3rd February 2012
When investments are made the currency the purchased asset is held in has to be bought by the investor, as it is the desired medium of exchange the seller has requested. Buying into a currency to invest in an asset increases the demand for the currency and artificially increases its purchasing power. This mechanism is what I call the "Investment Currency Mechanism" and is in my opinion the driving force of economic control on the international stage.
Investors seek security, this leads them to put their money where it is most likely to maintain its value and provide a steady return. The countries that can provide that security will generate demand from foreign investors, whose domestic economies are less stable. In short the more stable an economy is the more investment it will receive from abroad. This currency strength then enables the strong country to buy goods from other countries at lower prices due to the high desire to hold its currency as an investment vehicle.
This enables successful countries to enjoy an artificially strong purchasing power against other countries. However for this to happen, the country has to start with a certain level of stability to provide that security. America for example receives an additional artificial source of demand for its currency due to the standard medium of exchange for trading oil being the US dollar. Almost every time oil is purchased US dollars have to be purchased first to enable the transaction. This is partly because of the security the dollar has and the desire for the seller of oil to use the dollar as a safe investment vehicle in exchange for parting with the commodity.
The relationship with America and Oil is synergistic and perpetuating. It provides stability for the US dollar, which then provides a demand from the seller of oil to hold the US dollar due to its stability. It has been one of the main reasons for the economic strength of America for the last hundred years. The UK also has a commodity like oil that requires investors to purchase the British pound to obtain it. This commodity is not a physical commodity but the security of investment in itself. British investment products have a worldwide reputation for security and reliability that stretches over centuries.
The desire to hold British financial products creates demand for the British pound that gives the currency an artificially high purchasing power on an international stage. Therefore regardless of the commissions and bonuses the city earns and the amount the government receives in tax, the real benefit of the financial sector is the artificial purchasing power it creates for the British pound. The income generated in the city is only a small percentage of the total investments made. It is this investment demand that creates currency demand which creates the real benefit of the British financial sector to the rest of the economy.
If the financial sector in the UK declined not only would the income earned by banks and the government diminish, but the ability of the UK to purchase foreign goods would also fall. Anything that effects the operation of foreign investment in the UK will affect the currency value and thus the international purchasing power of the pound. I therefore believe the introduction of a financial transaction tax would be devastating for the UK, as it would act a repellent for foreigners to invest in the UK due to the increased cost of doing so.
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