Watch out for Osborne’s foreign currency plans

A few ears pricked up on budget day when George Osborne announced a surprising and potentially expensive plan to rebuild Britain’s foreign currency reserves.

There are two methods of executing this plan. The first is to print sterling to buy foreign currency. This could be regarded as quantitative easing (QE) by another method. Indeed, it might have been an effective way to execute QE in 2009, though it would probably have caused a riot in the Eurozone as other governments – ignorant of the fact that a fall in the exchange rate caused by loosening monetary policy brings no lasting effect – would have accused us of indulging in competitive devaluations.

The second method is that the Debt Management Office (DMO) or possibly the Bank of England (BoE) could issue bonds and use the funds raised to buy foreign exchange reserves for the government. This is expensive. The government pays interest on the bonds and earns no interest on the foreign exchange. It is possible that Osborne is intending that we buy foreign currency bonds rather than cash reserves. In that case, interest would be earned on those bonds but there would then be inter-governmental credit risk: today’s high quality asset is not necessarily tomorrow’s.

One gets the impression from the debt management reports that Osborne proposes the second route – however, it is possible that they were written before he decided to make the announcement.

Read the rest of the article on the City AM website.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

2 thoughts on “Watch out for Osborne’s foreign currency plans”

  1. Posted 31/03/2011 at 07:16 | Permalink

    ” high quality asset is not necessarily tomorrow’s”

    Exactly he should not play speculator with the nations currency, he should buy commodities. The UK should of never sold half the country’s gold reserves. Brown was a that time spectatoring with the nations wealth and look where it got us, he sold it at the bottom of the market.

  2. Posted 31/12/2012 at 09:16 | Permalink

    I’m confused by the above (anonymous) comment. If it makes no sense to hold foreign currency reserves, or indeed any other reserves, while the pound is free-floating, why does it then make sense to hold gold? As I understand it, there are just four statutory reasons for holding reserves:

    1) for checking undue fluctuations in the exchange value of sterling;
    2) for securing the conservation or disposition in the national interest of the means of making payments abroad;
    3) for the purpose specified in Section 1(3) of the International Monetary Fund Act 1979 (payment of charges under Section 8 of Article V of the Articles of Agreement of the International Monetary Fund);
    4) for carrying out any of the functions of the Government of the United Kingdom under those of the said Articles of Agreement which relate to SDRs.

    As Prof. Booth rightly points out, building reserves equates to speculating in the currency markets. Logically, this also holds for gold reserves. Therefore, one might argue that Brown was being LESS speculative by selling 55% of our gold. Indeed, given the very limited uses to which we can put the reserves, it behoves those who criticise the sale to tell us where they WOULD sell the gold. There seems little reason to simply sit on a hypothetical profit without specifying where you would take profit. Its is easy to criticise the manner in which the gold was sold, much harder to criticise the logic.

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