Weak Pound: Good or Bad?

[Puppycow]

EU Officials Concerned about Weak Pound

Feb. 25 (Bloomberg) -- European Union officials are concerned that the pound’s slide to a record low against the euro could destabilize the British economy, according to a document prepared last month by European Commission and EU finance ministry officials.

The pound’s “very rapid” drop “raises questions about the financial stability of the British economy,” said the document, which was prepared ahead of the Feb. 14 Group of Seven meeting in Rome and obtained by Bloomberg News. The currency’s weakness “is a source of concern for the euro area.”

The report contradicts Prime Minister Gordon Brown’s argument on Feb. 13 that a weaker currency helps rather than hinders the economy. With the pound down 18 percent against the euro in the past year, it also underscores investors’ concern about Britain’s fiscal health as the government racks up debt to fund bank bailouts.

The one-page document, titled “Recent exchange rate developments - G7 preparation,” was circulated at a meeting of EU officials before the G-7 gathering in Rome. The document also outlined the EU’s position on the U.S. dollar, the yuan and the yen before discussing the pound.

The Obama administration’s expressed support for a “strong dollar” is “reassuring,” the document says. It also calls for a “continued real effective appreciation” of the yuan against the euro. Japanese authorities “should not intervene to reverse the past appreciation of the yen,” it says.

So, with respect to all currencies other than the euro, the position of those EU officials is that they want those currencies to be stronger, not weaker. Gordon Brown thinks it is good that the pound is weak. The Japanese and the Chinese want their currencies to weaken (or not to rise). Japan, btw, actually has a trade deficit for the first time in a long time. America says that it is for a strong dollar, but it seems to be of two minds about that. Congresspeople, for example, often say that they want the Chinese to allow the yuan to rise against the dollar (which is to say that they want the dollar to weaken).

So basically, most everybody wants their own currency to be weak, and they get anxious when their own currency gets strong rapidly. Makes perfect sense, right? Why would you want your own money to be worth more?

The answer, of course, is because countries want to have a positive balance of trade, but it doesn't make sense for it to stay unbalanced forever. In the long run, trade should balance out ideally. So it was inevitable that Japan's perrenial trade surplus would eventually have to end, and it was also inevitable that Britain's perrenial trade deficit would eventually have to end.

So I have to agree with Gordon Brown here rather than the EU officials.

Eventually, in the long run, the US and China trade will also have to find a sustainable balance. This is in both countries' long-term interests I believe.

 

[Francesca R]

So, with respect to all currencies other than the euro, the position of those EU officials is that they want those currencies to be stronger, not weaker. Gordon Brown thinks it is good that the pound is weak. The Japanese and the Chinese want their currencies to weaken (or not to rise). Japan, btw, actually has a trade deficit for the first time in a long time. America says that it is for a strong dollar, but it seems to be of two minds about that. Congresspeople, for example, often say that they want the Chinese to allow the yuan to rise against the dollar (which is to say that they want the dollar to weaken).

Apart from China, none of these countries have an exchange rate policy. Deliberate weakening of the currency to boost competitiveness is called "beggar thy neighbour" and is a type of protectionism. You are correct to point out that it is the strength of the EUR that bothers the Euro-zone countries most rather than the weakness of the GBP. If they can't accuse the UK of deliberately pushing the GBP lower (which they can't), then the next best idea is to say something like "It's bad for you [the UK] and it's in your interest to want a stonger GBP [like we do]". Since the Bank of England is independent and there is a whelk-in-a-supernova's chance of it increasing interest rates (and so is the ECB and it will reduce rates when it's good and ready), then it will have to be left to the vagiaries of markets. And markets seldom attach any importance to jaw-boning.

So basically, most everybody wants their own currency to be weak, and they get anxious when their own currency gets strong rapidly. Makes perfect sense, right? Why would you want your own money to be worth more?

There are significant exceptions to this, most glaringly countries that have large short term foreign currency liabilities, public or private. If their currencies fall they enter a debt trap. Latvia is one such.

In the long run, trade should balance out ideally. So it was inevitable that Japan's perrenial trade surplus would eventually have to end, and it was also inevitable that Britain's perrenial trade deficit would eventually have to end.

There's no particular economic reason why a trade balance should average zero. Japan's surplus vanishing is probably temporary, and due to merchandise trade volumes slumping worldwide.

 

[Puppycow]

There are significant exceptions to this, most glaringly countries that have large short term foreign currency liabilities, public or private. If their currencies fall they enter a debt trap. Latvia is one such.

Good point. Countries that can't borrow as much as they want payable in their own currency. I'm thinking mainly of the large first-world economies and China.

There's no particular economic reason why a trade balance should average zero. Japan's surplus vanishing is probably temporary, and due to merchandise trade volumes slumping worldwide.

No particular reason? Even in the long term? This seems like getting a loan that never has to be fully repaid. If that's the case, isn't the country that runs the perpetual deficit getting the best end of the deal? Eventually, the creditor country will have so much money that they have to start buying things or see its value simply evaporate. It also seems like, absent currency manipulation, over the long term the currency of the creditor country would strengthen and shift the balance of trade toward neutral.

 

[Francesca R]

Good point. Countries that can't borrow as much as they want payable in their own currency. I'm thinking mainly of the large first-world economies and China.

Due to its capital controls, China's CNY borrowings are mostly required to be held by domestic investors. If it wanted foreign capital (not FDI) it would probably need to issue in USD.

No particular reason? Even in the long term? This seems like getting a loan that never has to be fully repaid. If that's the case, isn't the country that runs the perpetual deficit getting the best end of the deal? Eventually, the creditor country will have so much money that they have to start buying things or see its value simply evaporate. It also seems like, absent currency manipulation, over the long term the currency of the creditor country would strengthen and shift the balance of trade toward neutral.

Trade deficits aren't comparable to loans. I will run a deficit in visible goods as long as I live, because I earn income by another means. However, if a country runs a persistent deficit in goods and services it will either use up FX reserves doing this (yes--could print some more and devalue, as above) or it will end up being increasingly foreign owned. A big chunk of Australia's capital stock is not owned by Australians. Japan owns big chunks of other countries' capital stock. I suppose you could have all of Australia being foreign owned. It would still be sovereign territory.