The European Union is turning into a very dysfunctional family. Greece, now combining deep economic pain with political instability, is the troubled teenager threatening to leave home for good. Spain, having a few years ago won praise for the way the authorities oversaw its banking system, is starting to look as if it might need the rest of the family to club together and help it out.
France, the flamboyant uncle whose disco days are over, is trying to relive the glory days when it could tilt the Franco-German axis towards growth.
Even Germany, the fatherland figure, is not immune from the mood change. Though Berlin looks resolute against any hint of a generalised fiscal relaxation, the Bundesbank is open to German inflation in future being above the eurozone average.
Though that is a logical requirement if other eurozone economies to regain their lost competitiveness, it would once have been sacrilege for the Bundesbank.
Where will it all end? Willem Buiter, chief economist at Citi, the bank, has raised his probability on a Greek exit from the euro, a “Grexit”, to 50%-75%. He thinks it most likely it would be combined with a massive EU/European Central Bank exercise to ring-fence other eurozone members from being forced out by the market backlash, though concedes that other more damaging scenarios are possible, including “uncontained” euro contagion.
As for France and its new president Francois Hollande, financial markets are relaxed about austerity being combined with more growth-friendly measures, including additional infrastructure spending. As noted last week, they see the new president working with rather than against the eurozone consensus.
That is unlikely to satisfy those who voted against austerity. The euro project was always as much political as economic. Politics will decide whether and in what form it can survive.
Where does that leave Britain, the black sheep of the family? Two things have happened since the Greek and French elections. One is that gilt yields have hit record lows, with the yield on 10-year government bonds, dropping below 1.9%.
This would be extraordinary at any time but for a country borrowing £126 billion with an inflation rate of 3.5% it is phenomenal. “Safe haven” is overused but gilts are clearly a port in the eurozone storm.
The other development has been that the pound, which has been looking perky for a while, received an extra fillip from euro woes. Sterling has been trading at close to 1.25 euros, a far cry from the days when the global financial crisis almost pushed it below one-for-one parity with the single currency. Even tourists have been getting more than 1.20 euros, welcome news for many ahead of the summer holidays.
Is it, however, very bad news for exporters, the great white hope for Britain’s recovery and rebalancing? Will it mean firms will lose their advantage in overseas markets just at the time the economy needs it most?
A few facts. At 1.25 sterling is a lot stronger than it was 2-3 years ago. It is still, however, considerably weaker than in the early months of 2007, the eve of the crisis, when it averaged nearly 1.50 euros. A 16%-17% depreciation is still worth having.
What is true against the euro is also true against other currencies. As recently as July 2008 the pound traded at more than $2; now it is in the low $1.60s. The sterling index, which measures its average value against currencies, is some 19% below pre-crisis levels. Britain’s exporters still have a big exchange rate advantage.
They have been using it, though it is customary to register disappointment about Britain’s export performance. Export volumes, excluding oil and so-called erratic items of trade, are up by around 23% from their recession low in the spring of 2009.
The trouble is that imports, on the same basis, are also up, by 20%. Because of the pound’s fall those imports have increased significantly in price, leaving Britain with a large trade gap.
Will the pound’s revival continue? Against the euro I have always had in mind a “fair value” level of 1.30 to 1.35 euros, so there is a little way to go to get there.
David Bloom, currency economist at HSBC, says that as well as benefiting from eurozone woes, the pound is gaining as a result of M & A (mergers and acquisitions) flows into Britain resulting from the takeover of British firms. The government, despite its political woes, is also hanging on to its reputation for fiscal discipline.
The level of the pound is important. Its long period of strength from autumn 1996 to autumn 2007 was instrumental in shrinking Britain’s manufacturing sector and the loss of 1m jobs in industry.
Some firms could not live with an overvalued exchange rate, while others shifted production overseas. In that period Britain lost a lot of suppliers of components, so-called semi-manufactures, a loss we are paying for in the trade figures now.
For sterling, how much is too much? I would argue that the pound moved from clear overvaluation before the crisis, buoyed by flows of international money into Britain’s banking system, and then went to an undervalued position when those flows stopped and it fell very sharply.
Its recovery now, bearing in mind how far it remains below those overvalued levels, need not do much harm. Indeed, some firms have been waiting for the bounce (which always happens) to assess what level of sterling they will be dealing with in the long term, and before planning their export strategy. They are naturally cautious about betting the firm on what might only be temporary weakness.
Some of the fall was temporary but much will stay, as is commensurate with the country’s changed economic position. That leaves plenty for exporters to go for.
In the end, of course, it is not just the exchange rate. Demand, strong in non-EU markets, weak in most of Europe, is the prime factor affecting export demand. Design, quality, reliability and service are other key determinants of export success. Get them right and a bit of perkiness for the pound should not be a problem.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is posted with permission.
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