On devaluation

This week marks 40 years since the 1967 devaluation of the pound. (You may have seen some of the archive coverage on BBC Parliament over the past couple of days.)

How appropriate that we are marking this anniversary now, one of the most famous episodes in British economic history.

Of course, there are lots of other notable episodes in history - the 1931 devaluation, the 1949 devaluation and the 1992 devaluation all come to mind.

But 1967 has a special place. It was the one that saw Harold Wilson famously draw the distinction between the falling value of the pound abroad, and the stable value of the pound at home - the pound in your pocket.

He was sort of right in that distinction incidentally, but not quite right. Devaluations only work when they make people feel a little poorer. Because whatever they do, they have to stop us spending quite so much on foreign goods by making them more expensive.

Now this is a good time to reflect on devaluations because next year we might see our currency fall quite sharply again.

To see the similarities between the sixties and now, we have to understand what a devaluation does.

Back then, we worried a lot about the trade deficit, and devaluations were seen as a way of improving our trading position. The falling pound raises import prices and cuts export prices.

But there's another way of describing the effect of a devaluation, more relevant to our economy today. Falling currencies are the best way an economy can reorient itself from away consumption towards saving.

In fact, the trade deficit is often just an expression of too much spending and borrowing... and not enough saving.

Falling currencies, rising savings and increasing exports are often all part of one and the same thing.

A country that saves more probably has a falling currency. Why? Because if we all choose to save, we lend money to foreigners rather than borrowing it from foreigners, so we buy foreign currency to lend - the pound falls.

You can think of a falling currency as either helping the trade deficit, or increasing savings. They're often the same thing.

Now that's what our economy needed in the 1960s, and it's what it might need now.

Back then, we couldn't afford to keep spending, so we had to increase exports to keep the economy moving. Today, the same is true. We've borrowed and spent enough. If we ask who then can buy our output, it's foreigners. That'll probably take a lower pound now, as it did then.

Of course, the pain of successive devaluations means we have now decided not to join any fancy currency fixing schemes - we'll fix the pound against the price of eggs using an inflation target. Not against the price of Dollars or Deutschmarks.

But just because we don't have a fixed rate pound to devalue, doesn't mean the pound can't fall anymore.

Comments   Post your comment

  • 1.
  • At 09:48 AM on 20 Nov 2007,
  • Colin Smith wrote:

Nothing to do with a 15% per annum increase in the money supply then...

  • 2.
  • At 01:42 PM on 20 Nov 2007,
  • Stephen Wyman wrote:

Evan, this article is very misleading & one might say dangerous.

A major devaluation of Sterling cannot take place unless there is a major devaluation of the Euro.

Sterlings future is linked to the Euro beause if the pound eere to collapse. It would be the end of Sterling as an international currency. As the only way out of it would be to fix sterling against the euro and join the euro club.

So it no longer matters how big the UK's trade deficit is with the rest of the world. What matters is how well Europe trades with the the four major economic Blocks (i.e. The Americas, the Far East, the Developing Nations and the rest of the world (i.e. Australia, New Zealand etc).

Now demand for the Euro is rising very sharply and will continue to do so until the Yuan is freely floated.

Once that happens the Yuan could well become the worlds second most traded currency. As Chinese exporters switch from asking for dollars for their goods to Yuans.

All this spells the end of the dollar as the worlds most respected currency and sterling will be just caught in the crossfire as a usefull reserve currency for buying Yuans and Euro's.

So those wishing for a Sterling devaluation are going to be unlucky. Also those thinking that the dollar has reached rock bottom are also going to be unlucky. For the world is in danger of becoming awash with dollars that nobody wants.

The world is changing fast Evan - Keep up with it!!!!

  • 3.
  • At 03:19 PM on 20 Nov 2007,
  • Chris S wrote:

I am curious as to which currencies the Pound is expected to devalue against? Surely most Western nations are borrowing too much, on the back of the savings of a number of export led countries, many of which have currencies more or less pegged against the dollar? If the pound devalues against the dollar and these currencies, won't this just reverse the appreciation we are currently seeing, and we will be back where we started?

  • 4.
  • At 03:20 PM on 20 Nov 2007,
  • DaveH wrote:

Or indeed, the fact that Germany is the world's largest exporter with a currency that has never been devalued and was so stable that Nigel Lawson tried (and failed) to peg the UK Pound to it.

Devaluation is not far off as the BoE is now signalling reduced interest rates - good time to buy European stocks or perhaps even US ones.

  • 5.
  • At 07:19 PM on 20 Nov 2007,
  • Manolo Conozco wrote:

The British Pound has been, especially after WWII, extremely overvalued for the economy it represents. Whether be it a matter of national pride, a tradition of representing an empire that no longer exists, a self imposed economic “apatheid” from the European continent, or a hedge against future devaluations, there is no real reason why the Pound should have been more expensive than the United States Dollar. Back in 1989, I visited London for the first time. The exchange rate was about $1.70 per Pound. I was apalled at how expensive everything was: from a McDonald’s meal, to the same shirts I saw at The Gap at almost twice the price I’d find back in the US. Small wonder then, why so many British families take their vacations in the US, particularly in Florida, where everything we sell them is relatively cheap to them. Perhaps a weaker pound would have spared Britain from some of its growing pains, especially its unemployment, in the years of Margaret Thatcher’s administration. It will be ironic to see how in time, US exports and production will help the nation to export itself out of debt and deficit while in Britain the trade deficit will most likely increase.

  • 6.
  • At 07:39 PM on 20 Nov 2007,
  • Mike Dixon wrote:

I largely agree with Stephen (2 above) but would like to add a couple of points from a Euro zone perspective.
Firstly what matters to Americans and the rest of the world is what is and will happen to the U.S. dollar. The cutting of the base rate by the Federal Reserve has sofar simly pussed the dollar down quicker. I believe there are two main reasons for this. Firstly, the U.S. economy is very heavily dependend on imports of oil the price of which has risen sharply in dollar terms. Secondly, and even more worrying, the level of indebtedness at every level of American society from the Federal Government down to the vast majority of individuals is such that it is difficult to see were any savings can come from.
China is perhaps the key to the problem. Unless the trade inbalance is overcome quickly either by less good being purchased from her, or more good sold to her even in the short run no frealist level of adjustment in exchange rates can change the underlying problem. The situation has echos of that between Germany and the United States at the beginning of the 1930s. Germany owed vast sums for War Reparation but were unably to sell goods to the U.S. in payment. The German Mark collaped and we all know what that lead to. Today the United States owes vast sums to China which it cannot pay - what next?

  • 7.
  • At 09:11 AM on 21 Nov 2007,
  • Jonathan Davies wrote:

Stephen Wymans comments don't make a great deal of sense to me. Why can't sterling devalue against the euro? In fact this has already been happening to a large extent: the pound has fallen from a peak of 1.72 euro in 2000 to 1.40 today and the rate of decrease has accelerated in the past few months.

There are no plans to join the EMU-zone at any time in the near future and therefore there is no political target for the euro-sterling exchange rate. I expect that sterling will continue to depreciate for precisely the reasons that Evan outlines.

  • 8.
  • At 02:57 AM on 22 Nov 2007,
  • Mark wrote:

"A country that saves more probably has a falling currency."

Oh that's rich :-) Tell that to Americans who probably have the lowest savings rate in the industrialized world and whose currency is falling now.

I remember when the pound was devalued in 1967. Didn't it drop from about $5 US on the pound to about $2 US, just about where it is now?

A falling currency makes imports more expensive and exports cheaper to those whose currency is not pegged to your own. As I see it, this is one economic weapon the US is using against Europe. Right now in my local supermarket in Central New Jersey, ordinary French blue veined cheese is around $12 a pound while some of the best cuts of meat nicely marbleized (USDA choice grade "Angus Certified"), porterhouse, rib eye, New York strip steak are around $6 a pound when they're on sale. I've bought chuck steak and pork spare ribs as low as $1.49 on sale. Now which do you think I will buy? Roquefort cheese is running around $19 to $21 a pound while factory aged (soft as butter) rib steaks are around $15 a pound and the best cuts of the finest beef (fine restaurant quality-USDA prime grade) are no more than around $25 to $30 a pound. I haven't been eating much imported cheese lately. Lots and lots of beef and pork though. Love 'em grilled. We like to drink our beer very cold.

  • 9.
  • At 09:38 AM on 22 Nov 2007,
  • Richard wrote:

But economies will not reorientate themselves back towards saving. As our money is being being robbed while we sleep through very real double digit inflation, we will not be saving. The majority of us will be even bigger into debt, or if we're clever, we'll be converting our cash into gold, oil and other commodities that governments cannot reproduce and devalue. It does not pay to save in an inflationary environment.

  • 10.
  • At 01:31 PM on 22 Nov 2007,
  • Sally Hemings wrote:

Interested in how the dollar devaluation will help US economy. It will affect imports from Europe and japan but most asian currencies esp China are linked in some way to the dollar so chinese goods will not rise in dollar terms and will remain cheaper than homegrown US versions. US imports of commodities esp oil will rise in dollars while in europe the rise will be offset by fall in dollar. Will US exports increase? I wonder. Chinese goods will still be cheaper so why buy US. Look at software or movies. I use US software not because of the price but because for a PC "windows" is pretty much the only game in town and a drop in price won't change that so sales will stay the same regardless. I don't expect the ticket price at my local multiplex to go down but even if prices did fall I'm unlikely to queue for "Disney's Axe Slasher IV" just because the ticket is a few pennies less than last week. I'll make an entertainment choice based on criteria other than just price. What does US have to sell that a lower price will tempt me to buy??

  • 11.
  • At 05:06 PM on 22 Nov 2007,
  • Stephen Wyman wrote:

Let me expand slightly on my above comments.

The United Kingdom is nowadays a collection of European States and although we do have laws coming out of our independent parliaments. These laws have to to be tempered somewhat by the laws coming out of Brussels.

As the highest court in the land is the European court of Human Rights and what they say goes. The European Courts can even overule the House of Lords.

So although we do have some degree of opt outs that allow us to follow a slightly different economic policy from the rest of Europe. It has to be structured around the economic rules created by the European Parliament.

Therefore our econcomy is nowadays irrevocable linked to Europe. Also if the United Kingdoms economic policy is wrong, then Europes economic policy is wrong.

This raises the question that, be that as it may - Why, if the UK's economic policy is so bad does it requires a devaluation, are the rest of Europe trying to emulate it.

France is currently going through industrial strife as the French government try yo come closer to our penion regime (albeit in the end it will be better funded because that is the Frech Way). Even Germany has been trying for years to reform their economy along the United Kingdoms lines.

So if Sterling needs to be devalued, then the Euro needs to be devalued.

Consequently Sterling is locked within a Trading range of 1.20 to 1.50 Euro's because if it was to fall below 1.20 then sterling as an international currency would be finished. As it would be viewed as a major currency crises, which could only be solved by the UK adopting the Euro.

So Sterling has a floor and Sterling has a ceiling Euro. The United States on the other hand has neither.

Therefore although there can be a minor devaluation of Sterling (i.e. down to 1.20 Euro's). There can no longer be a major one against the Euro in the likes of what happenned in the Wilson era.

  • 12.
  • At 07:40 AM on 23 Nov 2007,
  • Mike Dixon wrote:

Both Mark (8) and Richard (9) are right. Problem is that while Mark is right in the short term Richard is right in the medium term. Least that was our experience in the U.K. almost exactly 40 years age when the Pound Serling was devalued from $ 2.80 = £ to $ 2.40 = £.

The Federal Reserve was and is caught between a rock and a hard place. Damned if rates go down and dammed if rates go up.

I feel very sorry for the ordinary American caught up in all this through no fault of their own.

  • 13.
  • At 12:41 AM on 24 Nov 2007,
  • Mark wrote:

Mike Dixon;
"I feel very sorry for the ordinary American caught up in all this through no fault of their own."

I wouldn't feel too sorry. America has faced far far worse in the past and not only survived but prospered. Adversity only seems to make it stronger and it is in a state of perpetual self renewal. Everyone who ever took a bet against the US from King George III to Saddam Hussein lost. There's an old saying that has it that God looks out for drunks, fools, and The United States of America.

I feel sorry (but not too sorry) for Europe. Western Europe lives in what's left of the bubble of the Pax Americana when the US for its own security reasons needed Europe to be prosperous and made enormous one way concessions. That's over now but only the UK took steps to adjust to the reality of the globalized market economy while the rest of Europe deluded itself into thinking its success was the results of its own efforts. The French government has spent itself bankrupt while Germany has taken on the onus of rebuilding East Germany and now all of the affluent nations of the EU have taken on rebuilding the European remnants of the old Soviet empire. Good luck. I just feel lucky to be on this side of the pond. Let's see where each of us winds up in say 5 or 10 years from now.

  • 14.
  • At 06:47 AM on 26 Nov 2007,
  • Martin Cleary wrote:

I think DaveH @4 makes a valid point. The DeutchMarks's strength provided the bedrock for the growth of Europe's biggest economy. A strong currency means that a country has a strong incentive to create, and to try very hard to add value. A country's sheer power is clearly linked to its monetary strength. For example, if the dollar continues to slide, the US economy will become literally smaller and weaker relative to the rest of the world, and this will slowly chip away at the might of that country.
A devaluation of the pound next year might be inevitable, might be desirable..who really knows. But essentially, the BOE should just plough on, eyeballing inflation & interest rates, allowing the pound to do its own thing...If the pound falls, so be it. As the article implies, this may be related to increased saving, in itself no bad thing. But long term, IMO, to oversee a falling currency, whether by fault or by design, is a folly.

  • 15.
  • At 01:04 PM on 26 Nov 2007,
  • GAM, Belfast wrote:

Most economists talk about imports/exports and relative costs. Can someone tell me what the UK manufactures anymore to export? My understanding is that Manufacturing now accounts for a small percentage of GDP (15%?) and is still in freefall (look at the £25k Engineers are paid compared to other professions!). The financial industry and service industry thus make up the majority of the county GDP. Do we export these 'goods' and does it really increase the wealth of the country? Do the 'old' economic models still apply with minimal manufactured goods?

  • 16.
  • At 09:21 AM on 27 Nov 2007,
  • Gregory Weaver wrote:

I think that all of you have failed to take into account the international perspective of trade. You look at it as only trade between Europe and the US and in reality it is trade between every country that will matter. European goods are going to become more expensive in relation to US goods and as a result companies around the world will choose American Made because the quality is about the same but the price will be less.
This will most notably affect the Aerospace, automobile, and banking industries. You will see that people will stop buying these goods and services from Europe and start buying them from the US; even faster the faster the dollar falls. This will of course absorb dollars on the open market and cause the dollar to reach a more sustainable level.
As to high oil prices; woe to the countries that are causing the high price. For the US will eventually adapt and switch to a different fuel source which will spill over into Europe, Japan, and then the rest of the world. The longer high oil prices occur the more likely that the US will switch fuel sources. You can see this already with more hybrid vehicles being sold and some States within the US are already building hydrogen fueling stations most notably California. These trends will increase the longer oil prices remain high until the US no longer uses oil as its main fuel source.
As to the cause of all of these problems it all stems from the fact that the Chinese government refuses to free float the Yuan against all major currencies. At current levels of change that the Chinese government allows it could take years for the Yuan to be at where it supposed to be now. Furthermore we have no guarantee from the Chinese that they will not manipulate the Yuan in the future. This must change in order for the economies of US, Japan, and Europe to remain steady.

  • 17.
  • At 08:44 PM on 27 Nov 2007,
  • John wrote:

The pound will devalue not because of an increase in saving but an increase in the UK government printing money.

The Dear Leader has promised the end of boom and bust and has been prepared, while we were in a period of benign global conditions, to increase taxes, employ the fat end of a million extra public service make-weights and their associated overheads ie office space and unfunded pensions. On top of that he's been pump-priming the economy to the tune of 30bn a year of borrowed cash. 'For Investment'.

So with the feel-good factor of perpetual house rises in the US and the UK about to look a lot less perpetual and the knock-on effect that will have to the retail industry, car sales (Pendragon down 35% today) etc he's going to have to come up with a little more dole money than he'd planned. And a fair bit less tax revenue than he'd planned for too.

I can see it now, poor Darling having to stand up and explain that due to circumstances on a global scale beyond our control we're going to be borrowing 10% of GDP this year. And next year. And the year after that. For investment you understand. The UK will be covered in shiny new schools, hospitals, crossrail sized projects, anything at all to get that borrowed money out there and keep the pump primed.

And all that increasingly valueless paper will be what does for the pound.

Just like it did in the '70's.

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