Stephen King: The weak pound offers a quick fix but no long-term solution
Monday 28 September 2009
Devaluation is a dirty word. It stinks of failure. Every so often, the British economy succumbs, most famously in 1949, 1967 and 1992. Each time, as the UK lost its economic footing and sterling collapsed, the people of Britain were left to inhale the stench of political desperation.
Given all this, it's fortunate that the UK no longer pegs its exchange rate to anything in particular. The great advantage of a floating exchange rate is that there is no exchange rate policy to defend: sterling can go up and down, it can appreciate and depreciate, but it cannot be revalued or devalued as that would imply it was moving from one pre-ordained level to another. Nowadays, British policymakers supposedly don't bother worrying about the exchange rate, but rather with the performance of inflation. The exchange rate ends up wherever it needs to be for price stability: up, down or sideways.
Despite all this, Mervyn King, the Governor of the Bank of England, still managed to give the foreign-exchange markets an attack of the willies last week. In The Journal, a Newcastle-based newspaper, he observed that "The fall in the exchange rate that we have seen will be helpful [in rebalancing the UK economy] ... There's no doubt that what we need to see now is a shift of resources into net exports." Was the Governor suggesting that exchange-rate weakness might be a good thing and that Britain might benefit from a further fall in the value of the pound?
The Governor's point is, in one sense, obvious. We need more exports because, for too long, the UK economy has been dependent on debt. For a while, higher debt levels fuelled decent economic growth and everyone felt pretty good, living off the temporary high created by excessive borrowing.
However, the idea that the UK should continue to progress by creating a nation of shopaholics no longer seems quite so sensible. Existing debts need to be paid off. New debts need to be avoided. In the process, we need to find new sources of economic growth. Maybe exports might be able to play that role.
How can we wean ourselves off the nasty addiction to debt? In part, the answer comes from an economic form of cold turkey. Banks are no longer able to fund themselves so easily – unable to rely on the sale of securitised assets, they've had to depend on trusty old deposits alone – leaving many businesses and households unable to get hold of the quantities of credit they might have enjoyed earlier in the decade.
So far, however, debt repayment has been postponed. Attempts by the private sector to repay debt – which, on their own, might have led to a catastrophic meltdown in economic activity – have been offset by massive increases in public-sector debt.
The Keynesian fiscal stimulus over the last couple of years was, on its own, perfectly sensible. Collapsing confidence associated with the madness of crowds could have thrown the UK into a deep and persistent depression. Stopping depression, however, is not quite the same thing as promoting recovery. Economic life is often binary – boom followed by bust followed by boom. But it doesn't have to be. In the middle, there's a no-man's land where all on offer is persistent stagnation. If the nation was saddled with debt before the crunch, it is saddled with even more debt today. Before the crunch, we borrowed from abroad, either directly via the generous spirit shown by Icelandic banks or indirectly because our own banks borrowed from others operating in international capital markets. Now we borrow from our children, in the form of huge increases in government debt which will have to be serviced and repaid by future taxpayers (either directly or, God forbid, through the nasty inequitable effects of higher inflation).
With all this debt, where will future economic expansion come from? Labour having finally agreed with the Conservatives that public-spending cuts will be needed over the years ahead, the public sector is hardly going to be an engine of growth. Once upon a time – notably in the Thatcherite 1980s – paying down government debt by reducing the budget deficit was considered no bad thing. Lower government borrowing would reduce the government's hold on the nation's saving, thereby lowering interest rates. So long as the private sector was better able than the public sector to allocate resources efficiently, the economy would expand more quickly, to everyone's benefit.
It's not clear whether this mechanism ever worked particularly well. But if it ever did work, it is certainly not likely to work now. With interest rates already very low, we're unlikely to be on the verge of a private-sector lending boom. Saddled already with too many debts, consumers will struggle to return to their bad old ways. Meanwhile small and medium-sized companies are struggling with a credit crunch which, for them, is still an everyday reality (notwithstanding directives from the commanding heights of government for the nationalised banks to lend to all and sundry.)
Mr King's argument is simply one of logical deduction. If consumer spending, government spending and investment spending are going to be weak, the only likely source of growth is exports. One way to boost exports is to adjust the relative price of goods and services produced in Britain, and an obvious way of doing this is to encourage sterling to fall. Unlike the individual eurozone members, the UK still enjoys exchange-rate flexibility. Mr King's approach has been interpreted as "if you've got it, flaunt it".
The Bank likes to dress these arguments as "rebalancing". But this is, arguably, no more than a polite description of devaluation. I agree that stronger exports will help rebalance the economy. I'm just not sure that devaluation is the right route. It seems like yet another attempt at a "quick fix" for the UK economy.
With increased competition from China and other emerging nations, a quick fix on the exchange rate is likely to be followed by slow failure. Our export prospects ultimately depend on upgrading the quality of the goods and services we produce. A falling exchange rate will merely allow us to sell cheap tat for a little while longer. The next few years are going to be tough. I doubt a drop in the exchange rate will do very much to alter that underlying prospect.
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