Jeremy Warner: UK not drowning, only waving

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The Independent Online

Outlook Jim Rogers, former partner of George Soros and something of an investment guru in his own right, has again been sounding off about sterling and the UK economy, which he believes essentially finished. Sell sterling, he says. Sell all UK assets. The country is bankrupt. North Sea oil is all used up, and the financial services industry is now gone too. The country has nothing left to sell.

As if on cue, the pound took another hammering in foreign exchange markets yesterday, unnerved by the sheer scale of the latest bank rescue package and the growing realisation the crisis might end in nationalisation of one or more of the major high street banks.

No disrespect to Mr Rogers, but he's not got this right. Nobody can say how far sterling might fall. Currency markets operate according to their own will, and the pound could yet devalue quite a bit further before it recovers.

Yet it has almost certainly already overshot fair value and will at some stage claw back some of its losses. I'm not sure I share the confidence expressed last night by Mervyn King, the Governor of the Bank of England, that the latest batch of policies to address the banking crisis "will eventually work", but nor will they "bankrupt" the country, as some suggest.

Even if the Government eventually feels obliged to nationalise one or more of the major banks outright, national insolvency is a quite unlikely outcome. That's not to underestimate the scale of the problem. Iceland has gone bust and Ireland appears perilously close to it. There is no reason to believe economies can remain immune to the death spiral of confidence that afflicts global capital markets simply because they are relatively large.

The potential liabilities for the taxpayer involved in this week's raft of policy initiatives are frighteningly big. Outright nationalisation would make them a good deal larger still. The size of Royal Bank of Scotland's balance sheet alone is £2trn, or around one and a half times annual GDP.

Yet in return for underwriting the liabilities, the taxpayer would also get the assets, which though they may look a busted flush right now will, if held to maturity, almost certainly pay back in full. It's not as if Britain is alone in suffering these problems. All countries are being afflicted by them in almost equal measure. Unprecedented policy action is being taken the world over to prop up banking systems.

What makes Britain potentially more vulnerable is that it has its own currency. Other European nations are to some extent protected by membership of the euro, which, like the dollar, has taken on reserve currency status. When there is an independent currency, markets can make their judgement on a nation's creditworthiness by trashing the exchange rate, until eventually the currency becomes as worthless as confetti. At that point, even the Government, let alone business and homeowners, would find it impossible to borrow internationally, except at penalty interest rates.

This is the nightmare scenario propounded by the likes of Mr Rogers. Yet it is still a relatively unlikely outcome. We are at that point of the cycle when all hope seems to evaporate. Apocalyptic predictions such as those made by Mr Rogers rule the roost. As Mr King said in his speech to members of the CBI in Nottingham, "time is a great healer, even for banks".

But though we may not be about to go bankrupt, we have to reconcile ourselves to a long and painful period of adjustment, involving rising taxes and declining relative living standards. Public policy is for the time being focused on slowing the pace of the correction, so as to limit its impact on employment and output. Yet unfortunately, the adjustment cannot be altogether avoided. Past attempts by policymakers to neuter these adjustments are one of the major causes of the present crisis. If the markets had been left to do their worst, bankers wouldn't have been able to write all the junk that lies at the heart of the crisis.

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