11 March 2017

Dollar Hedges Help UK MoD Keep Calm In Age Of Trump & Brexit


A British and an Estonian soldier during NATO exercise Sabre Strike 14 in Latvia.

WASHINGTON: Despite a turbulent Trump administration and a plummeting pound, the Anglo-American defense relationship remains strong, said the senior civil servant in the Ministry of Defence.

“Under any circumstances, we’re going to continue to work very, very closely with the States,” Stephen Lovegrove, Permanent Secretary of the UK Ministry of Defence, told reporters this morning. “Whatever is going on in the political backdrop over here, I think we’ll keep on working on, really.”

Lovegrove is in D.C. for his first visit in his current job, which he took last year. (He previously visited as permanent secretary of the Department of Energy & Climate Change). He and his aides admitted the trip was complicated by the sheer number of vacant positions in the Trump Pentagon, where Secretary Jim Mattis is the only Trump nominee so far in place. As reporters were led through the British Embassy after the roundtable, we noted a diagram of Trump appointees — with at least one recent withdrawal prominently crossed out.

“I wanted to come over here anyway,” Lovegrove said, “because the relationships and the relationship is vastly more important and enduring than any one or two given individuals. There is just a continuum of activity and discussion we need to maintain no matter who is in place or who isn’t in place.”

Closer to home, arguably Britain’s biggest problem is the decline of the pound, which has lost more than a sixth of its value since last June’s referendum vote to leave the European Union. That’s been a boon to British tourism and exports, but it’s potentially problematic for the Ministry of Defense, which imports much of its equipment. Major UK purchases include the US-made F-35B Joint Strike Fighter and P-8 Poseidon patrol plane, as well as the missile compartment for the Dreadnought strategic nuclear deterrence submarines, which are being built in tandem with the American Columbia class.

British F-35B

“More than any other UK. department, a lot of our kit is denominated in foreign currency… particularly dollars,” Lovegrove acknowledged, but “we have a very prudent hedging program with the Bank of England and the Treasury, so we feel pretty comfortable we’ve managed to mitigate most of the currency risk there.”

Specifically, the MoD contracts with the Bank of England to buy dollars and euros on a future date at today’s market rates (what’s called forward buying); that way, it still has enough foreign currency to make planned purchases even if the pound drops. There is some impact from the current currency fluctuations, Lovegrove said, but the impact is in “low tens of millions” out of a £36.5 billion annual budget.

According to the latest NATO figures, the UK spends 2.21 percent of its Gross Domestic Product on defense. That’s just above the alliance’s target of 2.0% and in third place after Greece (2.38%) and the United States (3.61%). Almost every American president since Eisenhower has urged NATO’s European members to spend more, but Trump has been the most strident on the subject, at one point in the campaign suggesting he might not fulfill treaty commitments to defend NATO allies against invasion unless “they fulfill their obligations to us.”

British troops board a Royal Air Force C-17.

Since then, though, Secretary Mattis and other US officials have strongly defended NATO, even as they repeat the call for 2% spending — which the UK supports, Lovegrove emphasized. “It’s obviously been reinforced by Sec. Mattis as well as by the president, but it’s (also) been reinforced by our Secretary of State, it’s been reinforced by our Foreign Secretary, by our Prime Minister.”

The British government also agrees with the administration that NATO needs to reform. In particular, Lovegrove said, the alliance must increase its rapid response forces and streamline the current cumbersome, consensus-based process for making decisions in a crisis.

NATO’s crisis response capability is increasingly important for Britain given that British troops will soon deploy to the front lines to deter Russia. A British armored cavalry squadron will go to Poland as part of a US-led battalion, and a British-led battalion will go to Estonia, the tiny Baltic State that has so far suffered the most of any NATO member from Russian cyber-attack. A German-led battalion will go to Lithuania, a Canadian-led one to Latvia, with each of the four battalion task forces over a 1,000 strong. A British advance contingent is already in Estonia to set up communications systems, Lovegrove said, and the full force will be deployed in another month or two.

Royal Air Force Eurofighter Typhoons take off from Amari Air Base in Estonia during a Baltic Air Patrol mission.

“It’s a substantial deployment: a battalion is 800-850 people,” Lovegrove said, “(though) I don’t think it takes away from our ability to operate in other parts of the world.”

“Let’s not mischaracterize this,” he said. “It’s not the British Army of the Rhine,” the multi-division force stationed in West Germany during the Cold War. “It’s not meant to be the answer to absolutely everything that could conceivably happen up there…It’s a statement of support and intent.”

“We need to understand the risks that are apparent or could become real to our troops in Estonia,” Lovegrove said. “It is clear that Russian doctrine has developed…into a blurring of peacetime and wartime activity, a blurring of what constitutes home and away, what constitutes the limits of risk that they are prepared to contemplate.”

“Their risk appetite has gone up quite a lot in 2016,” Lovegrove said.

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