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.