"The Bank of England has dragged the UK economy into a fight that it cannot win by engaging in the skirmishes of a currency war against superior economic forces". The combination of economic and militaristic language in that sentence makes it a little bit more interesting than simply talking about the problem of trade imbalances. However, it also emphasises the situation that the UK, and indeed the world, now finds itself in.
We know that we have a growth problem in the UK - but, to properly understand where the problems lie we must look at the components of what is missing. GDP is made up of consumption, investment, government spending and exports, minus imports. Consumption in the UK is in trouble for obvious reasons. Inflation is, and has been, consistently above target for the best part of four years now, while wage growth has been less than a quarter of that figure. There has also been a significant negative wealth effect as a result of the fall in house prices and the subsequent fall in living standards has exacerbated rocky consumer confidence.
Investment from businesses has slipped, as they seek to cut costs and refuse to commit vital capital to speculative projects while the crunch in bank funding markets has further served to hurt those businesses who wish to expand.
The challenges for government spending are fairly obvious. Typical Keynesian economics will say that a government can and should step in to the void when consumers desert the economy, to keep aggregate demand buoyant. Unfortunately modern day debt dynamics are such that this is no longer appropriate and so the focus has shifted to exports.
In recent times, politicians of every stripe have come out in support of 'rebalancing', 'refocusing' and 'retooling' their economies. It is obvious that we need to make our exports more attractive to the outside world, and, as a nation, we can do two things to help achieve this. We can either make sure our goods are so much better than the competition, that they are the natural choice (ever driven a Rover?), or we can make them cheaper. It is easier to go with the second.
But it's not just us. The Bank of England has engaged in a strategy of competitive devaluation in a bid to weaken our currency in order to promote growth in our domestic industries. Similar moves have come from the US, Japan, Switzerland, Korea, China and a host of other nations in the past three years.
Simple supply and demand theories dictate that if you increase the supply of a good, and the demand stays the same, then the price will have to fall. It has and sterling got within a wobbly trading session of breaching parity with the single currency during the illiquid Christmas markets of 2008.
The combination of the £200bn that the Bank of England had printed, alongside the European Central Bank's paranoia when it comes to inflation, has combined to keep GBPEUR 21% below purchasing power parity.
The scene was set: With the pound weakened, the world would lap up British exports in a fashion not seen since the days of Empire. The problem is that it hasn't worked. Anyone in manufacturing will tell you that. Industrial production levels have remained weak, whilst little to no investment has been forthcoming into new manufacturing arenas from Whitehall.
The lack of infrastructure in the manufacturing sector meant that for all the competitive market conditions there was nobody to fill the gap. Metaphorically speaking, you can give an athlete great running spikes, but if he's half as fit as the competitors he's never going to win.
But for every action there must be an equal and opposite reaction (or so my physics teacher would ball at me as I attempted to catch up on some sleep in the class room).
The reaction has come in the form of a crippling bout of an inflation that has been imposed on us by the Bank of England. UK inflation has remained sticky above target throughout the entire crisis while prices elsewhere (EU, Japan, The US) have seen some form of settlement back to normality. In real terms the Bank of England has made each one of us poorer without any subsequent growth being shown in the UK economy.
The CIA World Fact book tells me that that the UK's largest imports by value are manufactured goods, machinery, fuels and foods... I would wager that it has actually been inflation.
Any further UK QE is likely to have an ever decreasing effect on economic growth prospects. A key UK advantage remains, however. We have do have a self-governing Central Bank in this country and can control currency to suit conditions.
In conclusion, it is fair to say that Bank of England has foisted inflation upon the UK by trying in vain to get the economy going. The monetary policy lever is broken and the Bank should return to its mandate of controlling inflation.
The government should immediately cut business rates and, should further asset purchases be used by the Bank of England, pass an emergency law to make sure that the extra liquidity is passed on to SMEs and not kept on balance sheets.
Difficult circumstances call for innovative measures and the Bank needs to realise this and move away from a currency plan which has run its course.
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