The fall of the pound has been the political event of the week, but is it all bad news? Many thanks to Civitas for allowing us to republish the below essay, an extract from a pamphlet (pdf) about the merits of a low currency and case for keeping the pound at its new competitive levels.
Many people in the market and much of the commentariat are currently concerned with the recent weakness of the pound on the exchanges. They are barking up the wrong tree. The real sterling crisis is that the pound has been too high.
Accordingly, the Brexit-inspired bout of sterling weakness was extremely good news for the British economy. Far from panicking about the lower pound, the UK authorities should be concerning themselves with the question of how they can ensure that the pound continues to trade at a competitive level in the future.
The exchange rate of the pound is vital to the success and health of the UK economy and the fact that it has long been stuck at much too high a level bears much of the responsibility for the economy’s current ills. These results have not exactly been intended. Despite the exchange rate’s importance for the UK, for almost 25 years there has been no policy for it. As a policy variable the pound has been left in a state of neglect, in the belief that other things (principally inflation) should determine policy, and/or because ‘the markets know best’. This latter belief mirrors the establishment’s faith in the financial markets prior to the crisis of 2008/9.
But we have subsequently learned, if we did not know it beforehand, that, left to their own devices, the financial markets may systematically misprice financial variables, and that they may behave in a reckless way in the pursuit of individual short-term gain that puts the long-term stability of the financial system at risk.
Interestingly, although such reasoning is now widely accepted in relation to the equity and property markets, recently no one seems to have made these points about foreign exchange markets – until now. This would be surprising to an earlier generation of economists schooled in the crises and policy disputes of the 1930s. They were brought up to believe that, not only could markets malfunction dramatically, but they could produce and sustain a destabilising set of exchange rates, which could have devastating consequences for the real economy.
No one was more aware of the importance of exchange rates than John Maynard Keynes. In the 1930s, a series of devaluations and the imposition of protectionist trade policies were major contributors to the Great Depression. Following that experience, Keynes was determined to establish for the post-war world a global exchange rate regime that placed equal obligations on deficit and surplus countries to adjust, thereby ensuring that the new system did not have a deflationary bias.