In the summer of 1981, Nigel Lawson wrote a memo to the then-Chancellor Geoffrey Howe that, by his own admission, prompted astonishment among Treasury officials.
Sterling had taken wing after Margaret Thatcher’s election win in 1979, rising 20 per cent over the subsequent two years. Far from acting to prevent this, Mr Lawson wrote to his boss, the Government should encourage its ascent. The currency’s surge would help to combat Britain’s 11 per cent inflation rate and would shore up financial market confidence in the Government. “The strong pound,” the pugnacious Treasury minister wrote, “is the biggest thing we have going for us.”
Substitute the word “weak” for “strong” and you would have a succinct summary of government policy today. Since the onset of the credit crunch, a policy of benign neglect, coupled with unprecedented interest-rate cuts and money-printing by the Bank of England, have engineered a wilting in the value of sterling, which has sunk more than 20 per cent since its pre-crisis peak.
Unlike his Thatcher-era predecessors, George Osborne has displayed no desire to see sterling recover. The weak currency has contributed to a resurgence in British exports, which are rising at record levels, according to business surveys. Any rebound in the currency would quickly derail the Chancellor’s hopes for a “rebalancing” of the economy towards industry and away from a reliance on consumer spending.
So it was striking to hear the Chancellor saying in his March 23 Budget that he wants Britain to rebuild its foreign exchange reserves from their present, depleted levels. This, according to a Treasury document released with the Budget, was “partly” in order to help to ensure that the UK has the resources to contribute to beefed-up activities of the International Monetary Fund, which no doubt is true.
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But the decision to lift the reserves by an admittedly modest £6 billion this year was also taken by some City economists as a signal from the Treasury that it is taking an active interest in the value of the pound and that it might be willing to put some financial muscle behind the goal of keeping it steady. Both Roger Bootle, of Capital Economics, and Geoffrey Dicks, a former member of the Treasury’s Office for Budget Responsibility, have said that it sounded like a call for a weak currency.
The rocketing pound contributed to the decimation of manufacturing in the early 1980s under Margaret Thatcher. Further damage was done after Labour took power in 1997, when sterling once again headed skyward, appreciating 26 per cent against the dollar over the following ten years. The Treasury does not want a re-run of that now.
Britain is hardly the only country trying to bolster its competitiveness by engineering a weak exchange rate. China’s managed exchange rate has long infuriated politicians in Washington, who see it as a shameless mechanism for conferring an unfair advantage on their exporters. Yet the Fed’s $600 billion quantitative easing scheme has been seen in Beijing and other emerging markets as a naked and aggressive attempt to devalue the greenback and ease America’s crippling debt burden.
Self-interested currency policies are only adding to the mire of mistrust and misunderstanding prevailing at G20 level. It is telling that while the G20 is now meant to be the premier forum for the resolution of global economic tensions, it was the long-established G7 grouping of advanced economies that proved its continued relevance as it undertook the co-ordinated currency intervention after Japan’s earthquake.
A G20 meeting in Nanjing, China, last month generated more acrimony than accord, as delegates squabbled over currency policies and the ways to correct the skew between the world’s debtor and creditor nations. The US Treasury Secretary Tim Geithner continued to argue that fixed exchange rates in developing countries were generating higher inflation and “protectionist pressures”. But the view in Asia and Latin America is that the Fed has been pursuing a unilateralist monetary policy that is flooding developing markets with cheap cash and driving their currencies higher.
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Countries ultimately will pursue their own self-interest, including via monetary and currency policies. The difference between the days of Nigel Lawson and today is the degree of integration within global financial markets. Niche events in a single country, such as the collapse in the sub-prime corner of America’s property market, rapidly spill over across the world financial system.
As HSBC economists said in a note last week, the loose-money policies in the West are having far-reaching consequences beyond their shores, as they feed the commodity price upsurge and fuel global inflation pressures. The European Central Bank appears to recognise the dangers and is set to lift interest rates this week, even if it means running the risk of a higher euro. On the other hand, the Fed is likely to remain inactive for some time to come, thus tolerating an acceleration in inflation that is crushing real household incomes.
In Britain the position is harder to read, given divisions on the Bank of England’s Monetary Policy Committee, but if Mr Osborne’s “growth strategy” is to bear fruit, he will want to see the pound remain at competitive levels. The evidence to date is that Bank’s Governor Mervyn King, who is tolerating 4.4 per cent inflation with striking equanimity, is willing to play along.