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Markets hate uncertainty. That much everyone knows. And if they didn’t know it a few weeks ago, they sure know it now. You can’t turn on the radio or TV these days without hearing some sad City head shaker explaining that the uncertainty around the UK’s intention to change the terms of trade with some of its neighbours is causing terrible things to happen in the currency markets (the pound has fallen 17 per cent since June 23).
But something markets really love — and home markets love even more than most — is devaluation. Look back to our big ones. The devaluation in 1949 (from $4.03 to $2.80) marked a major market turning point — a three-year bear market came to an end that November (the FT Index fell below 100 for one day — it then ended 1950 at 115.7). The same happened in 1967 when sterling was devalued again (from $2.80 to $2.40): the market rose 30 per cent in 1968.
You can see it again in 1985 when All Share index ended the year up 15 per cent after an effective 30 per cent devaluation against the dollar (10 per cent trade weighted) the year before; in our departure from the European Exchange Rate Mechanism (8 per cent in two days); and of course in the past few months (the FTSE 100 has risen 10 per cent since June 23).
The reasons for this are obvious and much discussed — a very large percentage of the revenues of UK companies come from exports and overseas subsidiaries. So falls in the value of sterling give them a double whammy of cash straight to the bottom line and the potential via the competitive advantage of lower export prices of even more cash hitting the bottom line in the years post devaluation. That’s nice — and something we can already see happening: the manufacturing sector had a good September.
But it should also be a reminder that there is good to come out of the fall in the pound. Think about the things financial columnists are always worrying about. We fuss that the UK’s huge current account deficit (about 6 per cent of GDP — near a peacetime record) means we are dependent on continuous flows of speculative cash to keep our show on the road. Mark Carney thinks this is about the “kindness of strangers”.
But markets aren’t kind: everyone else knows it is about the greed of strangers, something that can turn on a sixpence. We worry that the UK as a whole is living beyond its means — eating tomorrow’s lunch today by borrowing against unproductive assets (houses) for unproductive activities (buying clothes). And we know that very low interest rates are creating a crisis for pension funds — and hence for a large number of our oldest and best companies.
So we want interest rates to rise. We want house prices to fall. We want the economy to rebalance away from finance and towards a more real economy. We want the north of the UK to be less economically dependent on the south. And we want (or rather we know we need) a little inflation to help us with our increasingly nasty public debt problem.
We won’t get all these things from our falling pound. Our exports aren’t as price sensitive as they were in the 1940s, 1960s or 1980s, for example (a couple of percentage points in price is neither here nor there if you are selling legal services or high tech medical devices). And we can’t be sure that the Bank of England will take its chance to stop us eating all of tomorrow by raising interest rates. There will also be some nasty side effects to the sterling slide: for me the fact that Unilever wanted to use it as an excuse put up the price of Marmite should be considered a brilliant Brexit bonus, for others it is a disaster (I say “excuse” because Marmite is made in Burton-on-Trent out of a byproduct of the brewing industry, so the fall in the pound should have no effect on the cost of producing it).
But we will get some of the things we want. Even the most irritated of the reverse-the-referendum crowd are honest enough to acknowledge that, because of the constant flow of speculative capital into London, the pound has long been horribly overvalued (I’ve been writing articles pointing this out since at least 2008). It might now be mildly undervalued. But that, to my mind at least, represents a change for the better: if we all get even part of some of things we have been longing for, our latest devaluation should be considered a good thing.
With that in mind you might look across the Channel and for a moment stop worrying about why the pound is falling so much and start thinking about how awful life would be if it wasn’t able to.
If that were the case, every time we found that our effective exchange rate was too high we would have to do what the likes of Greece, Italy and Portugal have been through. This is the stunningly painful process of “internal devaluation” — slashing wages and costs in our own currency until we got things down to a low enough price to attract interest. Along the way we might end up with their kind of 40 per cent youth unemployment rate — perhaps even more. Note that the suffering countries of Europe can at least rely on Britain and Germany as their employers of last resort.
The horrors of being stuck inside a currency trading at a price that doesn’t suit your economy are not lost on the Europeans suffering from it. Look to Italy. There, notes Louis-Vincent Gave of research group Gavekal, “historically the way the nation held together was that northern Italy paid for southern Italy in constantly devaluing liras”. Since the euro took this option off the table things have become financially and politically more complicated: the northern league started to gain in strength from the moment the euro was introduced in the EU.
Europe’s elite have every reason to want to keep the EU and the eurozone in their current form (they benefit from it). But with the UK on the way out, the voices of the losers getting louder and no floating national currencies around to help sort things out, it is hard to see how they can keep having everything their way.
This is not to say that UK investors have nothing to worry about — just that our own troubles come with huge silver linings in the form of stock market gains (history tells us there will be more) and the potential for relatively painless rebalancing. Those of the eurozone countries just don’t.