How low can the pound sink? At the start of this decade, a pound bought €1.70. At the start of this week, it bought only €1.08. Parity with the euro, unimaginable when the single currency was launched, looks inevitable within the next few months. Right now, Britain is happy with that. The government looks on with benign neglect. The governor of the Bank of England, Mervyn King, even seems to be talking the currency down. Devaluation is seen as part of the policy mix, along with printing money, that will eventually lead to recovery. And the markets have been more than happy to oblige.
Sterling is the new whipping boy of the trading floors. Its weakness against the dollar has been masked, to a degree, by the frailty of the US currency. But it is its value against the euro, the currency in which most of Britain’s trade is carried out, that reveals how friendless sterling has become. It has been falling steadily against the single currency for most of this year. After recovering slightly from the all-time low of €1.02 at the height of the financial crisis, it has resumed its decline. Parity now looks a certain bet. In many ways, that’s a rational response to the dismal economic outlook the UK now faces. France and Germany were badly hit by the crisis, but their economies are starting to recover. Their public-sector deficits, while serious, are nothing like as bad as the UK’s. Their economies weren’t anywhere near as dependent on the bubbles in property and finance. And the European Central Bank has proved a far sturdier defender of monetary stability than the Bank of England.
Small wonder then that investors are selling sterling.
More surprising, however, is the tacit encouragement from our central bank. In an interview last week, King described the fall in the value of the pound as “helpful”. So it was only to be expected that currency traders, who still fret about the cost of finding themselves on the wrong side of a fight with a central bank, took note and gave the pound another downwards shove. In all fairness, King was only expressing the mainstream view among policy makers and economists. A cheaper pound will revive manufacturing and kick-start a more general rebalancing of the British economy. The trouble is, this is nonsense – and dangerous nonsense too. Comparisons are regularly made with the early 1990s, when Britain’s ejection from the European exchange-rate mechanism, and the big fall in the pound that followed, helped trigger the long upswing of the 1990s. But the comparison is bonkers. The pound then had been fixed at too high a rate against the German mark. The UK had a structurally reformed economy held back by an overvalued currency. That isn’t true now.
There’s no reason to suppose the pound was overvalued a year ago. As for the fundamentals of our economy, let’s not even go there. This looks far more like an old-fashioned sterling collapse, of the sort the UK witnessed repeatedly throughout the 1960s and the 1970s. And they never heralded any sort of revival – they were part of the problem. To imagine that a service-based economy such as the UK can devalue its way out of trouble is daft. Britain is barely a manufacturing economy – certainly not one that can compete on price with eastern European or Asian factories. It is an exporter of high-value, intellectual property: financial services, insurance, legal advice, media and science. What goods it does export are high-tech and design-intensive. They aren’t being sold on price – if they were, there wouldn’t be any orders at all.
All you do when you devalue the currency is reduce the income of those sectors to the extent that they price their work in sterling. That makes the country poorer, not richer. To imagine that Britain is suddenly going to become a low-cost manufacturing centre implies a savage reduction in living standards – and that presumably isn’t what the advocates of devaluation want. The government and bank should keep a closer eye on sterling. If there is a collapse of confidence in the UK, and if the IMF does have to bail the country out, it will be the currency markets that pull the trigger. Britain is critically dependent on foreign capital. It is running a trade deficit of £6.5bn a month, close to record levels. There is no sign of it closing despite the huge fall in the pound’s value.
Worse, the UK is critically dependent on foreigners to finance its yawning budget deficit. Savings are so low that there is no way the British can buy £200bn of government debt a year – even before the crisis, foreigners accounted for a third of all gilt sales. While the bank buys up gilts with freshly minted money, that might not matter. But when it stops, there won’t be many buyers for all that debt in a depreciating currency. Debauching the pound isn’t a solution – it’s part of the problem. And if it gets out of hand, it could yet provoke a real crisis. If confidence in sterling were to collapse suddenly, the bank would have to hike interest rates sharply to defend the currency, and the government would have to slash spending to restore faith in the markets. Either would turn a recession into a full-blown depression. Both together would be a catastrophe.