Britain still needs rebalancing

The emergence of London as a centre for trading in the Chinese currency points to both the strengths and weaknesses of the British economy.

It is certainly a coup for London that the Chinese authorities have agreed to launch direct trading between the renminbi and the pound on the capital’s foreign exchange market. This will build on a process that has gone on for several years with London already responsible for two-thirds of renminbi payments outside of China and Hong Kong – albeit the total amount is still small.

The announcement of the agreement was timed to coincide with an official visit by Li Keqiang, the Chinese premier, to Britain. In an article in the Times he praised, among other things, Britain’s “dynamic financial sector”.

It is not hard to see why the development of London as a renminbi trading centre is beneficial for both sides.

For London it is essential if it is to maintain its role as a truly global financial centre. According to estimates from TheCityUK, an organisation that promotes British financial services, London accounts for about 40% of global foreign exchange turnover. It is hard to imagine the City maintaining its leading position in this market if it does not have a prominent role in trading the currency of the world’s second largest economy. Although the renminbi’s international use is limited at present it looks bound to increase substantially.

It is also important for London to have a significant share in all the main segments of financial services. As financial centres go it is akin to supermarket – offering a wide range of products to all those who use it – rather than a niche or even a regional player. Only New York can match it is this respect. Even leading Asian centres, most notably Hong Kong and Singapore, are not quite truly global.

It is also clear why the Chinese authorities are keen for renminbi trading to be established in London. If China is to be a global power it needs its currency to be traded internationally. It cannot simply confine the use of the renminbi to domestic transactions.

Yet although the two sides benefit from their relationship it is asymmetric. London needs Chinese business far more than China needs London.

China has other alternatives if it wants to encourage the emergence of renminbi trading hubs outside of Asia. No doubt other centres, such as Frankfurt and Luxembourg, would be willing to serve in such a role. These places do not have the weight of London in global finance but they are likely to be happy to oblige their Chinese clients.

In contrast, London desperately needs the renminbi business if it is to remain a global financial centre. And Britain is heavily dependent on London’s financial prowess for its continuing prosperity.

Despite all the talk in recent years of rebalancing the British economy back towards production this has not materialised in practice. According to official figures production industries – which include manufacturing and mining – decreased from a 42% contribution of GDP in 1948 to 15% in 2012. Although a return to the position in the late 1940s is extremely unlikely there is significant scope for some swing back in the opposite direction. This would involve Britain increasing its capacity in high technology production.

Services, in contrast, have come to play an increasingly important role in the British economy, with financial services particularly central. As TheCityUK points out, the financial and professional services sector is Britain’s leading export earner, contributing significantly more than any other sector.

This is both a considerable achievement and an indication that Britain’s economy has become severely lop-sided.

This blog post was first published on Fundweb yesterday.