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Tuesday, 29 September 2009

The falling pound drifts by my window

Since you came to power the days grow long
And soon I'll hear old winter's song
But I won't miss you at all, Mr. Darling
When New Labour starts to fall

Last week Mervyn King told us that a weak pound will be good for British exports, and this week, Kraft's offer for Cadbury looked more competitive because the relative value of Kraft shares was boosted by the higher value of the dollar denominated Kraft shares relative to the sterling denominated shares held by the Cadbury shareholders.

But that is only half the story, and in fact probably less than half the story because we don't export that much. Yesterday, the ONS released data on the balance of payments. The current account recorded a deficit of £ 11.424 billion for the last quarter, equivalent to 3.3% of GDP. We may export a few cars from our factories, but a lot of our manufactured exports are simply components. Rolls-Royce won't sell more aero-engines and Pilkington won't sell more car windscreens because of a weak pound, although their cost base will be reduced relative to their foreign currency based earnings.

The BoE's quantitative easing programme involves printing £225bn more pounds. The greater the supply of pounds, the less demand and hence the value of each pound will fall. But the real danger is that a falling pound makes the UK a less attractive place for international capital to invest. Kraft may want to buy Cadbury, but that is an international operation, albeit that the shares are priced in sterling. Kraft may decide that having bought Cadbury any expansion will be in more dynamic economies.

What incentive do foreign owned power and water companies have to invest if they see the value in their home currency of UK domestic revenues diminish? Better to expand and invest back at home.

Worse still, the budget deficit is as about as big as the QE programme, somewhere between £175 bn and £225 bn, around the 13-15% mark. When the borrow and spend party is over there will be the mother of all headaches, with the same 13-15% lopped off GDP, and foreign investors can see through the headline GDP figures to the smaller sustainable economy. No wonder they have been rushing for the exit,

1 comment:

Demetrius said...

Harold Wilson's 1967 Devaluation talk is on the BBC web site. It makes for an amusing few minutes. The bit I like is when he says that the pound in your pocket is worth just the same.