Since the end of 2007 the value of the Pound has fallen by about 20 % as can be seen in the chart below.

This is a fall not against either the Dollar or the Euro, but against them both as they stand in proportion alongside the other currencies with which we have transactions: currencies that are all represented in the basket of currencies that has long been maintained by the Bank of England as the Sterling Index.  The chart  is based on this index. It can be seen in greater detail by clicking on it twice.

The fall began with the credit crunch and the Pound has not recovered since the crash that followed it. This fall is bigger than that suffered by the Dollar on the US Dollar version of this index.

This current fall in the Pound is bigger than the fall that the Pound suffered in the 1990s when it was thrown out of the European Exchange Rate Mechanism.  Then the  Pound fell only by about 10%.  That devaluation lasted only from late 1992 to August 1996 – that is 47 months. The current devaluation since the credit crunch has already gone on for 42 months.

Devaluation as policy

Many commentators say that although devaluation does add to import prices (which today include food and energy for the UK)  it should also make our exports cheaper to overseas buyers. The use of devaluation – or the hindering of  rises in value of one’s currency – as a way of building up countries’ dominance in export markets has long been understood. The US has been complaining that the Chinese have been doing it for over a decade.

However, this is not the first time the US has claimed to detect such predatory undervaluation of currencies. They were claiming that Germany was doing  it in the 1920s and 1930s. And in 1945, the US Treasury Secretary highlighted its workings in a book where he outlined how Germany must never again come to be a  power in world manufacturing.

Anyhow, Germany did as can be seen in the comparison in manufacturing employment here (left).

One of the main reasons why Germany still is the workshop of Europe is because old West Germany was able to devalue the Deutschmark in the 1980s during the very years when worldwide admiration for the ‘strength’ of the Mark was at its height.

This devaluation can be seen in the chart below, showing the equivalent of the Sterling Index for the old Deutsche Mark. Alongside it can be seen the index for the old Italian Lira. The Lira was known as one of Europe’s supposedly weaker currencies.  But clearly here, the Mark is the currency that pulls off a clear devaluation. (All these  indices show real competitiveness by deducting inflation in the countries traded with.)

So devaluation has been a stratagem that has worked for Germany over the decades. For the UK it worked when John Major was Prime Minister, during the period after we ‘bounced’ out of the ERM in 1992.

Major Devaluation

Back in 1992, manufacturing employment in the UK was just a little higher as a percentage than in Germany today. In Birmingham, where LWM is based, manufacturing employment showed its most dramatic recovery during that devaluation. That was when BMW took over the Rover factories at Longbridge, and boosted our whole Midlands’ automotive sector. Factories like Lucas boomed again,  making components also for the new Japanese-owned factories opened up further north by Nissan and Toyota. However these Birmingham Lucas factories stand only as piles of demolition rubble today.

However, even these somewhat temporary jobs would not have come here but for the UK government  having done very unusual deals with the Japanese motor giants in the late 1980s.  Mrs Thatcher’s Industry Secretary negotiated their investment here in the UK, including agreements to source components here, in exchange for the UK insisting that these vehicles had a place in the protected European Community market place.

What an export offensive looks like

Neither over the last 40 months of devaluation, nor in the period before that, have there been huge new factories coming on line in the UK. The Major devaluation worked because there had been preparations for an export offensive: preparations of a sort we have not seen since.  Besides, a whole bunch of  Far Eastern silicon chip manufacturers turned up in the UK soon after the Sterling devaluation as well. But any such preparations for an export offensive would not in 2011 have the sort of returns that occurred under John Major, unless manufacturing industries had been built up under Tony Blair.

This is because in the decades since, manufacturing employment has now eroded in the UK, as shown at the begining of this report.  Manufacturing jobs would now have to grow at phenomonal rates to make contributions to buoying up the UK employment market comparable to how manufacturing did so even under John Major.

 

The crucial arithmatic

It can be seen here, how manufacturing jobs would need to expand by 10% to contribute 1% to total employment. With a similar boost to German manufacturing it would have nearly two and a half times the impact on the German labour market.

The current devaluation presided over by Mervyn King and the independent Bank of England experts looks as if it is just going to erode living standards and the domestic economy for no significant purpose in terms of  ‘export-led growth’. None of the champions of this sort of growth ever acknowledge how unprepared for it the UK is. One has to wonder what thought was given to it by our very unrepresentative Bank of England before they decided to let this devaluation continue.

One of the most important reasons why Germany was able to live with a currency that tended to keep a lower value than many thought, was that they had a whole raft of systems in their domestic economy that acted to restrain inflation. We have mentioned them before in various of our monthly reports – most recently in relation to energy prices. Very little thought has been given to this in the UK, and certainly not by the Bank of England.

In the near future this devaluation needs to be reversed. Better interest rates for businesses, and for sections of society such as pensioners who are otherwise tempted to keep their money out of Sterling, are needed. We have previously suggested that the Bank of England needs to set guidance on savings rates, given that their guidance on Base Rate is so out of touch with reality.

Just how out of line with comparable countries our inflation levels are, can be shown by reminding readers of  some of their most recent figures.

 

Keeping a better grip on inflation

In the USA , the CPI-U, representing the broad urban population, was  3.2%  in April.  But they also give a CPI-W figure for ‘urban wage earners and clerical workers’ which was  3.6 %.  But they don’t just give a national figure for each of these populations. They also give a CPI-U figure and a CPI-W figure for most of their big cities and the US census regions.

This has made the USA very sensitive to emerging inflation and has prompted the USA to be one of the world’s lowest inflation economies.  A worker in Chicago and the Mid-West knows whether his prices are rising in line with the official figures for his area, in a way that someone working in Birmingham, England cannot because we only get a couple of different national disembodied averages for our official figures. So if the US figures are out of proportion with what workers are finding in the American cities the figures can be challenged in a way they cannot in the UK.

A slightly more detailed outline of how the US inflation indices (and the other overseas systems outlined below) have both evolved and worked can be found in our report of September 2010 here.

France also has an index that is intended to represent the total population as well as one that represents what is called an urban household  headed by a worker. This latter is particularly used for adjusting the minimum wage. For France  inflation was  2.1%  for the main population in April and 2.0% for the worker’s household. Until the 1960s France used to only calculate an inflation rate for Paris and say that that was the French inflation rate.

The Italian indices for registering inflation are today pretty much identical to the French system.  In April the inflation rate for the broadest population was 2.6 %, and also 2.6 % for workers’ families. Unfortunately the Italians no longer translate their full monthly release. It can be deciphered with only a basic French/Italian at the link here. The big cities all each have a separate published figure.

German inflation for April was 2.4%. Germany now only does one figure for the broad population of Germany. But most of the large federal states have produced a figure for their own local population since the 1960s.

The State of Hesse, which is home to Birmingham’s twin city of Frankfurt, had an inflation rate which was  lower at 2.1% . We also have a twin city in the former East Germany which is Leipzig in the state of Saxony. The Saxon inflation rate was slightly higher at 2.5%.

From what has been shown here of how other G7 countries register inflation, you will be able to appreciate that the basis of what we are proposing should become our future UK  framework of inflation indices.

Our report for February, which outlined how the global price spiral had to become the focus of our domestic economic policy, can be found here.

 

Andrew Lydon

Regional Prosperity & Inflation Project

A later piece on the role of the Bank of England can be found here