Euro arguments

I debated the euro with Peter Oborne of the Daily Mail yesterday on Radio 4's You and Yours phone-in programme. It wasn't quite down to Galloway levels, but it was not a discussion characterised by profound mutual respect.The Mail ran a news story - a news story - on 28 December 2001, three days before the introduction of euro notes and coins that began: "Holidaymakers will face chaos when they go to the Continent as shops and businesses battle to get used to the euro from January 1." And the newspaper's confident predictions about those bungling foreigners have been undiminished since.

Sean O'Grady, the economics editor of The Independent, wrote an article last week entitled "Why I am Glad We are Not in the Euro". Slightly to my surprise, as "a fellow, but far less distinguished, son of Leicester", he commended the views of the late Sir Alan Walters. (As I pointed out in my post on Walters, I'm a son of Leicester too. Sean, the economics writer Chris Dillow and I all attended the local grammar school. Higher up the school was Andrew Bailey, now the Chief Cashier of the Bank of England, whom I ritually greet with the feeble joke that it's kind of him to take time from his busy schedule of signing banknotes.)

Walters's famous critique of the system was wrong. He argued that the ERM would result in a convergence of nominal interest rates, thereby ensuring that, perversely, higher-inflation countries would have lower real interest rates. They didn't. It may seem pedantic to point this out, given that the ERM did fail, as Walters predicted. But it's important to be clear on the reason. The ERM failed because policymakers were reluctant to subordinate exchange-rate stability to other goals. The same policy dilemma doesn't apply to the euro, because by definition there is no longer any exchange-rate volatility between the eurozone's members - they have a common currency.

I'm sceptical that the sharp depreciation of sterling in the second half of last year will provide respite from the recession, as Sean suggests. (November's trade figures are dominated by the collapse of global demand.) Competitive devaluations can work in certain circumstances. They do so by cutting real wages (through an increase in import prices) while the nominal wage remains constant. But opponents of the euro never, from my experience, deal with the costs of the vaunted flexibility of a floating exchange rate.

You can't just choose the level of sterling on the foreign exchanges: exchange rates are set in the asset markets, and asset prices overshoot. I have never come across a trader, a fund manager or a financial economist who disputes this. So far from protecting us against shocks, a flexible exchange rate may itself be the source of shocks. This, in my view, is what's likely to happen to the UK owing to the financial crisis. The risk premium on UK sovereign debt will rise because of the exchange-rate risk to international investors holding sterling-denominated assets. There is a cost, in the literal financial sense, of staying out of the euro.

The notion (which Oborne is strong on) that smaller eurozone members will seek sanctuary outside the euro is - ahem - not borne out by recent experience. On the contrary, opinion is swinging sharply in Denmark and Sweden towards euro membership. Iceland (which is not even in the EU) and Hungary will be desperate to join. Among other reasons, countries with currencies that are not widely used internationally have a problem where their banks have substantial liabilities denominated in euros. As Barry Eichengreen writes:

"It is European countries outside the euro area, still with their own currencies, that have suffered the gravest difficulties [in the financial crisis]. Because their currencies are not widely used internationally, many of their bank liabilities are in euros. They can't print the euro liquidity that the banks desperately need. This renders them dependent on interest rate hikes to attract that euro liquidity via the market and on swap lines from the ECB. So far, those swaps have been forthcoming, but with delay and political baggage attached.

"The implication is clear. National banking systems need a lender of last resort. In small countries, where a significant share of bank liabilities is in someone else's currency, the national central bank lacks this capacity. The only options are then to slap draconian controls on the banking system or join the euro area."

It's all very well to say the ECB has been slow in easing monetary conditions. The Bank of Denmark increased interest rates in October (though it has since cut them by 50 basis points) for the reasons Eichengreen identifies.

All the predictions made by the eurosceptics about the euro have been wrong. They said the euro wouldn't get off the ground; that there would be an exchange-rate crisis as the date for monetary union approached; that the euro would spark chaos for consumers; that the euro would fall apart in the first sign of economic crisis. Oborne now forecasts that the euro will collapse within the next decade. I'll offer my own prediction. There will be drastically fewer European currencies in 2019 than there are today; and the euro will be overwhelmingly the most important of them, to wide economic and political benefit.

Comments

[Blimpish]

Not that it's directly relevant to the context in which you raise him, but you don't mention that Eichengreen explicitly discounts Britain from that analysis at the end of his paper, because its currency has a sufficient market use to stand outside.

(From yet another son of Leicester, although Wyggeston Boys had become a sixth form by my time.)

[James Hamilton]

Interesting to know that about Dillow; he likes to give the impression that he grew up in a cardboard box at the wrong end of the ditch.

[David Duff]

Well, I have just listened to most of the programme - the joy of the play-back system is that one can skip through the various 'fruit 'n' nut' cases who 'phone in.

I realise, Oliver, that you eschew too much passion in your political discourse probably because you realise that remaining cool and detached gives you the advantage over the impassioned, but even so, you were, I thought, less than convincing. In your own words, paraphrased from memory, 'the micro economic advantages of joining were very strong but the macro advantages were equivocal'. Hardly much of a rallying call. (Still, you are an intellectual, not, thank the 'Intelligent Designer', a politician or a salesman!)

You kept pointing to the disadvantages of exchange rate volatility. Well, obviously, at either *extreme* (and I do mean truly EXTREME!) which we have not yet reached nor anywhere near it, it can be hugely damaging. But what of the *advantages*? First of all I consider an exchange rate to be the equivalent of price information, it tells you at any time what those with no other consideration except making money think the value of our currency, which reflects our economic worth, will be in the future. That tells an ignoramus like me how well or badly our government is doing judged by outsiders. Now, I am not totally naive, I realise that the collective wisdom of the markets can get it wrong, and indeed, the exchange rate is always an expression of a comparison between one country and another, but even so, I would rather have it than not.

Finally, and if I appear suspicious of your motives it is because, as a pro-European you mix in dodgy circles, you had very little to say concerning the political dimension. The whole thrust and purpose of the EU movement is, and always has been, political. Now here, even more than in the debate over the economics, nothing can be proved, everything is a matter of judgment. Mine tells me that the European system of government has very, very strong anti-democratic tendencies and we enter it at our peril. The pro-Europeans always keep very quiet, when they are not actually lying (see Heath, Ted: passim) about the political ramifications of us joining the Euro, and I wonder why? "J'accuse!"

[Michael James]

You seem to avoid the strongest microeconomic argument against Britain's membership of the eurozone, advanced by several prominent commentators, which is that its interest rate was too low for the UK, and would have generated an even more severe housing boom and bust than we've had (as in Ireland and Spain). Long-term economic convergence would solve the problem, but it isn't happening; if anything the eurozone economies are diverging further on a rough north-south divide, making the single interest rate even more contentious.

These may not be knockdown arguments against the UK adopting the euro, but you will surely have to address them if you want to make a convincing case for us joining the eurozone.

[Tommy Murphy]

Great

[SteveF]

if I appear suspicious of your motives it is because, as a pro-European you mix in dodgy circles

What, Bilderberg?

It's nice to see that good old fashioned raging paranoia still has a place at the anti-European table.

[David Duff]

Sorry, Steve, are you telling me that the line spun by Ted Heath 'et al' during the referendum to the effect that we had simply joined a free trade area was, as I like to think of it, the 'actualite'? Personally, then and now, I thought it was a load of bull manure but a lot of people believed it then, which is understandable, but a tiny minority believe it now, which is not.

You say 'paranoia', I say 'fanaticism', let's call the whole thing off!

[Andrew Duffin]

Two points:

1. The current crisis is hardly over; in fact it may barely have begun. Let's wait and see what happens in Ireland, Greece, Spain, and Italy, before we conclude that only small countries on the periphery of the Empire are having serious problems.

2. How about the argument from principle that we ought to run our own affairs even if that leaves us worse off, because we prefer to be a free, self-governing people? Does that argument have no merit at all amongst the elite?

[Lorenzo]

Speaking as an Australian and therefore a user of a dollar which bumps around so much it is sometimes nicknamed "the Pacific peso", I would not worry too much about negative exchange rate shocks as such.

Our collective experience has been that the shock-absorber effects of a floating exchange rate easily trumps any other disadvantages.

Of course, our financial institutions have also largely avoided the current fracas. Largely, I suspect, because our prudential regulation is strong; though that judgement is provisional on what any fallout proves to be if and when our housing bubbles burst.

[Anth.Sun]

This is a rather long post again (my apologies for that), but I do find this topic so important interesting and fascinating! I listened to the debate on BBC I Player – my first experience of it, and I thought the programme was excellently presented by the BBC presenter (Mr Worricker) with very interesting contributions from all concerned, including the two protagonists, and those contributing by outside broadcast, live phone in calls or by email.

The point that really interested me was in the political section of the programme, (the programme divided in two, the first half dealing with the economic argument, the second the political argument, the latter focused on whether the sovereign states of the EU felt that their independence had been diminished through joining the Euro, with contributors including English people living in France, commenting that the Euro had the French equivalent in francs appearing on bills (which is the case), and discussing whether each nation was free to print an image of its own on its Euro currency), when Peter Oborne raised an argument in reply to Oliver’s, which had never really occurred to me before.

Referring to France, he said that France’s history, politically speaking, had been disastrous during the last century; it had a great cultural language literary and gastronomic heritage, but “as a political project”, the last one hundred years had been disastrous for France, alluding to its invasions and defeats in two world wars, and the Vichy government, while Germany, he continued, were terrified of their history. One can but assume, however, that they too are proud of their cultural and literary traditions and achievements (which are manifest) although that was not commented upon. This compared with Britain which had a strong history, and one that it was rightly proud of, as in rising up against Nazism, we defended freedom. We had made a great contribution to the world. Apart from thinking that if we joined the Euro, our sovereignty would be up for grabs, he was concerned that we should not give up our political system, which would happen if we joined the Euro. I do not disagree with most of his sentiments, nor I think did Mr Kamm (few I think will), the reservation being that joining the Euro was not primarily a political decision. Mr Oborne too said he did not disagree with Mr Kamm’s views entirely, accepting that there had not been a dilution of French nationhood from the cultural or heritage standpoint. Both countries therefore, France and Germany, and one can add other countries if one wants, really wanted to forget their political history, at least that of the early to mid 20th century, if not the late part of the 19th century. By contrast, the UK had, as already said, a far more positive attitude towards its history, having been the winner of two world wars, and justifiably proud of its political systems and traditions. The implication underlying this thinking seems to me to be that if the political point being made was reliant on a historical perspective, then Britain did not fit in, nor should it have to adapt to fit in. The paradox is really that the only country in Europe to have a history to be proud of in the last century, in the context of winning wars and defending freedom against right wing fascism, or, in any event, the principal country is Great Britain; and this, notwithstanding that either we do not feel ready or simply do not wish to be a part of the continent that we played such an important role in liberating, or the founding fathers do not feel that we are ready; put shortly, because our respective histories and political attitudes, when compared with those of France and Germany, disclose divergence, rather than convergence, the EU and a fortiori the Euro are not for us, although to attribute such an attitude, at least currently, to the Franco-German axis is probably unfair. To use that curious idiom, our defence of liberty in two world wars has “marginalised” us, when it comes to our playing an effective role in Euroland, this process only increasing and worsening when we give up the sacred right of setting our bank rates independently of the ECB’s governing council, and thus risk being unable to arrest an economic decline, which could see in Europe a return of the ultra right wing beliefs of the past. So the argument goes that there might be serious political consequences if we were unable to set our own interest rates. I share Oliver’s concern with regard to that point, merely wishing to stress here (as Oliver did) that the member states do have more budgetary freedom, and an easing of the restraint imposed on them under the Growth and Stabilization Pact, should their economic situations warrant it. This, then, the political argument, particularly from the historical point of view, all said, was a new point to me, and I have thought about it quite a lot (my previous post under “EMU at 10” refers to some general arguments excluding the new historical one). My view is that the Eurozone is primarily an economic issue, certainly an extension of the Euro ideal, but one to which we can contribute and continue to be part of whether we ultimately accept the Euro or not. It will not lead to a serious erosion of independence nor will it lead to a dilution of the political sovereignty of the EU member states quite as soon as one is led to believe, although ultimately, with the mobility of labour it fosters and encourages, as well as the prospect of intermarriage or partnership between nationals of member states, a closer connection demographically speaking is bound to have strong political implications. If political division occurs in Europe, because of economic problems, these are unlikely to be resolved or reduced by having or maintaining independent currencies. If one member state feels so weakened by the Euro that there is a sudden shift in its policies to the right, and the spectre of fascism resurfaces, not only in that country but then other member states, then Euroland will break up economically and politically; the same applies to shifts the other way as well. Whether that will occur or not, no one knows. For the time being there is no reason why we cannot submit our application to join the Euro, and there are strong arguments for doing so, fully aired in previous posts and threads. If there is a political standpoint to adopt, it is that it would be inappropriate to dwell too much on the past, although I am of the opinion that there is one thing that history continues to teach us, and that is that we seldom learn from history, or are at best somewhat tardily reluctant students of it. We know a lot but it seems learn little. Churchill’s intention was always to be magnanimous in victory, and one must not forget what an ardent post-war European he was, although we remained out of the ECC, until joining much later.

Despite the difference in approaches, and my view remains that whether it is good or bad for us, membership of the Euro is inevitable, one must not forget that some of the decisions this and indeed all countries make are wrong; we are familiar with arguments in support and rebuttal of the EU and the Eurozone – I will not repeat them, but my argument or instinct is that people do like to use, or to sense that they are using their imagination. Now and then we do “this vision thing” as the first President Bush once remarked, before his term of office started, while admitting that he did not know what it was, although circumstances have now radically and unpredictably changed. What is the “vision thing” in this case? It is that the British, apart from some obvious economic benefits, and currency stability within the criteria set by the Growth and Stabilization Pact as applied and interpreted by the Council, subject to budgetary flexibility appropriate to the economies of the member states, and I will not rehearse these points here, like to think (just like the members of most nation states) that at times they are in control. Those who know all the arguments wish to have goals in their mind to test one against the other. And the chattering classes to show familiarity with and appreciation of the pros and cons will be keen to satisfy them, to show that they have not been dumbed down, but are ready for discussions that elevate the issues to talk about, with people trying their hardest to take the arguments “on board”, and hold forth or talk further about them. So, although they will be using bits of knowledge as they converse (one with the other) the pattern that will emerge in discussions is that no one can know for certainty what will happen, and it is the absence of certainty that will actually make it all the more a subject for debate, and any political party that closes its mind to this debate, does so at its peril. You have to take into account that the Iraq war is slowly drawing to a close, and Afghanistan might follow thereafter, particularly as the global economic crisis begins to take its toll. People like to think that they might be part of the answer, even though they are not. Imagination is more important than knowledge, as Einstein said (and you will be familiar with that), and the Eurozone debate however it is distilled, whether in macro or micro economic terms, or as a debate in politico-historical terms, underscored by a flattish economy, and uncertainty about the future of Euroland, will empower people or allow people to feel that they are empowered so far as their country’s future is concerned, although I am against having a referendum on it, notwithstanding that one will probably be held. The Middle Eastern back drop will not go away, but nor will the Euro. Matters will begin to crystallize when we have to ratify the Lisbon treaty, and I suggest that it will be ratified whether by statute or otherwise; if ratified by statute, there is no reason why such ratification could not be subject to a referendum, which might also ask at the same time whether or not we were in favour of joining the Euro, thereby killing two birds with one stone.

There is another point, and this relates to the “faceless bureaucrats in Brussels”, and those who through the Council of the ECB usurp our right to set an interest rate appropriate to the country or member state. There are counter arguments to this, namely by surrendering this right, you gain in other ways (Oliver’s argument) through currency stability and in other, I think, macro-economic ways.

Another point now occurs to me, and that is that during the past ten years, this country as other member states, and many countries in the world, have espoused capitalism with a fervour that with the benefit of hindsight was bound to fuel excess, gross excess. People became greedy taking on more debt than they could manage, a common human weakness. Now if there are those faceless bureaucrats in Brussels, or others advising the ECB’s Council, it is arguable that the criteria set with regard to, and to ensure, sensible financial housekeeping would have made the banks think twice, because the Bank rates as set by the ECB were more conservative, and did not permit (as much) of the excesses to which the Bank of England succumbed. Now, that can be contradicted by the fact that many states in the eurozone area are also in recession, although some would say with certain exceptions, their indebtedness is less than ours. At this point, I have a problem with my own argument, because in so far as our own indebtedness rose because of the part we played as a member of the coalition forces, I cannot fault such a debt, because I think the steps Blair took were mostly right. However, the point remains, and can be argued, quite positively, that in having our rates set by the Council, subject to the flexibility permitted, we will for the future have some fail safe mechanism to warn us about our expenditure, in so far as this is attributable to capitalism’s inbuilt weakness - the tendency to spend what we cannot afford both individually and as a nation. Indeed, the manner and coordination of such regulation is perceived as not only a European but global phenomenon and necessity.

Finally, as change is in the air, the only changes I can perceive to be initiated here are less government regulation allowing individuals to feel more empowered, and/or the joining of the Euro. Letting go of your national currency, and exchanging this for a new European currency, the Euro, will fulfil this need for change. There is also talk in bloggerland about the US dollar (the greenback) becoming the Amero, a unit of currency that would embrace the dollar, the Canadian dollar and the Mexican peso. http://en.wikipedia.org/wiki/North_American_currency_union The Amero may be not quite as fanciful a concept as it sounds.

I also watched on the ECB website Jean-Claude Trichet’s address on the 15th January regarding the Eurozone and base rates, and this was indeed a powerful address, as he announced the reduction of the interest rate by 50 base points saying that as from the 8th October it had gone down by 225 base points, with journalists being allowed to question him for 45 mins or so and some very clever questions were put to him. He referred to the 329 million people who use the Euro, the latest and 16th member state being Slovakia, and I learnt that the ECB’s Council’s views are highly pragmatic, as, whilst having policy, ideals and intentions, they are permitted to have knee jerk reactions if the circumstances warrant, although, in the medium term, he kept reminding us, that it was always “Less than two, but close to two”, referring to the Euro inflationary targets, “but never pre-committed” - “the Council’s needle in the compass”. So the Governing Council of the ECB will continue to act in that way, however difficult it is for nation states to adhere to the Euro requirements under the stabilization requirements. If Samuel Johnson were alive today, I am tempted to think he would probably expand his famous dictum, by saying that nothing was certain except death taxes and the Euro. Others (largely non-European) of course, might wish to substitute a different currency of their choice, but I will stay with the Euro.

Now if the UK had had members on the council, as the President announced the newest member Slovakia, I was wondering how they might have influenced the decisions and the address. Clearly, the significance and degree of representation should perhaps reflect member states’ contributions, although at the same time take into account the strength or weakness of the pound at the time of entry. Our input might have consisted of some cleverly worded proviso. Again, no rate alterations or criteria are set in stone, and variables may be applied. There could even be two or three Euro banks, one for those who were able to show adherence to the Euro rates, and others who had difficulty who would be demoted to the second bank, the third bank being left for the Euro laggards. In this respect, it will reflect the Football or FTSE clubs and public companies changing or being required to change ranks and loyalties depending on their success and ability to perform within the appropriate criteria. You could have a fast track Eurozone entry system, for countries that were very credible and regarded as conscientious in their national house-keeping, or even a two or three tier system, to reflect member states’ budgetary skills at adhering to the criteria.

So the ECB will evolve, with or without the UK being a member of it, and the Eurozone will as well.

Most people will ultimately wish to be part of these processes, whatever the outcome. I think our first step, if we are to do our own research, should be to speak with people from countries who use the Euro, whether we (or they) are on holiday, or they work here, to find out their views on how they cope with the change. In most cases, they will probably reply that it was difficult at first with the prices, but it is fine now.

[David Bouvier]

I don't really buy the idea that Walters was wrong because the politicians wimped out.

I assume Walters would predict that the stresses would increase until the politicians decide that exact or re-valuation was preferable to blowing any more of the countries reserves.

That the pain-threshold was lower than you think it should have been is not relevant.

Or are you saying that the economic data does not show that interest rate policy led to divergence rather than convergence of growth rates?

Surely Ireland is the poster-child for Walter's Critique's continuing relevance.