måndag 14 januari 2008

The plummeting £

The £ has dropped 9% against the Euro since November. This is a comparable rate of decline to that which occurred in the run-up to Black Wednesday in 1992. That led to Britain's enforced exist from the exchange rate mechanism and demolished the Conservative government's reputation for economic competence.

Fortunately for the present government, the newspapers now devote their headlines to trivia and to stirring up anti-immigrant emotion. But this respite will be short lived. The inflationary effects of the falling pound, of around 3%, will quickly find their way into the shops in the form of higher prices of foods, especially out-of-season produce imported from southern Europe, where higher costs will be augmented by recent fuel price rises. These are likely to lead to pay demands, which will further compound the inflationary pressure.

The weaker pound will also cause problems in the Eurozone as producers find it more difficult to export to Britain, and this could hit growth in those countries, thereby leaving the European Central Bank in a dilemma.

The government's reputation for economic competence will certainly not survive substantial inflation. Now the supposedly independent Monetary Policy Committee is meant to use interest rates as a means of keeping inflation below its target figure. Its only option is to push up interest rates significantly. But if it does this, then there will be a precipate collapse in land values, which will show up in falling house prices. This will induce a recession, negative equity and mortgage defaults and repossessions. Thus the MPC will probably bow to pressure for interest cuts, destroying confidence in its independence and with it, confidence in the pound. We shall see.

Looking back over the period since the Labour government was elected in 1997, it is now apparent, as some people recognised at the time, that its success was not due to any action on its part but to the fact that it was elected on the rising side of the eighteen year land price cycle. Now that the cycle has gone through the boom and is approaching the inevitable bust, the consequences will stick to Brown's reputation. There is nothing that can be done now as all options are going to hurt. Most likely, the government will decide to hit the prudent and thrifty rather than the foolish who lent too much and borrowed too much, and so the stage will be set for the election of a Conservative government, which will probably last until the next boom and bust, in around 2025. Unfortunately, the Conservatives appear to have little to offer other than their usual tired policies and a few gimmicks. But if they were to deal with the underlying causes of the boom-bust cycle, and it is well within their power to do so, they would be doing everyone a great favour and go down in history as one of the country's great governments.

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