A weak pound could be our strong suit in chaotic times
SO, A new Prime Minister, a new Chancellor, a new Cabinet … and the same old problems. To judge by what has been happening to sterling — a two-year low against the dollar and more than 10% below its level ahead of the Brexit referendum — professional investors are profoundly gloomy about the new team’s ability to dig its way out of all this. The clutch of ministers jumping before they are pushed rather adds to the perception that they won’t. A trio of former Prime Ministers, Major, Blair and Brown, have added their dire assessments, and it would be odd if this did not have some further impact on international opinion. Conclusion: sell sterling.
Whatever happens in the next few weeks I think we have to accept that the pound, and UK assets in general, will remain profoundly unfashionable for some time. I suspect that even when the exit arrangements with the European Union are settled one way or another sterling will remain in the doghouse.
That raises two questions. Is the pound a good indicator of the underlying prospects of the UK economy? And might a weak pound be rather a good thing to have if the world economy is going into a downswing?
On the first, the answer must be a clear no. Look back over the past half century and the pound’s gyrations have had little relation to the performance of the UK. Take the dollar rate because
we don’t of course have a euro rate before 1999, and look at the earlier plunges. There were two notable ones. The first was in 1976 when we were bailed out by the IMF — the rate fell to $1.56, which does not sound too bad now but was way down from the fixed rate of $2.40 before it floated in 1972. The other was in 1985, when it went below $1.05, the nearest to parity that it has ever been.
Now look at the peaks. There was one at the beginning of 1981, when the combination of North Sea oil revenues and the early successes of Margaret Thatcher’s government pushed it up above $2.40. Then it was back above $2 on a couple of occasions in the early 1990s, and finally hit a peak of $2.10 in November 2007.
So was it a good guide? Rather the opposite. In 1976 the Labour government under Jim Callaghan started the long painful slog of restoring financial discipline, while in 1985 the Thatcher reforms were beginning, equally painfully, to turn round the real economy. As for the peaks, the over-strong pound of early 1980s led to the destruction of swathes of UK manufacturing industry, the early 1990s saw a serious recession, and as for the euphoria of 2007 — well, we know what came after that in 2008/9.
Now to the second question: is a weak pound good or bad?
On a long view sterling has been a crummy currency over the past century, associated with relatively high inflation with all the social and economic ills that that has helped generate. But in the short run a weak currency can be a useful buffer against adversity. We may be heading into a global currency war. Donald Trump has accused both China and Europe of trying to gain trade advantage over the US, running up huge surpluses by depreciating their currencies. You can argue whether this is fair or not, but the plain fact is that the US will be on the attack against what it sees as artificial currency manipulation. As for Europe you could argue that the negative interest rate policy of the European Central Bank has held down the euro, so when a China trade truce is settled, expect American guns to swing towards Europe.
The one thing no-one can accuse us of doing is artificially depressing sterling. It is depressed for sure, but that is because of the tsunami of negative international opinion, not the Treasury or the Bank of England thinking “Gosh, we’ve got to push down the pound to help our export industries”.
So will the weak pound really help us through the next global downturn? At the margin it must. Global trade flows are less affected by exchange rates than they used to be, partly because companies have got used to coping with their gyrations and partly because price seems to matter less than quality, delivery dates and so on. Nevertheless, for many industries price still matters, and thanks to the cheap pound the UK will be a relatively low-cost producer. If the downturn gets nasty, which it may, the UK looks positioned to roll with the punches.
The coming weeks are going to be chaotic. Sterling may fall further. We should welcome the new PM, though I expect the markets won’t. But actually I think we should be more worried about the downturn than about British politics. It matters more.
Whatever happens the pound, and UK assets in general, will remain profoundly unfashionable for some time