Will A Return To The Dollar Premium Be Necessary If The UK Leaves The EU?

With the UK’s referendum coming up on June 23 2016, the possibility of the UK leaving the Eurozone is becoming a probability, according to polls in the UK.

While global financial markets have been tensioning up ahead of the votes and the discussion has targeted the financial situation for the UK with only emotive discussions on immigration, one issue remains unmentioned. That is the ability of the pound to continue as a currency without ‘protections’.

Around 100 billion pounds has left the UK for other currencies. That figure must be increasing now, but still remains ‘containable’. Should the UK actually vote for the exit we would expect a huge exit of funds to leave the UK pulling the pound’s exchange rate down heavily [some forecast at least 12%, or a rate of $1.25 to the Pound, unless action is taken to prevent it from leaving!

Both the E.C.B. and the UK have put in place plans to cope with such outflows and inflows. Their objective will be to:

1)    Calm capital flights into and out of the UK and Eurozone.

2)    To maintain stability in exchange rates for Commercial transactions, while restraining capital flows in and out of the two areas.

How can this be achieved?

The Dollar Premium

Originally instituted to discourage new investments of British funds into the United States, the Dollar Premium in 1971 was applied to the investment of funds into any areas outside the Scheduled Areas [The UK, Channel Isles and the Isle of Man and Northern Island].

Without going into the technicalities of the Exchange Controls of the time, in essence capital that wanted to leave the UK had to go through the ‘Dollar Premium’ pool of capital purchasing it at the discount to a set exchange rate [related to the exchange rate at the beginning of the imposition of the Dollar Premium]. Should any capital want to enter the UK during this time it benefitted by the discount, gaining the ‘Premium’.

For Example:

• Money out: Dollar Premium at a 30% discount to the exchange rate, say $2.60, was an exchange rate of $1.82.
• Money In:   Foreigners who introduced funds would get the reverse. Instead of paying $2.60 for the Pound, they paid $1.82 earning a premium of 43%.

In addition, other rules were imposed to prevent the exit of capital [25% Surrender rules].

The effect of this in 1971 was to achieve the objectives above until the premium/discount was reduced to zero and exchange Controls abolished.

South Africa imposed similar exchange controls at the same time then re-imposed them in 1986. While there is no ‘Financial Rand’ or ‘Commercial Rand’ now, exchange controls remain in position in the country today.

[The author was a currency dealer at the time dealing in foreign exchange and the Dollar Premium, and subsequently dealt in the Financial and Commercial Rand.] 

Exchange Control after ‘Brexit’

Today, sees a much bigger problem, as a result of the relative integration with the E.U., from banking to European operations.

The volumes of capital which could well move are vastly greater than they were in 1971 onwards. In addition the vast amounts of global investments by UK companies overseas [e.g. The Republic of Ireland is a favourite for company locations and remains part of the EU and uses the euro].

 We would expect far more than an emergency ‘budget’ from the Chancellor of the Exchequer after ‘Brexit’ by way of the imposition of Exchange Controls.

And what of the EU?

It seems unlikely that the Eurozone will simply let the euro be battered alongside the pound. But while they have plans in position to control the exchange rate of the euro, they may well only use them when the euro moves in a brutally volatile fashion. Then the extent to which they impose exchange controls will vary in line with the intensity and volume of those moves.

We will have wait until the 24^th June to see what they will do.

Whatever happens:

-      We have never been closer to Exchange Controls than now!

-      We have also never been closer to Protectionism than now!

-      We have never been closer to major, escalating global financial crises than now!

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 - Julian D.W. Phillips of Gold Forecaster & UGT/Stockbridge Management Alliance Ltd

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