Hey everybody, time for a quiz. Here’s 15 graphs of the pound’s exchange rate vs. the dollar. The scale is the same on all of them: 60 days on the horizontal axis, from 100 (the initial value) down to 75 on the vertical axis. So, which one is the past two months?
Answer below the fold.
OK, that wasn’t very hard. It’s the last one. You might guess by the sharp fall at the end, or by the fact that they’re in chronological order. But you would not guess by the magnitude of the fall. If we make a list of the biggest falls in the pound since 1980, the current one wouldn’t make the top ten. In fall 1992, when the pound was forced out of the EMU, it fell by 25%. And yet, plenty of people who think the recent 10% fall in the pound is a disaster, think that one was a blessing in disguise — if it hadn’t happened, the UK would presumably be on the euro now.
Probably the panic, the sense of crisis was similar in late 1992 to today. But if you look at GDP or employment in the UK, there’s no obvious break, growth just chugs along. Perhaps there were consequences that don’t show up in the macro data.
I don’t claim exchange rate movements don’t matter. In some cases, clearly, they matter a lot. What I claim is that floating exchange rates move around a lot. They don’t smoothly respond to trade imbalances or price level differences, they change abruptly and unpredictably. In three weeks over December 2015 and January 2016, the pound declined by 6% — more than half the most recent decline. Then it gained almost 10 percent between April and May. You may believe this reflects varying objective probabilities that Leave would win. I don’t.
The claim that leaving the EU will be costly economically, comes down to the claim that large changes in relative prices disrupt the concrete activity of production and exchange. But if the fall in the pound, and the future changes in tariffs(trivial) and regulatory trade barriers (not trivial) are costly, so must be the exchange-rate changes generated by the market. If economies can’t easily adjust to changes in relative prices, floating exchange rates are a bad idea.
Here’s the thing. If the fall in the pound triggered by last week’s vote is a catastrophe, it’s a catastrophe that foreign exchange markets already generate every couple years. One day they impose the equivalent of 10 percent tariffs on European exports to the UK, the next day on exports the other way. That’s the argument for fixed exchange rates — a tightly integrated system of production can’t deal with large, unpredictable changes in prices across borders. But what if fixed exchange rates aren’t practical? Then maybe we need capital controls to make them practical. Or maybe it would be better to just have less trade and international finance. Maybe it would be better it national economies were less connected with each other. If, as Felix Salmon says, “the burghers of rural England have managed to destroy trillions of dollars of value globally,” might that not that suggest that the “value” wasn’t securely founded to begin with? But in today’s environment that is an unthought.
NOTE: The figures are November 1973-January 1974, March-May 1976, June-August 1981, January-March 1983, December 1984-February 1985, March-May 1988, April-June 1989, February-April 1991, September-November 1992, March-May 2000, May-July 2005, August-October 2008, December 2008-Februrary 2009, November 2011-January 2016, Aprril 2016-June 2016.