Archive for the ‘Devaluation’ Tag

The Pound in Your Pocket

The value of the British Pound is in steady decline. It fell by 7% in the first two months of this year alone and it continues to fall against the Dollar, although its fall relative to the Euro has been slightly softened by the impact of the Italian general election and the Cypriot crisis.

Some sections of British industry and some economic analysts are arguing that the decline of the British Pound is a good thing. On the face of it there is a strong case for welcoming the falling price of Sterling. After all, weaker currencies are good for exports, right?

Switzerland was certainly hurt by the price of the Swiss Franc relative to the Euro being driven up as a result of the Euro crisis. The Swiss economy being a particularly sensitive to the price of its exports, their government took swift action to keep the price of their currency low. Could devaluation benefit Britain in the same way?

A lower Sterling allows British businesses to offer more competitive prices on exports and Britain is certainly in need of more competitive exports in sectors other than financial services and the arms trade. Further, the added demand for British goods could boost growth. We could grow our way out of recession. Couldn’t we? This is a flawed argument. In the past it is certainly true that a reluctance to devalue for political reasons has cost the country dear. But does that mean devaluation is good for us today?

Devaluation essentially has two effects, it makes our currency cheaper to buy thus making it cheaper for foreigners to buy from the UK, on the other hand it makes foreign currency more expensive and drives up prices on goods imported from abroad. The simplified story is that strong currency is good for imports and weak currency is good for exports. Neither is inherently better than the other, it’s a balancing act and which is better depends on the situation.

Public Domain

“It does not mean that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.” – Harold Wilson talking out of his arse.

I would suggest that since the days of Harold Wilson, the harm done by an increase in the cost of imports has risen and that the advantages that can be gained by making British exports more desirable has collapsed. The cost to consumers cannot be understated. British workers have become hugely dependent on imported goods: most of our food is imported, electronics are imported, cars are imported, energy is imported. Back in 1967 Harold Wilson commented on his reluctant decision to devalue to pound saying that here in Britain “the pound in your pocket” is not worth less. That wasn’t true then and its even less true now.

All this pain might almost be justified if the increase in exports boosted British industry, got the economy growing and we were all better off in the long run. But it seems like it may well all be for no benefit. British exporters are also importers, whose costs will rise. The cost of capital goods rises along with that of consumer goods. The much noticed rise in the cost of fuel, in no small part a result of the falling pound, could have a devastating impact on costs all on its own. Suddenly the number of producers who stand to see a net gain shrinks considerably.

Moreover, exporters are also employers of labour, the cost of which is tied to the cost of living, which in turn is tied to the cost of imports. In the UK the cost of living is highly sensitive to the cost of imports and hence to changes in the exchange rate. It’s only those industries which are least sensitive to changes in the cost of labour which can fully reap the benefits of a low exchange rate.

Why, then, does the Government not appear to consider this a cause for concern? The answer, I would suggest, is that while the inflationary effects of devaluation can mean pain for workers they can be a boon for governments. It’s much easier to cut or suppress real wages in times of high inflation that low inflation, especially if contracts are only renegotiated every few years, and those public pay or benefit freezes go a lot further when you drive down the value of that capped figure. For a government fixated on a programme of austerity, knocking a few points off the pound every now and then is stealthiest and least politically harmful way of picking every pocket in the land; if done well, it’s less likely to provoke strikes than direct pay cuts and it’ll cost them fewer votes than tax hikes and benefit cuts.