15 November 2011

Paul N Goldschmidt: Why British Eurosceptics are about to drive the last nail into the coffin of the City!

Rather than to rejoice in such a calamitous outcome, Eurosceptics – and particularly MPs and MEPs – should consider carefully the consequences of such a development that they are helping to bring about. In the present environment, the future of the City may not necessarily draw much sympathy or be at the centre of the preoccupations of the majority of citizens suffering from the consequences of the financial crisis. Nevertheless, financial services remain one of the few remaining areas where the UK has unquestioned competitive advantages due to unquestioned knowhow, a broad pool of skilled personnel, a performing infrastructure, an attractive regulatory and fiscal environment etc. 

There is little doubt that, should the status of the City as the dominant financial centre within the European time zone be lost, the consequences would have negative ripple effects reaching far beyond the “square mile”, harming correlated areas such as the housing market, employment, tax revenues, etc.

A brief reminder of the historical prowess of the City’s ability to maintain its relevance ever since it came to prominence in the 19^th century is in order:

As the UK extended its Empire after the Napoleonic wars, the City became the unquestioned centre of international finance, a position it maintained until the end of World War I. Thereafter, even if it had to concede prominence to New York and the US dollar, it remained unrivaled in foreign exchange and commodity markets as well as the centre for the worldwide insurance market, based on the development of international trade in which the Commonwealth played an important role.

After the loss of the Empire that followed WWII (the culmination of the financial crisis of the 1930’s), the City rebuilt its financial power as deregulation freed progressively the movement of capital and goods. Of particular relevance, starting in the late 1950s, was the situation created by increasing US dollar balances held by foreigners and a very insular approach by American authorities which allowed London to become, by default, the world centre of a mushrooming “euro-dollar” market. This attracted to the City two complementary types of participants: the US financial institutions (banks – investment banks) anxious to “follow” their domestic clients abroad, and European (and Japanese) institutions wishing to access on behalf of their “high saving” clients a growing amount of fiscally-attractive “offshore” investments. Only London presented the required characteristics to serve as a base for this fast-developing international financial services market.

As time passed, the United States entered a period of progressive dismantling of its protective financial regulatory framework (abolition of the interest equalisation tax, of the rules limiting foreign investment, providing access to foreign borrowers to its domestic market). This led many European institutions to open affiliates in New York(German – Swiss – French – banks, etc.) which grew in parallel to their London operations. Rapid technological innovations in communications and computer capability induced an ever-great globalisation of financial markets where 24-hour trading became the norm requiring representation in each of the 3 main time zones of the globe.

As New York progressively re-appropriated control over most of the US dollar denominated trading, the City was able to adapt by converting itself to become the centre of the nascent “Euro” market. This evolution was underpinned by the “foreign” operators active in London. Indeed, in addition to its performing infrastructure, the City benefited from the fact that most EMU domiciled participants had existing operations in London and that none were prepared (especially France and Germany) to concede pre-eminence in “Euro” trading to another. The Americans were happy to use their London bases for getting involved in the market of what became very rapidly the second most important world “reserve currency”.

Let us now turn to the consequences of the financial crisis in Europe: we face today the possibility of the dismantling of the eurozone and of the euro. This is due to the excess indebtedness embedded in the financial system in which the solvency of  banks and Governments have become inextricably interdependent, making the European banking system simultaneously “too big to fail” and “too big to save”. The inability of the politicians to complete their bold initial thrust towards European integration has left an incomplete Monetary Union, a quasi nonexistent Economic Union, and has deprived the eurozone of some of the basic tools necessary to conduct a competitive economic, fiscal and foreign exchange policy, most notably a Central Bank capable of acting as lender of last resort.

If the euro fails and national currencies are reinstituted, there will be no longer the slightest reason for “foreign” financial institutions to maintain operations in London; trading in dollars is now controlled from New York, Sterling is of no interest to the world at large, and all European “successor” national currencies are likely to be subject to tight exchange controls for a significant period following a €-collapse. Eurosceptics might revel in the “repatriation” of powers from Brussels but they stand to witness an even greater departure of economic power from the City; they will bear a significant share of the blame for such a disastrous outcome.

The ability of the “euro” to surmount its present difficulties is predicated on the ability of the eurozone to transform itself progressively into an economic and fiscal “Federation”. If that happens - and it is indeed a very big IF - then the most likely scenario is a parallel extension of the eurozone to all non-EMU Members that are obligated by the existing Treaty. Denmark is bound to follow suit leaving the UK facing a stark choice:

Either it goes it alone, withdrawing completely from the EU and renegotiating its relationship with a “Federal Europe”. In this case there is no chance that the EU will contemplate leaving the hub of the “euro” market in London which will relocate most likely to Frankfurt. This option will lead to the withdrawal of foreign institutions from Londonas described above.

Or, realising suddenly what is at stake, the UK will bite the bullet and join EMU. In that scenario London could save most of its competitive advantages and remain the unquestioned financial centre for the euro and for the European time zone. It could well be the start of a new golden age for the City.

The new born Europe could then assume its full role on the international scene and exercise influence commensurate with its economic power, its wealth, its highly educated population and its human and cultural values. It would be capable of dealing on an equal footing with the other great powers in a fast-developing multilateral world, protecting efficiently the European social model that has served its citizens so well.

There can be no doubt that, in the face of such an obvious choice, the earlier the UK engages proactively in the process of entering EMU, the greater will be its influence in shaping the future of the Union and the better it will be for all 450 million Europeans. It should also encourage the UK Government to show its full solidarity with the eurozone in surmounting the huge challenges ahead.

Paul N Goldschmidt, Director, European Commission (ret); Member of the Thomas More Institute

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E-mail: paul.goldschmidt@skynet.be                              Web:www.paulngoldschmidt.eu

© Paul Goldschmidt