Last week I found myself back in the City of London at a party for the launch of Tom Bulford’s new book.
Brexit was discussed over white wine and canapés. Views were aired. Leavers and remainers politely disagreed over immigration, the City, the need for a general election. But everyone seemed to agree on one thing: “the pound has dropped – so at least Mark Carney is happy”.
The idea is that the weak pound is a sort of silver lining in all of this, because a weak pound will stimulate growth. It’s a common view among those who write about investing for a living.
But I think it’s dead wrong. It gets things backwards.
The weak pound is an opportunity for some British companies, no doubt about that. In fact my latest pick for The Penny Share Letter is one such company. But a weak pound is not good for the country. And Mark Carney definitely won’t be happy about it.
The two types of crash
Last week I said there are two different types of recession. There’s a supply-side recession, where the economy can’t produce as much stuff as before. And there’s a demand-side recession, where people hoard their money rather than spend it. On the surface they look the same, but they have different causes.
It’s sort of like that in the currency market too. The price of the pound is determined by supply and demand. If the supply of pounds goes up, all things being equal, the price of the pound will fall. Equally if the demand for pounds goes down, all things being equal, the price of the pound will fall.
In other words, you can’t tell much from a price change on its own. Any price change could be caused by changes on the demand side or changes on the supply side. So you need to know whether supply or demand has changed to know what’s really going on. Price doesn’t tell you that.
The price of the pound has fallen relative to other currencies. So what’s going on there? Is it good news for Britain? Is it what Mark Carney and the Bank of England are after?
The exact opposite
Central bankers around the world have printed a lot of money in the last seven years. When central banks print money, it causes the currency to fall. So you might think weakening the currency is what they’re trying to do…
But that’s not what they’re trying to do! When central bankers like Carney, Yellen, Draghi and Kuroda print money, they’re doing it because there’s not enough demand in the economy. By printing money they hope to create some inflation, and boost demand. Printing money increases the supply of money, and it has the side effect of reducing the value of the currency.
Example: In 1992 Britain left the exchange rate mechanism, which in effect meant it printed loads of money. That caused the pound to fall. And soon after, the economy took off. This is an example of a money printing curing weak demand. It’s not an example of a cheap currency curing the economy!
Now compare that to what’s happening with the pound at the moment. The pound hasn’t fallen because the central bank is printing money in order to boost demand in the economy… the pound has fallen because there’s less demand in the economy. It’s the exact opposite situation to what Mark Carney wants: a strong economy with strong demand.
It doesn’t make Britain better off. In fact, it’s a sign that Britain is worse off. As Sam Bowman of the ASI puts it: if you take a pay cut, you’ll find it easier to get a job. But you’re not better off.
Winners from Brexit
That’s the big picture view of the overall economy. But it’s not to say, of course, that there aren’t winners and losers from a weaker currency. Companies which make things in Britain and sell them overseas are having a great time.
And there’s plenty more Brexit drama to come. Will the City get chucked into the channel? Will anyone invoke Article 50? The EEA option?
There’s a lot of unanswered questions, and lots of scope for the pound to drop further.