Blog

EEF blog

Insights into UK manufacturing

Currency wars debate: some conclusions

Felicity Burch November 16, 2010 10:23

A currency war is on hold – though it depends on the performance of the US Economy

 “The prospect of a full blown trade war is unlikely; it benefits nobody” … “it is not in China's interest to provoke the US”
World_First

Additionally, currency intervention… “May go off US agenda if QE2 works/economy grows” … “I suspect that a war will be averted”
JeffreyPeel

“The G20 is split - Washington consensus is dead. But sanity may prevail. No-one really wants no-win #cwars or #fx wars”
JeffreyPeel


Chinese currency depreciation is not win-win

JohnPullin asked “What will be effects on scarcity of raw materials including strategic metals?”

“that is defintely one of the aces up China's sleeve and should we see supply concerns come to the fore then the pressure will rise”
World_First

“If the West achieves its objectives re. Chinese revaluation may mean more expensive input costs”… “may be good for US steel and other traded goods though - China hasn't all aces”
JeffreyPeel

For UK manufacturers the largest impact of currency wars is likely to be price volatility

We asked whether the UK would “be collateral damage from fx volatility?”

“you have a point. To an extent it depends how much the Chinese are prepared to pump-prime and how much US resists”
JeffreyPeel

“we are advising manufacturing clients to hedge at these GBP levels to negate volatility and lock in profit”
World_First

 

Or, as we put it on twitter: "currency war is on hold as QE2 gets going & eurozone distracts markets. But..." "QE2 could go down like the Titanic if it hits China's raw materials iceberg." "So for now, UK manufacturers have little to worry about, except maybe protecting themselves from #fx volatility."

Currency wars: what does it mean for manufacturers? #fx #cwars

Jeegar Kakkad November 15, 2010 11:30

Although we've blogged on how global demand - especially from emerging economies - is helping drive the recovery in manufacturing, today's news out of Ireland is a pretty stark reminder of the risks posed by the global economy.

The G-20 meeting in Seoul managed only loose commitments to resolve the economic imbalances behind the currency war.

China is signalling it’s concern about inflation (which is code for their going to let the reminbi appreciate), which has knocked 5% off the Shanghai markets. This could have been typical pre-G-20 posturing, or it could reflect significant concern about rampant credit.

And now rumours are swirling of Ireland requiring, but shunning a bailout.

Where does this leave UK manufacturers? Many UK businesses I’ve talked to are concerned about the impact on three key points: demand, costs and profits, with further Sterling volatility being the worrying wildcard.

The concern about demand

If goods exports to China have risen by 44% since the start of the year, a trade war involving China and other developing economies, such as Brazil, could undermine the demand that is helping to drive growth in the UK. Most manufacturers worry that, if the currency battles slip into protectionism, then developing economy demand may dry up, profits could get hit or materials costs could rise (e.g. China produces 97% of global rare earth mineral supply).  

So far, so good. But what will happen to UK exports if the UK doesn't try to competitively devalue its currency? Would that help mitigate the damage from a trade war? Would the UK be viewed by China, Brazil and others as a benign trading partner, and so avoid the worst of the restrictions? Or would UK exports become collateral damage, caught in the crossfire between the US, China and others?

With the bulk of exports still headed for the EU, UK firms will have a decent buffer against such global headwinds. But the longer a trade war between the US and China persisted, the more likely the global economy - and UK exports with it - will suffer.

Profitibility could be hit 

Over the past decade, many firms protected themselves against a strong pound by buying and selling in dollars and eruos rather than pounds. This is standard practice for firms operating out of small, open economies and with exports making a big contribution to turnover. This way, if sterling moves, then firms take the hit on profits rather than on orders. This is why, as sterling fell during the recession, EEF's Business Trends survey showed improving profit margins on exports, even as world trade fell.

What's this mean for a currency war?

If the UK doesn't try to devaule it's currency, sterling will probably rise, for example, relative to the dollar. As discussed above, this will hit profitability, while potentially protecting orders. The knock to profits could eventually feed through to greater caution on investment and employment intentions.

If the UK tries to devalue the pounds, for example, through further QE, then profitibility could be temporarily protected, but at the cost of demand if protectionist measures begin to bite.

Cost of commodities

Over the past couple of years, a weaker dollar has meant rising commodity prices. Allowing sterling to appreciate could insulate UK firms from rising costs, while also helping to dampen down inflationary pressures in the UK (as import costs reduce).

But as we said before, getting caught up in competitive devaluations could mean getting caught out on access to China's supply of rare earth minerals.

A spanner in the works

The one issue that could through all this analysis - and firms' best laid plans - out the window is further exchange rate volatility.

Stirling volatility over the past year or so made planning for the recovery difficult, and another bout of it could keep cash-rich companies' on the sidelines of the economy until the G-20 manages to either resolve the currency crisis or settle the Doha trade round.

TWITTER DEBATE: Do UK companies have anything to fear from currency wars? #fx #cwars

Felicity Burch November 15, 2010 11:02

Do UK companies have anything to fear from currency wars?

Join the debate!
(Monday, 15 November 2010, 15.00 - 15.45)

On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars.

 Time:  3.00pm - 3.45pm 
 Hashtags:          #fx #cwars
 Participants:

@EEF_Economists (Moderator)
@World_First (panellist)
@JeffreyPeel (panellist)

 Key questions:      1. What is a currency war and should we be worried?
2. How would a currency war impact Sterling?
3. What, if anything, should UK manufacturers be worried about?
4. How should the government and the Bank of England respond?

Pre-debate, we've put together some background information: 

Currency wars: the story so far

Currency wars: the best of the press

Currency wars: the view from manufacturing

--

16/11/2010 Update

Here is a summary of the discussion -

Currency wars debate: some conclusions

 

Currency wars: the best of the press

Felicity Burch November 11, 2010 15:43

In the G20 meeting in Seoul last week one of the key issues was how to avoid the currency wars which threatening global economic recovery. Although some agreement was made over continuing discussions, tensions have not dissapated. On Monday 15th November at 3pm EEF is hosting a twitter debate on the impact of currency wars on the UK, and UK companies. 

 

As a background to this, here are some key articles and blogs that have been written on currency wars in the last couple of months:

 

What is a currency war?

The BBC’s animated guide: http://ow.ly/388kiOr, if you’d prefer something to read, Stephanie Flanders’ summary is here: http://ow.ly/38bb7

When did this one start?

The first rumblings of currency hostility started in March 2010 when 130 bipartisan US Congressmen sent a letter last week to US Secretary of Commerce Gary Locke, calling for the government to identify China as a currency manipulator. However, it was Guido Mantega, Brazil’s finance minister, whose announcement on September the 28th branded competitive depreciations as “currency wars”. Reported by the FT: http://ow.ly/38bp8

Who is fighting whom?

The BBC’s Andrew Walker sets out the key players and the main battlegrounds: http://ow.ly/388oq What impact could currency wars have on the global economy?Competitive depreciation could represent a very serious risk to the global recovery. In particular, the global rebalancing which debtor countries are relying on to boost growth could be hindered by surplus countries accumulating excess reserves to boost their own exports. The FT reported here: http://ow.ly/38bOK

What has happened with currency wars in the past?

Douglas Irwin at the Wall Street Journal summarises how high tariffs and currency wars caused problems in the 1930s: http://ow.ly/38bxy

What happened at the G20?

According to the Guardian "the summit set vague "indicative guidelines" to measure imbalances" however "the leaders were unable to agree on how to identify when global imbalances pose a threat to economic stability, merely committing themselves to a discussion of a range of indicators in first half of 2011": http://ow.ly/39MMK  

 

Therefore, questions remain: What would trade wars mean for the UK? Crucially, how will UK companies be affected if exchange rates become increasingly volatile, or if currency tensions lead to increased protectionism?

 

Join the debate! On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars. The debate will start at 3pm and last for 45 minutes. 

Currency wars - the story so far

Felicity Burch November 10, 2010 13:19

 

Next Monday at 3pm EEF will be hosting a twitter debate asking "Does the UK have anything to fear from currency wars?"

The image below gives a summary of the 'currency wars' story so far. 

 

Click the image to view an enlarged version

To join in the debate follow @EEF_Economists on twitter, or the 'hashtags' #fx and #cwars. The debate will start at 3pm and last 45 minutes. 

Currency wars - timeline (updated).pdf (15.46 kb)

 

Trade figures look good: how can government maintain the momentum?

Felicity Burch November 09, 2010 09:41

The UK’s trade deficit in goods improved in September, falling to £8.2 bn compared with £8.5 bn in August.

The value of exported goods rose by £0.5bn over the month, and there was an increase in import values of £0.2bn. This is good news in both cases - increased exports mean there is a potential for more balanced economic growth, while continued demand for imports reflects strength in consumer demand.

The value of UK exports has grown markedly and is currently nearly 25% higher than at the low-point of the recession. Year on year growth in exports is well above the long-term average.

What is more, the outlook for trade is good.

Emerging markets are providing opportunities for export growth. Between 2004 and 2009 (the last complete year for which there is data) the volume of exports to BRIC countries rose by 77%. The proportion of UK exports going to China and India more than doubled. UK manufacturers are keen to take advantage of these opportunities and have been developing their presence in emerging markets. This is already paying dividends: according to UKTI in the first eight months of 2010 alone goods exports to China rose by 44%, to £4.5 billion. Even better news is that recent surveys have repeatedly showed companies reporting increased export orders. One thing is clear: exports have the potential to drive growth.

However, the global marketplace is likely to become an increasingly competitive environment. And the potential for trade wars is threatening the global recovery. The government is rightly keen to promote UK exports, something which is clear from current Trade Mission to China. The importance of trade missions should not be understated. However a long-term strategy for growth is what industry needs to provide the clarity and certainty that will enable the necessary investment to drive exports. Therefore, manufacturers will be looking to the Prime Minister to make good on his commitments to back industries where the UK has a competitive advantage in the government’s upcoming White Paper on growth, and the Manufacturing Framework.

How can government build on the current strong growth rates?

Felicity Burch November 01, 2010 14:30

The manufacturing PMI for October is out and – at 54.9 – it is both higher than expected and indicative of an acceleration in manufacturing output.  The PMI now shows that there have been thirteen months of expanding output, and eleven months of faster-than-average expansion in manufacturing sector since the recession ended.

Figure 1: Manufacturing PMI

This is good news, but after two months of data suggesting that growth was slowing, it must be remembered that the PMI is a volatile indicator. The last time manufacturing came out of recession the PMI was so volatile that it returned to the below-fifty level associated with contraction for some time. Manufacturing output was also unsteady.

At this stage of the recovery, growth cannot be taken for granted. As we have already noted, there remain significant downside risks to the recovery. Given that increased exports are currently driving growth, the possibility of a global currency war is particularly concerning. In addition reduced domestic demand as a result of consumer caution following public sector cuts will hurt companies who are more UK-focused. For these reasons, the government must deliver on its growth strategy. It can do this by: becoming a better partner to business; providing clarity and stability; and investing in the UK’s productive capacity.

Growth story so far - UK:OK?

Felicity Burch October 26, 2010 10:31

Today’s GDP figure, showing quarterly growth of 0.8% may look a little below par compared with second quarter growth of 1.2%, but there are three things to note here.

The first is that 0.8% is a good figure:

The long term average growth rate (between the end of the recession in the 1990s and the start of the recession in the 2000s) was 0.68%. Compared with this, 0.8% is actually slightly higher.

Figure 1: GDP growth compared with long-term (non recession) average

The second point is that growth tends to be a bit bumpy coming out of recession:

In the few years following the recession in the 1980s quarterly growth rates oscillated between -0.7% and 1.5%; similarly in the few years following the 1990s recession growth rates swung between -0.2% and 1.4%.

In addition, the last quarter’s strong growth was in part due to the economy catching up from a low base. This sort of rebound cannot be expected to continue over a sustained period. In fact, if we allow for the impact bad weather in Q1 had on Q2’s growth figures, underlying growth in Q3 was broadly similar to the second quarter.


Finally, the cumulative figure looks good:

Compared with previous recoveries, the economy has gained more ground at this stage than was the case in the 1980s or the 1990s. GDP is now 2.8% higher than in was at the end of the recession. At this stage in the 1980s this figure was 2.0% and in the 1990s this figure was 0.5%.

Figure 2: GDP index (last quarter of recession = 100)

However, forecasts suggest that, after this quarter, the pace of growth will be slower than it was following the 1980s and 1990s recessions. This reflects significant downside risks to the recovery, including the possibility of a global currency war, and domestic consumer caution following public sector cuts.

For this reason, the government must deliver on its growth strategy to ensure that manufacturers and the rest of the private sector are able to create jobs, generate wealth and make the investment needed to rebalance our economy.

 

What are the alternatives to a currency war?

Jeegar Kakkad October 11, 2010 09:38


Brian Cronin via Wall Street Journal

Writing in the Wall Street Journal, Douglas Irwin (an Economics Professor at Dartmouth College) looks at what history can teach us about how currency wars tend to escalate into trade protectionism:

"...[I]f some countries intervene unilaterally—as China is rightly accused of doing, with other countries appearing to follow suit—nominal exchange rates are affected; goods priced in Chinese yuan become cheaper when purchased with dollars or euros. The experience of the 1930s shows that this sort of situation breeds trade disputes and can trigger a protectionist response."

But he notes that a currency war doesn't have to lead to a trade war. For example, during the Great Depression, countries that left the gold standard were able to grow their economy through expansionary monetary policy, boosting growth. Others stuck to the standard and had no other economic policy tool but protectionism. Irwin says:

"Had it been coordinated so that exchange rates did not change abruptly, protectionism could have been kept at bay."

So coordination on exchange rates will help keep concerns on currencies from becoming trade tensions.

But even if all the world powers struggle to agree on coordination (as appears to be the case from this weekends meetings at the IMF), then Irwin say that expanding monetary policy can be an effective means of combating others manipulations:

"If all major central banks were to intervene on foreign exchange markets to drive down the value of their own currencies, none would succeed in changing nominal exchange rates, but it would be equivalent to a world-wide easing of monetary policy....If [growth meant] fears of deflation were to subside and employment were to expand more rapidly, the pressure for a protectionist response from Washington would dissipate. When the economy is performing well, currency disputes become background noise."

This may be part of the reason the US Fed is looking at more quantitative easing.

What does this mean for the UK economy? Well, the simple implication is that if coordination fails, looser monetary policy might help buffer our economy from any global economic turbulence.

Whether that fits with the Bank's inflation target is a question for another day.

 

Disclaimer
This is an informal blog about manufacturing and the economy written by EEF's policy and representation staff. While it is written from an EEF perspective, contributions should not be taken as formal statements of EEF policy, unless stated otherwise. Nor does it cover all the issues on which we campaign - you can check these out in more detail at our main site.

We welcome and encourage comments, but we reserve the right to remove any that are offensive or irrelevant. We are not responsible for the content of external internet sites.

About EEF

EEF helps manufacturing businesses evolve and compete.  We provide business services that make them more efficient and management intelligence that helps them plan.  Our work with government encourages policies that make it easy for them to operate, innovate and grow.

Find out more at www.eef.org.uk