Saturday, 19 April 2014

* Reality check for zealots of weak currencies

Financial Times

Stephanie Flandersis chief market strategist for JPMorgan Asset Management in Europe

They never told us we could do that,” said Sidney Webb, a bruised former minister, when Prime Minister Ramsay MacDonald took Britain off the gold standard in 1931. So began a curious love affair with currency depreciation that permeates the British establishment to this day.

That momentous decision – forced on the government, in the end, by a mutiny of the Royal Navy – took 25 per cent off the value of the pound and scarred the Labour party for decades. But it also saved Britain from the Great Depression.

Read nearly any account of Britain’s encounters with the foreign exchange markets since the second world war and you will find a familiar storyline. The country is imprisoned by an overstrong exchange rate, which politicians cling to for too long. This causes pain, misery and ultimately chaos.

Then, finally, we devalue and the consequences are not nearly as bad as people thought. They may even be miraculous, as in the case of Black Wednesday, when in 1992 the UK left the European exchange rate mechanism, inaugurating the longest period of continuous economic expansion since 1945.

Whether it is 1992 or 1967 or 1944, the lesson you learn as a student of our postwar history is that depreciation sets you free, and a strong currency is a problem. All of which probably explains why British policy makers and business leaders applauded the nearly 30 per cent fall in the pound in 2007-08. And why they are so nervous now that the value of sterling has started rising.

They should stop worrying and enjoy the fact that our global purchasing power is actually going up. So should the rest of us, and not just because a bottle of rosé on the continent is going to be a bit cheaper this summer.

The rise in the pound has probably done more to ease the “cost of living crisis” for UK families than three years of stop-start recovery. I think it will also do more good than harm for the broader economy, helping to make the current pace of growth more sustainable without derailing our hopes of becoming net exporters.

Traditional economic models say the opposite, that a higher exchange rate will hurt growth by making UK goods less competitive and so hurting the trade balance. But I am not sure that model takes enough account of the realities of a global economy, or of Britain’s real-life experience since 2008.

Most of the faster growth we have seen in the past year has come from households saving less. Although George Osborne, the chancellor, talked about encouraging savers in his Budget last month, the official forecasts showed the savings rate falling further in the years ahead. Household debt is forecast to start rising again as well.

It would be better for the recovery if the growth in consumer spending were the result of higher real earnings. But it is hard for employers to pay people more when their average productivity – output per head – is still so much lower than it should be and lower than many of our competitors.

When we solve that “productivity puzzle”, we will find the so-called cost of living crisis a lot easier to manage as well. But until we do, our best hope for a rise in real average earnings lies in the stronger pound.

Inflation was always going to fall this year, as temporary factors such as the rise in university tuition fees stopped affecting the figures. But it is the falling price of imports – especially energy and food – that mainly explains why inflation has come down much further and faster than the Bank of England expected.

What about that much longed-for rebalancing of the economy away from consumption and borrowing towards exports and investment? Will a stronger pound not put that in jeopardy? No one can say for sure. But we do know that the more than 25 per cent depreciation in the value of sterling since the financial crisis has not produced a lot of rebalancing so far. Rather the opposite.

Net exports have barely made a contribution to growth since 2009, and our current account deficit – the amount we have to borrow from the rest of the world to make our balance of payments add up – is even larger now than in the late 1980s, when the pound was a lot stronger.

It is true that net exports have picked up lately, adding more than a percentage point to growth in the last three months of 2013. But that has been a long time coming. If there is going to be harm from a stronger currency it looks as though that will take a long time as well.

The British Chambers of Commerce last week reported service-sector export orders were at an “all-time high”. Very few of the companies winning that business are competing on price alone.

Careful studies by the BoE find little evidence that the cheaper pound from 2008 onwards helped manufacturers to raise market share. That should not be so surprising – then you consider how much of the value that goes into British manufacturing is now imported from somewhere else.

For companies that are part of a global supply chain, a cheaper domestic currency is a mixed blessing. For some it may be no blessing at all. Yes, the exchange rate matters. But it is far from the only thing that counts.

The great depreciation of 2007-8 did one great service to the nation. By pushing up inflation, it made it easier for us to handle our mountain of public and private debt. But that same rise in inflation also held back the recovery by tightening the squeeze on household incomes.

Of all the freedoms we have retained by not joining the euro, the freedom to tank the pound seems the one we are most proud of. With the signal, painful, exception of the 1980s, a weak pound has been our “get out of jail free” card since 1931. But it does not come free of charge. It makes the world a more expensive place for British people to live in. This time the costs for ordinary households have been particularly steep and the benefits particularly hard to see.

No doubt the pound has more bouts of depreciation in its future. We live, after all, in a world of free-floating currencies. But 2008 may be the last time that UK policy makers all saw a collapsing pound as a blessed release.

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