torsdag 10 januari 2008

The state of the UK Pound

Now the pound is down to the point that one Euro is worth 75 pence, and there is no sign of any respite. This is its lowest value against European currencies since 1996 and its lowest ever against the Euro. Aggravated by higher fuel prices and consequently higher transport costs, it will quickly feed through into higher prices of food and goods that come from Europe, including staples such as vegetables.

What next? The Bank of England's Monetary Policy Committee (MPC) has decided not to reduce interest rates again this month, which may check the fall, but the pound remains vulnerable to political pressure and the MPC would have to hold firm or even raise interest rates for several months running if confidence in the UK currency is to be restored.

In the meantime, the lower value against the Euro, together with higher fuel prices, will quickly lead to higher prices of food and other commodities in the shops. This will put pressure on wages, and could lead to industrial unrest. It is not surprising that public sector workers' unions are against the proposed three-year pay settlement. They have no confidence that all-round prices generally will not be significantly higher in 2011.

To use interest rates alone as a tool of economic management is to charge the MPC with an impossible task. In the present state of the economic cycle, as boom turns to the inevitable bust, to raise interest rates would help the mortgage-led bubble go down faster, leading to tumbling land values (usually misrepresented as "house prices") and growing numbers of mortgage defaults, with economic activity going down in its wake.

But whilst putting interest rates down would help stave off the collapse, if only for a while, the effect would be to further weaken the pound, leading to higher prices, initially of imports, but eventually of everything.

Whatever policy is adopted, recession is on its way. This one is genuine, being land based and coming 18 years after the previous one, in accordance with the workings of a cycle which has been running since the start of the nineteenth century. The government will be faced with rising costs, for example to cover welfare benefits, and falling receipts as economic activity declines.

It then has two options. It can raise taxes or print money. It is more likely to adopt the latter course. Then Britain will be back to the inflation levels of the 1970s. Whether the US and Eurozone countries fare any better is doubtful, as they are in a similar state. The value of money is set for a fall.

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