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DEC 13

An informal cap on the pound is the only way to rebalance our economy - Telegraph

Below is an article that featured in the Telegraph by Rodger Bootle, about the value of the pound, the detrimental effect it is having on UK exporters and possible solutions.  Much of the comments and sentiment can be related to economic situation with the New Zealand currency.  


Whenever something goes wrong with the UK economy you can bet your bottom dollar that a misalignment of the pound is somehow connected with it, either as cause or effect, and sometimes both. So it is at the moment, as the pound has recently become unhealthily strong.

Last week, sterling’s trade-weighted index, which is a pretty good guide to its average value, was 9pc higher than its recent March low and stood at its highest level since August 2009. Against the dollar the pound has been trading at well over 1.6 and against the euro it has been at 1.2.

The reasons for the pound’s strength are not difficult to divine. The recent signs of the strengthening British recovery have raised the market’s expectations about future UK interest rates. Meanwhile, intermittent softness of American data, coupled with the apparent dovishness of key Federal Reserve members, have persuaded the markets that it will be some time before the US Fed raises interest rates.

And, on the continent, the European Central Bank has just cut interest rates and the talk is of what it may do further if, as seems likely, the eurozone economy continues to be very weak.

Now, you may well think that all of this is good news. And there certainly are some winners from a strong pound – anyone importing foreign goods and services will pay less for what they buy and Britons going abroad will get more foreign currency for their money.

But, that does not mean that the stronger pound is good for Britain’s economy. Nor is it right that the markets always get the exchange rate “right”. There are plenty of examples where they have sent the currency to levels not justified by the long-term fundamentals and have then caused some further dislocation when they have sharply taken it lower again. This happened after Margaret Thatcher first came to power in 1979 and the overstrong pound caused devastation in British industry.

It happened again when Labour took power in 1997. The strong pound during the Blair/Brown years seemed to produce a market validation of the then economic policy, yet it actively contributed to the severe unbalancing of the economy by clobbering exporters while enriching consumers. The point is that a stronger pound makes imports cheaper and our exports more expensive.

That tends to retard export performance and increase imports, which reduces GDP, income and employment.

Whenever I write about the exchange rate I receive a barrage of letters from “Disgusteds of Tunbridge Wells” who think that I am in favour of a quick-fix solution that never works, namely a weak currency. Let me make it clear that I am not suggesting that a lower exchange rate is the answer to a maiden’s prayer, or that it will solve our productivity problems or transform our economy into a success story – let alone liven up Tunbridge Wells.

Nor am I saying that there is something magical about exports. Indeed, I have previously criticised the export fetishism of both Germany and China. Exports are the price we have to pay for imports. But the UK is running a massive deficit in its overseas dealings.
That is to say, we are buying much more from abroad than we are selling abroad and borrowing hugely to pay for the difference. So, our international asset position is deteriorating. Moreover, this situation is linked to the small share of manufacturing in our economy since a large share of what we manufacture is exported.

So many people don’t seem to grasp that the exchange rate is the link between price levels at home and abroad. If I said that we should improve our position by raising all domestic price and wage levels by 9pc not many for you would think this was a good thing.

But what has happened to the currency since March is the equivalent of this. And, if currency values don’t matter, why have countries as diverse as China and Japan put the importance of a competitive exchange rate at the centre of their economic policy? Certain “Disgusteds” (you know who you are) focus on the comparison with Germany. They say: “I remember when there were 12 Deutschmarks to the pound. Then the pound went down and down but it did no good. The Germans continued to outperform us.”

In fact, Germany began its post-war success story with the Deutschmark undervalued. This helped its export performance. The currency was then allowed to appreciate in line with, or even behind, its export success. There is nothing wrong with a strong currency, if it is justified by the economic fundamentals. Germany’s was – ours is not.

When the Coalition took office, as well as reducing the government’s budget deficit, it wanted to rebalance the economy away from the public sector and consumption and towards exports and investment. The strong pound runs completely counter to this objective. Admittedly, it will help to reduce the inflation figures. Indeed, if the recent strength is sustained, inflation may fall well below the 2pc target next year.

That will tend to boost consumers’ real incomes and thereby to increase consumption. So it will exaggerate the tendency already observable for this upturn to develop as a straightforward consumer and housing-led recovery of the sort which normally end in tears.
The exchange rate is also relevant to rebalancing more broadly, as the plausible prospects for exports will heavily influence investment in manufacturing. Why would you lay out on new plant and machinery, if your profit margin can so easily be wiped out by a move of the exchange rate?

What can be done? I think that the exchange rate needs to be put more prominently into the policy agenda. It should be a key consideration in how the Monetary Policy Committee (MPC) thinks about interest rates and other policy measures – and it should say so.

Ultimately I would like to see the pound capped, just as Switzerland has done to the Swiss franc. But our obligations to our fellow members of the G7 would not permit this. So, if we cannot declare a formal cap, we nevertheless ought to establish an informal one and the Bank should be prepared to intervene on the exchanges to sell pounds whenever this risks being breached.

If the pound continues at this level or goes higher then UK policymakers will be giving a clear signal that rebalancing is for the birds. Forget laying down new export capacity. Stick to building shopping centres and car parks.

tags: exports, pound, uk, exchange rate, telegraph, manufacturing
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