Valuing The EU

Two kinds of nation are found in the modern world — a minority (28) that belong to the European Union and a majority (more than 160) that do not. Most of the world’s roughly 190 nations have their own currencies. All have assets that constitute national wealth, and a great many have stock exchanges where the assets can be bought and sold.

Economists and others have put forward numerous theories to explain the valuation of both currencies and assets, where the word “assets” embraces houses, land, equities, bonds and so on. Currency markets behave crazily from time to time, but the most plausible view is that an exchange rate is just another price. Like every price it is set by supply and demand. If governments and central bankers create too much money relative to demand (as they did in Germany in 1923 and Zimbabwe in 2008, and as they are doing now in Venezuela), the value of money falls.

No theory proposes that the value of a currency depends on the nation’s loneliness, its geographical location or its abstention from this or that international organisation. Counter-examples are so obvious that they can be limited to one paragraph. Switzerland is a country of eight million people, little more than 1 per cent of the continent (defined mostly widely) in which it is situated. It does not belong to the EU and until 2002 it did not belong to the United Nations. The Swiss franc is about as lonely a currency as could be imagined. But it has appreciated against all the world’s other currencies, including the euro, in the last 50 years. Japan could claim to be Asia’s most peripheral nation, in the atlas sense. But, again, its currency has been impressively strong for much of the last four decades. 

Further, not one school of macroeconomic thought has argued that assets within EU member states have systematically more expensive valuations than nations which are not EU member states. No evidence whatsoever has been presented that companies quoted on the stock markets of Germany and France are more highly rated (in terms of price/earnings ratios, market-value-to-book ratios and so on) than their equivalents on the stock markets of the US or Australia, or that any such superiority in valuation is attributable to their EU membership. Not a single published academic paper has attempted to claim that EU membership by itself improves the valuation criteria of corporate equity.

Yet the promoters of Project Fear and far too many headline writers have been busy in the last few weeks with silly alarmism. They say that the day after a vote for Brexit will see collapses in the value of the pound and the stock market. Can they not see that Brexit would merely result in the UK becoming just like any other non-EU nation? No facts or data show that EU membership affects the long-run valuation basis of the currencies, stock markets and assets in general of EU member states relative to the currencies, stock markets and assets of non-EU member states. The sky hasn’t fallen in because the US, Japan, Canada and others are not EU members; the sky will not fall in because the UK is not an EU member.

Remember that the UK has had a dress rehearsal for the day after Brexit. In the summer of 1992 its economy was suffering from a severe recession clearly due to its membership of the European exchange rate mechanism. A number of observers — including a weirdly-named “Liverpool Six” group of economists (of whom I was one) — said that the Exchange Rate Mechanism, with its fixed exchange rate between the pound and other European currencies, was responsible for too-high interest rates. The UK therefore needed to leave, so that monetary policy could again be geared to our own needs.

But the then Prime Minister, John Major, disagreed. According to his memoirs, “We had looked at the precipice and decided against jumping.” In the event, the UK did not jump over the precipice, or leap in the dark, or plunge into the abyss, or otherwise throw itself downwards into some great unknown. Instead, it was pushed. Overwhelming selling pressures in the foreign exchange markets forced the pound out of the ERM on “Black Wednesday”.

Except that it turned out not to be black at all. Although the pound did indeed fall in late 1992, interest rates came down and the economy recovered. The period to the May 1997 general election saw steady output growth with moderate inflation. Black Wednesday became Golden Wednesday. The pound’s value against other currencies was higher when Major lost the general election than when he and his Cabinet colleagues had behaved so idiotically on Black/Golden Wednesday almost five years earlier. When politicians use words like “precipice” and “abyss” in matters of economic policy, they are waffling. Even more than usual, they don’t know what they are talking about.  

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