Causes and Impacts of the UK Currency Devaluation - Essay Example

Causes and impacts of the UK currency devaluation The pound sterling has been the unit of monetary measure in the United Kingdom since the inception of the official currency records. It holds a special importance among the currencies trading in the international market at the present instance. At one time it used to be regarded as the most important unit, during the days of the British Empire. Even today however, it ranks as a fairly important one. As of 2007, the pound Sterling followed the US dollar and the Euro as the third largest reserve currency in the world (Pan). It also held the position of being the currency with the fourth highest trading volume in the foreign exchange market behind the US dollar, the euro, and the Japanese yen respectively (Pan). The sterling has been generally regarded as one of the high value based currency reserves of the world. Its value, in respect to the other currencies, has been on the higher side. This has been because of various reasons, one of the main being the good and reliable financial markets that the United Kingdom is able to offer to investors worldwide. Due to the stability within the UK, and the ensuing level of trust, it has been able to attract massive inflows because of the bourses and financial markets, particularly in London, providing burgeoning returns. The high value further, allowed greater consumption by the people of the United Kingdom, allowing greater imports and out of country vacations. The current financial crisis however sees the Pound Sterling being drastically devalued. In recent months, the Sterlings decline in value in relation to the euro is interpreted by economists and some political elements within the United Kingdom as evidence of diminishing faith in the British economy on worldwide currency markets. Political elements, especially those belonging to the liberal side have rushed to blame the policies of the Prime Minister Gordon Brown for the collapse in the Sterling’s value (Heffer). Sources close to the treasury hinted that the decision in the pre-Budget report to increase borrowing to fund reduction in taxes had led to a downturn in economic confidence and thus had affected willingness of people to spend, ultimately leading to the drop in the Pound. A Liberal Democrat Treasury spokesman observed that while the decrease in interest rates had been the main reason behind the fall in the sterling’s value, it was supplemented by the expectation that the rates would decline even further (Heffer). The sterling fell almost 17 per cent compared with the euro in 2008 as the Bank of England decided to cut rates from a peak of 5.75 per cent to a more-than-50-year low of 2 per cent. Political opposition points squarely towards the failure of the Government as the reason the interest rate cut had been necessitated in the first place (Mnyanda and Finch ). A general level of feeling can be said to be observed pointing towards the United Kingdom’s economy being weaker than it seems and the housing bubble that plagued most of the western world being actually bigger in the country. Some amount of blame can be laid on Downing Street for not being able to do much to address it. Taken from www.thisismoney.co.uk This rapid fall in the fall in the Pound’s value is beginning to have far reaching effects on the country’s economy. The United Kingdom’s consumer inflation level went up to around 3.8 percent, which slammed the expectation of quickly accompanying cuts in rates. The Office for National Statistics pointed out that Consumer Prices Index, the indicator of the inflation level, went from 3.3 percent in May 2008 to the drastic level reported above in June (Mnyanda and Finch ). It was the highest level of inflation since 1992 and made the Government’s planned target of 2 percent appear silly. With the British currency trading at a value less than the euro, it can be said to have crossed a certain psychological barrier. In one way, the vulnerability in the sterlings value made a strong argument for the United Kingdom to become attached within a large currency block, namely the Euro. Considering the timeline, how Britain expressed doubts about the inception of the euro, its long term survival and whether or not it will emerge as a stable and powerful currency in the world markets, now that the Euro trades higher than the Pound, it may be time to do the next thing in the time line and join the system. Factory production in the United Kingdom responded to the sharp changes in interest rates and inflation and unexpectedly shrank for a continuous fourth month in June. This was accompanied by figures illustrating that the construction sector showed its weakest performance in nearly eleven years during the month of December in 2008 (Thompson Financial News). These tangible symbols aside, even today the pound Sterling’s position is in jeopardy. From a one time high during the days of the Empire, the sterling has clearly become the “second” monetary unit after the strong foothold of the dollar. With the increase in its volatility and its value, it will increasingly come to be compared with the Euro which could actually have helped London city as a big financial market to flourish and the British industry to operate well. What is under consideration now is not whether the country will join, but actually how much more losses it would incur before the leadership agrees to join the Euro block. One thing to consider is than will the sterling drop even further in the future. There may actually be a very good possibility of that and in the worst case; a collapse of the Pound sterling could even be witnessed. Government finances are deteriorating because of the circumstances and the turn the economy is taking. In a theoretical scenario, they could deteriorate at a much greater speed than speculators anticipated. This could lead to a severe loss of confidence in the Government with investors not being interested in purchasing British gilts. Thus now if the Government attempts to raise capital through that means to deal with the emerging budget deficit, it would lead to disaster. Traditionally, devaluation in the UK’s currency should have benefitted its manufacturing sector by giving its goods a competitive edge in the international market. This has escaped the industry this time in the case of Britain. The manufacturing sector was getting weak to begin with, nearly a million people pertaining to the sector becoming unemployed. One of the country’s major economic pillars, the financial services sector too is now surprisingly weaker. Just as the manufacturing sector has seen a decline and globalization has gripped the economy, most of the factory input costs like those of raw materials, machinery and power have become exceedingly priced in other currencies. This has accelerated the dip for the United Kingdom this time. The potential benefit to manufacturing sector has also been lost to a great extent because of the present state of the world economy following the financial crisis. The competitive advantage to UK’s manufactured goods because of the currency devaluation is largely going without gain because of a dip in demand from the main Eurozone and United States markets as well. Consumption has fallen and the consumers and industries there are also badly hit. The countries themselves are busy planning bailout schemes for various sectors of the economy; British goods would obviously not see that high a rise in demand. This analysis is complimented by the position of the housing market. The slump in that sector has begun to affect the related brick and cement manufacturing industries. Output in these industries dipped to about 26 percent below comparable rates in 2007 during only a three month period. An evaluation of the current state does lead to some criticism of the present Government. Some of the gains attained in Tony Blair’s time in public sector reform have been washed aside by the one under Gordon Brown. The public sector in the British economy has been one of the main lagging factors. Brown’s government went even further by patronizing it. Even more bad news for the current Prime Minister is that his policy of tackling the problem of debt with further debt became an impetus for the downfall as well. Steps following that have been feeble as well. The rise in investment on the infrastructure may be led to waste. The dip in Value-Added taxes could have been accompanied by efforts to relieve some of the employment tax and creating jobs for people. As things stand, the steps didn’t work out and as of now, the Government may have to devise new ways to relieve the economy, like increasing the money supply, as speculators predict borrowing costs to become nil soon. With the question of joining the Euro block looming now, it has to be analyzed what could go wrong there. There is a possibility that with the policies accompanying entry into the Euro system, the UK’s situation could have been worse. Having lesser interest rates when in the zone, the current situation because of the real estate bubble could have been worse for the country. However, conversely, UK businesses may also have benefitted immensely from it and the other sectors could have helped stem the tide a bit. The steps that are going to be taken however, will define the future direction of the British economy. Works Cited Heffer, Simon. "Gordon Browns behaviour is simply immoral." Telegraph 19 Dec 2008 12 Jan 2009 . Mnyanda, Lukanyo and Finch. "Pound Slumps to 93 Pence Euro for First Time After Jobless Data ." Bloomberg 17 Dec 2008 12 Jan 2009. Milliken, David. "Thompson Financial News." Forbes. 09 Jan 2009. Forbes. 12 Jan 2009 . Pan, Aaron. "Pound set for biggest annual gain since 1990 ." International Herald Tribune 28 Dec 2006 12 Jan 2009 . Read More