British Trade Boost Shows Currency Devaluation Works

April 06, 2017

By Jeff Ferry, CPA Research Director

Establishment free traders often claim trade policy reform is futile, urging us instead to simply trust the free market. Recent experience in Britain shows that one trade policy—currency devaluation—does work, and pretty quickly too. Despite imports growing more expensive, both consumption and exports increased.

The British trade deficit has, in recent years, been even bigger than America’s as a percentage of GDP.  Since the Brexit vote last year, the pound sterling's trade-weighted value fell by 13%.  The result has been an astounding 53% reduction in the UK’s current account deficit.

According to figures published last week, the U.K. current account deficit narrowed from 25.7 billion pounds in Q3 to just 12.1 billion pounds in Q4. To put it another way, the current account deficit shrunk from 5.3% of GDP in Q3 to 2.4% of GDP in Q4.  Inside those figures lies a substantial (17%) improvement in Britain’s trade balance in goods and services, from negative 39.2 billion pounds in Q3 to negative 32.4 billion pounds in Q4.

The British government’s Office of National Statistics (ONS) confirms that the fall in the value of the pound sterling caused this trade balance improvement. Sterling was in the $1.50-$1.60 range for most of 2015, but following the June 2016 referendum when British voters voted to leave the European Union (Brexit), the pound tumbled rapidly and today sits at about $1.25. As usual, critics and nay-sayers saw only the negative, claiming a lower currency would raise import prices and hurt UK consumption and overall UK economic growth. UK consumption has continued to rise. Exports have risen even more quickly. According to the ONS, sectors that have seen a strong export boost include aerospace, automotive, electrical machinery, and chemicals.

Recent developments in the automotive sector have been particularly noteworthy.  After the Brexit vote, there were concerns that large multinationals could leave Britain out of fear that it might lose free access to the large European Union market. There was speculation over Nissan, the Japanese carmaker that operates a large plant employing 7,000 people churning out half a million vehicles a year in Sunderland in the northeast of England. In October, Nissan announced not only that it would stay in Sunderland, but that it is embarking on an expansion plan to enable it to build two additional models at the plant (in addition to the SUVs, sedans, electric vehicles, and Infinitis it already builds there). 

Then last month, Toyota announced plans to invest an additional $300 million in its Derbyshire plant in central England. Toyota employs 3,000 people in Britain. Toyota said it is watching the Brexit negotiation carefully and concerned about any tariffs between Britain and its European neighbors. The company is also planning to build more auto parts and components in Britain to take advantage of the cheaper pound and simplify its supply chain. Toyota already makes engines in Wales. Finally, sports car and race car maker McLaren announced in February that it is investing $62 million in a new plant in Sheffield, to design and manufacture lightweight carbon-fiber chassis.

In many ways, the UK economy is analogous to the US economy. The UK has run trade deficits every year since 1998. The UK manufacturing sector was hollowed out. Industrial decline and urban decay in cities and one-industry towns was pervasive in the Midlands, north of England and parts of Scotland and Wales. In the US, we’ve run trade deficits for more than 40 years, with widespread industrial decline and decay throughout the non-metropolitan US.

Political leaders and the mainstream media inexplicably focus on political negotiations on trade deals—the UK media is obsessed with its impending negotiations with the EU bureaucrats while over here all eyes are on President Trump’s meetings with China’s President Xi. But, as business leaders know, the most important factor for business and economic success is to make a good product at a good price and clear out the impediments to honest international competition such as mercantilist practices, trade cheating, and misaligned exchange rates.

The international trade community has forgotten that trade should balance, usually driven by currency values. The pound, like the dollar, has been overvalued for many years. That’s true simply by virtue of the fact that if you run deficits for many years, your currency should come down to put your trade back into balance. By surprise and without any effort, fate has given Britain a more competitive pound, and businesses appear to be responding, and quickly. There’s a lesson in there for the United States. 

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  • Bruce Bishop
    Currency manipulation is effective where the trading partners are in the same league. We, and Britain, are in the same league as Germany and Japan.
    China is in a league of its own. China can produce anything we can produce at one-third to one-tenth the cost. Unless we devalued our dollar by 90%, we could not compete with China. The only way to take back manufacturing from China would be to impose hard limits on the trade deficit. This was proposed by Warren Buffett back in 2003. You can Google “Balanced Trade,” for the whole story.

    I don’t have a problem with the fact that we have trade deficits with Germany and Japan. They make superior products that Americans want. To compete with them, we will have to learn how to make superior products. We, and China, make products that are adequate to mediocre. China makes those products much cheaper, so they get the jobs.
  • William Ryan
    There is a big lessen to be learned. First we should be making more efforts to lower our dollar. The continual rise of the dollar is only benefiting Wall St. and the bib banks. The strong dollar does nothing for manufacturing, makers, producers or real job creators. China knows this as does Japan and Germany and have been playing this game for a long time as all our jobs were siphoned out of the country. This is where to economic play field was tilted in their favor at the expense of manufacturing who the government picked to be the looser for all the every day low prices we got from Wal-Mart. We got their ultra low priced finished goods in return for all our wealth creating innovation driven good paying jobs. What a deal made in heaven for the self serving oligarchs who drew all the wealth from and still do to this day.