Thank goodness we can have a run on the pound when we need one
Martin Vander Weyer looks ahead to next week’s Pre-Budget Report and reflects on George Osborne’s contentious remarks about the devaluation of sterling. It looks like Gordon Brown is getting away with his borrowing binge — leaving the Tories isolated On Monday afternoon I rang a distinguished City economist and asked him a rather technical question about the relationship between issuance of gilt-edged stock and movements in the dollar-sterling exchange rate. ‘Not really my specialist field,’ he replied suavely. ‘But I’ll give you my overview: George Osborne is a prat.’ And that, I’m afraid — expressed with varying degrees of bluntness or circumlocution — was pretty much the consensus of all the experts I spoke to this week about the shadow chancellor’s much-quoted remarks to the Times at the weekend: ‘We are in danger, if the government is not careful, of having a proper sterling collapse, a run on the pound... The more you borrow as a government, the more you have to sell the debt and the less attractive your currency seems.’ Sterling has in fact already lost a quarter of its value — from $2 to $1.48 — since July, and has reached a 13-year low against a basket of currencies. Whatever the underlying cause (urgent liquidation of hedge-fund positions by all available means probably had as much to do with it as any general wave of negative sentiment about the UK economy), you might think this already constitutes a ‘run on the pound’ which we should be worried about. In that sense Osborne is right to highlight it, as Cameron was perhaps right on Tuesday to abandon his pledge to match government spending plans. After all, the so-called convention that senior politicians should not mention the exchange rate for fear of ‘talking down the pound’ is no more valid, at a time of crisis, than that other convention, breached at Glenrothes by Gordon Brown as soon as he scented victory, that prime ministers do not campaign in by-elections.
So why has Osborne walked into such a hail of flak? Partly because Lord Mandelson, despite the serpentine smile and silken wit with which he received his Spectator Parliamentarian award from the hand of Osborne last week, is plainly on a mission to do as much damage to the shadow chancellor’s career as he can, in revenge for Corfugate and to remind us what a political ninja he really is. Thus, according to the Business Secretary talking on the Today programme, Osborne was not so much trying to draw attention to the risks attached to unfettered government borrowing as ‘trying to undermine the confidence of the markets, undermine the confidence of traders. It was reckless and irresponsible.’ That was a vicious accusation, but it stuck. And the fact that the pound rallied slightly against the dollar on Monday did not let Osborne off the hook. Indeed, it added insult in the form of ‘Markets ignore Osborne’ headlines, while leaving ministers the option of blaming the Tories if the pound takes another dive any time in the next few weeks. And if it does not take a dive, or happens to rise because of a change in sentiment towards the dollar, they will claim ‘a vote of confidence’ from the markets. So Osborne loses whatever happens.
All of which obscures the fundamental point, made to me by my distinguished City economist friend who must remain nameless, after venting his feelings about Osborne but in similarly plain language: ‘Sterling has been overvalued. The UK needs a weak currency. That’s all there is to it.’ Likewise, a senior economist I can name — George Magnus, adviser to UBS Investment Bank — told me: ‘I don’t agree with the shadow chancellor. At a time when the private sector is in a funk and we’re seeing a wave of destructive deleveraging, I think the government can borrow as much as it likes; effectively it is substituting for the contraction of private-sector credit. I really don’t think there’s an imminent danger of a drop in the pound in response to the government’s borrowing plans — and even if there were, it wouldn’t be a bad thing.’ So let me try to unpack this story in more detail. First, let us consider whether there are specific points on the sterling-dollar exchange rate graph at which we should feel relatively optimistic — and other points at which we should resort, as I advised here recently, to the Scotch and the shotgun. Second, will the government’s plans for unfunded tax cuts, to be announced in next week’s Pre-Budget Report and coupled with the Prime Minister’s already declared Keynesian belief in spending our way out of depression, eventually do damage to what Harold Wilson famously called ‘the pound in your pocket’? Finally — hold your breath for this one — does all of this constitute a message that it’s time for Britain to reconsider applying for membership of the euro?
As to the ‘right’ level for the pound on the foreign exchanges, there is nothing magical in any particular number, but let us remember that the all-time low was fractionally above one dollar in February 1985, and the most recent high was $2.11 last November; the range for the past quartercentury has been between those two figures. And it is a special pleasure to remind you of Christopher Fildes’s oft-recurring gag in his ‘City and Suburban’ column, which ran for much of that era, about the quest for the $2 martini. Whenever the exchange rate crept towards $2 to the pound — as happened, for example, in the summer of 1992 — he would yearn ‘to fly westwards towards some reliable source of martinis (the Ritz-Carlton, Boston, offers a choice of 16) and mop them up while the illusion lasts’. His point was that if a decent cocktail could be had for the equivalent of only a pound, then that pound must be overvalued — and the best thing any of us could do was to take advantage of the anomaly, ‘the illusion’ as he put it, for as long as it lasted.
Likewise in 2004, when the pound rose to a peak of $1.94, we might have labelled this same phenomenon the WAG Index: the more frequently the future Mrs Wayne Rooney, Coleen McLoughlin, crossed the Atlantic to shop, the more evident was the pound’s overvaluation. At a time of economic downturn, what we want is for Americans to come over here — to shop, buy tickets for West End musicals, or invest in British companies. In simplistic terms, the balance begins to shift in that direction when the exchange rate is in the lower half of its longterm range. Appetite for British exports perks up not only in the US, but in every other country whose currency is pegged to or aligned with the dollar; our own appetite for imported goods correspondingly weakens, while UK equities, bonds and businesses look more attractive to foreign investors. Naturally, there is a psychological point at which sterling may be felt to have fallen too far (we would all be overcome with profound gloom if a pound became worth less than a euro, for example, though some analysts are predicting that will happen this winter) but for the time being the weaker pound is helping British businesses of all kinds to stay alive, and is a welcome development.
As to the level of government borrowing, Gordon Brown has got away with tearing up the fiscal rules he set for himself, which he declared in 2002 would apply ‘at all times — now and in the future’. Instead, he repeatedly points out that Britain’s ratio of debt to GDP — at 43.6 per cent in 2007, give or take Northern Rock and a steaming pile of offbalance-sheet PFI deals — was lower than that of 49 other countries, including Japan at 170 per cent, and Germany, Canada and France all in the 60 per cent-plus range. On this measure, even tightfisted Switzerland, at 44.2 per cent, turns out to be more profligate than we are. So that’s OK then, and if the public sector borrowing requirement, net of gilt redemptions, has to soar above £100 billion for the next couple of years, so be it: Brown’s going to do ‘whatever it takes’, and have himself measured for a Superman outfit into the bargain.
Well, most economists now think he’s not wrong, however wildly he has deviated from his own previous rhetoric. By borrowing heavily to fund tax cuts for the less welloff, maintain benefit payments at a time when tax revenues are falling, and fund vital infrastructure projects, he aims to make the recession shorter and shallower than it might otherwise have been — which means that tax revenues will also recover quicker. And while Osborne and others bleat about the ‘burden’ of debt we are leaving for the next generation to repay, Brown knows that is not really a problem at all: in normal circumstances the debt will simply be rolled over as it matures, while growth and inflation gradually diminish its overall scale. The real limiting factor is the cost of servicing the debt — paying the interest on it — when the same money could be used to provide much-needed public services; but that is secondary to the more urgent challenge of heading off a slump.
So stand by for the borrowing binge of all time. If foreign investors, who usually take up a quarter to a third of all new issues of gilts, are deterred by the fear that sterling will fall, and are inclined to cash in their current gilt holdings, then guess what: by the self-fulfilling magic of the market, sterling will indeed fall — until it reaches a level at which the foreigners are eager to buy gilts again, at which point the exchange rate will begin to strengthen. And in the meantime (as Jamie Dannhauser of Lombard Street Research kindly explained to me) it will be no bad thing if new issues of shorter-dated gilts are largely taken up by UK banks, providing them with the liquid assets which for the time being they critically lack.
Economists also agree that what is crucial to this strategy is that the government makes plain that it is a temporary response to an unprecedented emergency, and that behind it is a real plan to restore fiscal balance, through spending cuts and tax rises if necessary, when circumstances allow in the two-to-five-year term. We will listen avidly to what the Chancellor has to say about that next week. And if he gets the tone right, it is hard to imagine how George Osborne can respond without digging a deeper hole in which to bury his own chances of succeeding Alistair Darling in the job.
Finally, will these experiences make us wish we had joined the euro, as both the former Monetary Policy Committee member Professor Willem Buiter and the FT columnist Wolfgang Münchau have been suggesting? Will we decide, like the bankrupted Icelanders, that having a free-floating currency and an independent economy is no longer desirable in such a dangerous world? Quite the reverse, I suggest: as we watch the likes of Spain going through agonies of real-wage adjustment which might have been alleviated by a floating peseta and localised interest rates, we will be all the more glad that we can still have a run on the pound when we need one.
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