The most important questions in economics always come in the simplest form, and this one is enormously important. We have just had the current account figures for the final quarter of last year, when sterling suddenly shot up to within a whisker of its old ERM rate. It has come at the end of a year of decent, if unspectacular, growth, and a decent, if unspectacular, rise in living standards. And at a time when UK house prices have at last begun to rise in earnest.
Popular wisdom would have expected that under these circumstances the current account deficit would widen sharply as a result of rising imports, for whenever Britons have felt prosperous in the past they have tended to rush out and buy things that have been made abroad.
But this time it does not seem to have happened. Instead of the current account deficit widening in the final quarter of the year, it disappeared. In fact there was a surplus of pounds 873m. It is a bit like the time when everyone predicted that sterling's devaluation following the exit from the ERM would lead to a surge in inflation: most were wrong.
When figures turn out to be very different from what might be expected there are three possible explanations: the figures are wrong; the figures are right, but there has not yet been time for the economy to respond to the change, so after a time-lag the figures will move in the expected direction; and something radical has changed.
The first explanation is always worth testing. Current account figures have long been notoriously unreliable, and may even be becoming more so. You might imagine that it is easy to measure what comes in and out of the country and for physical trade that is pretty much the case. But even measuring physical trade has become more difficult as EU integration has proceeded. In any case on the export side such trade accounts for only half our foreign earnings, and these "invisible" earnings are notoriously subject to revision.
It is always possible that invisibles have been miscounted. One of the reasons the figures are better than expected is that foreign investment earnings (denominated in foreign currencies and translated into sterling terms) have apparently not suffered as much as might be expected from the currency conversion. These figures will be revised again several times as more data comes in. But I think it is unlikely the figures will be so wrong as to be completely misleading. They have to be wrong as to direction as well as magnitude and that really is unlikely.
The second explanation - that they are right but that there is a lag in the economy's response to higher sterling - is more plausible. The conventional theory is that there should be a lag of up to a year in the response of trade to changes in an exchange rate. Economists talk of the J-curve, for when plotted on a graph, the response to a devaluation looks like a "J". The immediate reaction to a devaluation is for the trade account to get worse, not better, because it takes a while for volumes to improve and in the very short term the lower prices received for exports and the higher prices paid for imports make matters worse.
We are talking here of a revaluation, not a devaluation, so in this case the J is upside-down: in the first few months the effect of revaluation would be to improve the current account - which of course is what seems to have happened. There is no doubt there has been a sharp shock to the competitiveness of our companies; witness the way in which unit labour costs have been pushed back to pre-ERM exit levels, as the left-hand graph, from ABN Amro Hoare-Govett, shows .
The "lag" explanation looks even more convincing when you consider other aspects of the economy. Thus we are not responding to the rise in house prices by rushing out and buying as many BMWs as we did last time, because we are not yet too sure of the durability of the rise. After all, everyone knows that interest rates will rise after the election (and after a rise in US rates which may happen this week); higher interest rates tend to knock house prices, and people will therefore wait a while before having a splurge. Companies too are not rushing out to buy more capital equipment because they too are cautious about the durability of domestic demand.
So it would be surprising if there were not something in explanation number two. But I don't think one can dismiss the good current account figures simply on the grounds that the rise in sterling is too new to have done much damage. I think that explanation number three - that something really has changed - is also valid.
Have a look at the graph on the right, based on work by brokers PaineWebber. You can see how over the past 15 years there has been a close relationship between the pound and exporter confidence. The pound scale is inverted, so that the higher it goes the lower exporters' confidence. In the past few months exporter confidence has indeed fallen, but it does not seem to have deteriorated as much as one might have expected, given the scale of the movement in the currency. Exporters are concerned, but not nearly as desperate as they were in 1982/3 or 1990/91. Maybe they feel they can stand a rise in sterling better.
That is just physical trade. Maybe there is a change in the invisible account too. Some of our invisible exports will not be sensitive to currency movements: the mark-up on financial services, for example, is so high that the odd 10 per cent on sterling will not affect the volume much. Travel? Tourism is always sensitive to currency movements and it would be surprising if there were not some effect. But it may be that the rise in sterling is not yet big enough to change travel plans radically.
As for other invisible earnings like royalties and patents, plus interest and dividends - the only real loss of revenue is through currency translation, and the early sign seems to be that this is not too serious.
The correct answer to the question at the head of this column, therefore, is this. "The current account has not deteriorated partly because it hasn't yet had time to do so - expect some deterioration though this year. But do not expect it to get seriously out of control because the economy is better able to cope with strong sterling than it was even five years ago." At least, that is the correct answer until it is proved wrong.