Currency Depreciation and the Lessons from History .......

Thursday 20th October 2016

Currency Depreciation and the Lessons from History .......

ref:- "Unsettling signs from a sliding sterling", The Financial Times, ECONOMICS by Chris Giles

Despite seeming like a momentous event at the time for those intimately involved, historically speaking large downside adjustments to a particular currency's value happen quite regularly. Depreciation is generally a recognition that prevailing values are unsustainable and can be a liberating force for good, or a belated recognition of some uncomfortable truths that points to difficult times ahead. There are plenty of examples of both in the history books, and the problem facing anyone trying to draw any lessons can be to identify which episode from the past most resembles their own circumstances.

Ideally, we wouldn't want to be banging on again about the post-Brexit travails of sterling. On the other hand though, they are instructive about the cause and effect of large currency moves more generally..... and besides, not only is sterling's slide the issue of the moment in foreign exchange markets, but the UK has a long and not very glorious history of currency depreciations going back to 1931 when Britain was at the forefront of desertions from the gold standard.

Basic uncompetitiveness forced the devaluation of 1949 and again in 1967  ---  remember PM Harold Wilson's famous assertion that it did not mean that the pound in your pocket, purse or bank account had been devalued ? Marvellous stuff, and a "little white lie" or blatent nonsense, depending on your point of view. In the 1970's it was a Britain in the grip of militant trade unions and rampant inflation that was the culprit, but Chris Giles in the FT draws comparison with two more recent examples : the 18% fall in the value of sterling after abandoning ill-advised participation in the exchange rate mechanism (ERM) in 1992, and the 25% depreciation wrought by the global financial crisis in 2007/8.

In the first instance, the following five years saw average annual GDP growth of 2.9% and export growth averaging 7.7% per year. Britain's current account deficit was eliminated and unemployment slashed. We can say with little fear of contradiction that the sterling depreciation was A GOOD THING. By way of contrast, the years following the financial crisis saw an average growth figure of 1.9% whilst with imports rising faster than exports the current account deficit grew from 2.7% to 4.6% of national income  --  definitively, NOT SUCH A GOOD THING.

So, even though no two set of circumstances that bring about big downward reassessments of a currency's value are ever the same, which is the more relevant example with regard to sterling's current slump ? Well, hardly uniquely amongst commentators Mr Giles veers firmly towards the latter, and his reasons are based on the causes of the depreciations.

Back in 1992, sterling's abrupt and painful departure from the ERM effectively removed a severe and artificial restraint on the British economy. A large part of the rationale behind joining it in the first place had been to help keep inflation under control, and in this it was largely successful. But at what cost? By 1992, the plainly overvalued exchange rate dictated by membership of the ERM and the soaring interest rates required to sustain it were damaging the economy hugely. The pound's sudden exit, and the relaxation in interest rates that went with it, was a boon to exports, domestic demand and business investment.

The same cannot be said of the rapid and dramatic depreciation that followed the financial crisis. That lower assessment of sterling's worth reflected the massive harm done to Britain's financial services sector, such a huge component of total exports. As such, it represented a fundamental re-evaluation of the country's prospects (not too good!) rather than a liberating release from an economic straightjacket.

The current post-Brexit depreciation has been exacerbated by the government's intimations that in the interest of pursuing a political agenda reflective of the referendum vote (immigration curbs etc), it is prepared to sacrifice what might seem common sense in strictly economic terms. Financial services and a tariff-strangled motor industry  --  which faced bleak prospects in 2008 due to the contraction in world trade  --  look to be most at risk, just as they were eight years ago.

To continue on the pessimistic bent (if you're that way inclined), the runes for the future do not make encouraging  reading. Even with the benefit of a weaker currency, the continuing slow-down in world trade growth means that export growth will be hard to achieve. Brexit has brought, and will continue to bring, deep uncertainty and as we know, uncertainty destroys investment. A weak currency will bring escalating inflation and make life increasingly difficult for normal families. And the breakdown in the trading relationships the UK has become used to, which will also contribute to higher import prices, will not be easily offset by greater efficiencies within importing companies or by the establishment of new trade deals which at the very least will take some time.

Mmm ..... dark days ahead, then?  What about exporters and the bigger profits they might expect, or the boost to areas of the nation accruing from the weak pound through increased tourism etc? Welcome but no compensation, says Mr Giles, who is not to be put off his downbeat assessment. With a nice nod towards those words of Harold Wilson, he quotes Angus Armstrong of NIESR, who says: "The pounds in our pockets are worth less and we wont have more of them".

Have a nice day ......