The Bank of England can’t just go on doing down the pound

Devaluation has now become an end in itself at the Bank of England – but it’s no panacea and we risk a lost decade like Japan

There has been a persistent bias towards devaluation in British economic policy ever since leaving the gold standard in 1931. Ever since, policy-makers in Britain have reached for devaluation whenever in real trouble Photo: Alamy

 

 

 

When the banking crisis erupted, it was fashionable to dismiss as alarmist suggestions that Britain and other advanced economies at the centre of the collapse could end up like Japan, condemned to decades of economic stagnation. The US and UK were structurally different, it was argued, and adaptable enough to avoid such an outcome.

Regrettably, this complacent consensus has proved incorrect. We are five years into the crisis, or halfway through the first decade of lost growth, and the UK’s performance is, if anything, slightly worse than Japan’s post-bubble experience. Few would put money on us breaking out of this economic funk in the near future. Yet, despite the obvious similarities with Japan’s banking boom and bust, there are key differences, at least as far as Britain is concerned. Unfortunately, few of them point to a more positive outcome. Against Japan’s generally high current account surplus, the UK continues to experience a stubbornly persistent deficit; as a nation, we are still spending much more than we earn. Inflation also remains elevated, whereas in Japan they’ve experienced years of deflation. And sterling has devalued dramatically, while Japan constantly has to battle a strong yen.

For policy-makers at the Bank of England, devaluation seems to have become an end in itself, a panacea that can help the economy rebalance away from the debt-fuelled public and private consumption of the past and towards investment and net trade.

The policy was reaffirmed in the minutes published this week of the Monetary Policy Committee, with the Bank’s Governor, Sir Mervyn King, acting as its cheerleader. Having only recently said that central bank money printing, or quantitative easing, was not the silver bullet he had hoped for, it now appears he wants much more, in part because it helps keep the pound low and therefore may assist in reaching the Holy Grail of a more balanced British economy.

If that was Sir Mervyn’s intention, it worked; the pound, which has been under pressure for some months now, fell further. Is this going to help us avoid Japan’s fate? So desperate has everyone become for anything that might kick-start growth that even Japan, under Shinzo Abe’s new government, appears ready to follow Britain’s lead. Abe’s economic strategy implicitly accepts that some inflation, traditionally anathema to this savings-addicted nation, is preferable to years of further deflation. I have to confess to being in a quandary about these policies. There are good arguments on either side. But first, a little history.

There has been a persistent bias towards devaluation in British economic policy ever since leaving the gold standard in 1931, an act widely judged to have been a success in that it helped the economy avoid the deep depression of the US and large parts of Europe. Ever since, policy-makers in Britain have reached for devaluation whenever in real trouble, as if it were a big bazooka that would blow away all our troubles.
Unfortunately, post-war experience has been more mixed. Harold Wilson’s “pound in your pocket” devaluation set the scene for more than a decade of rampant inflation and relative economic decline. And whereas the ERM debacle is sometimes cited as a further example of successful devaluation, in fact it was the rapid decline in interest rates that disengagement from the Deutschmark allowed, rather than the devaluation itself, which reignited the economy in the 1990s.
The buffeting the pound has received this time around in fact exceeds these previous devaluations. Against the euro, it is down about a quarter, having been even lower. Little good does it seem to have done, either. So far, it has self-evidently not helped the economy to rebalance, while, by adding to inflation at a time of very low interest rates and stagnant wages, it has damaged savings and household consumption.
On the other side of the ledger, it may have helped the UK avoid the crushing rise in unemployment that has engulfed eurozone periphery nations such as Spain and Ireland. On many financial measures, the British economy looks a basket case, but there is no arguing with the creation of more than a million private sector jobs over the past two and a half years. This is little short of miraculous for a supposedly nil growth economy.
All the same, there is a sense in which by flooding the system with liquidity, Britain has merely put the crisis on hold. The economy does not any longer have a shortage of money. The problem lies elsewhere, and yet the only solution proposed is to print even more of the stuff. By doing so, the Bank of England treads a dangerous line. The sell-off we have seen in the pound may or may not help the competitiveness of British goods, but it could easily turn into a full-blown rout if foreign investors start to lose faith in the value of sterling assets. This would force a steep rise in interest rates, a fiscal crisis and another deep recession.
All this “looking through” the inflation target to the sunlit uplands of more normal economic conditions, which supposedly lie just the other side of the next spike in prices, has gone on far too long. We’ve tried devaluation, and it doesn’t seem to have worked. Conventional economic analysis is that Western economies are over the worst, as indeed it has been ever since the near-death experience of the banking implosion. Sadly, that still doesn’t look the way to bet.