Effect of Current Devaluation on the Currency: Brexit and Manufacturing Industries

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29/03/19 Economics Reference this

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a) What are the immediate consequences for an economy of a devaluation of the currency?

b) To what extent is UK manufacturing industry in a position to take advantage of the fall in the value of the pound and increase exports since Brexit was announced?

Devaluation of a currency is the fall in the value of a currency compared to other currencies within a fixed exchange rate system. For example, the pound might depreciate against the dollar this means that the pound buys less dollars. Britain has had a lot of experience of a devaluing currency. In 928 AD you could buy 15 cows for £1, during world war one the pound dropped considerably £1 was equivalent to $4.7, in 1967 the pound devalued to the equivalent of $2.4 and in 2016 when the UK voted leave the pound dropped to a 30-year low. (Parker, 2016)

Countries who have a weak current account deficit and high inflation rate normally have a depreciating currency. If it depreciates slowly a depreciating currency can be good for an economy as it may improve its trade deficit over a period of time. However, a quick change may worry foreign investors, who could pull out of investments because they are unsure how much further the currency might fall, this puts a lot of pressure on a currency. (Radcliffe, 2017)

There are a lot of reasons why a country might devalue their Currency. This includes to make exports cheaper, which make the country more competitive to overseas buyers, this could increase the number of jobs needed in the export sector. As well as to shrink a trade deficit (when there are more imports than the value of exports). If exports increase and imports decrease this is because exports are becoming cheaper and imports more expensive this reduces the demand for the imports. Instead of importing expensive raw materials countries may look to produce them domestically. It can also increase economics growth which will cause a higher real GDP and a higher inflation. A government may want to reduce their debt expenses, so they devalue the currency to make their payments less over time. However, this could cause a currency war, which is a race to the bottom, as lots of countries do have some debt to pay. There are also other negative results from devaluing the currency, it causes uncertainty in the global markets that can cause a recession. It also causes high risk of inflation. Devaluing the currency is considered to be the last stage after all other methods have been tried. (Economicshelp.org, 2017)

There are people though who are benefitting from the devaluation of the pound. Visitors to the UK are as they have more money to spend, they get more pounds for there dollar or euro. Also British manufactures like it because their goods look cheap to foreign buyers. Foreign investors who find British assets or housing cheaper and UK firms who earn profits abroad. But people are suffering from the devaluation of the pound for British people foreign holidays are more expensive and it is more expensive to import goods. Foreign firms exporting to the UK. (Pettinger, T , 2017)

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The consequences of a devaluation of a currency includes is it likely to cause inflation. Increase in price of imports e.g. raw material and labour this causes cost push inflation (figure 1). Aggregate supply shifts left from AS1 to AS2, real national output decreases from Y1 to Y2. Demand of the goods remain the same causing the price to increase from P1 to P2. (Economicshelp.org, 2017)

Figure 1: Cost push inflation graph

Aggregate demand increases as the goods are more attractive causing Demand Pull inflation (Figure 2). It is caused by consumer’s demand being high. Lots of consumers purchasing the same good will cause the price to increase from p1 to p2. It is described as ‘too many dollars chasing too few goods.’ Demand pull inflation is caused by a quick rise in exports. Exports are becoming cheaper so manufactures have less incentives to reduce costs and become more efficient, overtime price will increase causing inflation. However, a rise in demand may not always cause inflation for example, when an economy is in a recession and there is spare capacity, if other components of AD were not increasing (AD=C+I+GS+X-M). Fewer incentives for firms will also cause inflation to rise as exports are cheaper for foreign buyers they become competitive without companies having to do anything therefore they have less reason to cut costs therefore costs will increase causing inflation. (Economicshelp.org, 2017)

Figure 2: Demand pull Inflation

The J-curve (shown below figure 3) is a curve that falls and eventually rises to above the starting point making a J shape. The j-curve effect happens when a country’s trade balance falls after a devaluation of a currency this causes the drop in the curve. The trade balance increases causing the curve to rise. If a currency appreciates there could be a reverse of the J curve. (investopedia, 2017)

Firms and exporters do not need incentives to reduce costs as they can now rely on the devaluation of the currency to improve competitiveness. There is a long term concern that devaluation can cause a drop in output because of the decline in incentives.(Economicshelp.org, 2017) It makes it more expensive for British people to go abroad because they get less money for their pound. Imports become more expensive e.g. raw materials and petrol. This reduces demand for the imports. The pound depreciating also makes it less attractive to foreigners to come and work in the UK, it also makes it more attractive for British workers to work in America where the dollar is higher. (Pettinger, T., 2017)

Brexit is short for Britain’s Exit. It is talking about the outcome of the referendum that happened in June 2016 for Britain to leave the European Union. The result was not expected and caused the pound to fall against the euro, and the Prime Minster to resign. The process of actually leaving the EU started in March 2017. (Floyd, 2017)

Manufactures do well from a fall in the value of the pound as it makes exports more price competitive. Rain Newton-Smith who is the CBI chief economist said “UK manufacturers are firing on all cylinders right now, with domestic orders up and optimism rising at the fastest pace in two years. The weaker pound is driving export optimism for the year ahead but is having a detrimental impact on costs for firms and ultimately for consumers.” This is saying that the manufactures are benefitting from the devaluation, they have had an increase in the number of sales but it is a disadvantage for the consumers as goods for them are now more expensive and for firms as it is more expensive to import raw materials. (Elliott and Kollewe, 2017)

Exchange rate movement is the biggest concern for them as it creates a risk for manufactures business plan. The graph below (Figure 4) shows this- more people thought it as a risk to their business plan after Brexit at 75% than before at 42%. However, the manufacturers that sell locally are failing due to customers not wanting to buy their products e.g. cars. Since the Brexit result manufacturers are finding that imports are rising so are finding it difficult to buy raw materials, the devaluation of the pound starts off good. The restrictions of free movement of people within the EU could create issues with finding labour in factories and other parts of the manufacturing supply chain. If migrants are made to leave the UK it will cause more disadvantages for the manufacturing industry. UK workers may expect higher pay and EU migrants are willing to work for less, and they may have to train staff as they lack skilled workers. In August net migration was at its lowest it has been for 3 years, mostly caused by EU citizens leaving and few entering after Brexit. (Inman, 2017)

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Figure 4- A graph showing what manufactures opinions on what they actually think of the exchange rate movements.

The amount currently being invested into plant and machinery by the UK manufactures has decreased and is currently at 6.5% turnover whereas 7.5% last year. This is because companies have stopped investing as they want more information on what is going to happen with the Brexit deal. (Monaghan, 2017)

The UK’s factory output has risen in the last 5 months because of the weaker pound and the global economy rising. Manufacturing production has increased by 0.7% last month and 1.1% in the third quarter of 2017 as seen on the office for national statistics. It also looks like the trade in Britain is improving, after the trade deficit being down in September by £700 million. (Elliott, L, 2017)

The UK car industry have been hit hard from Brexit, the new tariffs could cause an increase in price of an imported car and make exports more expensive too.  It will increase the price for manufactures too as delays in customs could cause up to £850,000 costs a year. People believe that the choice of cars in the UK is going to reduce as less people will trade with the UK. (Roberts, 2017) Also the number of cars sold in the UK will decrease as it is more expensive for UK manufactures to import good such as component parts. It was said that car manufacturing was down 13.7 per cent in June compared to the previous year and that for the long term it is going to be terrible for the industry. The government have announced conventional internal combustion engine cars must not be sold by 2040 and that the UK need a manufacturing facility to produce electric and battery operated cars. (Grady, 2017)

Manufacturing which is 10% of the economy has grown by 2.7% over the past year but it remains lower than it was when the UK were in the deep recession in 2008/9.  (Elliott, 2017)

The manufacturing industry is largely the cause of the economy growing, in the last three months of 2016. Gross domestic product increased from 0.7% to 0.6%.  (Kollewe, J,  2015)

In October the FTSE 250 which is large companies listed on the stock exchange but aren’t big enough to make it onto the FTSE 100 was closed at a record high of 20,251.24 which is up 0.41% and FTSE 100 met a record high of 7,556.24 points. The increase for the FTSE 100 AND FTSE 250 has been due to Brexit discussions (the talk about the divorce bill). (Wearden, G. 2017)

Unemployment has been rising and the fall in the value of the pound is making exports cheaper and imports more expensive but the retail figures only look acceptable because of the boost in the spending from tourists overseas. (BBC, 2015)

After the second world war the pound was worth four US dollars, the old pound was worth $2 but now the £1 is worth $1.30. It plunged after the financial crisis. Now after the Brexit vote the pound is down 11% against the dollar and 15% against the euro and continued to drop for several months after. The devaluation of the pound is causing uncertainty therefore causing some traders to sell their sterling. Devaluation can cause low interest rates- these have been very low since 2009 but have lowered to 0.25%. Low interest rates are good for borrowers (e.g. mortgage owners) as they will see a lower interest rate, the currency will fall which is good for exporters, the government can borrow from the private sector at low interest rates reducing the interest costs on public sector debt. Low interest rates are bad for banks as they find it hard to be profitable and attract deposits, although it is cheap to borrow it may be hard to get the necessary finance and savers will get lower interest payments on their savings. (Pettinger, 2017) Faltering growth and high inflation (in 2016 inflation was 0.4% but it has risen and is currently at 3%). Only when the future of the UK is clear is the pound likely to settle down. (BBC News, 2017)

Since the pound is depreciating it is likely to encourage the change away from imports to locally produced goods and services will have become reasonably cheaper. However, international trade is important for the economy. About 28% of goods and services that we produce are sold abroad and 30% of what we buy comes from other countries. Our main trade partners are the US and European countries. Imports have been increasing over the past year despite the devaluation. (Walker, 2017) The devaluation has made it cheaper for exports and more expensive for imports, yet in May the UK’s imports increased by 4.8% and exports only increased by 2.5%, this caused a larger trade deficit from £1 billion to £11.9 billion. Also unemployment levels in the UK have fallen, but business growth has fallen, and earnings are low. (Elliott, 2017)

Brexit is the main reason for the devaluation because the UK left the EU with no trading relationships and so has also lost its biggest trading partner who is the EU.  They could trade between EU countries and not have to pay any tariffs. This is known as the single market which was created in 1992 and allows free trade between EU like it were a single country. (Hunt and Wheeler, 2017)

Deindustrialisation is a steady decline of the manufacturing sector as a percentage of total economic activity. Deindustrialisation is the opposite of industrialisation and is a decline in the growth of an economy. It can be measured by the percentage share of the economy. UK has been in a period of deindustrialisation the reasons for the decline are not enough money has been invested into new technology, there is limited government support. (Crossman, A, 2017)

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In 2016 the UK decided that they would leave the European Union. The UK paid 13.1bn but received a 4.5bn for spending while part of the EU. When joined with the EU the UK got free trade and inward investment.  Now they have the opportunity to make their own trade agreements. More jobs will be lost as their wont be free movement of people across the EU which create a lot more job options for people in the UK. (The Week UK, 2017)

Overall, the devaluation of the pound was expected to benefit manufactures as their goods looked more competitive to foreign buyers. However, the cost of imported goods used in manufacturing has also increased. The manufacturing sector benefitted initially but no longer are. Therefore, they are not in a very good position to take advantage of it.


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