Friday, 19 December 2008

The upside of the plunge

"The fall in the pound may have been disconcertingly large but it marks an overdue adjustment after a long period in which sterling was overpriced. A measure of the sustainable value of a currency is the exchange rate that would equalise the prices of goods and services in two countries. According to the OECD, sterling’s purchasing-power parities against the dollar and the euro are $1.50 and around €1.30 respectively. This suggests that the pound is now close to its underlying value against the dollar and about 15% below its long-term value against the euro. [...]
Advocates of British membership of the euro found it difficult to make their case while sterling was thriving. Now the pound is being pounded they are finding a readier audience. Yet monetary sovereignty is all the more crucial when the economy is in trouble. The Bank of England has been able to cut interest rates below those in the euro area for the first time since the single currency started in 1999. That in turn has pushed sterling down, a stimulus all the more welcome since monetary policy is less effective than usual because banks are reluctant to lend. The need for such a boost was underlined this week by figures showing that the number of people claiming unemployment benefit increased by 75,700 between October and November, taking the total above 1m."

I've had a number of theories about this and also made the wrong point that currency values react to news: they probably do that but far more slowly than stock prices, for example. Naturally, they reflect a national economy as a whole, not just the value of one company. (Probably somebody could explain to me what I can tell from the value of a currency in comparison to what I can tell from stock market indices such as the Dow Jones or Austrian's ATX?). I didn't know that the pound was overpriced though, that is new information. "The underlying value". Isn't that one of the points of this crisis, that all of a sudden the underlying value of everything is revealed?

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