Gross domestic product (GDP) is the monetary value of all finished goods and services produced within a country's borders in a specific time period.
The value of a nation’s goods and services, when compared to other nations, are normally calculated according to the purchasing power parity (PPP) of a currency relative to a selected standard (usually the United States dollar). Basically the value of any nations’ goods is determined by the price in domestic currency against the US dollar. So, what effect might a vote for Brexit have on our GDP?
The UK will not overnight stop producing goods or services, and they will remain the same value in UK pounds. However, the value of the UK pound could drop dramatically. This would mean that our exports suddenly become very cheap and our imports very expensive.
As a net importer that is a problem.
Currently the value of our exports is 453 billion dollars; but the value of imports is 628 billion dollars. Any significant fall in the value of the pound would lead to a trade deficit. In simple terms this is where the UK cannot afford to import goods due to reduced revenue as the value of exports falls.
But is a fall in the value of the pound likely? The argument by the Bank of England, the International Monetary Fund and the World Bank is that the UK economy will be affected negatively by voting to leave the EU. This does not just make David Cameron and George Osborne nervous, nor the businesses whose trade is almost exclusively with other EU member states. It also makes currency speculators nervous.
The people who trade internationally in currency will be watching the vote in the UK carefully. If polls get tight and as polling day nears they may well be trying to identify the optimum time to dump currency to make a quick profit and avoid a longer term loss. If lots of pounds end up on the open market then they become of less value. In the same way as any other market goods with a surplus have a lower value than prestige items. There is a strong likelihood that very quickly speculators will be able to buy a lot of pounds for their US dollars, Euros or Yen.
Some have suggested this is unlikely, arguing the UK has weathered financial crises before and survived. But any crisis, even short-term, can have significant political and economic consequences. Black Wednesday, 16 September 1992, saw the British government forced to withdraw the pound from the European Exchange Rate Mechanism (ERM) because it was unable to keep the pound above its agreed lower limit in the ERM.
George Soros, one currency speculator is said to have made over £1 billion profit short selling sterling. In contrast, the cost to the UK Treasury was £3.3 billion with trading losses of £800 million. Prolonged uncertainty, protracted trade negotiations for example, could have made the situation far worse.
Weathering a global financial crisis is different. Speculators wait and watch and, with most major currencies affected, it makes no sense to exchange one for another. But if only one nation’s currency comes under threat there is an increased risk of speculators dumping a currency.
The problem is compounded by the fact that it makes no difference whether a national economy is under a real threat. The problem is if there is a perceived threat, and a high chance other speculators will sell a currency, then those with most to lose or gain will try to buck the market. Large sales of a currency lead others to sell and the value spirals downwards.
The campaign environment, with key messages talking of extreme threats, and the closeness of the polls, both suggest speculators will be trying to decide if and when to sell.
The UK’s GDP is in their hands. Anyone with foreign holidays booked later in the year may be wise to buy their currency earlier rather than later.
Dr Darren Lilleker, Associate Professor in Political Communication