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Dan Lewis: How low can we go in sterling slump?
STERLING'S slump has been unprecedented both in its speed and scope. The loss in value against the UK's two main trading currencies since the end of September, 18 per cent against the dollar and more than 12 per cent against the euro certainly looks severe enough.
And it's even worse against the Japanese Yen, sinking by nearly 30 per cent. Yet while this makes for terrible headlines and may even dent our national pride, it is not necessarily a bad thing. Holiday purchasing power apart, no one wants to go into a recession with a strong currency as we did so disastrously in 1991.
Distressingly though for Gordon Brown, most of that decline has occurred since he decided to "save the world", by fighting debt with more debt. You can be sure that the increase in infrastructure spending which he mandated will largely be wasted. And the temporary cut in VAT would have been better directed at reducing employment taxes and keeping Britons in work.
However, there probably wasn't much of an alternative to the great bank recapitalisation. It has bought the banking industry some solvency time, although the jury is at least out on whether it will totally feed through until late in the first quarter of next year. By then the annual accounts of our banks will be published and they will reveal to the world, and most importantly to each other, the extent of their losses. Only then might we see banks prepared to start lending to each other at anything like the scale they used to and so bring down the cost of debt for the rest of us.
Meanwhile, Brown and his Chancellor Alistair Darling will
be keenly aware that the world has changed much since the
last recession. Back in 1992, Britain escaped from disaster through its forced exit from the Exchange Rate Mechanism which had saddled us with a strong currency and high interest rates. Coming out of that recession, there was an export-led recovery – both in manufacturing and services. After that came foreign direct investment, jobs, higher growth rates and the recovery of the property market.
This time around, that looks nigh-on impossible. Since 1997, one million jobs have been lost in manufacturing, and that
other British economic pillar, financial services, is now alarmingly weak. Just as Britain's manufacturing has declined and the economy has globalised, so many of the factory input costs – stuff like raw materials, components, energy commodities – have become increasingly priced in foreign currency. So the competitive edge a devaluation brings to the UK is much less than it used to be, but it's still better than nothing.
That's one of the reasons why those who see an opportunity to adopt the euro in this financial crisis are gravely mistaken. Had we adopted the euro from the outset, with its lower interest rates, the debt and property bubble would have been far bigger and the ensuing recession would have been ruinous. Think of it as the financial equivalent of being waterboarded at Guantanamo Bay.
And while our own monetary policy committee, with the honourable exception of David Blanchflower, today looks distressingly like an academic tea party, the antics of the European Central Bank which so misjudged matters in raising interest rates in July are beyond the pale. There is a real possibility that Euroland will massively crash and split the currency between North and South.
Yet since 1992, we have not escaped the unstoppable rise in EU-derived regulation, punishing small businesses more than ever. One can talk dry facts and figures but, as usual, it's the anecdotal evidence that is the most poignant.
The other day, a small businessman with 10 employees told me that – through no fault of his own – his bank had unilaterally decided to increase his overdraft interest from 4.5 per cent to 6.5 per cent. Small businesses rely on overdraft facilities because often their much bigger customers are slow to pay them and in a downturn, they get even slower. Cashflow is the life and – all too often the death – of a small business, and the small businessman is not too
hopeful.
Can the pound go any lower? Yes and in one scenario there may even be a collapse in the pound. Picture this: Government finances deteriorate much faster than anticipated, and in trying to raise more capital to pay for the exploding budget deficit, investors refuse to buy UK gilts, because they
think the Government is not good for the money. I'm told that the odds of this happening have risen in the last few months from the unthinkable to something like 15 per cent.
It all could have been so different. After 16 years of growth, we could be entering the recession with a big cushion – a large counter-cyclical budget surplus. Instead, Gordon Brown, after a prudent start, chose to reward his client state of
quangos and trade unions and blocked nearly all of Tony Blair's earlier and mild attempts at public sector reform. We may not like to hear it but the abdominal fat in the British economy is all in the public sector. And, just as in the 1970s, it may take the pressure of a sterling crisis and the IMF to deliver some real weight loss.
Let's hope that our political class measures up before that.
Dan Lewis is research director of the Economic Research Council.
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Saturday 26 May 2012
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