Is a falling pound bad for the UK economy?
Holidaymakers have been on the front line in facing the effects of a devaluation in sterling this summer. For those who change their money at airports, it will have come as a shock to receive fewer euros than pounds over the past month, while some bureaus are merely offering parity with the dollar.
Nevertheless, the plight of those travelling abroad for some sun is often considered with a degree of triviality - at least in a broader macroeconomic sense. It is a given that a tumbling pound is bad news for them. The more interesting, and complex question though, is whether it is good or bad news for the UK economy as a whole.
Analysing currency devaluation
In terms of economic theory, there is no categoric answer to that question. The economist Thomas Sewell points out that even words such as 'weak' or 'strong' with respect to currency are misleading. A 'strong' currency does not necessarily denote a 'strong' economy, and it can actually be to a country's detriment.
Put another way, countries have often devalued their currencies for economic gain. Why would they do this, you might wonder? There are three primary reasons. Firstly, a weaker currency can make exports more competitive. In a globalised world, manufacturers (and service providers) must compete with rivals both home and abroad, and a depreciating currency automatically makes it cheaper for other countries to purchase their goods and services. In this respect, China has become renowned for strategic currency devaluation, although others have followed suit.
And although not a tactic as such, export-heavy Germany is widely accepted as being a beneficiary of the euro, given that the old Deutsche Mark would be valued considerably higher. Conversely, many argue that growth in economies such as Greece and Italy are stymied by a euro which is overvalued in their respective nations.
The second reason currency devaluation can be advantageous is intrinsically linked to the first: reducing trade deficits. Trade deficits are not thought to be sustainable in the long run, with high levels of debt usually the inevitable consequence. A depreciating currency is thus a positive stimulus for a country's balance of payments, as, not only do exports usually increase, but imports are deterred as a result of the relative rise in costs.
The other common motive is to reduce the real-terms value of sovereign debt. Government debt is often serviced with fixed repayments in local currency, so a fall in its value effectively renders these less expensive as time goes on.
So is it good for Britain?
On the face of it, the above rationale appears ripe for an optimistic view of sterling's recent decline. Britain has both a significant trade deficit, and a national debt which has soared over the past decade. So, shouldn't the plight of the suffering pound be a golden opportunity to rebalance our economy, minimise this debt burden, and spark a boom in exports?
Unfortunately, economic theory doesn't always play out in practice. And, historically, currency devaluation on these shores hasn't been associated with happy times. Think of the economic woes that followed the run on sterling in 1931. Or Harold Wilson's infamous 'pound in your pocket' speech back in 1967, following the 14.3 per cent devaluation against the dollar as a means to resolve our balance of payments crisis. All that ensued was runaway inflation.
Then there was the sterling crisis of 1976, when high levels of tax precipitated the Wall Street Journal to encourage the sale of sterling investments. What followed was a bailout from the IMF. The crash in the value of sterling is also synonymous with Britain's ejection from the Exchange Rate Mechanism on Black Wednesday, amid deep recession (albeit that a strong recovery was to follow). And at various points during the 2008/09 financial crisis, the pound slumped to €1.05, without any apparent boost to exports.
It is since the EU referendum that sterling has endured its latest struggles; stabilising in the intervening period, before once again falling in recent weeks as the prospect of a no-deal Brexit grows, and growth figures have deteriorated. However, those who believe a weaker pound will benefit the economy are by no means a minority group, and selected data would seem to substantiate their case.
After 23 June, 2016, exports of manufactured goods rose sharply, according to the ONS, with growth peaking at 9.7 per cent in March 2017, when the exchange rate against the dollar was even lower than it is now. Debt has also continued to fall as a share of GDP, while the FTSE 100, which sees a large proportion of companies earn their profits in dollars, enjoyed a barnstorming run after the Brexit vote. And while inflation has risen, it has remained within range of the Bank of England's 2 per cent target over the past three years.
So what's the problem then?
In the short term, data tends to be mixed following devaluation, and the impact is seldom a sudden or dramatic one. The exchange rate 'pass-through', as referred to by economists, invariably takes time to make its presence felt too. As such, it can be difficult to definitively assess the impact of a weaker currency either way.
But there are signs that the bad has begun to outweigh the good. Research by the Economic and Social Research Council estimates that the average British household is £404 worse off as a result of rising inflation over the past three years. This is backed up by Bank of England estimates, which equate a 5 per cent depreciation with a 1 per cent rise in the price of consumer goods in the medium term.
Then there is the issue of our trade deficit. Despite the post-referendum surge in exports, our balance of payments for much of the last three years has actually worsened; in particular, widening earlier this year as manufacturers sought to stockpile ahead of the original EU departure date of 29 March.
And this isn't necessarily a surprise either. In reality, pure exporters are few and far between. Most exports comprise a high proportion of imports. For manufacturers, producers and service providers, that could be raw materials, parts, labour or intellectual property. As the pound devalues, these components of business become more expensive, resulting in a mixed overall impact on export competitiveness.
Where does that leave us?
Nothing happens in a vacuum, and both sides of the currency debate will continue to argue their case in the absence of statistically-significant evidence to the contrary. Whether the coming years hold boom or bust for the UK economy, it will be difficult to attribute success or failure to a single economic construct at a given point in time - especially one as volatile as currency.
Yet we shouldn't forget that, rather than being a deliberate policy or master plan, sterling's present devaluation is a direct result of capital flight, and a lack of confidence among currency traders and our international partners. Let's hope it ushers in an era of prosperity, reduced debt, and a healthier balance of payments in the years to come. But, in the meantime, it appears more probable that the beneficiaries are going to be hedge-fund managers and traders, rather than the average British family.
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