Devalue the pound

An easy route to economic recovery

February 13, 2013
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Almost everyone has a gloomy outlook for the UK. It is expected to face years of austerity, high unemployment, cuts in expenditure, nil or negative growth, disfiguring inequality and relative if not absolute national decline, as we struggle with increasingly unmanageable debt. But this dismal outlook is not necessary. It is directly the result of avoidable policy mistakes which would not be that difficult to correct.

Our basic problem is that we cannot pay our way in the world. We therefore have a payments deficit which sucks money out of the economy. The gap then gets filled by more and more borrowing by the government and by private consumers. There is a simple reason why there is too much debt: we do not export enough to pay for our imports. Most of our exports are still manufactured goods and we have allowed our country to deindustrialise to a point where we do not have enough manufactures to sell to the rest of the world to pay for everything we want to buy from abroad.

Why is our manufacturing base so weak? Because it is far more expensive to produce almost anything here than it is elsewhere in the world, especially in the Far East. The exchange rate in the UK—and indeed in many other western countries—is far too high compared to what it needs to be to make our exports competitive in world markets.

How did we find ourselves in this predicament? In the 1970s and 1980s, when there was a big problem with rapidly rising prices, economic policymakers prioritised bringing down inflation. To do this, interest rates were raised, the money supply was tightened dramatically, unemployment went up—and price rises did slow down. But the exchange rate also rose—in the UK, by over 60 per cent between 1977 and 1982.

Unfortunately, this happened just as South Korea, Hong Kong, Taiwan and Singapore— the so-called “tiger economies”—were getting into their stride and as China was entering the trading world. The result was that the east’s cost base (the relative cost of manufacturing a product) from the 1980s onwards has been about half the west’s. Because of western policymakers’ obsession with keeping inflation down, it still is. The result is that we have deindustrialised while the east now has a disproportionately large share of manufacturing.

We have to get the value of the pound down until the UK cost base is sufficiently low for us to compete. Some fairly simple calculations, based on readily available statistical data, indicate that we would need a depreciation of about 25 per cent from where we are now. This would generate enough additional exports to eliminate our payments deficit, allow the economy to grow at 3 or 4 per cent per annum, reduce unemployment to perhaps 3 per cent and provide the funding we need for public services.

If the government were determined to get this done, it could do so relatively easily. Fears about a subsequent rise in inflation are unwarranted. Inflation actually fell when we devalued by almost 20 per cent as we came out of the exchange rate mechanism in 1992, and it was slightly lower in 2009 than in 2007 as the pound came down from about $2.00 to $1.60—after a small spike almost entirely caused by higher fuel prices. There would be little chance of other countries retaliating, as our economy is now too insignificant. But such devaluation is unlikely to happen for now because practically every politician, civil servant, political commentator and academic supports policies which keep the pound far too high.

Eventually, however, it will come down. This is because with no growth and mounting debts, sooner or later we will become insolvent—a bit like Greece. When we reach this point, sterling will fall and our economy will recover, just as it did after the all too temporary devaluations of 31 per cent in 1931 and 19 per cent in 1992. In both cases inflation went down and almost everyone’s standard of living went up.

Now is the time to repeat this remedy—not to waste years in a completely unnecessary and avoidable depression.