquarters and gave Lehman fulsome praise for its contribution to ‘the prosperity of Britain’. Coming four years before Lehman’s implosion and a debilitating financial crisis, that statement now looks, how to put it, less than well judged. However, it was just one of the many accolades for the City given by successive British governments. It also reflects a longstanding reality: the City plays a key role in the world financial system and that system benefits British capitalism.
One sign of the financial system’s importance to Britain’s economy is shown by the balance of payments data for 2015. While the UK trade deficit in goods was £125bn – nearly seven percent of GDP – this was offset by £41 billion of net financial services revenues and another £15 billion from insurance and pension services. The current account still recorded the biggest ever deficit, a little over five percent of GDP, but it would have been much worse without these factors.
These points help explain UK government policy. While massive debts, bailouts and examples of financial excess lead people to see an injured ‘real’ economy as the victim of a ‘financial’ perpetrator, that perspective fails to understand how modern capitalism inevitably takes on a financial form. The City is better understood as a nerve centre of a troubled mechanism rather than as a cancerous tumour in an otherwise healthy body.
Britain has long had a trade deficit, even in the nineteenth century when it was the ‘workshop of the world’. Before 1914, these deficits were far more than offset by large revenues from shipping, insurance and other financial services, and by a huge income from foreign investments. The latter resulted in an annual current account surplus of some five percent of GDP from 1850-1914. However, two world wars, a reduction of foreign assets and a falling back of Britain’s position in world trade and finance destroyed that ascendancy.
In the decades after 1945, the City’s business slowly recovered, but it was principally through the newly developing ‘euromarkets’ for international loans and bonds, and by the City using the US dollar. The City was no longer the major provider of capital to international markets as it had been before 1914, but a dealing intermediary using other people’s money denominated in other countries’ currencies. Even after the removal of exchange controls in 1979, the sterling share of this business stayed small, and was less than 20 percent in 2013.
The US is the major power in world finance, with Fed policy driving global interest rates and US stock markets the largest and most influential. However, not many recognise that the UK is the biggest centre of international banking, the principal foreign exchange market, with more than twice the volume of US-based trading, and that it has close to half of the world’s trading of interest rate derivatives between banks and their customers.
London’s role as a major hub of global financial dealing was boosted by government policies from the 1980s, including the ‘Big Bang’ of 1986. This reflected wider trends in the world economy as other major countries were also liberalising their financial markets. The boom in dealing was not limited to financial companies. All big corporations are players in financial markets, managing their interest rate and foreign exchange exposures, issuing bond and equity securities or doing mergers and acquisitions to consolidate their market power. Demand for large-scale funds not easily available in domestic markets, the growth of international investment and the exigencies of today’s economy underpin such financial developments. While the deals clearly benefit financial companies, the underlying rationale is driven by the nature of modern capitalism.
Financial markets today mediate the ‘law of supply and demand’ for goods and services. A company’s market status is more readily shown in the value of its equities, the yield on its bonds and its access to finance, than in the demand for its products. Having financial clout is critical. In 2014, for example, Facebook bought WhatsApp, a company that had never even made a profit, for more than $19bn, largely paid for with its own shares. This was the price Facebook was able to pay to absorb a potential rival, given its existing market position. Such is the nature of contemporary markets. It is a mechanism that the City facilitates and from which the British economy profits.
Tony Norfield, 13 May 2016