Monday, 17 November 2008

The UK disease

From today's FT.....

"One interpretation of the drivers of this persistent (Sterling) overvaluation would be a Dutch disease story, where the role of the natural resource sector in the standard version of the Dutch disease is taking by the UK banking sector.

In this interpretation, a long financial industry bubble in the UK has driven up the real exchange rate in the whole economy and crowded out other sectors producing internationally tradable commodities. The recent sharp depreciation of sterling corrects this long-standing anomaly."

Willem Buiter, Professor of European Political Economy, London School of Economics and Political Science

Yes. Yes. Yes.

This is exactly the problem with Sterling. While the UK bubble continued, the financial sector grew and pulled in huge capital inflows. As a consequence, the pound appreciated, and UK exports became impossibly expensive. Soon we were a one industry economy.

Now that the bubble is over, the inflows have slowed, and the financial sector is shrinking. This has reduced demand for sterling.

The Bank of England accelerated this process by cutting interest rates, which discouraged inflows and put further downward pressure on sterling.

The danger we face is that the decline could turn into an uncontrollable rout.


Anonymous said...

Sterling - how low can it go?

Nick von Mises said...

Can't agree with the second last paragraph. Note Iceland had the same problem in the face of continually hiking interest rates. Higher rates encourage a carry trade and hot inflows.

Anonymous said...

Mark my words: dollar par by xmas. Get ready for it.

Man in a Shed said...

Thats an interesting take I hadn't heard in that form before.

Its also worrying, very worrying.

About a year ago I blogged about the passing of ICI and nobody being intrested. They should have been.