When does devaluation become a Sterling crisis?

Readers of this blog will not be surprised by the fall of the pound. I wrote about our freefall currency on 16th August last. Today the front pages of the newspapers tell us what a big story it has become.

If we were still living in an era of fixed exchange rates, or managed ones, we would be deep in a huge crisis by now. The UK government would be borrowing abroad to buy pounds to try to stop the currency falling. The foreign money lenders would be demanding cuts in public borrowing and spending as part of a package of better economic management. Floating rates takes the immediate sting of such a crisis away from a Chancellor wishing to prolong his holidays away from London.

A little bit of devaluation, when you are running a big balance of payments deficit, is no bad thing. It helps your exporters become more competitive, so they can sell more. It puts people off buying a few luxury imports, so you spend less. The balance of payments start to correct. Just as Japan found a little bit of inflation was preferable to deflation, so a little bit of devaluation for the UK is fine in current circumstances.

The problem is, we are now getting a big bit of devaluation. There is a sense of carelessness, even of incompetence in the air, underwritten by the Chancellor’s foolishly pessimistic remarks from his Scottish holiday home. Overseas holders of sterling have got the message that the government does not seem to care about the value of the currency, and is taking none of the steps to run its own affairs prudently that you expect from a strong country wishing to have a strong currency.

This does now matter. Oil has fallen from around $145 a barrel to around $115, a fall of around a fifth. This started to bring welcome respite from inflation that was getting out of hand. Unfortunately in the last few weeks the UK has lost half of that advantage – oil has gone up by 10% in sterling terms thanks to the fall in the pound against the dollar. $145 a barrel oil at $2 to the £1 was costing us £72.50 a barrel. $115 a barrel oil at $1.80 to £1 is still costing us £64 a barrel, a much smaller fall than the fall in the dollar price. You will see the latest fall in the pound in the pump prices. The same is true of the thousands of commodities and products we import that are priced in dollars, or in Euros. The pound hit a new low against the Euro yesterday.

There is likely to be an immediate price to be paid for this imported inflation. The Bank of England will feel it has to keep interest rates higher for longer than it would otherwise. The Bank, if it were truly independent, would tell the government we need lower interest rates badly, but can only afford them if the government takes other action to reassure foreign holders of sterling, sufficient to stop the collapse of the pound.

What should the government do to stop the slide? It needs to reassert itself in a way which breeds confidence in its actions and in the UK economy as a whole. That includes:

1. Changing the language. The government cannot carry on using the bland and out of touch complacent language it has been using prior to the Darling outburst, nor should it go over to Mr Darling’s own excessive gloom. It needs to find words which show it has understood the severity of the financial situation, but do not exaggerate the bad news. It needs to say there are limits to how much it can spend and borrow to “help” us in the squeeze.
2. Changing the forecasts. It will not do to carry on with the Budget forecasts, as no one in markets now believes them. Nor can we wait until the official Autumn forecast to see the revisions. The markets need answers to two simple questions immediately. What growth rate does the government think the UK economy will manage in 2008-9 and 2009-10? In the light of that, how much is the government planning to borrow in each of those years?
3. Getting in control of how much it is spending. Spending growth has been far too fast since the Budget, and borrowing will be boosted by the slower growth than forecast which cuts revenues and raises spending further. The government needs to cut out more waste and less desirable spending, and accept some discipline on how much it can afford to borrow and will be allowed to borrow by sceptical markets.
4. Stopping its own contribution to inflation, by freezing public sector prices, charges and taxes where it has a monopoly, and making their delivery more efficient instead.

Floating exchange rates are usually a good thing. They allow adjustments to be made in easier ways than fixed rates allow. If a government thinks they give it carte blanche to spend and borrow as much as it likes it can get away with it for quite a long time, but there comes a reckoning. The first thing to go is the currency. That is now happening to the UK. Later it might become difficult or too costly for the government to carry on borrowing at the level required. They need to get a grip now. That’s why we need the Chancellor full time in London, and we need Parliament back to put some pressure on them to take the necessary stabilising action.

The odd billion pounds for the residential property market is not going to turn it round – the sum is too small. Another billion on the deficit is a further increase in an already alarmingly large figure, and does not help restore confidence in the conduct of public finance.


  1. Kit
    September 2, 2008

    Are you still of the opinion that interest rates should be lowered even though this would weaken the Pound still further and stoke inflation?

    Reply: I want interest rates down and public spending controlled – you have to do the two together. That would then strengthen the pound. Lower interest rates in the US has brought a stronger dollar, because the markets think the US authorities do know how to bring about recovery.

  2. Tony Makara
    September 2, 2008

    The time has now come for an independent world central bank to end the uncertainity of currency differentials, which are themselves the root cause of boom and bust. This is particularly true for nations that are increasingly dependent on imports.

    A world central bank, given charge over a world currency, to run alongside existing national currencies, with fixed exchange rates but periodic currency upgrades awarded depending on need and performance, would eventually be able to pull all the worlds currencies and thereby each nations purchasing power into sync. The world was too quick to adopt floating currencies, driven by academics and other soothsayers who placed more faith in abstractions and imagined consequences than in hard commonsense economic reasoning.

    If politicians are serious about having a global economy then they must push for a world central bank to oversee matters, if not then a new strategy must come into play in which nations create the conditions for national economy and internal markets. It has to be one or the other, under a system of floating exchange rates, it cannot be both.

    1. Acorn
      September 2, 2008
      1. Tony Makara
        September 2, 2008

        Acorn, thanks for the link. A world currency unit, to facilitate world trade, not to replace existing currencies, is an idea that will eventually come to fruition, out of necessity more than design. The very fact that the instrument used to measure value, money, is of itself open to variation, invites arbitrage. Not only would such a system be a way off ending mass currency speculation, like we saw in Asia a decade ago, but would also be a way for developing countries to improve living-standards as their own currencies move into sync with more established monies. Of course this would not happen over night but a structure would be in place to eventually equalize the currencies of the world. The world would also be liberated from the blackmail of OPEC and commodity marketeers.

  3. Johnny Norfolk
    September 2, 2008

    I know how much notice they will take of this free sound advice. Nothing. You cannot tell Labour anything. They are in their own little world distant from ours. They think they are right and everybody else is wrong. Brown just has no idea

  4. Alfred T Mahan
    September 2, 2008

    I agree with you that £1Bn is too small a sum to have much effect on the housing market. That being the case, isn't it irresponsible of the government to encourage the poor to buy an illiquid asset, where the appreciation/depreciation risk is significant and relative to overall wealth enormous? If the housing market continues to slide – as most commentators expect – then the government will only be enticing more people into negative equity. And it is exactly the people who can least afford the risk too.

    I call that immoral.

    Reply: the quesiton Hazel Blears was not happy to answer was just that this morning – Would you advise a young friend of yours to buy a flat or house now at these prices? saving 1% on Stamp Duty is not enough if house prices are going to fall another 5 or 10%.

  5. Neil Craig
    September 2, 2008

    A few days ago the BBC did a round up of the economic position & the government's options. All the options mentioned involved spending money, which also seems to be everything the government is talking about. The BBC reporter ended up by pointing out that the government are already beyond their borrowing limits but suggested that, since they had already passed that they might as well go for broke (not exactly the phrase used but that is what they meant).

    Since most people aren't going to study such things they are bound to get a lot of their economic "information" from the BBC. It is grossly improper & damaging of the state broadcaster to report purely in such irresponsible, dishonest & economically illiterate terms.

  6. no one
    September 2, 2008

    scrap the ID card scheme and use the 5 billion quid saved to do something useful, spend it on private tuition for poor kids, pay for folk the nhs has not bothered to treat to go private, etc

    house prices i am afraid need to crash in this country, its a necessary part of the economic cycle, and the country is uncompetitive with prices this high, prices are out of all proportion to sense

    of course planning rules need freeing up so that builders can actually build the houses folk want to buy, eg with parking, as opposed to far too many flats

  7. APL
    September 2, 2008

    Tony Makara: "A world central bank, given charge over a world currency, to run alongside existing national currencies, "

    You mean the US Federal Reserve. The US$ is currently the world currency, although for how much longer remains to be seen.

    Tony Makara: ".. with fixed exchange rates but periodic currency upgrades awarded depending on need and performance, would eventually be able to pull all the worlds currencies and thereby each nations purchasing power into sync."

    Ah, a sort of currency peg board.

    Who is to evaluate the world currency, to determine exactly what it is worth in US$, UK£, French Franks, Zimbawbian (whatever)?

    Who has better knowledge of the value of a currency than the market, and how do they know better than the market?

    Why not simply allow the market to evaluate the performance of an economy and assign a value to the currency of that economic zone accordingly. Currencies will float or sink according to the performance of the economy.

    No need for another SupraNational organisation with their own SUPER John Lewis List, we can save ourselves a great deal of money, by simply using the system we have at the moment.

    The UK £ is dropping because of the reckless behaviour of the British government. Simple as that!

  8. Tony Makara
    September 2, 2008

    " Who is to evaluate the world currency? "

    That would be the job of a world central bank, there must be no political imput.

    " Who has better knowledge of the value of a currency than the market? "

    The market isn't one unified entity pulling in the same direction, its lots of vested interests pulling in different directions. What is needed is a financial system that allows the market to operate with as little turbulence as possible, the starting point must be global financial stability.

    " Currencies will float or sink according to the performance of the economy "

    This is exactly the sort of thing that leads to boom and bust and must be avoided. If currency differentials can eventually be equalized the market will work better for everyone and not just be tilted towards those who trade in commodities, the people who always use the failure of fiat money to blackmail the world with higher prices.

  9. The Other Adam
    September 2, 2008

    World currencies are daft ideas, and proponents of them (usually socialists) don't understand their purpose. Currencies are essentially loans, backed up by the goods and services provided by the issuing economy (or entity).

    Firstly, you would be asking the world markets to accept a currency issued, and backed up by a large, corrupt, unaccountable and completely unproductive centralised "world" organization. Short of being a stabilizing influence, with fundamentals like that, this "world currency" would have trouble maintaining its own value!

    Secondly, assuming it did work, world currencies would encourage the world's less palatable regimes to default on their loans. After all, why would they bother to repay debts when someone else will pick up the tab? The Zimbabwean regime is the perfect example. It has no intention of repaying its debts (and indeed, no way of doing so) so it's currently paying what's left of its workforce with worthless scraps of paper.

    Currencies collapse for a reason. Usually, it's because of the dire economic and fiscal policies of corrupt and incompetent governments, as in Zimbabwe. But the world currency would unhelpfully maintain its value, backed up by the rest of the world, so the rest of the world would in effect be subsidising the continuation of Mugabe's murderous regime.

  10. Tony Makara
    September 2, 2008

    " Firstly, you would be asking the world markets to accept a currency issued, and backed up by a large, corrupt, unaccountable and completely unproductive centralised “world” organization "

    A world central bank would have to make international trade exclusive to its members and nations who choose not to join or deliberately decide not to accept its fiscal policy would be excluded from trading with nations who are members. This would serve as the credibility of the issue.

  11. APL
    September 2, 2008

    Tony Makara: "This is exactly the sort of thing that leads to boom and bust .."

    The thing that led to the bust under the last Tory government is the tranzi 'one world' faction of the Tory party, trying to fix the value of sterling so that it could become part of the Euro. That is, just the sort of thing you advocate.

    The thing that led to boom and bust under this current administration was the idea that there should really be no constraint on public spending, including but not limited to:

    1. The government can raise taxes on the productive sector of the economy and spend it in the public sector. On some pretty stupid and unnecessary schemes – the NHS 'spine' or super computer when the internet is avaliable, or the ID database, when it is clear that most people can manage their own 'identity' perfectly well without the government. In fact the government is incompetant in that area too.

    2. The government can deliberately cause economic drag (impede economic growth) with its hair brained environ – mentalism.

    3. When it thinks that perhaps it is taking too much tax in 1. for the productive sector to bear, it raises more tax by borrowing. Government borrowing is always a tax on future generations, we will all be poorer in the future because of government waste today.

    Tony Makara: "If currency differentials can eventually be equalized the market will work better for everyone and not just be tilted towards those who trade in commodities,"

    They can never be equalized, there will always be differentials in the performance of the underlying economies. Do you really think that an economy like Zimbabwe, and an economy like France could have a fixed exchange rate for more than three minutes?

    Tony Makara: "and not just be tilted towards those who trade in commodities, the people who always use the failure of fiat money to blackmail the world with higher prices."

    Ah! the nasty capitalistic internationalist financiers holding us all to ransom. Who do you think will populate the board of the World Bank? Tom from down the pub? I don't think so.

    The 'tilt' you describe is a recent phenomena, there was no such 'tilt' in the '80s or '90s in fact commodities were pretty cheap. It is only in the last seven or eight years that commodoties have been 'booming'.

    But you do just touch on the reality, our fiat money system, is the root of our problems. It has allowed Greenspan and now his successor to expand the US$ money supply seemingly with no relationship to the underlying health of the US economy.

  12. Tony Makara
    September 2, 2008

    APL, the Euro was/is a political currency intended to represent the political superstructure of the EU, it cannot be compared to a world currency which would exist to facilitate trade and would not impact on national currencies. Developing countries will never escape the crushing burden of poverty and corrupt regimes unless their purchasing power is increased overtime by currency realignments, which would have to be imposed. Pure market conditions lead to entropy and at times are even chaotic, as we have seen recently.

    A structured system built on a world currency and a world central bank is not socialistic or capitalistic but pramatic and necessary in the modern world. Any such world bank would have its membership composed out of member states, which in turn would provide experts in the field of banking who are afforded operational independence. A global banking system would be able to respond to any world financial crisis and would have the ability to cast out any nation that tries to circumvent the modus operandi of the world central bank.

  13. Neil Craig
    September 2, 2008

    We used to have such a world currency. It was called gold & it was accepted precisely because it wasn't backed by bankers with printing presses. It could fluctuate a bit when somebody found a new gold field but nothing like how it would if it were "guaranteed" by politically acceptable bankers.

    So long as we have competing currencies there is some incentive to stability & if the US can't get a premium from having reliable money the Swiss & Chinese will.

    We could back it with something other than gold (I have suggested a kwh of electricity delivered by space satellite anywhere in the world) but without some backing it is just a conjuring trick.

  14. mikestallard
    September 2, 2008

    It only seems a couple of days ago that we were discussing much vaguer things like reducing the government's incontinent waste and expense, whether or not we should put inflation control before bank rates and so on.
    Now we are getting down to the nitty gritty of how to stave off an immediate crisis caused, frankly, by complete incompetence by a divided and broke government.

    I want to return to the original blog, if I may.

    APL says, quite rightly, "Why not simply allow the market to evaluate the performance of an economy and assign a value to the currency of that economic zone accordingly. Currencies will float or sink according to the performance of the economy."

    The government ought to be working full tilt to achieve this objective in this hour of "sterling crisis". It's the economy, stupid.
    They ought to be doing, urgently, things that put the economy together again.
    Like cutting waste on silly quangos. Like changing bureaucrats into people who are making the economy stronger instead of weaker. Like getting people back to work even if it means cutting the welfare. Like cutting taxes for people who are getting us the money from abroad. Like encouraging production and foreign earnings. Like giving the MBE to people who win us production abroad. There are a lot of things that a competent government could be aiming at achieving.

    Instead they are answering the original question of whether this is a Sterling Crisis in the Sunny Jim Callaghan way:
    "Sterling Crisis? What Crisis?"

  15. figurewizard
    September 2, 2008

    In almost exactly a year the pound has devalued against the dollar by 13% and there is as yet no signal from the markets that it will stop there. Unless the Bank of England follows its brief and starts to raise rates to defend it inflation will become a chronic feature of the economy. This must eventually lead to a substantial increase in wage demands, most especially from the public sector as the standard of living continues to fall. Factor in a housing market, which is more or less all that has accounted for economic growth over the last seven years and is now collapsing, together with a fractured and incompetent Labour government and the 1970s look set to make a comeback from the beginning of next year at the latest.

  16. Patriotic Thinking
    September 3, 2008

    When all is said and done, a falling currency is merely a symptom of a weak economy. From here on in, the currency level should be understood as a prime indicator of our competitiveness. The only problem is as you say: floating exchange rates allow governments far too much wiggle room. You must keep banging on about this in the MSM. Only that way will the public begin to understand the implications of what is happening.

  17. Adrian P
    September 3, 2008

    Boom and Bust are deliberately caused, ther Banks offer lower interest rates to het people hooked on thin air credit and worthless fiat paper money.
    Then, when enough have been hooked, they raise the rates, hauling in the assets of those who have over extended themselves.

    All those assets, homes, buisness, cars etc, all created out of thin air.

  18. Paul Craythorne
    September 4, 2008

    I have over 3000 euros in a euro account with a major UK bank.

    This is earning me no interest.

    As the £ is falling against the euro should I now convert a large proportion of these euros to Sterling and place the money in my high interest Sterling account?

    Reply: Under the law I am not allowed to offer investment advice from this site.

  19. Peter McClough
    September 8, 2008

    After many years living in Spain, I look back at England through the TV and occasionally local papers. As a victim of the collapse of the English pound I deeply regret having assets in England and worse still illiquid property based assets included. Many say that I should have firesaled the English assets last year and saved 20% of my life savings. The only thing that keeps the English pound alive is national pride and it is important that they realise that they are now just a small island nation off the north west coast of Europe – not a world power. Currencies gain or lose value according to supply and demand and internationally the pound is being shunned by all. Regulation of financial services is a stanglehood on small financial firms but give a free rein to the big institutions. The current crisis has come about because of the greed and irresponsibility of big institutions initially in America. Moving to property, I have never been able to understand why people in England worry about a mere 10% fall in values when over here, property is selling at 50% of last year's value! England has the lowest transfer taxes in the world and I believe these have been abolished on property under £200,000(?). No wonder one could buy on Monday and sell on Thursday at a profit in the good days. Here we pay 10-12% transfer costs on every sale and if you make a loss, the tax man will not believe you and you will be fined!

    1. mike stallard
      September 9, 2008

      Yes but when you buy, you only declare half the price!

  20. Peter McClough
    September 9, 2008

    Totally wrong! When were you in Spain last? Today, if you declare less than 80% of what the state decides is the correct value, the state has the right to buy the property at the declared price. If you declare more than 80% but less than the tax man's opinion as to value (even qualified lawyers cannot reliably ascertain the correct declaration value – and I speak from first hand experience!), you risk a complementario or in plane English a fine for underdeclaration. If you sell at a loss (as you will in today's market) the capital loss will not be recognised and you are fined. Full documentary evidence of payments is not considered sufficient as it is always assumed that there is a black element. Over declaration is often needed but the headache is trying to pursuade a foreign buyer to accept this as in England I believe they always declare the actual transfer value less legal costs(?).

    1. mike stallard
      September 9, 2008

      We sold up in 2004. We had a Franquista casa in Lo Pagan, Murcia.
      I regret that we took legal advice when we bought and lots of cash sort of went across the table.When we sold, sort of lots of cash went into the local bank too.
      Complementario? No lo se.
      Even then, in just a couple of years, a lovely village by the side of the mar manure turned into a concrete mess full of empty houses. YUK!
      I suspect that (!VV Zapatero!) Spanish Socialism in getting like our own dear Trots.

  21. Peter McClough
    September 10, 2008

    You are a brave man to face England again! On my last passage through Stansted airport a few years ago I was stopped and told my bum bag counted as a piece of hand baggage and would have to be checked in. As it contained money and dox I protested strongly and a member of the security police said "I can have you arrested on the spot–" for protesting! Hence I was forced to comply! Not a friendly country to visit or to stay in!
    There's a saying here going around – "The English are controlled because they like to be controlled". (words left out-ed) God help us! Give me the corruption of Spain any day rather than the subtle corruption in high places in England threatening to turn that country into a third world republic. How many pounds to the Zim dollar now?

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