Brexit aftermath: The value of the £

Everyone, on both the Remain and Leave side (including myself), expected a drop in the value of the pound and a shock to the economy in the event of Brexit. That was never in question. What was always contentious about the Remain claim was the severity of this event. The doomsayers point to a drop in the value of the pound, and a drop in the value of the share price of FTSE100 companies, as an actual loss to the economy. They even say that the size of the UK’s economy has dropped from 5th to 6th place overnight, being overtaken by France.

Here’s the problem with this argument: economies cannot shrink overnight. The size of France’s economy has always come a close 6th to UK’s 5th, with some benchmarks even putting France ahead of the UK. The shrinkage of the UK economy is a mere technicality, a direct consequence of the reduction in the value of the pound. The real value of the economy hasn’t dropped yet, and cannot drop so suddenly in such a short period of time. If it does do so, it will be over much longer period of time before it is measurable. It should be pointed out that nobody is expecting there to be no teething issues – the period of temporary pain is always to be expected as the economy adjusts to the change in circumstances.

What caused the drop in the value of the pound then, and what are the consequences of such an occurrence? To answer this, we have to understand what gives value to a currency in the first place. A currency gains in value when its economy grows in strength, because trading with that economy requires using that economy’s currency, thus a strong economy leads to high demand for that economy’s currency. It also gains in value due to the activity of speculative investment, when the market has confidence in that economy and therefore currency investors find it an attractive place to invest their money. A major incident such as Brexit is a shocking event, which understandably increases uncertainty, temporarily reducing market demand for that currency, as well as the confidence of currency speculators. Notice though, that this does not necessarily affect the productivity of the country or how willing buyers are willing to trade with the UK, so the economy hasn’t necessarily shrunk. If anything, the lower value of the currency means UK products are cheaper on the world market, which should directly increase the volume of exports. It would also increase the activity of foreign direct investment, simply because it is cheaper to do so. The only thing that is immediately affected is the confidence of market speculators, whose actions add no value to the economy, and uncompetitively pushes the value of the currency up anyway. A lower value of the pound would mean temporary pain for British spending their money abroad, but it overall means good news for the British economy.

What about the FTSE100? Many claim that the drop in the value of the FTSE100 has dwarfed the potential monetary savings of Brexit. However, the value of the FTSE100 is not the value of the economy. It is the value of the shares of the largest 100 publicly traded companies in the UK. The behaviour of share prices is rather like the value of currency – hugely affected by demand from speculation and confidence. Uncertainty will devalue these shares, but that has no direct effect on the performance of these companies and how much money these companies make for themselves. Saying that the economy has lost money because of the drop in company share prices is like saying the economy has lost money because the value of diamonds has fallen. Some people may appear to have lost money temporarily, but that doesn’t mean the entire economy has lost this much money.

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Author: Hoong-Wai

I'm a sinner. I have an interest in economics, philosophy, politics, science, sociology, technology, theology (in alphabetical order). I care about truth and justice. I can be a contrarian.

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