Franc likely to be dethroned in the battle to set currency rates

The French economy is growing slowly and needs devaluation or a cut in rates to get it going again while the UK economy is growing fast

There are two stories on the foreign exchanges at the moment: the heat is on the French franc for a devaluation; and heat of a rather different sort is on sterling for a further revaluation.

For anyone not intimately in tune with the strange logic of the exchanges this must seem a curious turn of events. France, with a current account surplus, virtually no inflation, tight monetary and a tightening fiscal policy, and of course a prospective core member of the European Monetary Union, has a much weaker currency than six months ago, even though there has been no real change in the economic numbers in the interim. Britain, with strongish growth and a current account balance, with a fairly loose monetary policy and an only slowly tightening fiscal policy, and with some signs of inflation a-looming, has a much strong currency, even through there has also been no real change in the numbers. What is up?

There is a one-sentence answer, which is this. The French economy is growing slowly and needs devaluation or a sharp cut in interest rates to get it going again, while the UK economy is growing fast and sterling has become a "safe" haven from the impending euro.

The trouble with that sort of answer is that it explains what is happening, but not why. The answer to the "why?" takes a little longer. It comes in two parts. The first is fashion. The world financial community has decided that EMU might not be such a brilliant idea after all. When the plan was for an enlarged DM zone, with the French franc bound in too, that seemed a reasonable prospect. Now, whatever happens, there will be problems. The euro will embrace several weak currencies, in which case it will be unattractive, or there will be great tension between the ins and the outs. The politicians have unwittingly managed to engineer a dramatic change of mood. There is a second and more substantial explanation for the change which relies not so much on fashion as on some hard calculations about the real underlying value of currencies. As we (or rather they) have got nearer to EMU people have started to try to work out whether the present relationship between the various currencies is durable: not whether they are "right", because there is no absolutely right rate; rather whether they are near enough to be credible in the long term.

If you say you are going to lock currencies together for ever and a day, you have to be absolutely confident that you have given the choice of rate your best shot. If the choice is cobbled together by politicians late on a Sunday night (as was the lira's re-entry to the ERM) this is unlikely to impress.

So what are "reasonably right" rates? I have just come across some purchasing power parity calculations published by the US investment bank, PaineWebber. These PPP rates, developed by comparing prices in the different countries, are not necessarily the best sustainable rates for the medium term, and certainly not for the short. Actual rates are affected not just by the state economies find themselves in at any one stage of the economic cycle, but by things like the relative competitiveness of export industries and by the willingness of citizens to save. A wonderful export sector, a fairly inefficient system of local distribution and a high propensity to save explains why the yen is so high. Very efficient distribution and a lack of savings explains why the dollar tends to be weak. Nevertheless PPP rates are a useful guide to where, eventually, you might expect exchange rates to settle.

Now have a look at the table. These are not the only calculations of PPPs by any means; others have done them with rather different results. But they are useful base from which to start. The dollar under-valuation stands out, of course, being nearly 27 per cent too low against the German mark and more than 36 per cent too low against the Japanese yen. The sterling rate is not too bad - PaineWebber reckons that the PPP rate should be $1.54, about where the pound was last summer, and that now the pound is 8-9 per cent overvalued against the dollar.

Few surprises there. But now look at the rates for sterling against the mark and the franc. The PPP rate is DM3.23, which is 20 above the present rate, but higher than the central rate of sterling when it was ejected from the ERM. Against the franc, we are some 17 per cent too high: the PPP rate is about Fr10 to the pound, that useful 10-to-one ratio that made it so easy to work out the prices on the menu in a French restaurant.

Is, on this basis, the franc over-valued against the mark? Yes, a bit - a 6 per cent devaluation should set them right. But compared with some of the others on the list, the franc is not the problem: the problem is the mark/dollar rate.

Now it so happens that that is very much what monetary officials have been saying. Europe's problem is not so much an internal one of the rates between European currencies, but an external one between European currencies as a whole and the dollar. Sterling at the moment is a half-way house, being overvalued against the dollar and undervalued against the mark and the franc. Most other calculations would put the pound a bit lower - I have seen rates between DM3.10 and DM2.50 - but they would not change the general picture.

What should the conclusions be from all this for the two issues noted above: the weak franc and the strong pound? The main one, surely, is that while there may be a case a slightly lower franc, it is not a powerful one. There is on the other hand a powerful case for lower French interest rates, and if the price for that were allowing the franc to slide down a little it would make great economic sense. As for sterling you can make a decent case for the recent appreciation, and it would be tolerable for that appreciation to move a little further forward. But while there is leeway against the main continental currencies there is none against the dollar. We could sustain another 5 per cent revaluation of the exchange rate, but we are heading into unsustainable territory if we go too far beyond that.

My guess is that eventually the markets will get their way and manage to dethrone the franc and that for a while sterling will become too strong. But that is not for any scientific reason: it is simply because the exchanges always overshoot; like supertankers, once they start heading in one direction it takes a lot to turn them round.

Sport
Louis van Gaal would have been impressed with Darren Fletcher’s performance against LA Galaxy during Manchester United’s 7-0 victory
football
News
people
Arts and Entertainment
Christian Grey cradles Ana in the Fifty Shades of Grey film
filmFifty Shades of Grey trailer provokes moral outrage in US
Voices
The new dawn heralded by George Osborne has yet to rise
voicesJames Moore: As the Tories rub their hands together, the average voter will be asking why they're not getting a piece of the action
PROMOTED VIDEO
Arts and Entertainment
Jo Brand says she's mellowed a lot
tvJo Brand says shows encourage people to laugh at the vulnerable
News
Susan Sarandon described David Bowie as
peopleSusan Sarandon reveals more on her David Bowie romance
Sport
Rhys Williams
commonwealth games
Life and Style
People may feel that they're procrastinating by watching TV in the evening
life
Arts and Entertainment
Southern charm: Nicolas Cage and Tye Sheridan in ‘Joe’
filmReview: Actor delivers astonishing performance in low budget drama
News
Isis fighters travel in a vehicle as they take part in a military parade along the streets of Syria's northern Raqqa province
i100
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Life and Style
fashionLatex dresses hit the catwalk to raise awareness for HIV and Aids
Travel
travel
Life and Style
The veteran poverty campaigner Sir Bob Geldof issues a stark challenge to emerging economies at the Melbourne HIV/Aids conference
health
Arts and Entertainment
Benedict Cumberbatch and John Malkovich talk Penguins of Madagascar at Comic-Con
comic-con 2014Cumberbatch fans banned from asking about Sherlock at Comic-Con
Arts and Entertainment
Chris Pratt stars in Guardians of the Galaxy
filmGuardians Of The Galaxy should have taken itself a bit more seriously, writes Geoffrey Macnab
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Test Analyst - UAT - Credit Risk

£280 - £300 per day + competitive: Orgtel: Test Analyst, Edinburgh, Credit Ris...

Trainee Recruitment Consultants - Banking & Finance

£20000 - £25000 per annum + OTE £40,000: SThree: SThree Group have been well e...

Graduate Recruitment Resourcers - Banking Technologies

£18000 - £25000 per annum + OTE £40,000: SThree: Huxley Associates are looking...

Graduate C# Developer (.NET, ASP.NET, HTML, SQL, RDBMS, Windows

Negotiable: Harrington Starr: Graduate C# Developer (.NET, ASP.NET, HTML, SQL,...

Day In a Page

Backhanders, bribery and abuses of power have soared in China as economy surges

Bribery and abuses of power soar in China

The bribery is fuelled by the surge in China's economy but the rules of corruption are subtle and unspoken, finds Evan Osnos, as he learns the dark arts from a master
Commonwealth Games 2014: Highland terriers stole the show at the opening ceremony

Highland terriers steal the show at opening ceremony

Gillian Orr explores why a dog loved by film stars and presidents is finally having its day
German art world rocked as artists use renowned fat sculpture to distil schnapps

Brewing the fat from artwork angers widow of sculptor

Part of Joseph Beuys' 1982 sculpture 'Fettecke' used to distil schnapps
BBC's The Secret History of Our Streets reveals a fascinating window into Britain's past

BBC takes viewers back down memory lane

The Secret History of Our Streets, which returns with three films looking at Scottish streets, is the inverse of Benefits Street - delivering warmth instead of cynicism
Joe, film review: Nicolas Cage delivers an astonishing performance in low budget drama

Nicolas Cage shines in low-budget drama Joe

Cage plays an ex-con in David Gordon Green's independent drama, which has been adapted from a novel by Larry Brown
How to make your own gourmet ice lollies, granitas, slushy cocktails and frozen yoghurt

Make your own ice lollies and frozen yoghurt

Think outside the cool box for this summer's tempting frozen treats
Ford Fiesta is UK's most popular car of all-time, with sales topping 4.1 million since 1976

Fiesta is UK's most popular car of all-time

Sales have topped 4.1 million since 1976. To celebrate this milestone, four Independent writers recall their Fiestas with pride
10 best reed diffusers

Heaven scent: 10 best reed diffusers

Keep your rooms smelling summery and fresh with one of these subtle but distinctive home fragrances that’ll last you months
Commonwealth Games 2014: Female boxers set to compete for first time

Female boxers set to compete at Commonwealth Games for first time

There’s no favourites and with no headguards anything could happen
Five things we’ve learned so far about Manchester United under Louis van Gaal

Five things we’ve learned so far about United under Van Gaal

It’s impossible to avoid the impression that the Dutch manager is playing to the gallery a little
Screwing your way to the top? Good for Lana Del Rey for helping kill that myth

Screwing your way to the top?

Good for Lana Del Rey for helping kill that myth, says Grace Dent
Will the young Britons fighting in Syria be allowed to return home and resume their lives?

Will Britons fighting in Syria be able to resume their lives?

Tony Blair's Terrorism Act 2006 has made it an offence to take part in military action abroad with a "political, ideological, religious or racial motive"
Beyoncé poses as Rosie the Riveter, the wartime poster girl who became a feminist pin-up

Beyoncé poses as Rosie the Riveter

The wartime poster girl became the ultimate American symbol of female empowerment
The quest to find the perfect pair of earphones: Are custom, 3D printed earbuds the solution?

The quest to find the perfect pair of earphones

Earphones don't fit properly, offer mediocre audio quality and can even be painful. So the quest to design the perfect pair is music to Seth Stevenson's ears
US Army's shooting star: Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform

Meet the US Army's shooting star

Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform