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Falling sterling isn’t helping the current account

Tuesday, November 19, 2013
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It isn’t supposed to be like this. The 'upside' of the recession and financial crisis was a steep depreciation in the value of sterling. That should have made our exports cheaper and imports dearer, thereby helping the UK to close its huge current account deficit. But as the graph above shows, it just hasn’t happened.

According to the Guardian, this is both disappointing and worrying, but hardly a shock. The newspaper says that what's happening is pretty simple. Britain's biggest trading partner by far is the euro area, where domestic demand is extremely weak. Consumer spending in the UK, by contrast, is recovering at a reasonably rapid lick, resulting in goods being sucked in from across the Channel.

The big fall in the value of sterling since the start of the financial crisis six years ago handed UK exporters a big competitive advantage. In the past, a 25% depreciation in the value of the pound would have led to an improvement in the trade balance. That hasn't happened this time, in part because of the long-running crisis in the euro area, but in part due to the shrinking size of the UK's manufacturing base. Why is it worrying? In the latest three months the UK ran a trade deficit in goods of £29bn. That was offset by a surplus in services, which is holding steady at just under £20bn a quarter. But a trade gap a little shy of £10bn a quarter at the start of an economic cycle is too big for comfort. And, if history is any guide, the trade gap will widen further as consumption expands more rapidly than production. It all seems depressingly familiar.

The Economist (source of the graph above) tells a similar tale. When in 2007 the pound began to slide, eventually dropping by a quarter in trade-weighted terms, economists assumed that exports would surge. That had happened in the early 1990s, pulling Britain out of recession. Not this time. Britain’s balance of trade improved, but not nearly enough to offset the hit to household finances from more costly imports. This helps explain why the economy stagnated in 2011 and 2012.

Part of the reason, argues the newspaper, is the slowdown in continental Europe and America, which take 54% and 17% respectively of British exports. Another is the gradual depletion of North Sea oil and gas. A third is that Britain’s strength is in services rather than in the raw materials, machine tools and handbags that emerging markets crave.

More of the familiar tale, revealing structural weaknesses in the UK economy.

There’s a revision quiz here and lots more exchange rate stories here, including T2U revision presentations.

This is also an ideal opportunity to flag up the concept of competitive depreciation, or 'currency wars'. This recent Economist article clearly and simply explains why most governments are happy to see their currency depreciate.


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AS & A2 Economics Revision Workshops

AS & A2 Economics - Intensive Exam Coaching & Revision Workshops: Book Now!

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AS & A2 Economics - Macroeconomics: National & International Economy (Unit 2),  Global/International Economy (Unit 4)

  • Tuesday 25 March 2014 - London (Stratford City)
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