What do the British want for their pound?

People like to be paid in strong currencies and spend in weak ones
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The Independent Online

Interest rates stay the same and sterling falls to another low against the dollar. Doubtless the CBI will rejoice, but what about the rest of us? And what about the longer-term view of the pound: has it become a fundamentally strong currency, at least compared with the euro?

Interest rates stay the same and sterling falls to another low against the dollar. Doubtless the CBI will rejoice, but what about the rest of us? And what about the longer-term view of the pound: has it become a fundamentally strong currency, at least compared with the euro?

These are big questions because they are not just about the degree of support that the pound has recently received from relatively high short-term interest rates but more about the long-term growth prospects of the UK economy.

They also concern Britons as democrats. If we really want a strong currency, and sterling really is likely to remain strong, then we will have the option of having one. How can one sensibly respond?

The first point is that judging what people really want has to be a guess. If you did a poll asking people whether they would like the pound to be a strong currency or a weak one, they would probably reply that they preferred a strong one.

If you asked whether people would prefer to be paid in a strong currency or a weak one the majority would presumably be larger still.

This is understandable: people like to be paid in strong currencies and spend in weak ones. Many Britons off on Continental holidays will have a pleasant surprise this summer when they calculate the prices - just as a generation ago they used to have an unpleasant one.

If on the other hand you phrased the question in terms of jobs you might get a different response. At the moment people do not associate a strong currency with job losses because the economy has continued to create jobs despite the strong pound. But that could conceivably change were the economy to turn down.

Still the preference for a strong currency is surely not just the result of some mercenary calculation. The feel-good factor matters most of all.

People like to know that their house or flat is worth whatever thousands, even though they have no intention of selling and their children will face equally high prices when their turn comes to set up home.

If this is right, why did we put up with a weak currency during the 1960s and 1970s? The answer to that is we didn't put up with it, for we voted out governments that weakened the currency, just as in the 1990s we voted out the government that allowed sterling to fall out of the ERM.

If this is right, one of the bull points for the present government is that it has enhanced the value of the pound. In electoral terms it would be better for the government were sterling to remain strong.

Indeed the recent dip of the pound below $1.50 may be rather bad news. In electoral terms the Government needs a reasonably strong currency in the run-up to the election.

Will it get it? The normal way in which people discuss the drivers of the currency is in terms of interest rates: high rates attract foreign exchange inflows and hence strengthen the currency.

But this is an unsatisfactory answer, it ignores the fact that interest rates tend to be high because growth is strong. To some extent the reason why high rates are associated with a strong currency is because both are a function of high growth.

The best explanation of the dollar's continued strength despite the yawning current account deficit is that money flows out of low-growth economies into high growth ones.

So what are the prospects for UK growth over the next few years? Even a couple of years ago most people would still have talked in terms of cyclical movements: the US and UK would end their growth phase, Europe would catch up, and then Japan would eventually take over the running.

The idea that one of these regions, the US, would consistently outperform and another, Japan, consistently underperform for very long periods was almost unthinkable.

Now our mind-set has shifted. Sure we accept that some sort of cycle still exists, but we focus more on the structural and less on the cyclical.

The judgement of the National Institute on differential growth prospects is fascinating in this regard, in that it projects that the British economy will grow at an average rate of 2.9 per cent through the period 2002-2006, way above the 2.25 per cent (or maybe if pushed 2.5 per cent) that the Treasury has assumed as the UK long-term underlying growth rate.

In fact that rate is higher than the projected growth rate for France and Germany of 2.6 per cent.

Projections are just projections and you don't want to take them too seriously. But they are helpful in focusing on the key issue of whether a step-change has taken place in the UK economy that we still do not fully understand.

We still talk in terms of industrial output and manufacturing exports and note that the performance of both has been pretty flat.

But actually manufacturing is becoming more and more a niche sector of our economy: around 18 per cent, and every year of good growth has the effect of reducing that proportion still further.

What manufacturing does is by pushing up its productivity in a most impressive way, it releases labour to join the much larger (and faster growing) services sector.

The strong pound, by squeezing manufacturing, hastens this transfer of resources. The strong currency, it follows, not only is justified by rapid growth; it actually boosts growth by forcing more rapid structural change on the economy.

So the intuitive feeling of ordinary people that a strong pound is a good thing may well be endorsed by economic logic.

We will see. You have to be careful not to be carried away when trying to understand structural change, for we are trying to analyse what is happening without any run of data to support the analysis.

All we know is that the economy seems to be able to grow at around 3 per cent a year without showing the signs of strain that such a growth rate would have caused in any other previous period.

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