Tuesday 3 May 2011

STERLING VS EURO



The long term chart of Sterling vs. Euro confirms the budget proposal that the Government and Bank of England will sell Sterling to build up reserves of currency. Tight fiscal policy will be counterbalanced by weak monetary policy; QE keeping longer term rates artificially low and a weakening exchange rate to boost the export sector.

Unfortunately this policy is typical of a "race to the bottom" where countries try and weaken exchange rates (UK, USA) or impose capital controls (Brazil) to gain competitive advantage. It might be the case that countries that act in this manner quickly will get an advantage over countries that do not, but the sum total of such mercantilist behaviour is usually zero at best. A competitive battle between Coke and Pepsi where bottom line is paramount is quite different to a win-lose battle between countries. Mercantilism does not succeed now and Ricardo's view of comparative advantage means that free trade and cooperation always wins over a nationalistic competitive ethos. We are back to the 1930s.

On top of this, the UK policy of zero rates is understandable in terms of preventing a deflationary nightmare but zero rates distort capital formation. Investment is eschewed for speculation (commodities) hoarding (gold) or simply flees to other currencies that do pay interest.

We live in a world where there is little cooperation between the main players (G20) and if the UK and USA really think they can outwit China they are niave as well as isolationist.