Sterling down – exports and prices up.

The fall in sterling has been substantial in recent months. A pound bought 1.51 Euros in January 2007, 1.34 Euros in January 2008 and only 1.26 Euros in May 2008, a drop of 16.5% over the last 17 months. It is also beginning to weaken against the dollar after a long period of strength, falling from more than $2 to the pound in 2007 to $1.95.

Why is this happening?

There are the first indications that after a long period of US neglect of their currency they are now trying to stabilise it. The authorities seemed to favour a lower dollar in recent years to price US products back into the overseas market. Now they think the decline has gone far enough, and maybe they will now tighten their money stance which has been loose to deal with the Credit Crunch.(The publication of poor unemployment figures and a surge in the oil price led to a further dollar fall shortly after this was written, but that fact does not necessarily mean the sentiment of this paragraph is wrong)

In Euroland the Bank is firmly in inflation fighting mode, and has kept interest rates up at a time when the UK has lowered rates a bit to deal with the problems in financial markets. Markets are now more concerned about the impact this policy is having on the fragile economies of Euroland. Italian industry is being badly damaged by a Euro which is too strong for their exporters, whilst in Iberia a property crash is exacerbated by a monetary policy that has not suited local conditions, being too loose on the way up and now too tight on the way down. Markets think the next move in Euro interest rates will be down, although not any time soon. They think the Euro is quite high enough. Recently the EC Bank has sown doubt about this, suggesting rates have to stay up or even go up to control prices. This may just work for the stronger German economy, but will cause further trouble for the weaker peripheral economies of the Union. Markets are not sure which way the Euro will go for a bit.

The UK has experienced a move from boom to bust in credit markets. The money supply has been expanded quite considerably, first to fuel a boom on the basis that Asian competition would take care of price increases, and then to make markets more liquid to mitigate the crash. The volatility of sterling against both dollar and Euro shows the need for floating rates here in the UK, because the economy is not harmonised with either that of the US or Euroland. It remains stubbornly mid-Atlantic, and will need to become more Pacific oriented as the rise of India and China continues apace.

What does it mean?
The fall in sterling means higher inflation. We have relied for a long time on ever keener prices from Asia to curb inflation. We now have to look forward to dearer goods from Asia, both because inflation has taken off in India and China, and because the Chinese currency is likely to appreciate further.
We should also be able to enjoy greater growth of our exports, as they will be that much more competitive given the fall in the currency. There should also be more scope for import substitution from home production.
As people’s incomes are squeezed, so they will be able to afford even fewer of the imported goods whose prices are going up thanks to cheaper sterling. Manufacturers will be able to sell more abroad at keener prices, and will also probably increase their profit margins at the same time. This is a slowdown where the corporate and government sectors do not intend to suffer much, intensifying the squeeze on individuals.

Should we join the Euro?
Twice this week in meetings with seemingly intelligent business people I have been told we ought to be thinking of joining the Euro, as it is now a stronger currency and becoming an important reserve currency for the world. Why can’t these people grasp the enormous damage sterling’s entry into the Euro would do both for the Euro and for us? Don’t they see the volatility of the pound against the Euro tells us the UK economy is different from that of Euroland and would destablise the Euro area if joined? Can’t they see it is better if some of the adjustment is made by changing the currency rates, rather than all the adjustment having to be made by fewer jobs and lower wages here in the UK?

And why do they always suggest the Euro and not the dollar? If it really were the case that we could benefit from belonging to a bigger world currency with an important role in financing world trade, would not the dollar be a more natural choice? We are mid-Atlantic, but closer in important ways to the US cycle and experience than to the French and German.

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9 Comments

  1. NickL
    Posted June 6, 2008 at 1:49 pm | Permalink

    John – to the point as always.
    The dive in Sterling started with the Northern Rock debacle, reflecting the resulting loss in confidence in British economic management – what might be seen as the blinkers being pulled off the markets' eyes.

  2. Adrian Peirson
    Posted June 6, 2008 at 3:54 pm | Permalink

    More Unbacked Fiat Money that our Govt can Borrow into existance at will leaving us the Taxpayer to Pay it back to the Lender ( The Global Elite Banks ) Plus Interest.

  3. Freeborn John
    Posted June 6, 2008 at 6:25 pm | Permalink

    It is an interesting point that the US dollar is never mentioned as a possible single currency for the UK. The reason of course is that champions of the Euro are motivated by a desire to see greater involvement in the political EU project. However in the technology industry we do only use one currency and it is the US dollar. You cannot buy our products direct in Paris, Berlin or Timbuktu in any other currency. All internal budgets are in dollars. All negotiations with external partners or customers in the UK, throughout Europe and beyond never even mention any currency unit at all because it is automatically assumed that everyone is talking about dollars.

    Of course this is a convenience when working with large companies. The practical issue you raise for the Euro as a retail currency would be equally applicable to the use of the US$ should that be the currency in people’s pockets.

  4. mikestallard
    Posted June 6, 2008 at 6:33 pm | Permalink

    Your economic analysis is, as ever, truthful and I, for one, thank you for putting it so clearly.
    I was on the dole in 1992-3. It was not fun. Most of the people on it with me were nice, innocent sort of people who had crashed a business, been laid off or who were at the tail end of a profession – there were,for instance, several young lawyers from universities. Please do not let us go through all that again.
    Why don't we actually stick to our own people who speak our language and who think like we do? I refer to the Australians, the New Zealanders, the Canadians and, yes, the USA. this is one of those mysteries which completely escapes me.

  5. William B.
    Posted June 6, 2008 at 6:35 pm | Permalink

    The experience of countries within the Eurozone illustrates three points which are relevant to the debate about the expansion of the EU's powers.

    First, it goes without saying that the larger the geographical area covered by a single policy (be it social or economic) the greater the chance that the policy will not be effective for all. What will always happen is either: (i) the more powerful countries will insist on a policy to their benefit whereas the smaller and weaker will be disadvantaged or (ii) a compromise will be adopted which will not suit anyone.

    Secondly, the mechanism for effecting a change in policy is inevitably cumbersome where discussion has to involve numerous national representatives.

    Thirdly, the distance between the people and the decision means that practical pressures which help to form acceptable policies in the UK are ineffective. We have seen numerous examples recently of the UK government introducing poorly thought-out policy initiatives which they have been forced to abandon or vary at short notice through the pressure public opinion has exerted. We should, in my opinion, never underestimate the importance of by-elections, the press and such debates as those held on Question Time on BBC1. They all keep our politicians in touch with the mood of the country.

    It might be that a decision taken at EU level would be better than one taken in the UK but at least the UK government knows that its very existence depends on its decisions. It might be that our government ministers are intellectual pygmies compared to the EU boffins, but they are our pygmies and the closer they are to us the greater the chance that government will continue to be by consent and not by diktat.

  6. Steven_L
    Posted June 6, 2008 at 8:43 pm | Permalink

    … and then the US go and announce massive job losses, the DOW crashes 300 points and all of a sudden the dollar begins out-weakening the pound once more.

    A year ago most people I knew thought it was inconceivable that house prices could crash. Funny how perceptions change.

    I wonder how low sterling and the dollar could go before the Euro breaks?

    I also think that the emerging economies maintaining these dollar pegs is a major cause of the imbalances.

    Reply: Yes, an abrupt change yesterday – even more important was the amazing $11 rise in the price of a barrel of oil in a single day.

  7. Tony Makara
    Posted June 7, 2008 at 5:29 pm | Permalink

    The problems caused by currency differentials and imported inflation could be resolved by a world currency unit running alongside existing national and regional currencies. Of course this would mean an end to floating currencies and would lock smaller economies into a lower rate of exhange but in the course of time less developed economies could have their rate of exhange upgraded as their economic infrastructure and capacity for production is expanded.

    A world currency running alongside national currencies would allow nations to uphold economic sovereignty while at the same time providing stability in international trade. Any hopes that a national currency could act as an international benchmark died a death when the Dollar collapsed in value. Any such new currency would have to be international and established collectively by all major economies around the world. Such a system would restore the credibility of fiat money and stop the damaging flight into commodities, it would also end the destabilizing problem of arbitrage.

  8. Mark Wadsworth
    Posted June 8, 2008 at 11:06 am | Permalink

    All these arguments in favour of or against joining the Euro (or the US $, or even inventing a New World Currency) are all very interesting, but the debate is pointless.

    As a simple matter of historical fact and economic logic, there are economies and diseconomies of scale to currency zones; many 'smaller' currencies have disappeared and been amalgamated, sterling was for a long time the global currency, since replaced by the US $ (and quite possibly Euro, who knows?), but conversely most currency unions have fallen apart again (for good or bad reasons). If the reverse were true, that there only economies and no diseconomies of scale, then by now the whole world would be using the same currency.

    You can look at languages as a form of currency – most minor languages have died out because you are at an advantage speaking a language that is much more widely used. Happily enough, English seems to have been chosen as the language of international trade. But it will be some time before English is the only language spoken, if ever – for the time being, we have a few large 'language unions' (English, Chinese, Arabic, Spanish) where the benefits of dropping your language and using a more common one are cancelled out by the short run costs of the switch (as well as cultural resistance).

  9. Tony Makara
    Posted June 9, 2008 at 3:06 am | Permalink

    As trade deficits worsen with America experiencing its seven biggest trade deficits in the opening few years of this century, it is a sign that the Dollar is now completely finished as the dominant base currency. The inevitable flight into commodities and resulting price hikes are a sign of things to come. We need to find a way to restore faith in fiat money if we are serious about controlling inflation worldwide.

    The current floating system leads nations into boom/bust cycles as a contraction of the money supply is needed to keep the cost of imports down. Britains post-war economic problems accelerated after Sterling was floated and continue to this day. If exchange rates were fixed and anchored to one international currency with periodic revaluations for each country in line with economic growth we could gradually bring the smaller economies into line with major economic powers. Such a system could create unprecedented prosperity over time.

    National currencies could still exist but foreign currency reserves could be replaced by the world currency. Of course such a system would have to be run by a council of the worlds central bankers so that it doesn't become hostage to political pressures. If we don't do this fiat money is finished and with it the ability to create liquid credit and prosperity.

    Reply: Fixed exchange rates, large currency blocs and the like would be worse than floating rates, leading to lower output

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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