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Why a high Liberals' voting score will support the British pound

by David Marsh

A sea-change in British politics looks likely on general election day on 6 May. But it’s not to everyone’s liking. The apparently sharp increase in voting popularity of the UK Liberal Democratic Party – the perpetual “third force” in British politics – has thrown up a specter for the bond markets. A so-called “hung parliament”, where no one party wins enough seats to command power on its own, could be highly dangerous for sterling and the markets. That is at least the view being put around by the Opposition Conservatives, who see the Liberals as possibly thwarting their bid to overturn the Labour government that has been in power since 1997.

However I believe this pessimism goes too far. Let me venture a bold counter-prediction. The higher the Liberals’ voting score, the more apparently "uncertain" the election result, the higher sterling will be against the euro.

Particularly in Germany, Schadenfreude on the pound is all the rage. According to German media reports, England stands before the precipice. Foreign bailiffs will shortly be knocking on the door of 10 Downing Street. And, so the stories go, if the Greeks get around to selling the Acropolis to, say, the Getty Museum, then the British will have to follow suit by pawning the Crown Jewels for an emergency IMF loan.

Such fantasies are wide off the mark. Britain will not need the IMF, any more than the US will. Certainly the British economy has its share of problems, mainly due an extended state deficit that is around 12 percent of national income (almost on the Greek level). But due to the dramatic deterioration of the euro situation, see the pound as one of the stronger currencies in the next six months.

And a 'cliffhanger' election result that gave no party an absolute majority might actually be quite good for sterling and the financial markets. Coalition governments can be effective, as has happened in the past in the UK, just as the one-party administrations favored by the British first-past-the – post election system can lead to economically disastrous outcomes. As Liberal MP Chris Huhne, one of the party’s star performers in the election campaign, explains, the most creditworthy countries in the world (including Germany) are generally run by minority governments. Bringing in different skills into the cabinet through a multi-party government might achieve a stabilization of the exchange rate and the bond markets quicker than with the mainstream parties.

One background factor helping sterling is the miserable situation of the single currency. Due to non-membership of the euro, the UK has been able to keep hold of its autonomy in interest rates and monetary policy – generally a good thing. The less competitive Euro-Mediterranean members Portugal, Spain and Greece, unfortunately, do not come into that category. The Greek cumulative current account deficit since the late 1990s, for example, adds up to almost 300 billion dollars, more than 100 percent of GDP. In the coming years, the Greek deficit, according to the latest IMF forecasts will decline only little. The necessary future funding, as we all know now, stands on shaky ground. Most of the existing debt, too, is owed by the state to foreigners, not to domestic bond-holders or pension fund managers. Compare this with the much better position in the UK, where the British current account, which appeared in 2006 to get out of hand, is back in the direction of one percent of GDP and where the government can benefit from a deep and liquid bond market.

My conclusion: the Lib Dems, because they will sharpen up the process of government and make senior Treasury ministers “lean and hungry” , will be good for sterling. German politicians and journalists should not weep crocodile tears for the pound, but should rather take better care of their own monetary system. So the message to the Brits is: vote for the Liberal Democrats – you’ll support the pound.