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If having a more competitive pound provides the only realistic solution to our economic problems, why don’t we do it? Part of the reason we don’t is that we have been conditioned for decades to believe that the opposite policy is best.

Who wants a ‘weak’ pound rather than a ‘strong’ one? Who wants to see sterling going down rather than up? Who wants to see a lower value for sterling making foreign holidays more expensive? The problem is that cheap foreign vacations are not really cheap at all if they help to impoverish the UK economy as a whole.

There are several more reasons why many people think that a more competitive pound is a bad idea – but actually none of these reasons make any more sense than the argument for cheap holidays overseas. Consider the following objections to a more competitive pound:

A more competitive pound is bound to increase the rate of inflation because imports will all be more expensive

Nearly everyone believes this to be true. But they can’t have looked at the many statistics available showing that this is not what happens. When we devalued by nearly 20% in 1992, for example, almost everyone thought that inflation would go up – but actually it went down. Here are the figures for year-on-year price increases:

  • 1990 - 9.5%
  • 1991 - 5.9%
  • 1992 - 3.7%
  • 1993 - 1.6%
  • 1994 - 2.5%

There are many other examples from our own history and those of other countries showing similar results. Why don’t higher import prices push up inflation? The answer is that prices of everything bought in from abroad will go up but lots of other costs will come down. Interest rates will tend to be lower and so will levels of taxation. Longer production runs mean lower costs. Goods which might otherwise have been imported will be bought from home supplies because these will now be cheaper.

Some people even believe that if you have a devaluation the extra inflation that this will produce will wipe out any extra competitive advantage initially gained very quickly. In fact, however, there is absolutely no evidence that this is likely to happen and overwhelming amounts of data showing economies which have devalued do much better than they did before with little or no additional inflationary problems.

Devaluing the pound will make us all worse off.

Again, many people believe that if the pound goes down this must make everyone’s standard of living lower than it was before. Once more, however, people who believe this cannot have looked at the figures which invariably show the opposite. Indeed, if the economy grows more rapidly than it did before while the population stays the same, output per head must go up and not down.

Of course, the cost of imports – and foreign holidays – will go up, but on average the pound will go on buying the same amount in the shops as it did before. If incomes then go up – which they would – everyone on average finishes up by being better off. Again, our experience after the 1992 devaluation is instructive. Far from living standards going down, they sharply increased.

It is impossible to change the exchange rate which is fixed by market forces and not by the government

This cannot be true because lots of governments have in fact been very successful at changing their exchange rates or holding them where they want them to be against market pressures. The Japanese, for example, have deliberately over the last year devalued the yen by about 30% - and as a result the Japanese economy is doing much better than it was. The Swiss government recently stopped the Swiss Franc getting stronger, as a result of money pouring into the country because of the damage which would otherwise have been done to Swiss exports. The UK devalued by about 30% in 1931 as a result of which the UK economy recovered strongly in the 1930s compared to the poor performance in the 1920s, when the pound was much too strong.

A particularly interesting case is Germany, which began after World War II with a very highly undervalued and competitive currency. This enabled German industry to become very strong as it has remained ever since, still capable as a result of stunning export achievements. What happened then was that very rapid increases in German productivity kept their inflation rate down and made their exports more and more competitive even though the DM got stronger. This is why the German economy is the most powerful in Europe. The UK adopted just the opposite strategy with an over-valued currency which made the economy weaker and inflation higher.

The UK has tried devaluation in the past and it does not work

It is true that we have had several devaluations since World War II, although there have also been periods since then when the pound got much stronger again. The problem is that all the devaluations we have had were too little and too late. The main reason for this is that Britain’s weak economy has caused inflation to be higher here than elsewhere in the world and the inevitable result is that the exchange rate had to be adjusted sooner or later to take account of this. Because devaluations were always put off as long as possible, and because when they took place the reduction in the value of the pound was always on the low side of what was required, we never had the benefit of a truly competitive currency.

What is true, however, is that even though the devaluations we have had have been smaller and later than they should have been, our economy has always performed better after them than before, and certainly much better than if the devaluations that have occurred had never taken place.

Of course the pound did come down from $2.00 to about $1.50 between 2007 and 2009 and some people think that it must therefore be at a competitive level. Unfortunately, it isn’t as you can see from the big deficits we still have. The reality is that the pound was absurdly over-valued for much of the 2000s and at its current level of about $1.60 to the pound it is still far too high.

If the UK devalues the pound, other countries will retaliate.

If we were a major economy in the world, this might happen but because our share of world trade is now so small – at well under 3% - what we do really does not make much difference to everyone else. When the pound did come down recently from $2.00 to $1.50, there were no significant repercussions.

Furthermore, it is one thing for an already very competitive economy, such as China’s, to do all it can to keep its currency down. It is quite another for a country like ours which has such huge problems paying its way in the world to be stopped by international pressure from getting our currency to be more competitive.

The real cause of much international financial stability is countries with big surpluses, which have to be matched by deficits somewhere else. We don’t need to run a surplus, causing everyone else a problem. All we need to be able to do is to get our economy to grow at a reasonable speed and to get unemployment down by expanding our economy without have balance of payment constraints.

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