Saturday, November 15, 2008
Osborne upset that floating exchange rate, er, floats!
George Osborne has today accused the government of causing a "sterling collapse, a run on the pound". No doubt he is trying to evoke memories of 1970's "sterling crises" (Osborne is rather obsessed with the 1970's - when Labour nationalised Northern Rock in February, Osborne's response was to say "We will not back nationalisation. We will not help Gordon Brown take this country back to the 1970s.")
However, you can only have a sterling crisis if you are within a fixed exchange rate system such as Bretton Woods, or the ERM, or if you have borrowed in a currency not your own, which means that movements in the exchange rate affect the government's ability to service existing debt (eg Hungary has a lot of euro-denominated debt, and the collapse of the forint has meant that existing coupons are suddenly more expensive as they have to pay these in euros). None of this applies to Britain at the moment - we are not in a fixed exchange rate mechanism, and our government only borrows in sterling.
The whole point about floating exchange rates is that they float, shock horror! This means, Georgie-boy, that they go up, down, and occasionally sideways, and it doesn't always mean much due to hot money overwhelming fundamentals. See the chart at the top (click to enlarge it). Sterling collapsed in 1985, but this did not mean that the economy was in trouble - indeed the economy was far stronger in 1985 than it was in 1981. Similarly, the economy was stronger in 1993 than it was in 1990, the economy was stronger in the lead up to 2001 dot.com bust than after it. The exchange rate reflects more speculation and hot flows of money than anything else (though relative performance between economies plays some part too). At the moment, there is massive deleveraging going on in the markets. Money borrowed in dollars and invested elsewhere is returning back to the USA so that loans can be repaid (and this is also happening to the yen, hence that currency's sudden strengthening to the dismay of the Japanese - BTW Japan's sovereign debt is over 150% of GDP, so much for Osborne's theory that high sovereign debt weakens currencies!)
Does a weaker currency help or hurt the UK? It should help. The reason we have had a negative trade balance in recent years (i.e. imports are greater than exports) is because sterling has been so strong for so long. The currency level dictates the trade balance, rather than the trade balance being independent of currency as some ignorant Tories are suggesting. It's is cheaper to buy foreign goods and services than to buy local when you have a strong currency, and very difficult to export in these conditions. This should start to reverse.
We are already seeing people taking their holidays in the UK rather than going abroad - in the stats, this counts as a reduction in imports of tourism services. It's no longer worth people making a Christmas shopping trip to New York as they did last year - it's now cheaper to shop at home, to the relief of the retailers. I imagine supermarket buyers are already seeking to stop sourcing goods in the dollar and euro zones and looking to buy locally. We'll see fewer blueberries and cranberries and more blackberies and raspberries on the shelves.
Businesses like Airbus price their planes in dollars, but their costs are in euros and sterling (the cost of staff is always the biggest expenditure in modern manufacturing businesses). They were suffering under the strong pound and euro, but will now experience a competitive advantage over Boeing. Businesses that export IT services such as Sage will also benefit - they price their products to Europeans in euros and to Americans in dollars. Most international contracts are priced in dollars (especially to the Far East). The dollar is still the currency that the world does business in, and the Americans in recent years have been trying to borrow growth from the rest of the world with a weak currency. We have respite from this at the moment. How long it will last is anyone's guess - it will take a little longer to deleverage and longer than that to see how economies perform relative to each other. But British exporters of goods and services should make hay while they can.
Oh - there was some suggestion in the Times that Osborne was "talking down the pound", which made me chuckle. He has such a poor understanding of economies and such a poor standing in the world, I doubt very much that he has the ability to move anything. Vince Cable pointed out how odd it was that the Tories were complaining about the floating currency being flexible. Tories do have a tendency to worry about exchange rate flexibility - the last time they were in power they tried to shadow the D-mark, then when they got into economic difficulties, their solution was to remove flexibility completely and join the ERM! And now here we have Osborne thinking that the job of the govt is to maintain a certain exchange rate. Labour however knows that you should simply leave the exchange rate to do it's thing, and not interfere or worry about it (it's impossible to control the forex markets anyway and there are more important priorities for the government to concentrate on).