Mail & Guardian reporters The G7 industrialised nations intervened on behalf of the euro last month to test whether the clamour for United States assets, which has been boosting the dollar on the foreign exchanges, had been overdone, the Governor of the Bank of England, Sir Eddie George, said recently. Since the euro was launched, the US has accumulated a current account deficit of $500-billion (about R3800-billion), but has invested $750-billion internally, while the single currency zone had seen a net outflow of $275-billion. Investors had been attracted to the US by the improvement in rates of return engendered by the “productivity shock” in the US economy, George told a conference in Paris. But he argued that that would eventually be discounted by a change in asset values – including the exchange rate. “The problem is that we simply do not know how close we are to that point – or indeed whether we have already passed it. “Putting that question to the market was, for me, the real point of the recent G7 intervention.” The weakness of the euro was not a result of any obvious macro-economic failure in the eurozone. “It is much more likely that it reflects the magnetic attraction of the US at present as a destination for long-term investment.” Though Jean-Claude Trichet, the Governor of the Bank of France who shared the platform with George, stressed that Britain would be warmly welcomed into the euro, his United Kingdom counterpart was cool on the prospect of Britain signing up for the single currency in present conditions. George warned that if Britain had signed up for the single currency from the start, the lower interest and exchange rates would have meant that Britain would have been likely to have experienced “something of an inflationary boom”.
He acknowledged that the pound was, on most calculations, “substantially overvalued” against the euro and that this was causing problems for sections of the British economy which had to compete against rivals in the eurozone. He argued that Britain’s cutting of interest rates sufficiently to bring down the value of sterling “would destabilise our domestic economy”. It might bring short-term benefits but the problems would reappear. “And in the meantime the whole economy would be exposed to accelerating inflation which we would be powerless to address through national monetary policy.
“Frankly, it is not clear to me that this is a risk which it would be in the interests of either the UK or the eurozone to take in today’s conditions.” “For the time being,” he said, it would be better for Britain and the eurozone to pursue macro-economic stability in parallel and to hope that the euro would recover “as I continue to expect that it will”. “That strikes me as a more reliable path to sustainable convergence.” The strength of the euro is of considerable interest to South Africa, as the weakness of the rand has tended to track the fledgling currency’s woes. Meanwhile, the remarkable strength of the British pound, not to mention the Danish rejection of the single currency, continues to strengthen the hand of British eurosceptics. It’s a mystery, said George, when asked about the pound’s strength. Equally baffling are the latest trade figures which show Britain recording a trade surplus with Europe for the first time in five years, despite the runaway pound. Export volumes were up an impressive 10% over the past three months, compared with a year ago So why are the figures holding up? Firstly, manufacturers are slashing profit margins to keep a toehold in European markets, warding off competition at home from cheap continental imports. As a result, manu-facturing profitability has fallen sharply since the start of 1999. Firms are tightening their belts in order to stay afloat. In the first quarter of this year, rates of return fell to below 7%, around half the rate earned in 1998. Faced with declining profitability, firms have moved upmarket in search of high-quality products where they are no longer competing on price. Those stuck in low-growth commodity markets – textiles, bulk chemicals and basic metals – are closing or moving overseas. The changing composition of Britain’s manufacturing sector demonstrates the search for value: the fastest-growing sectors are electrical and optical equipment, biotech and drugs, all producing goods which are less price sensitive.
Britain’s trade balance with Europe has been improving for nearly a year, which suggests that the pound may not be as overvalued as the markets are assuming.