I argued in my previous blog that sterling is overvalued. Objections to this usually take one of two forms. The first is to argue that UK exports are uncompetitive, not because of the exchange rate, but because of the general failing of UK manufacturers: they do not invest enough in research and design, are insufficiently aggressive in seeking out new markets or otherwise incompetent. All of this may or may not be true but strikes me as beside the point. They are what they are. Government exhortations to improve their behaviour seem unlikely to be fruitful and far less effective than a fall in the real exchange rate. This would not only make UK exports more competitive, but would raise the profitability of exports and encourage both capital and competent management to move into the sector.

The second objection is to claim that sterling has been weak and that the failure of this weakness to improve exports shows that the exchange rate is not to blame.

The problem with this argument is that, by selecting different starting points, sterling can be shown either to have fallen or to have risen. For example, by April 7 this year sterling has risen by 58 per cent against the US dollar since February 26 1985 and fallen by 18 per cent since July 31 2007. Read more

Last year the UK ran a fiscal deficit of 6 per cent of gross domestic product. Its main counterpart, as chart one (below) shows, was the current account deficit – ie, 70 per cent of the deficit was financed by foreign savings (RoW). (Due to statistical discrepancies, which I have added to the rest of the world, the figures shown in the chart for foreign inflows are almost but not exactly equal to the current account deficit.) The data go back to 1987 and, as the chart shows, the UK has run a current account deficit in every year since then. If the fiscal deficit is to fall, so must the current account deficit.

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Fixed capital investment, which excludes changes in inventories, comprises business investment in equipment and intellectual property, such as research and development, government investment and housing. In total, as I show in chart one, there has been a slight pick up since the trough of 2010 but, as a percentage of gross domestic product, it is still lower than it has been in any year between 1948 and 2008. This is the case for business investment in plant and equipment as well as for investment in total.

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Before the recession of 2008/09, the US economy grew fairly consistently at about 3 per cent a year. This was, for example, the growth rate achieved up to the end of 2007 whether it is measured over the previous 20 or 30 years. In the four years since the economy hit its nadir at the end of 2009, it has grown at 2.6 per cent a year. It is widely assumed that the trend growth rate of the US economy, ie, the long-term potential growth rate of the US economy, is at least equal to this lower rate of 2.6 per cent a year. Read more

Japan increased its consumption tax from 5 per cent to 8 per cent on April fools’ day. It seems unlikely that the negative impact of this on demand will be totally offset by other changes in the budget. There is therefore a risk that Japan’s economic growth this year will fail to match its trend rate (ie, its economy will grow less than its potential). The most likely way that this will be avoided is for Japan’s exports to pick up.

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The Chinese government decided some years ago to keep its exchange rate undervalued by buying foreign currency and building up its foreign exchange reserves. The result has been dramatic. Reserves have risen by $3tn over the past seven years. This has occurred despite a strong rise in the exchange rate, as I show in chart one.

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Japan has a national debt amounting to 250 per cent of its gross domestic product and, as its fiscal deficit is running at about 10 per cent of GDP, the ratio is rising rapidly. At some point this will cause a crisis. What cannot go on for ever will stop; when I do not know, but Japan does need to start bringing down its budget deficit and it will not be able to do this unless it reforms its corporate tax system and, in particular, brings down sharply the allowance allowed for depreciation. Read more

“When will the Bank of England raise interest rates?” is the usual question. “When should it?” is the important one. The bank has a long history of “acting too little and too late”. As I explained in inflation and deflation, inflation is more dangerous than deflation and prudent central bankers would rather act too soon to raise rates than be too late and then be forced to cause a recession to get inflationary expectations back under control.

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The Japanese government is trying to encourage the country’s companies to increase the amount they invest. This is like trying to push water uphill. Japan as a whole and in terms of business already invests too much.

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Comments are flying around about whether inflation or deflation is the greater risk. This is almost invariably interpreted as asking which is the most likely and therefore misses the central point. Inflation is a much greater risk – not because it is more likely but because its consequences are far worse.

Deflation has been demonised. It has been harmless or even beneficial in Japan. While I think it would hurt the eurozone, its impact would be mild and easily reversed – or it would be if German economic policy was not so obstinately foolish. Inflation poses a much more serious problem, particularly in Japan, the UK and the US. Read more