ON MONDAY sterling had the largest fall since it was forced out of the ERM on Black – or White? – Wednesday in 1992. The pound was down 3.5 per cent against the dollar to $1.48, as well as 2.9 per cent against the euro, at 1.17. Yesterday, the pound also hit a 13-year low against the Japanese yen, at ¥137.14.
It says a lot about the welter of bad economic news in which we have been drowning for the past year that a sterling crash of this magnitude did not make it to the front pages except as a modest wing column in the Financial Times. Can we conclude that the fall in the pound – by 20 per cent since mid-2007 – is unimportant?
Not if the president of the European Commission, Jos Manuel Barroso, is to be believed. Barroso hit the headlines after he revealed that some highly placed source in the UK government had told him Britain would have fared better in the credit crunch had it been in the eurozone. Unaccountably, 20 bobbies from the Metropolitan Police did not raid Barroso's office seeking information on who might have said such a thing, though I can think of one pro-euro Cabinet minister who used to be an EU commissioner until a few months ago.
I am not convinced that British membership of the euro would have been in any way beneficial over the past years. For a start, British interest rates have been higher than those set by the European Central Bank until only a matter of weeks ago. Had the UK been inside the euro, interest rates would have been lower, meaning our housing bubble would have been even bigger – witness the Irish example. House prices would have been higher, credit card bills more gigantic and the current crash more disastrous.
True, abandoning the pound in 2000 would have meant that Britain did not see sterling climb to the dizzying heights of the past few years, meaning exports might have been greater. And the EU might have imposed some greater fiscal discipline on Gordon Brown. However, I'm not convinced that giving up UK-directed monetary policy – with all its flaws – would have been beneficial.
If Britain was trapped inside the eurozone at this particular moment, our economic situation would be even more dire than it is today. This is because we would not be able to devalue our way out of the crisis.
The British economy is suffering from a disastrous serious of imbalances that have to be unwound.
First, UK households have unsustainable levels of debt. In Europe, only Denmark and Ireland have higher levels of indebtedness relative to gross household disposable income.
Second, we have come to rely on an inflated financial services sector for growth, jobs and (above everything) financing our imports. The UK trade deficit was equivalent to a whopping 6.4 per cent of GDP in 2007. All those imported plasma televisions were available because the now despised bankers and hedge fund managers earned the foreign exchange to pay for them. With the City humbled, Britain needs to find other sources of foreign exchange.
Third, the UK has become a net energy importer. We have to find a way of paying for that oil and gas in dollars, other than by borrowing.
The only way of rebalancing the economy after the drunken party of the past ten years is to save more at home and sell more abroad. That can be achieved in only two ways.
We can take a collective wage cut, which is unlikely. Or we can depreciate the value of sterling, which is the only plausible way to go.
Had Britain been inside the euro, this year's fall in the value of the pound against the dollar would not have been possible.
Of course, a fall in sterling still means an implicit wage cut – it's just that we don't see it in happening in our wage packet. A cheaper pound means the imported plasma television is more expensive, as is everything else that is imported, including food, so our real standard of living has been cut. The charm of this approach is that the pain is spread equitably.
Even if we were minded to join the euro now – and Gordon Brown isn't – we are no longer in a fit state to do so. A key rule for countries seeking membership of the eurozone is that annual net borrowing should not exceed 3 per cent of GDP while total National Debt should be below 60 per cent of GDP.
Following Alistair Darling's Pre-Budget Report, our net public borrowing next year will be a stunning 8 per cent and will remain well above the 3 per cent limit to 2013-14 at least. Total UK government indebtedness will hit 68.5 per cent by 2013-14 (calculated on the EU basis, which measures gross debt). I dare say a few eurozone members will also breach these rules, but they are already inside the club and so can get away with it.
So much for the theory. The problem is that devaluations are like controlled demolitions – they sometimes go wrong and blow up in your face. Monday's sterling crash was partly market jitters following a welter of bad economic news from around the globe; and partly a flight of foreign investors worried by Britain's deteriorating national finances. In this uncertain climate, the pound could become very unstable for a period, which will destabilise all trade and investment decisions.
There is also a problem that if the UK uses its currency independence to devalue – in order to boost exports – other countries will retaliate in a tit-for-tat trade war. Crushed between the almighty dollar and the upstart euro, we might find it impossible to manoeuvre the pound where we want it.
Doubtless Barroso would argue that we would be better inside the euro, precisely to avoid such beggar-your-neighbour antics. He may have a point. But Germany is currently playing beggar-your-neighbour games inside the eurozone by getting everyone else to reflate their economies in order to buy German goods. Perhaps the UK should get its retaliation in first.
My big worry is that the recent fall in sterling is not enough on its own to create a positive UK trade surplus – at least if the projections in the Pre- Budget Report are to be believed. The report forecasts trade deficits of about 50 billion for each of the next three years, despite recession. The reason is that we make so little ourselves these days, UK consumers can't switch to buying internally – a telling point.
This suggests that we may not escape a more painful domestic adjustment in living standards before economic stability finally returns.