Monday, November 17, 2008

Run on the Pound - What's the Panic?

Recent observations by shadow chancellor, George Osborne about government policies threatening a run on the Pound has led to a spate of concerns over the future of Sterling. Many seem to take it for granted that the recent fall in the Pound (25% against dollar) 17% against Euro is just the start of a huge devaluation threatening the future of the economy. Rather bizarrely, Will Hutton suggests that this devaluation of the Pound gives us good reason to join the Euro [article at Guardian].

Here are Reasons Not To Panic at a Falling Pound:

  1. Fair Value of the Pound. At $2 to £1, the pound was overvalued. This summer the IMF suggested a fair value of the £ was £1 = $1.5. The recent devaluation partly reflects a correction to a long period of overvaluation.
  2. We are all doing badly. People see the falling Pound and imagine the UK alone is going into recession and increasing government borrowing. Actually, Germany has recently announced recession and poor old Japan announced yet another official recession today. The US economy is on the brink of a very serious recession. UK public sector debt is amongst the lowest of our main competitors.
  3. A Falling Pound is not such a Bad Thing. A depreciating pound makes exports cheaper and will help UK manufacturers. True, there isn't much global demand anyway, but, a devaluation will be much more welcome than an appreciation. Usually the problem of a falling pound is that it causes inflation. But, with the most prolonged recession in 2 decades, inflation is the least of our concerns.
  4. Improve Current Account Deficit. For the past 2 decades, the UK has mostly been running a persistent deficit in the current account. The economy has relied on consumer spending, imports and hot money flows to finance our consumer spending. The fall in the pound will help restructure the economy away from consumer led growth and reduce our persistent current account deficit.

Should We Join the Euro to Protect the Pound?

No, In the last recession of 1992, the big mistake the UK made was to strive to keep an artificially high value of the Pound, when it gave no economic benefit. It became only a matter of pride and stubbornness. But, keeping a high pound (which required high interest rates) only deepened the recession. In a recession a falling pound is more of a boon than curse.

Furthermore, the last thing the UK wants to do is surrender monetary policy to the ECB. If we do that, there is a grave danger the ECB could set interest rates higher than the UK needs. The benefits of the Euro are minimal, the disadvantages potentially huge.

Excellent article by Anatole Kaletsky at Times - Pound's fall will herald recovery

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