Bill Emmott - International Author & Adviser

Article

Pound-Euro Parity and The Benefits of Devaluation
Corriere della Sera - December 31st 2008

To some people, currencies are a national virility symbol. So the rapid decline of the British pound, in effect to parity with the euro, must be a national humiliation, a sign of a weak Britain and a strong eurozone? Well, so far the British seem unconcerned. Only a few dedicated promoters of British euro membership are using parity to revive their argument that Britain should join. Perhaps the British are just showing their famous stoicism, keeping a stiff upper lip as their troubles accumulate? Not really: many actually think the fall of the pound sterling is a good thing.

            Certainly, the move to parity has been a shock. We Brits had got used to thinking that one euro was worth about 70 pence, or £0.70. So now that pounds and euros are worth the same, prices look a lot higher to us in Rome, Paris and Spain’s Costa del Sol. British newspapers are starting to run stories about Italians and other Europeans coming to London to buy cheap houses and flats, and about the chance that more foreigners might come to Britain as tourists next year. But there is the clue to why we are privately pleased: it could mean that our economy gets supported by foreign money in 2009.

            A currency devaluation can be a dangerous thing for an economy. Euro members can readily recall the regular crises faced by the lire, the peseta and even the French franc in the past. Yet a devaluation is dangerous only if one or more of three conditions exist: inflationary pressure, which will just be reinforced by a devaluation as import prices rise; a large number of domestic companies that owe big debts in foreign currencies, as devaluation will make them harder to repay; and, third, a difficulty in persuading people to buy the country’s government bonds, since if so a devaluation will force bond yields higher, raising borrowing costs for the government.

            The reason the British are insouciant about parity with the euro is that none of these conditions currently exists. Inflationary pressure has gone, replaced by concern about deflation. Thanks to the City of London’s large, liquid markets, British companies are not overly dependent on foreign-currency debt. At least, they used to be large and liquid, so most existing corporate debt is denominated in sterling. And, for the moment, the cost of government borrowing has remained low. So far, therefore, the pound’s devaluation is all gain and no pain.

            Of course, that might not last. Britain’s recession currently feels as if it will be severe. Tax revenues are falling rapidly, so government borrowing will be even higher than Prime Minister Gordon Brown has foreseen in the fiscal stimulation plan that his cabinet announced during November. It is possible that British government bonds will lose their credibility, as this process goes on, and along with a falling pound there will be rising long-term interest rates to attract investors. This, however, is unlikely for as long as deflation remains the main expectation. For while that is so, the Bank of England will stand ready to finance government borrowing directly, simply by printing more pounds and using them to buy government bonds.

            Rather than economic pain, it is likelier that the pound’s devaluation will bring political tensions with other European Union governments. For it may be seen as Britain profiting at the rest of Europe’s expense. Germany’s finance minister, Peer Steinbrueck, criticised Gordon Brown earlier this month for the “crass Keynesianism” of his fiscal plan. His real target might well have been the British devaluation that has followed that plan. The more it is seen to succeed, the more that euro members such as Italy and Spain may start to regret that they too cannot devalue. And the more pressure they will put on Germany to expand its own fiscal policy in order to boost demand and rescue the European economies.


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