I think you are correct, but not significantly so – the emu share of world reserves is about 27%, and the UK’s GDP is about a fifth of emu GDP.

However, I think the future is clear, which is one reason why I thought that the UK should have seriously considered negotiating joining emu last year, when we could do so from a relatively strong position. Sadly, it seems to be the case that, when the British economy is doing well, we believe we can do without Europe. I have always envisaged that the UK will attempt to join emu for the worst of reasons – to jump mortgage rates lower when the markets are demanding increasing interest rates to lend to us. Just as we tried with the ERM!

Sorry if this parochial issue is of little interest to usual readers!

i agree that the risk of a total collapse of sterling is small, but it’s a bit like what economists like to call the “peso risk” – i.e. a small probability of a major fall in value that doesn’t appear in historic performance, but nonetheless causes a currency to be relatively undervalued. imo, market fears of a pound collapse are now an additional factor weighing on the currency’s value.

The pound was pretty much unsustainable at the levels at which it was at previously. However glittery the City, the rest of British economy wasn’t quite that glittery. The expansion of credit via unrealistic inflation of house prices means its problems are at least as bad as the americans, of course on the high end there are foreign investors to take part of the fall.

As for rebalancing, well, maybe via the euro route instead, either way, there’s no avoiding volatility or losses.

I cannot post a graph to show a trend here of course, but the sterling proportion of reserves for which the currency allocation was reported to the IMF grew from 2.7% in 1999Q1 to 4.7% in 2008Q2. The proportion might have gone slightly higher when sterling was at its strongest, but not much. Basically, sterling gained as a reserve currency when the introduction of the euro reduced the range of suitable currencies.

You can peruse the latest COFER report yourself at:
http://www.imf.org/external/np/sta/cofer/eng/cofer.pdf

I am not sure that a “collapse” of the exchange value of sterling from here is likely; I dare say that the UK is already looking like a cheap place to manufacture for the European market (eg Toyota, Nissan etc). But any attempt at inflationary repudiation of Britain’s debts would be interesting. Just about the last claim to economic responsibility the government has is the inflation targeting regime. Let that go completely (in my opinion it has already slipped a bit), presumably under protest from the BoE, and the government would not have a shred of economic credibility left.

brit – yes, agreed re inflation, though i suspect some surprise inflation may actually be a policy objective

wd – the reason for the pound’s excessive strength in recent years was to do with a kind of “dutch disease” connected with the financial services sector. london exported financial services. the huge profits made (and the playboy speculative bubble that went with them) created strong inflationary pressures in the london area. this resulted in much higher interest rates than suited the rest of the uk economy (there was always an interest rate premium over the eurozone) and therefore an overvalued currency that blighted our other exporting sectors, notably manufacturing.

a disorderly collapse of the pound is a risk because the uk economy has a humungous amount of debt (4x gdp). it is way more than our government could possibly shoulder on its own – i.e. if the recession gets bad our government cannot rescue the entire economy. and yet the credit crunch in the uk is becoming so severe that our government is now resorting to guaranteeing new bank loans to the private sector. another round of bank recaps (aka fullscale nationalisation) is also possible. when governments get into fiscal trouble they either default or debase their currency (debasement = devaluation / inflation). debasement is the more attractive option for the uk, as foreign currency liabilities are mainly held within the international banking sector and could be segregated and allowed to default if need be. but the risk is that foreign investors will realise the govt’s / boe’s ultimate strategy is currency debasement, in which case they will dump the pound and all gbp-denominated assets, including gilts.

re – i don’t think commodities being priced in dollars is at all relevant, unless you think “framing effects” are important. an oil forward contract can easily be hedged with a eur/usd forward. recent years have shown that when the dollar falls against eur, it also falls against oil etc, and vice versa. a lot of that is because commodity prices are driven as much (indeed more) by demand from non-dollar countries than from the usa.

i would be interested if you could reproduce the cofer data on gbp share of global reserves, including whether there is a rising or falling trend in its share.

Also, I would not dismiss the importance of sterling as a reserve currency to the UK economy. The last COFER showed sterling as the third largest reserve currency. Obviously, sterling accounts for a far smaller share of foreign exchange reserves than the dollar or euro, but then the UK economy is smaller too. Because there are not many convertible currencies issued by major economies, many countries hold some sterling in their reserves, especially commonwealth countries. I doubt whether their interests count much in deciding UK monetary policy though!

Makes sense to me.

http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=a2hZdL5hcipQ