There’s plenty of time left to choose some new shades, work on your tan, and decide what to read on the beach this summer. But unless you are planning on holidaying in Cornwall or Norfolk, this might also be a good moment to stock up on some foreign currency. That’s because another sterling crisis might not be far off.
Right after the credit crunch, sterling took a big hit. The end of ‘boom ‘n’ bust’, so monotonously proclaimed by former prime minister Gordon Brown, proved to be a complete fiction. Instead, the British boom of the noughties was largely exposed as a bubble, based on debt, public spending and mass immigration. The currency markets sold off the pound accordingly. Since 2008, sterling has been largely stable. Not for much longer, however.
The scale of the devaluation imposed by the markets on the pound in the wake of the 2008 financial crisis was huge – even by the standards of a currency that has always been prone to periodic collapses in confidence.
Back in January 2007, a euro only cost you 65p. You could look at that menu in Tuscany or that farmhouse in Provence and marvel at how cheap everything was – at least once you translated the price back into pounds. Now the same euro costs 87p, and at one point in 2008 it cost 96p as the two currencies came close to parity.
It was a similar story against the dollar. Back in 2007, a pound bought you $2.10. A trip to Disneyland Florida cost practically nothing, and you could fly to New York for your Christmas shopping and still save money. By 2009, the pound had dropped all the way down to $1.37.
The euro and dollar were, of course, both currencies with serious problems of their own. Against a really serious currency – the Swiss franc, for example – the decline has been even more marked. A pound bought you 2.49 Swiss francs in 2007. Today it buys you just 1.43. Wherever else you might be thinking of going, don’t put Geneva or any of the Alpine resorts on the list. Your credit card will never recover.
Sadly, the currency markets were completely right in their judgement. Much of the growth of the British economy in the decade leading up to the credit crunch was exposed as a sham. The economy was fuelled by debt, both private and public, and imports of hundreds of thousands of cheap workers. It was about as solid as a leaf of wet lettuce caught up in a hurricane. Afterwards, the UK was left with one of the biggest budget deficits in the developed world – as well as a long hard slog to put its finances back in order.
Nor was that a bad thing. A sharp devaluation of your currency is one of the best ways of restoring the competitiveness of your economy. The modest revival in British manufacturing since 2008 is evidence that it is working its magic – even if it is hard to believe the UK can become a land of factories once again. And yet the truth is that sterling hasn’t completed its devaluation yet. Here’s why.
First, the growth figures are very disappointing. The Office for Budget Responsibility is forecasting 1.7% GDP growth in 2011, rising to 2.5% in 2012. Right now, those figures look very optimistic. The UK economy has largely stalled in the past six months. It is going to have to accelerate a lot to meet those targets, and there isn’t much sign of that happening.
If growth doesn’t come through as has been forecast, the deficit will be worse than expected too. You can control the budget deficit by cutting spending. But by far the easiest way to do it is to keep the economy growing. The bigger the economy, the more taxes you collect, and the less you spend on benefits.
But when the economy stalls, the deficit inevitably gets worse. If the UK starts missing its targets for deficit reduction – and bear in mind that we have one of the biggest budget shortfalls in the developed world – then the markets are going to punish the currency sooner or later.
Next, and largely because growth is so weak, interest rates may stay at their current 300-year lows longer than most people expect. True, the inflation numbers are scary. There was another jump to 4.5% earlier this week.
But, rightly or wrongly, there is very little evidence that the Monetary Policy Committee is about to change its mind and make tackling rising prices rather than stimulating growth its main priority. And the longer growth stays very weak, the longer interest rates will stay low. There may even be another round of quantitative easing if growth doesn’t pick up soon.
Finally, we can’t assume the coalition is going to last the full five years just because the prime minister says it will. The Liberal Democrats got hammered in the local elections. The party could easily rebel against its leader, and quit the coalition. The new Scottish government may stage a snap referendum on pulling out of the UK. A country with no clear government, coming apart at the seams, would hardly be doing well on the currency markets.
In reality, the UK economy was in a terrible state by 2008. One devaluation of sterling fixed some of the problems. Another one is probably needed. How low could the pound go? Down to parity with the euro, and possibly below it. And down to 1.30 against the dollar. Just make sure you’ve bought some holiday spending money before it happens.