Since peaking in the spring of last year, the pound has depreciated about 10% against the US dollar. “The British currency is being slaughtered in international markets,” we are told. Of the five currencies underlying the International Monetary Fund’s reserve asset, Special Drawing Rights, only the Japanese yen underperformed the pound.

Traders seem to view the pound more as the currency of a struggling emerging market than of a stable advanced economy. And now, after Johnson’s resignation and the political uncertainty surrounding his replacement, the pound looks set to tumble further.

True, such opinions are subject to exaggeration. The British pound is not alone in weakening against the US dollar. Moreover, a 10% fall against the greenback is not a disaster.

But the pound’s decline is certainly not over. Additionally, the pound is often an indicator of Britain’s economic problems. On four occasions in the last century, crises in the pound have exposed the flaws in the economy. The crisis of 1931 unfolds against the backdrop of a crushing unemployment rate of 21%. There was much discussion at the time about whether high unemployment reflected Britain’s low productivity 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 (BoE) could not accept higher interest rates to prop up sterling amid chronic budget deficits and reports of a mutiny in the Atlantic Fleet created a crisis of confidence. Currency speculators knew this, so they rushed in, driving the pound off the gold standard.

The crisis that erupted in 1949 embarrassed a British government that sought to restore sterling’s role as an international currency. The financial trigger was the monumental overhang in sterling debt held by the country’s World War II allies, which the UK sought to lock in, unsuccessfully, with capital and exchange controls. The pound sterling that these countries used to pay for British exports could not be used to buy goods in the United States, where exports of motor cars and other British manufactured goods were uncompetitive. Moreover, Britain was short of dollars. Once the possibility of a devaluation was raised, the BoE experienced an uncontrollable run on its reserves.

The crisis of 1967 was embarrassing for Prime Minister Harold Wilson personally. Wilson feared that rising import prices would jeopardize the standard of living of his supporters. Still, he couldn’t help it. This crisis also had multiple causes, from the Six Day War to a strike by British dockworkers.

But the fundamental problem, once again, was low productivity growth, which translated into uncompetitive exports, a trade deficit and unemployment.

To stimulate demand and growth, Wilson’s Labor government cut interest rates and eased restrictions on borrowing for the purchase of automobiles. This led, as expected, to a further deterioration in the trade balance and a further run on the central bank. Wilson sought to reassure the public that “the pound in your pocket” was stronger than ever. Labor’s subsequent electoral defeat suggests that voters have seen through the pretense.

The crisis of 1992, when sterling was driven out of the European exchange rate mechanism, again occurred against the backdrop of low productivity in the UK. Output per hour worked had fallen from 96% of German levels in the early 1970s to just 87% by 1992. The peg of the pound sterling to the deutsche mark, Europe’s anchor currency at the time, therefore meant a cumulative loss of competitiveness. A weak US dollar and high German interest rates, which strengthened the Deutsche Mark, further increased the difficulty for the UK to maintain its currency peg.

To defend the pound sterling, the BoE could have raised its interest rates. As in 1967, however, internal and external goals were at odds. Higher interest rates would have meant more unemployment and demanded higher mortgage payments from Prime Minister John Major’s Conservative supporters. The BoE and Treasury caved in and, spurred on by currency speculator George Soros, so did the British pound.

This history offers a guide to the current and future outlook for the British pound. Basically, Britain is suffering from low productivity growth. This malaise, while not new, has been unusually severe since 2008, and especially since 2016. It has multiple causes, from fractured labor relations and outdated infrastructure to low investment and a shortage of suitably employed workers. trained. It is now compounded by the friction and inefficiencies caused by Brexit.

To support the demand for its production, the United Kingdom must therefore set more competitive prices for its products. This requires either less inflation than abroad or a weaker exchange rate. But less inflation is not happening, because Britain is being hit hard by the global energy price shock and because unions, after a decade or more of austerity, are demanding higher wages. Hence the fall of the pound sterling.

The Bank of England could always take traders on the wrong foot. This could raise interest rates faster than currently expected to curb inflation and support the country’s currency, but at the cost of a recession. Everything is possible. But a century of British history suggests that this scenario is unlikely. 2022/Project Syndicate

Barry Eichengreen is a professor of economics at the University of California at Berkeley and the author, most recently, of “In Defense of Public Debt”.

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