Sterling silver lining?

Some of my Year 11 students are fully signed up members of Citreon C4 Picasso admirers club. My own Picasso won't be getting its second outing to its homeland this summer because of the collapse of sterling - the Waltons will be holidaying in the UK.

It seems that holiday companies Pontins and Butlins are banking on more of us doing the same. Pontins are investing £50 million in their UK holiday facilities after a 20% increase in summer bookings. And Butlins is moving up market, opening a 'boutique hotel' in Bognor Regis (boutique in Bognor?). Families planning a trip to Cornwall could be disappointed as many holiday cottages are reportedly fully booked. Good illustrations of the impact on business of changes in the exchange rate.

The collapse of serling (the trade-weighted index is down almost 25% from its peak in 2007) is also worth Year 12 economics students exploring. One of questions posed in recent lessons was the relative importance of each of the components of aggregate demand (AD). Inevitably, most attention focused on the importance of consumer expenditure. Such a dramatic fall in the exchange rate, though, can have a significant expansionary impact on AD. Economists have a rule of thumb that each 1% fall in the exchange rate has the same effect on the economy as 0.25% cut in interest rates. If this is right, the collapse of sterling is equivalent to a whopping 6% cut in interest rates. On top of the interest rate cuts announced by the Bank of England, the expansionary impact is incredible.

As the full effects of both the falls in sterling and the interest rate have yet to fully feed through to output, maybe there is a silver cloud on the horizon?

My challenge
What are the parallels between this story and the UK's exit from the Exchange Rate Mechanism (ERM) in the early 1990s?

Impact of exchange rates on business

My Year 11 GCSE students have had a quick introduction to exchange rates in today's lesson. Tomorrow we will be considering the importance of exchange rates to business. A great illustration of the problems created by changes in exchange rates is to be found in today's news, with British Airways experiencing rising costs due to the fall in the value of sterling on foreign exchange markets.

Click here to read the short BBC article about the impact of the exchange rate on BA's costs.

Other useful weblinks

Robert Peston on the impact of the weak pound on retailers such as Next

Latest on the falling pound

New international debt crisis looming?

A new and worrying twist to the global financial crisis emerges today.

If we didn't know it already, the lesson of the past few months is that we can't go on living beyond our means. What applies to individuals also applies to countries who import more than they export. The difference between what a country earns (its export revenue) and what it spends abroad (its import bill) has to be paid for. This difference is known as a current account deficit on the balance of payments. Countries bridge this gap by attracting flows of money, measured on the capital account of the balance of payments. These flows take many different forms - foreign direct investment and private and public sector borrowing. All very well if those providing the capital carry on doing so or don't want it back in a hurry. Not so good if this source of long-term capital dries up or the investors want their money back.

Just as a loss of confidence in the banking system causes individuals to withdraw their cash (a run on the banking system), a loss of confidence in a country's ability to repay its 'debts' causes a run on the currency. Capital flight, as it is called, can send a currency into free fall and countries going cap in hand to the International Monetary Fund (IMF).

So much for the theory. It's happening. According to the BBC's business reporter, Robert Peston:
Queuing up for the intensive care ward are Iceland, Hungary, Pakistan, Ukraine and Belarus, all of which are in discussions about accessing special loans from the International Monetary Fund, the emergency medical service for the global economy.
But there has also been a substantial withdrawal of capital from South Africa, Argentina and - most worrying of all - South Korea.

South Korea's balance between its exports and imports (its balance of trade) is much healthier than the UK's and they are not nearly so dependent on financial services as a source of export revenue. Sterling is falling on the foreign exchange markets. Is this the start of a new international debt crisis? Will the UK be next in the queue at the door of the IMF?

Read Robert Peston's excellent blog here.