Cripptic Economics

October 25, 1948

Before the National Press Club in Washington on his recent visit, Sir Stafford Cripps, Britain’s Chancellor of the Exchequer, declared that the Labor government had “no idea whatever” of devaluing the pound sterling. He added that devaluation would “increase the price of our imports and decrease the price of exports, which is exactly the opposite of what we are trying to accomplish.” Later he explained that what he meant was that devaluation of the pound would swing the “terms of trade” still farther against Britain and require a larger volume of exports to pay for its imports.

Even if Sir Stafford’s theory of the exchanges were correct, his implied policy is hardly calculated to promote world revival. It treats an exchange rate not as something that reflects the real value of a currency, but as a weapon for exploiting other countries. The rate is to be manipulated so that the British can buy cheap and sell dear by forcing the rest of the world to sell cheap to and buy dear from Britain.

Sir Stafford’s theories, however, happen to be wrong. A nation cannot alter the terms of trade in its favor merely by manipulating its exchange rate.

Let us look at the matter first from the side of imports. If wheat is selling here at $2.16 a bushel, then a hundred bushels of wheat will cost the British $216. With the pound pegged at $4, they will cost the British buyer (ignoring subsidies) £54. If the pound fell to $3, the same wheat, it is true, would cost the British buyer £72. But it would not cost the British any more in dollars. And what Britain now complains of is not a pound shortage but a dollar shortage. The British Government can print all the pounds it wants. One of its troubles is that it has already printed too many.

Now let us look at the matter from the side of exports. The British sell cloth in our market, say, at $36 a bolt. At a $4 pound, the British exporter gets £9 for it. But if the pound fell to $3, the exporter would still be able to get $36 a bolt here. Therefore he would get £12 a bolt instead of £9. His sterling profits from export, and his incentive to export, would be that much greater.

Sir Stafford’s belief, therefore, that sterling devaluation would “increase the price of our imports and decrease the price of exports” is not true at all if we look at these prices in terms of dollars. And it is the supply of dollars about which the British bureaucrats are always complaining. If we look at these prices in terms of pounds, it is true that the price of Britain’s imports would be greater in pounds, but the exact opposite of the truth that it would get fewer pounds for its exports. On the contrary, it would get more.

It is the insistence of the British Government on keeping the pound above its free market value that is chiefly responsible for the chronic British trade deficit. An overvalued pound unduly encourages imports both of necessities and of luxuries. This forces the British bureaucrats to hold down imports by license, quota, and prohibition. And where the overvalued pound does not force British exporters to price themselves out of foreign markets, it makes the profit margin on their foreign sales so unattractive as compared with what they could get from domestic sales that the British Government has to order manufacturers to sell abroad, has to allocate goods for export, and has to forbid its own citizens from buying more British products than some arbitrary domestic allotment. Thus foreign trade is carried on by a series of compulsions on buyers and sellers, consumers and producers.

It is only Marshall-Plan aid that enables this system to keep going at all, by forcing the American taxpayer to pay for the trade deficit that the system creates. The European trade deficit could quickly be solved by free markets and free exchange rates, which would enormously stimulate exports at the same time as they would discourage imports. But most of the governments of Europe have no faith in free markets, do not understand their function, and will not permit them to operate. In addition, most European governments wish to conceal their inflations by holding down internal price levels by edict.