In the previous three parts of this series we have looked at how we’ve arrived at the monetary system we have today, so-called ‘fiat currency’, and reviewed how it works. I’ve tried to explain why I believe that, on balance, it’s a better system than any of the alternatives. Although it depends heavily on the banking system for it to function, it leaves the banks significantly less powerful than they were in the days of the Gold Standard. It also imposes some vital discipline upon the government of the day, whatever its colour.
In this final part, I shall discuss how different countries’ currencies are valued relative to one another, and the link between currency value and economic performance. Then (at last!) I shall be in a position to apply all this to Wales.
Supply and demand, again
Everything in economics comes down to supply and demand, so it’s no surprise that this does as well. The principal thing that drives the value of a country’s currency on the world market is the demand for the things that it exports – whether that be services, manufactured goods or raw materials. If a country’s ‘stuff’ is in demand, then so is the currency that you need in order to buy that stuff from it.
But there’s a problem: suppose my company is based in country A and makes widgets, and my main competitor in country B makes very similar widgets at a very similar price. We rub along quite well, with nice, stable businesses. Then world demand for fluffium suddenly explodes, and it turns out that my country has the largest reserves of high-purity fluffium on the planet. Great news! Well, not for me, no. Because every other country in the world is going to want to buy fluffium from my country, and they’ll need my country’s currency to buy it, the value of that currency is going to soar. If I carry on trying to sell my widgets for the same price as before, they’ll suddenly look very expensive to the people I used to export to. It will be much more cost-effective for them now to buy from my competitor in country B. Worse, even people in my own country will notice that my competitor’s widgets are much cheaper than mine, so they start importing them rather than buying from me. Unless I can drastically cut my costs, which will almost certainly mean cutting my employees’ salaries, I’ll go out of business. If my employees won’t agree to that, and go on strike, then I’m done for; the business is unviable and is sure to close.
Substitute North Sea oil for fluffium in that story, and you have Britain in the 1980s.
The race to the bottom
Every country wants to have a successful economy, and wants to be able to export so that it can also afford to import. However, if they export too successfully, then their currency appreciates in value and exporting becomes more difficult. Therefore countries do all sorts of things to try to keep the values of their currencies down.
The obvious thing to do is just to cut interest rates and flood the markets with currency, but that’s not the answer because it will cause inflation in the home market and kill productivity. Other strategies are called for.
What China does, in order to stop the Yuan from getting too expensive relative to the dollar, is simply to buy dollars – mainly in the form of US government bonds. Selling yuan to buy dollars increases the demand for dollars relative to the yuan, and so depresses the value of the latter and keeps Chinese exports competitive.
Tilting the playing field
Germany, Europe’s pre-eminent exporter, has a different strategy. When Germany had its own currency, the Deutschmark, it was plagued by the constant appreciation in the value of the Deutschmark relative to all the currencies around it – making German goods look expensive, and limiting German economic growth. By having entered a currency union with the countries to whom it sells most of its goods – the Euro – Germany avoids this problem. Moreover, since many of these countries have very weak exporting bases and under normal circumstances their currencies would be similarly weak, the effect of Germany’s economy upon the Euro is diluted so that it remains competitive with other currencies such as Sterling, the Dollar, the Yuan and the Yen.
Speaking personally, I remember when the realisation of this dawned on me in the midst of the Greek financial crisis; I previously hadn’t been able to understand why Germany was prepared to commit so much financial resource to keep Greece in the Euro, but then the penny dropped. I went from being an enthusiast for Britain joining the Euro, to being strongly in favour of Brexit, almost overnight. As a frequent business traveller to Europe, the rationale of sharing a currency with the rest of Europe had until then seemed self-evident to me.
Locked in
The sting in the tail is that, while Germany benefits from an exchange rate much lower than it would otherwise have, many European countries are struggling with exchange rates much higher than they would otherwise have. Thus Italy has had zero economic growth since joining the Euro in 1999, while the struggles of Greece and Portugal are also familiar to us. Part of the problem for these countries was also that they joined the Euro at excessively high valuations, but once locked in they have had no room to manoeuvre. The only option they have is ‘internal devaluation’ – in effect, cutting government spending (by up to 20% in some cases) and driving down wages in the private sector to force their economies to become more competitive. To be fair, in countries where this has been done – particularly in the Baltic states and in Ireland post-2008 – it’s been successful, and has resulted in strong economic growth which has cancelled out the effects of the devaluation and put their economies on a strong footing for future growth. But it’s a painful way of going about it.
And so we come (at last) to Wales, locked for the last 750 years into a currency union with our larger and much richer neighbour. Welsh businesses, generally small and with poor access to capital, have to compete in the world market with a currency geared to the interests of England with its very different economy. Wales’s economy is largely driven by manufacturing and energy, whilst England’s is much more service-oriented with a much larger trade deficit. Having a separate Welsh currency that was allowed to find its own level would give us a vital boost, increasing the competitiveness of our exports and so bringing in essential capital to invest in industry and infrastructure.
Discipline
As I’ve pointed out elsewhere, if the Welsh economy were to grow at the same rate as Ireland’s, then even if the fiscal deficit (the difference between public spending and taxes raised in Wales) is as big as the worst-case claims that are made, then it would be gone in three years. We see it as essential that a pre-independence government should take steps to improve the economy, allow growth and reduce the deficit; starting, at least, to repair the devastation of Labour’s twenty years of misrule.
Even so, it is likely that a future Welsh government will still need to borrow money from time to time, and borrowing in its own currency would be far more cost-effective than borrowing in someone else’s – since there’s always the risk that if you borrow in another currency and the exchange rates shift, then the debt can become unmanageably larger.
But a further advantage of a having our own currency would be the fiscal discipline that it would impose on the government: if borrowing became too high, the markets would give an unequivocal signal by demanding higher interest rates on Welsh government bonds while simultaneously bidding down the value of the currency. The government would have no choice other than to reign itself in. A situation such as we have today – where decades of mismanagement have laid waste to the Welsh economy, while London quietly bales us out to avoid the full awfulness of the situation being made clear – wouldn’t be allowed to arise again.
Even if Wales were to reach the position of having a net surplus, then there would still be a strong case for the government to issue bonds and for the central bank to issue debt to pay for them to regulate the amount of money circulating in the economy – just like the governments of Norway and Singapore do, even while they keep their vast sovereign wealth funds in the bank.
All we need now is a name
So this is clearly the way to go. All we need now is a name for our new Welsh currency, which we should introduce on the day that Wales achieves independence. Obviously the smallest unit of coinage should be the ceiniog, but my nomination is that 100 ceiniog should make up one Hywel. Hywel Dda, whose picture has been at the masthead of each of these four articles, was after all the first Welsh king to have issued his own coinage. I think that he goes far enough back in history to be able to remind us, each time we make a purchase, that we are an ancient nation with a history we can be proud of and a future to take control of for ourselves.