Brexit harm denial and the exchange rate

There seems at the moment some confusion in the Brexit camp: is all the bad news just wishful imagination by Remainers, or is it real but caused by Remainers. Some specific thoughts on the extraordinary Telegraph editorial are here, but one event that was not in anyone’s imagination was the depreciation in sterling as the result became known. Brexiters tend to think markets know what they are doing, so they have resorted to all kinds of arguments why this depreciation was not really bad news.

First, the reason why it is bad news. A depreciation in sterling makes everyone in the UK poorer, because the goods we buy that are made overseas or sold in world markets (oil) will cost more. That this depreciation happened as a result of the vote is beyond dispute. So what do Leave apologists have to say in response? So far I have heard the following.

The depreciation has a good side, because it gives a boost to our exporters.

Economists say never reason from a price change, but instead ask why prices have changed. There are two possible reasons why sterling may have depreciated immediately the vote was announced. The first is that markets think UK exporters need to become more competitive in the longer term to offset the impact of Brexit, because Brexit will make it harder to export to the EU. In short, we are poorer because of Brexit.

Now it is true that markets are anticipating a future event (Brexit has not happened yet), so in theory there will be a short term boost to exports as firms benefit from the depreciation now, but the costs of Brexit come later. But that brings us to the second reason for a depreciation: markets believe Brexit will cause an economic downturn in the UK, implying lower levels of UK interest rates. (In this they have been proved correct). The fact that they were expecting lower interest rates even though exporters get a short term boost tells you that this boost is at best just going to make things a bit less bad than they might otherwise be.

Either way, any short term benefits from the depreciation do not offset the fact that we are all poorer as a result.

Sterling was overvalued anyway

This is an argument put forward by Daniel Hannan. The idea is that a depreciation was going to happen anyway. It is an argument that makes no sense. Suppose you think the price of coffee is too low because markets have underestimated future demand from the US. An unexpected blight then wipes out half the coffee trees in Latin America, and the price shoots up. It is ludicrous to then say no problem, the price was too low anyway. The markets are still underestimating future demand from the US, and when they realise this the price will rise further still.

Sterling is only back to where it was ….

Imagine your earnings vary from month to month because of bonuses. Your boss cuts your basic pay, and tells you not to worry because when you add in the average bonus it is still going to be higher than when bonuses were really low. If you think that actually means your pay has not been cut, then you will be convinced by this argument.

It is just a temporary problem before things become clearer

This argument might just work, but only if you admit things that Leavers tend not to admit. First, it seems reasonable to assume that the short term economic downturn is because firms do not yet know what kind of Brexit we will get, and are putting things on hold until they do. Putting things on hold causes the Brexit Bust, which means the Bank cuts rates, which depreciates sterling. Now move forward to the date where things become clearer, and suppose the outcome is much better for trade than it might have been. (Basically we stay in the single market and accept free movement of labour.) The economy then recovers, interest rates rise, and sterling appreciates. If that happens (and it is a big if), all we need to do is ask who was responsible for all this uncertainty and the temporary damage it caused.