EMBARGO: 00.01 hrs, Friday 13th April 2012
Strong pound still hurting Britain
Lack of exchange rate policy is crippling hopes of economic recovery
The strong pound is a key contributor to Britain's languid rate of economic growth according to a new Civitas report. Despite a significant fall since 2008, the high price of the pound is still preventing exporters from pricing their goods and services competitively on world markets.
In A Price That Matters, John Mills, an entrepreneur and economist, challenges much conventional thinking on economic policy. He shows why policies which ignore exchange rates and international competitiveness, and focus only on inflation, have contributed to the decline of manufacturing, stagnant incomes for many, entrenched regional unemployment, and rising inequality.
Shooting ourselves in the foot
Mills adds his own experience as a successful importer and exporter in explaining how a number of key elements of manufacturing supply-chains have been blocked by the consistently strong pound:
My own experience has been mainly in generally available manufacturing techniques such as injection moulding, fabrication, metal pressing and assembly. Without intellectual property protection, all this type of industry is highly vulnerable to lower cost-base competition - which is exactly what has happened in the UK.
Mills argues that British manufacturing has become less competitive, whilst entrepreneurial rivals in the Far East have aggressively undervalued their currencies to keep their economies growing. The result has been a loss of jobs and a widening balance of payments deficit between the UK and the rest of the world. This is a key contributor to the longer than expected recession.
Bankers' paradise - Britain's misery
The Treasury and the Bank of England have acted as if the best policy can only ever be an inflation target (of around 2 per cent per annum). But they have discounted the effect of this policy on the pound's international exchange rate which has gradually risen relative to other currencies.
Mills notes that the main beneficiaries of this policy have been bankers, for whom a strong currency creates an attractive environment in which to store capital:
The City has always tended to favour a strong pound because of the increased leverage this provides everyone involved in international transactions. [p. 23]
But this approach has bled productive businesses in the rest of the economy, especially manufacturers. Their production costs are denominated in an over-valued currency but their export incomes are in relatively devalued foreign currencies:
... the exchange rate policy which we have pursued for decades has made it much more expensive to run most manufacturing operations here than in other parts of the world, especially the countries round the Pacific Rim. [p. 3-4]
A Price that Matters makes the case for a radical change in monetary policy. Rather than targeting inflation alone, the Government should also target international exchange rates and competitively devalue the pound relative to other world currencies, including the dollar and the euro.
Mills estimates that:
- a 10-15 per cent devaluation would be sufficient to close Britain's trade deficit;
- a 20-25 per cent devaluation would return Britain to four per cent annual growth. [p. 16]
He acknowledges the costs associated with this approach, including reduced spending power for British consumers when buying foreign goods. However, he explains that this is a price worth paying for dramatically increased job and growth opportunities in Britain:
It is true that there will inevitably be some losers as well as many winners, but… [o]n average, everyone will be better off in the short term and much better off in the medium and long term. [p. 24]
Dare the credit ratings agencies
While the Coalition Government has set its compass by the credit ratings agencies, John Mills argues that their advice is not in the best interests of the British economy:
If the credit rating agencies threaten downgrades, they should be ignored - even encouraged - because negative postings from them would help to bring the pound down. If interest rate rises are threatened, they should be counteracted by the Bank of England simply printing more money, instead of it having to be borrowed from the markets. [p. 19]
In addition, Mills proposes a large fiscal stimulus to boost social housing, channelled through local authorities:
More quantitative easing should be introduced, supplemented by lending directly by the Bank of England to organisations capable of paying the money back from income flows, such as local authorities and housing associations. This would enable them to finance house building. The government should deliberately increase its spending in relation to its revenues to widen the foreign payments deficit temporarily, to assist in making the parity of the currency fall. [p. 18]
Putting off the inevitable
Mills concludes with a warning that Britain will inevitably face a massive fall in the value of the pound in the future. The only question is whether it happens as a planned and orderly devaluation which might allow Britain to start balancing its books, or following a disorderly default on public debt:
... getting the exchange rate down is a matter on which, in the end, we will have no choice. If we continue to run up huge debts which we cannot pay back, sooner or later we will run out of creditworthiness… There will then be a major currency crisis and the pound will crash...
... The choice we have is whether we get this done in an orderly manner while we still have time for this to be arranged, or whether we wait so long that we finish up with a disorderly rout. [p. 35-36]
For more information contact:
Civitas 020 7799 6677
Notes for Editors
i. John Mills is an entrepreneur and economist. He is founder and chairman of JML, a successful consumer products company. He is author of A Critical History of Economics.
ii. A Price that Matters: Britain's Disastrous Exchange Rate Policy (RRP: £3.00) is available from the Civitas shop and by calling 020 7799 6677.
iii. Civitas is an independent social policy think tank. It has no links to any political party and its research programme receives no state funding.