Like the weather, the foreign exchange market changes every day and appears at the end of the evening news. Unlike the weather, though, the external value of the pound isn’t directly experienced by most people, except when they go on holiday. This creates something of a cognitive vacuum – into which a lot of politicised folk theories seem to get sucked and which makes the exchange rate one of our lowest-quality debates. Now the pound has reached its lowest level against the dollar for two years as the market starts taking the possibility of no-deal Brexit seriously, meaning that sterling makes a rare appearance as a leading news story.
On the one hand, there’s a tendency to regard the exchange rate as akin to the national share price, and to take pride in the fact that one pound buys more than one unit of nearly every currency in the world, apart from a few oil state dinars. On the other hand, the UK has a surprisingly vocal weak-currency lobby, based on memories of past episodes of tight interest-rate policy and of the squeeze placed on our manufacturing exports back in the 1980s, when we were briefly an oil state ourselves. To a regrettable extent, foreign exchange analysis is all about finding a story that’s convenient for your (political or financial) position and telling it as forcefully as possible.
What does the falling pound mean for holidays and prices?
But the reason that bullshitters find forex such a fertile ground to practise their craft is that in the short term, it’s difficult to prove them wrong because the signals are always mixed. If you’re looking at a wine list in the Algarve and realising that the prices might as well be in pounds, you’ll get one message. If you look at the value of a FTSE 100 tracker fund and see that it’s been marked up to reflect the fact that the majority of companies quoted in London have large overseas earnings, you get a different message. If you just go shopping, the effect on the cost of imported goods is there, but it’s hard to disentangle it from general inflation.
At its base, a currency depreciation is a price cut: it’s a means of writing down all the wages and prices in the country at once, as seen from the point of view of our trading partners. If this was happening as part of an intentional policy to stimulate demand it could leave us better off. But it looks like it’s just the result of capital leaving the country because the rest of the world doesn’t regard our government as serious people who are capable of sticking to agreements any more. So we are just, unambiguously, getting poorer in terms of how much stuff our national output and wages will buy on the global market.
Even the intuitive idea that a falling currency is “good for the exporters” is less true than it used to be. It’s good for tourism, and the cottages of Devon and Cornwall will be looking forward to a real increase in the staycation trade. But for manufacturing and services, in a world economy where exports are made out of imports, the benefits are short-term and small. After all, if currency depreciation was the way to industrial success, Italy before the euro would have been the powerhouse of Europe. Before long, the market share gains are lost, input costs rise and all the industrial and political problems that caused the depreciation are still there. It’s not a viable means of managing a developed world economy; it’s more like the kind of painkiller that you don’t realise you’re slowly becoming addicted to. That’s why volatile and declining exchange rates, in the long term, are associated with weak and unsuccessful governments. And it’s hard to admit, but that’s the way the world sees us now; with three prime ministers in the past four years, we look uncomfortably like pre-Berlusconi Italy.
It’s that kind of addiction that’s the real danger to the UK from the post-Brexit pound. Precisely because they affect us slowly and ambiguously, people don’t notice the long-term trends in currencies. We might have a bit of a political worry if and when we go below parity with the euro, and then another one with the US dollar, but there will never be a moment when the argument that “devaluation is good for the economy” will be decisively refuted. We’ll just look back in 50 years, and remember that there was a time when we used to compare our output and living standards to Germany and France, not Italy and Spain.
• Dan Davies is former Bank of England economist and investment banking analyst
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