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Boris Johnson leaves behind a sterling mess

Investors appear to view the British pound more like the currency of a troubled emerging market than of a stable advanced economy. With Prime Minister Boris Johnson’s resignation and the attendant political uncertainty, sterling is poised to sink further

British Prime Minister Boris Johnson’s chaotic government, and its equally chaotic collapse, are not the only source of panic in the United Kingdom nowadays. There is growing anxiety about the exchange rate of the British pound as well.

Since peaking in the spring of last year, the pound has depreciated by about 10 per cent against the dollar. “Britain’s currency is getting slaughtered on international markets,” we are told. Of the five currencies underlying the International Monetary Fund’s reserve asset, special drawing rights, only the Japanese yen has done worse than the pound.

Traders appear to view sterling more like the currency of a troubled emerging market than of a stable advanced economy. And now, with Johnson’s resignation and the attendant political uncertainty, sterling is poised to sink further.

Admittedly, such views are subject to exaggeration. Sterling is not alone in weakening against the dollar. A 10 per cent fall against the greenback is no catastrophe.

But sterling’s decline is almost surely not over. Moreover, the pound is often an indicator of Britain’s economic problems. Four times in the last century, sterling crises have exposed the economy’s fault lines. The 1931 crisis took place against the backdrop of a crushing 21 per cent unemployment rate. There was much discussion then of whether high unemployment reflected Britain’s poor productivity performance or the global depression.

In fact, it reflected both. The crux of the matter was that, with unemployment at stratospheric levels, the Bank of England couldn’t countenance higher interest rates to support sterling when chronic budget deficits and reports of a mutiny in the Atlantic Fleet created a crisis of confidence. Currency speculators knew it, so they pounced, driving the pound off the gold standard.

The crisis that erupted in 1949 embarrassed a British government that was seeking to restore sterling’s role as an international currency. The financial tripwire was the monumental overhang of sterling debt held by the country’s World War II allies, which the UK had sought to bottle up, unsuccessfully, with capital and exchange controls. The sterling these countries used to pay for Britain’s exports couldn’t be used to purchase goods from the United States, where British motor cars and other manufactured exports were uncompetitive.

Moreover, Britain was short of dollars. Once the possibility of devaluation was mooted, the BOE experienced an uncontrollable run on its reserves.

The 1967 crisis was embarrassing to Prime Minister Harold Wilson personally. Wilson worried that higher import prices would undermine his supporters’ living standards. Still, he couldn’t prevent it. This crisis, too, had multiple causes, from the Six-Day War to a UK dock strike.

But the fundamental problem, once again, was weak productivity growth, which was reflected in uncompetitive exports, a trade deficit, and unemployment. To stimulate demand and growth, Wilson’s Labour government cut interest rates and relaxed restrictions on borrowing for automobile purchases. This led, predictably, to further deterioration of the trade balance and another run on the central bank. Wilson sought to reassure the public that “the pound in your pocket” was as solid as ever. @ Project Syndicate 2021


The writer is an American economist and economic historian who holds the title of George C Pardee and Helen N Pardee Professor of Economics and Political Science at the University of California, Berkeley

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