If the world is so confident about UK economic policy, why has sterling been hit so hard by the markets? Well, I think we know the answer to that one, so try a harder one. To what extent will a weak pound be a blessing, or a curse, in the year ahead?
Obviously this is a keen issue for many families, as this holiday season is traditionally the time when people plan their next holiday season – where they will go in the spring or summer. And for anyone planning to go abroad, the plunge of the pound is a disaster. Expect a boom in people going to the few countries with even weaker currencies than we do: hoteliers in Turkey and South Africa, stand by.
But if there is going to be a global recession, and something like that is going to happen, a weak currency does in the short term at least help boost demand. You could almost say that it is a benefit to have an economy and a Government in which the world has so little confidence.
A couple of stories to illustrate this. One comes from a friend who plays the piano in an Italian restaurant in London. I was worrying that business must be terrible, given that one of the first things people cut down on when they are feeling poor is eating out. No, he said, all their customers were tourists from Europe who were flocking to London to do their Christmas shopping. The restaurant was full every night.
The other was an acquaintance who had moved to the UK to set up a hedge fund in London. Why on earth had he chosen London when he could have based it anywhere in the world? Well, London used to be expensive but now he could get offices cheaply and could hire high- quality staff. The only other realistic alternative was New York, and our capital was now more cost-effective.
So while it is true that many businesses have been savaged by the fall in the pound, particularly those that need to import goods or services, a lower pound should, on balance, give a boost to the economy. It will take a while for exporters to benefit fully because there simply isn't much demand in the main export area, the eurozone. The most recent data suggests that the combination of the soaring euro and the lack of international demand is hitting German business confidence even harder than the burden of debt and the lack of domestic demand is hitting UK confidence. The danger is that the fall in sterling will get out of control and start to have perverse effects.
You have to start by recognising that the pace and extent of the pound's collapse in the past year has been greater than at any stage since sterling left the gold standard in 1931. It has fallen by nearly 25 per cent. That is worse than the Second Word War. It is worse than the devaluations of 1949 and 1967. It is worse than the dreadful 1970s, when we had to get the International Monetary Fund to bail us out with a loan. It is worse than the ejection from the European exchange rate mechanism (ERM) in 1992.
After the 1967 devaluation, the pound dipped by 13 per cent for a year, then jumped back to the norm as the devaluation moved out of the statistics. (If you are wondering why the current devaluation is greater than the 1949 one when the pound fell from $4.00 to $2.80, it is because the trade-weighted fall was lower than the fall against the dollar as sterling area countries devalued along with the pound.)
So what is our past experience of devaluations? It is a mixed bag.
Starting with the most recent, the exit from the ERM was highly successful. It made sterling super-competitive and there was hardly any feed through into inflation because demand was low. Due to slack in the economy, business could not put prices up. After the collapse in the 1970s, the picture was more confused, but I think it would be fair to say that most of the competitive advantage we gained was thrown away in higher inflation. That was certainly the case after the 1967 devaluation.
The 1949 devaluation was effective in the sense that the old exchange rate was clearly unsustainable, but since many other countries devalued too, we did not gain much advantage for very long. And finally the 1931 devaluation. Well that was indeed a success as it enabled the UK to make a faster recovery from the Depression than any other major economy.
So what about this one? Simon Ward, economist at New Star, questions the consensus view that the lower currency carries little inflation risk. The output gap now is not as large as in 1992 and though headline inflation will come down (thanks to falling commodity prices), he fears that it might not come down as fast as the Bank of England expects.
That would lead to two dangers – one that the Bank can't cut rates further since to do so would not be credible, the other that confidence in the UK's financial management would face some kind of systemic collapse.
The former seems to me less of a concern, just because we are at a level where further cuts will be ineffectual. You can see what has happened in the US and Japan: rates go to zero, or just about, and nothing happens.
The risk of a collapse of confidence in the UK's creditworthiness must surely be a real one. Next year we could end up with a fiscal deficit of more than 10 per cent of GDP. Our national debt, if you include the liabilities of the Royal Bank of Scotland now that it is majority-owned by the taxpayer, would become the highest in the world relative to GDP. Even without RBS (and I think that is a fairer calculation), it looks as though it will go from under 40 per cent of GDP to something close to 80 per cent. I don't think Gordon Brown has any idea of the contempt in which he is held in the rest of the world. I sat at lunch next to a top European politician a few months ago and his assessment was unrepeatable. (He cheered up noticeably when I said that the PM couldn't win an election.)
The big point here is that a competitive currency is helpful going into a global downturn, but if it is associated with a collapse of confidence in the Government, it can be dangerous. Most obviously, the cost of funding the deficit will rise and that will crowd out other borrowers. Fortunately, I don't think we are quite at that tipping point yet.
So I suppose you could say the fall in the pound is not yet a disaster in itself, and if the interest rate recovers some in the months ahead, it will be a modest help. All currencies have their day in the dog- house – the euro has had one, the dollar too – so I don't think we should despair. But the underlying fiscal position of the country is quite dreadful and I worry about the ability of the Government to fund its debts. The collapse of sterling makes that harder still.
With the right deal, the taxpayer could save Land Rover and Jaguar
A bank, a car manufacturer and a chain of shops – all under pressure, all calling for government help. How does the government decide which to support?
We know part of the answer. Royal Bank of Scotland is bailed out and Woolworths is not. The bank is systemic to the economy, for bank deposits have an implicit 100 per cent guarantee. And the cost of the largest business bank group in the land collapsing does bear thinking about. We know that Woolworths, despite its history and its size, can disappear without too many tears. It is horrible for those involved, but its sites will be used for other purposes and money not spent there will be spent elsewhere.
But Land Rover and Jaguar are somewhere in between. A huge number of suppliers and dealers depend on them and they export many vehicles, bringing money into the country.
The Government rescued British Leyland and, though it sold it on, the eventual outcome was that its mass manufacturing division collapsed. Jaguar and Rover were part of that group and the Government is understandably chary of being sucked into an open-ended commitment that it cannot get out of.
Yet there does seem to be a strong case for some support. Tata, the new Indian owner, is under a lot of pressure at the moment but it is an honourable and competent company. True, it is more interested in Land Rover's potential than Jaguar's, but Jaguar's new XF range is a cracker and the astounding thing about a car company is that one product can transform its fortunes. It is also a highly cyclical business and this cycle is particularly vicious. Tata has, so-to-speak, bought Jaguar and Land Rover at the "wrong" time.
The trick will be to make sure that the commitment is not open-ended and I would suggest that there is some kind of bonus payment so that when the companies revive, the taxpayer gets some benefit. Maybe not a Jaguar on every drive but something for the risks the taxpayer is being asked to take on?Reuse content