Rates

Currency Exchange
Originally uploaded by Martin Deutsch

I’m getting really annoyed by the way people assume that a low interest rate and a low exchange rate are what this country needs.

To start with the latter, it used to be the case that a lower exchange rate, i.e., a devaluation, was a good way to get through an economic downturn because manufacturers would export more and there would be fewer imports.

However, these days almost everything is produced abroad – even those products that are technically produced here are often just assembled from parts produced elsewhere.

This means that devaluation leads to higher prices (= inflation) much more quickly and strongly than in the old days.

Sure, people will go on fewer holidays abroad and buy fewer or cheaper foreign products, and more tourists will come here and buy more, all of which will help, but there is no manufacturing industry that will benefit, so in practice most people will just be poorer and less tanned.

A low exchange rate also makes it very unattractive for foreigners to come to work here, and it makes it very appealing for British people to work abroad.

As an example, when I moved to Scotland in 2002, my salary looked attractive, but if the exchange rate had been where it is today, I would have earned the same by working in a supermarket in Denmark, so there’s no way I would have accepted the job.

Actually, fluctuating exchange rates is a huge problem. Around the turn of the millennium, when the pound was very strong, the UK was a bad place to do manufacturing, but because the salaries looked attractive abroad, it was a good place for multinational financial institutions. These days, it’s just the opposite.

But it takes years to start or change successful companies – you can’t just convert a bank into a TV factory overnight.

If the currency had been stable, for instance by being part of the euro, companies would have known what the UK would be a good “Standort” for.

Let’s now return to the interest rate.

Classic economic theory says that in a recession, you lower interest rates to make people borrow more money, thereby stimulating investment and consumption.

But this time the banks are hoarding money, so most mortgages are still high, and most companies can’t get the loans they need.

So the actual consequence of the low interest rate is that it makes it unattractive to hold British pounds, so the exchange rate collapses, pushing up inflation in the process and leading to all the nasty consequences described above.

I would therefore recommend putting up the interest rate again (not a lot, just to about one point above the Eurozone interest rate) in order to strengthen the pound and reduce inflation.

And as soon as possible after that, join the euro!