Sterling pays price of remaining outside euro zone
HERE in Britain, the euro project is seen to be not so much a basket of formerly independent currencies – but as more of a basket case. At the heart of the UK’s argument against joining the euro has always been the fear of losing independence or sovereignty over the country’s monetary and fiscal policy.
This concerns crucial matters such as setting interest rates, opting for quantitative easing as well as fiscal expansion (or contraction) and even the external value of the pound sterling. It is understandable that a proud nation like Britain – similar to Switzerland and the Nordic countries – wants to preserve that independence. But there is a high price to pay.
End of fixed rates
It is useful to remember that, after WWII, Britain in particular built up large, unsustainable current account deficits. Before long, in 1967, it had to devalue the pound by about 14 percent against the dollar and the deutschmark.
That marked the beginning of the end of fixed exchange rates. It was hoped that flexible exchange rates would eradicate imbalances quickly. The idea was that currency revaluations in surplus countries and devaluations in deficit countries would ensure that an equilibrium was reached through the adjustments in terms of trade.
The ensuing decades proved this was not so easy. Devaluations chased one another in the UK. There was only one period of short reprieve, when North Sea Oil gave a boost to the UK trade balance.
Then, there were currency speculators to contend with. Elsewhere in Europe, it was recognised that the uncertainty brought about by speculative surges was bad for investment, trade and business.
It had become clear that the financial tail was the wagging dog of the real economy. To relieve their national economies from these pressures, key European countries moved to institutionalise the euro in 2000. It has given its members currency stability not seen for decades.
The euro area, in spite of the big recession and problems in the periphery countries, has now moved from a current account deficit to a surplus, which is forecast to reach € 200 billion (R2.88 trillion) this year. It has returned to growth as well.
An important factor in all this is that companies from euro zone countries do not have to absorb the transaction costs when exporting or importing to each other. No expensive forward buying or hedging is necessary for the largest part of their trade, giving them a clear competitive edge.
The euro also now has the advantage of a weak currency, while neighbours suffer from speculative currency revaluations.
British deficit
Britain is probably worst off. The country’s current account deficit is heading for a new record of close to 6 percent of gross domestic product at £100bn (R2 trillion).
Britain is thus a country with a growing, unsustainable deficit and an ultra-strong currency that, across the channel, faces an area with a growing current account surplus and a weak currency.
Not only are the financial markets not eliminating the trade imbalances worldwide, they are making them worse. More often than not, these markets are at least one of the root causes of these deficits.
By what economic logic should the British pound have had a 36 percent revaluation since its low point in 2008 against the euro? This simply does not square with the realities of a rising current account deficit and anaemic productivity growth.
This exchange rate makes British exports uncompetitive. And it allows importers to gain market share in the UK.
The reason for this irrational behaviour is that interest rate expectations – rather than the real economy – have become the drivers of exchange rates.
Although the UK economy looks healthy and sported a 0.4 percent growth rate in the first quarter of this year, there are some dark clouds on the horizon.
What is Britain’s government or the Bank of England doing about counteracting these dangers? As far as I can see, they act as if they are helpless. Following the US economy on the path of moving interest rates up is surely not the answer.
Britain is paying a high price for its independence from Europe and opting to walk in the direction of the US. There is more pain and turbulence to come.
Although the UK economy looks healthy and sported a 0.4% growth rate in the first quarter of this year, there are some dark clouds on the horizon.