DEVALUATION – TRICK OR TREAT?

“The impossibly high exchange rate is pushing up interest rates and turning Britain into a rust-bucket economy,” declared John Edmonds, general secretary of the GMB general union, at the TUC congress in Blackpool last week. “Most people in industry know that the pound is overvalued against the Deutschmark. Realignment is now in­evitable.”

At the time, Edmonds was careful not to call explicitly for a unilateral devaluation of sterling, although it was clear that he thought that such a devaluation would be better than inaction. By Sunday, however, after the devaluation of the Italian lira, he came out explicitly in favour of similar treatment of the pound, describing the British failure to devalue at the same time as the Italians as a “missed opportunity”.

What is most remarkable about this in­tervention is that Edmonds is not the usual sort of Labour devaluationist. He is a long-standing enthusiast for European eco­nomic and monetary union (the GMB tabled the pro-Maastricht motion at the TUC) and a firm believer in British mem­bership of the exchange rate mechanism of the European Monetary System. In recent years, Labour proponents of devaluation have typically been Euro-sceptics, oppo­nents of ERM membership (or at very least unenthusiastic about it) and believers in a national-Keynseaian approach to economic management.

Probably the most consistent and coher­ent spokesmen for this point of view have been Peter Shore, the veteran anti-EC Right-winger, and Bryan Gould, now Labour’s spokesman on national heritage. Both of them start from a belief that ster­ling has been consistently over-valued for years. Gould made devaluation one of the cornerstones of his unsuccessful campaign for the Labour leadership and deputy lead-leadership earlier this year. “If we continue to defend an overvalued currency we will continue to crucify manufacturing in­dustry,” he told Tribune in May.

Gould has moved away from advocating unilateral devaluation of sterling: he now favours devaluation as part of a general re­alignment of currencies within the ERM. But his position is still tied up with opposi­tion to the process of European monetary union laid out in the Maastricht treaty. His assault last weekend on “governments which persist in defending an overvalued pound” followed a swingeing attack on the deflationary implications of Maastricht. The same hostility to Maastricht charac­terises the other prominent Labour politi­cians who have spoken out in favour of de­valuation in the past week: John Prescott, David Blunkett and Peter Hain.

It is, of course, unsurprising that the question of devaluation has been linked with that of Maastricht. The ERM semi-­fixed exchange rate system is envisaged by Maastricht as a stage in the process that ends in a single European currency and a European central bank. Even if the thesis that sterling has historically been overval­ued is wrong (and it is notoriously difficult to prove either way), there is no doubt that the pound’s value in the ERM has been sus­tained in recent months only by govern­ment intervention in the money markets and by high interest rates, which are hold­ing back the recovery of the British econo­my.

But what Edmonds’s intervention indi­cates is that there is a growing belief even among Labour supporters of the ERM and the Maastricht treaty that the government’s policy of maintaining sterling’s val­ue is having a disastrous effect on the British economy and that it is not enough for Labour to respond by changing the sub­ject or by arguing that the Deutschmark should be revalued upwards against the other ERM currencies.

On the Edmonds view, the problem is not with the ERM, semi-fixed exchange rates or economic and monetary union in principle but with the attempt to maintain ERM par­ities despite Germany’s decision to put up interest rates to dampen inflation in the wake of German unification. As a result, all the other ERM member countries, and all those with currencies “shadowing” the Deutschmark or the European Currency Unit, were forced to put up their own inter­est rates in order to maintain their curren­cies’ value against the Deutschmark. The Bundesbank eased the pressure on interest rates everywhere except Britain with its minuscule cut in interest rates on Monday, but the Deutschmark remains undervalued against most of the other European currencies.

Although the simplest solution would be simply for the Germans to revalue the Deutschmark upwards against the other ERM currencies, the argument goes, the unwillingness of the Germans and French to sanction any such course means that Britain should devalue sterling just as the Italians devalued the lira on Sunday.

This position would have been anathema to the Labour leadership before the elec­tion, partly for tactical reasons – devalua­tion means price increases on all imported goods, which would be difficult if not impos­sible to sell to voters, and the very prospect of a pro-devaluation party coming to power would create turmoil on the currency markets – but partly because of scepticism among Labour’s advisers about the useful­ness of devaluation as a tool of policy.

Devaluation, the sceptics argued, is not a means of cutting interest rates. It works (insofar as it does) by cutting real wages and could easily set off an uncontrollable spiral of wage and price inflation. Worse, in Britain it would not work very well. Domestic British manufac­turing was in such a dire state that British companies would not be able to meet the potential demand at home or abroad for competitively priced British-made goods. The priority for Britain was not devalua­tion but an effective strategy for overcom­ing the structural weaknesses of its econo­my: crumbling infrastructure, poor educa­tion and training and so on.

It is in this light that the reluctance of the Labour leadership in the past week to endorse devaluation must be seen. As Shadow Chancellor and trade and industry spokesman before the election, John Smith and Gordon Brown were wedded to an ap­proach to economic policy that eschewed devaluation; today, as Labour leader and Shadow Chancellor, they remain extremely cautious.

Smith responded to last week’s calls for devaluation by saying that he was “not in favour of a devaluation of sterling because that would not assist in reducing interest rates”, although he added that the EC should “not rule out a revaluation of the Deutschmark”.

His remarks were echoed by Brown, who announced that “Labour is not the party of devaluation”, emphasising the centrality to Labour’s approach of “an emergency em­ployment programme”, concentrated partic­ularly on housing and public works, and “concerted Europe-wide action” to bring down interest rates and end the recession. Brown reacted to the devaluation of the lira and subsequent Bundesbank decision to cut interest rates by calling for the British Gov­ernment to emulate not the Italians but the Germans.

Instead, after massive intervention by the Bank of England failed to stem specula­tion against sterling, the government put up interest rates by a total of 5 per cent on Wednesday. But sterling remains under pressure and many now believe that deval­uation is inevitable, particularly if the French vote no to Maastricht on Sunday. It would not take the most apocalyptic sce­nario now doing the rounds, complete col­lapse of the ERM following a French no, for Labour’s arguments over the past fortnight to be entirely irrelevant within a few days.