Jeremy Warner: Perils of sterling's devaluation

Outlook Nobody other than holiday-makers, second-home owners and retirees living overseas on a sterling pension seem much bothered about or even to have noticed the collapse in the value of the pound over the past year. This is not just because there have been more immediate matters to worry about, such as the near death of the banking system.

It is also because this very substantial devaluation has been positively welcomed by policymakers, who regard it as a reflationary tool just as important as lower interest rates. There are a number of ways in which a lower pound can boost the UK economy. First, it makes British exports cheaper and therefore more competitive while correspondingly making imports more expensive and therefore less competitive.

It also makes Britons less inclined to travel abroad to spend their hard- earned cash but may also attract more free-spending foreigners to our shores. In theory, the effect should be to help to rebalance the economy away from its over-reliance on debt-fuelled consumption towards a more productive profile. Unfortunately, in a world economy where there is no demand, these normally beneficial effects may be largely absent. There is little point in more competitive industries if there is no one willing to take advantage of them.

Equally unfortunately, there are a number of negative effects that spring from a weak currency. More expensive raw material costs are just one. But more importantly, a weak currency is only a symptom of capital exodus to more attractive or safer homes overseas. This matters because there is less money available to support economic activity back home.

Government ministers lambaste the banks for not lending enough, yet the reason credit is being squeezed is because it is no longer possible to borrow internationally as freely as we used to. In extremis, the flight of capital becomes a self-feeding phenomenon. The lower the pound falls, the more it frightens the money markets and the less inclined they are to lend in sterling.

Many international investors regard the outlook for the UK economy as truly dire. Its key strengths, the housing market and financial services, lie in ruins, and now there isn't even the attraction of high interest rates relative to Europe to keep the money flowing in. Like the banks, Britain as a country is being forced to deleverage, and most disagreeable it is likely to prove too.

The pound is now a good deal lower, both on a trade-weighted basis and against the euro and its precursor currencies, than it was even after Britain came out of the ERM. The diet of thin gruel we must now learn to live on may be entirely deserved after all those years of sponging off others, but a weak currency seems unlikely to deliver the more appetising fodder economic purists hope for.

Britain was a major beneficiary of the capital and trade imbalances of recent years. From a UK perspective, there's no particular reason to celebrate their demise. To the contrary, starved by a devaluing pound of previous infusions of foreign capital, it's actually quite hard to see where economic salvation might lie.