Money

Sterling’s faded illusion of sovereignty


Margaret Thatcher once told me that she would never allow “the Belgians” to decide the value of the British pound. At the time, the then prime minister was battling her chancellor Nigel Lawson’s plan to fix the value of sterling in the European exchange rate mechanism. For some reason she had identified me as one of the chancellor’s confidants. “The Belgians”, equally inexplicably, was her shorthand for the EU. 

The fight cost the chancellor his job, but a year or so later Thatcher was obliged to relent. Two years after it joined the ERM, sterling crashed out of the system amid a tsunami of speculative selling.

Thatcher by then had gone, replaced by John Major. Even so, the pound became an inviolable emblem of national sovereignty in the Conservative party’s long war with Brussels. Before too long, another Tory leader, William Hague, was promising to “save” sterling from the euro. Black Wednesday, you could say, mapped the Tory route to the Brexit vote in 2016.

I was reminded of the Thatcher encounter by a report published the other day by analysts at Bank of America. Since the Brexit referendum, the pound has rather lost its lustre as a store of value. It no longer bears comparison, the analysts said, with traditional peers such as the dollar, yen, swiss franc or euro. Instead, sterling may more closely resemble an emerging market currency, such as the Mexican peso. Sterling’s effective exchange rate has fallen by about 14 per cent since 2016, but twin budget and current account deficits promise further trouble. 

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In truth, Thatcher’s elevation of the pound into an essential pillar of nationhood belied its postwar role in Britain’s fortunes. For decades, an ever-present threat of devaluation was a ball-and-chain around the ankles of successive prime ministers. In 1945, about half the world’s trade was still transacted in sterling. From then on, it was all downhill. 

The failed effort to defend Britain’s global prestige through preservation of the so-called sterling balances held by overseas central banks and financial institutions left governments at the mercy of international investors and speculators.

It also produced a series of politically costly devaluations. In 1950, one pound bought about 12 Deutsche Marks. In the absence of the euro, the comparable figure today would be a little above two.

In effect, pressure on the pound measured the gap between Britain’s determination to hold on to its status as a world power, and the capacity of a stuttering domestic economy to generate sufficient resources to match its overseas ambitions and commitments. The price of propping up the pound was a ruinous stop-go approach to domestic economic management.

It was no coincidence that the devaluation that was forced on Harold Wilson’s government in 1967 sounded the final retreat from imperial pretensions with the subsequent withdrawal of British forces from east of Suez.

In the circumstances, one might think that sterling would have lost its talismanic status long ago. The sovereignty so preciously guarded by the Brexiters is an illusion. The truth Thatcher could never admit was that the appearance of national control does not change the facts of foreign exchange markets. The pound’s exchange rate, fixed or otherwise, ultimately depends on the confidence, or otherwise, of foreign investors in the nation’s political stability and economic performance — and, yes, that includes the Belgians.

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Mark Carney, the former governor of the Bank of England, has also remarked on how sterling has “decoupled” from its usual peers. Bank of America’s grim prognosis, however, is not universally shared among financial institutions.

Some think the pound’s present exchange rate anticipates more economic disruption after the expiry of the Brexit transitional arrangements. In the short term, the conclusion of even a fairly thin trade deal with the EU27 could see a temporary appreciation.

That said, trade deal or no deal, and even assuming a relatively robust recovery from the coronavirus-induced recession, Brexit will throw up new barriers to trade with Britain’s most important market. This promises in turn lower-than-otherwise economic growth, and a widening of the current account deficit. It is hard to find reasons for a positive view of the pound over the medium to long-term.

The government, of course, could treat sterling’s move to the sidelines as something of a liberation. For now, it has little problem financing its burgeoning government deficit. Devaluation would also provide at least a temporary route to improved competitiveness. It could even pretend, as Wilson did, that a weak currency does not cut living standards.

I am not sure this would sit alongside Boris Johnson’s expansive pledge to turn Brexit into the platform for the relaunch of “Global Britain”. The prime minister, I am told, is emotionally sympathetic to grand talk about carving out a new role in the Gulf and beyond.

But no one knows where the money would come from.

One way or another, sterling holds up a mirror to the world’s view of Britain. The signals are not encouraging. In the 1970s, the UK earned the sobriquet of “the sick man of Europe”. The danger now is it will become the invalid on Europe’s edge.

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philip.stephens@ft.com

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