I seem to have found a new hobby – taking issue with Sunday Telegraph columnists! Last week it was Janet Daley and this week it is Simon Heffer, another redoubtable writer who often has interesting things to say but yesterday talked complete rubbish about devaluation. It was just a short piece so here’s what he said in full.
“The latest thinking aloud by Mark Carney, Governor of the Bank of England, tells us that he believes interest rates should not rise until 2017. He’s wrong: but he’s changed his mind several times before, and will doubtless do so again. His remarks cheer those who believe sterling should be devalued to help our competitiveness. But that would also be helped if we improved our productivity, surely a much better idea. Those demanding a weaker currency need to be asked how weak they’d like it to be. Would like the Weimar Republic be enough? Or do they want the full Zimbabwe?”
NO, Simon, you cannot force the pace of productivity growth! In a free market economy it is simply the result of myriad decisions made by private individuals and companies. The best you can do is set optimum conditions for investment. To do that you have to stimulate consumer demand so companies have an expanding market to invest into, otherwise they won’t take the risk. But guess what? Even if we achieve this, our competitors are likely to be investing just as fast as we are. So we never catch up! Getting rid of an ingrained massive Balance of Payments deficit such as we have, which has the dire effect of exporting jobs, can only be achieved by devaluation.
Of course that is not easy, and you are right to point out the possible inflationary consequences. Inflation simply undoes all the good work and sets you back to square one. But it is not inevitable. Remember the Exit From The ERM? That was one of the most effective devaluations on record because it came when unemployment was very high so the inflationary impact was completely absorbed. As a result we got ten years of solid export-led economic growth.
The lesson here is that the best time to devalue is during a recession. Once again Osborne has failed to fix the roof while the sun has been shining (from that perspective), just as he has done by failing to set up a Sovereign Wealth Fund. However the global recession now developing may give us a second chance. Osborne should ask Mr. Carney and Treasury officials to put together a plan of action to get our BoP back into a small surplus within five years. To answer your question, that’s how weak (I prefer the term ‘competitive’) it needs to be.
Which leads us to consider what options may be open for this. What after all has caused the over-valuation in the first place? As you may have seen in my earlier post on Greece, the Eurozone and World Trade, a large part of the problem arises from the fact that capital flows through the foreign exchanges now swamp trading flows, so that the natural effect of having to finance a deficit no longer has a stabilising effect on our exchange rate. Thomas Piketty, in his recent book, observed that capital to GDP ratios have now risen to about seven, having been only around two at the end of WW2. It is a problem that affects the entire globe, and is the main reason why the Doha round disintegrated.
But it also gives us a clue as to the solution – to act on those capital flows directly. A bonus from setting up a Sovereign Wealth Fund would be that much of it would be invested overseas, thereby selling Sterling and making it more competitive. We also have at present very high levels of inward investment, which has the opposite and counter-productive effect. Partly this is due to Russian oligarchs and far eastern millionaires using the UK as a safe haven for their money (I have elsewhere advocated a big increase in stamp duty on foreign buyers of UK domestic property), but it is also due to the encouragement by successive governments of inward investment for infrastructure and industry. I say that is counter-productive and should stop. We will gain far more jobs from a competitive exchange rate that we do from mountains of inward investment.
And here’s a further twist. A failure to agree a new trade deal with the EU after exit could be a blessing in disguise. Just suppose that, in a fit of pique, Brussels chose to cut off their nose to spite their face and refuse a deal. What would happen? Well they would raise tariffs on their imports from the UK, reducing our exports. But of course we would give as good as we got, reducing our imports from them, which are far greater. What we would lose on the export swings we would more than gain on the import-substitution roundabouts. The deficit would be scaled back, and fewer jobs would be lost. Not only that, the import tariffs would provide useful extra fiscal revenue. A little bit of protectionism could be just what the doctor ordered!
John Poynton 