Anyone for the Euro?

People from the Irish Republic are rushing over the border into Northern Ireland to take advantage of the cheap prices in the shops as they flash their Euros. The shops in Kent and London are welcoming many continental trippers who find sterling prices cheap to them. On Sunday visiting a shopping centre in middle England in Oxfordshire, I was struck by how many of the voices were speaking foreign languages.

The market is beginning to work, to adjust the big imbalance in the UK balance of payments. Foreign shoppers will swell receipts, whilst UK shoppers will buy fewer foreign made goods as their prices surge. Families nervous of job prospects and finding it difficult to balance domestic budgets will cut back on foreign holidays. Gradually imports and exports will come into better balance.

The danger in the present situation is that many countries and currency blocs might like the sound of devaluation. The UK’s neighbours in Euroland are becoming unhappy about the very strength of their currency which makes UK goods and services such a bargain for them. The Euro area is demonstrating just how dangerous it is to impose currency union on economies and markets that had not properly converged in the first place.

There has been considerable worry about Portugal, Italy, Greece and Spain, sometimes ungallantly named by their initials. None of these economies had been brought fully into line with France, Germany and Benelux, the core countries of the currency union.

In the early days of currency amalgamation Spain had a boom based on interest rates which were too low for her conditions. Now she is experiencing the reverse, with a high currency and relatively high interest rates driving her asset prices down and giving her a severe economic hangover after the heady days of the boom. Spain’s property bubble was blown to greater size by premature membership of the Euro and a monetary policy which was too accommodating for too long. Ireland experienced exactly the same conditions.

Italy has struggled throughout her membership. Used to inflating and borrowing much more than Germany, Italy had for years survived as an exporting country by periodic devaluations. Now she is unable to devalue her way back to competitiveness, so she is suffering loss of export orders and needs to cut wages and restrict costs severely to become more competitive.

Greece too has suffered, entering the Euro area with more borrowing and inflation than was comfortable and now experiencing the rigours of a strong currency.

The cost of borrowing money has risen for the governments of the weaker economies of the Union, despite the fact that they are all part of the same currency area with some implied obligations from the stronger to the weaker members. The bond markets are becoming more suspicious of the sovereign debt of the heavy borrowers amongst the Euroland governments, placing a risk premium on their money raising.

Some Euro critics see in these pressures the beginnings of a break up of the Euro. They think that maybe one or more of the troubled countries will conclude they need to leave the Euro, devalue, and get more people back to work through such a realignment. Why not take the softer option to price yourself into work, rather than the tough option of staying within the Euro and having to cut wages and other costs?

I think this is a misreading of the Euro project. The single currency was always more of a political project than an economic one. The Germans saw it as their contribution to European union to offer a shared currency, drawing on the legendary anti inflation strengths of the DM. They do not expect other countries to cavil at the necessary anti inflation discipline which they built into the Euro, as they think it is good for all.

There is no easy way out of the currency. Whatever the people of the peripheral countries may think of their currency, their governments regard it as a matter of faith to stay in and manage the consequences. EU support for the concept has switched from arguing it is good economically, to arguing that the larger currency bloc gives members some protection from market hurricanes like those that engulfed Iceland recently.

At the same time as some members have to accept the pain that the common currency brings them, some are discussing British membership of the Euro again. German sources have confirmed to me that Germany herself does not think this would be a good time for the UK to join, as they are worried that at this rate of exchange the UK is too competitive for comfort. They see the recent large moves of the pound against the Euro, showing that the two economies have not converged. I think the UK government appreciates that 80% of the UK public are still against membership, and understand that the promise to hold a referendum before joining is a pledge they dare not break. Ministers regularly repeat the mantra that now is not the right time to join, even though they stick to the view that in principle they would like to.

My conclusion is the Euro club’s membership is going to be more stable than some commentators suggest. Weak countries will be reluctant to leave, and big new entrants will either be reluctant to join or kept waiting before they do. Looking at the economies of Western Europe it is difficult to conclude that the Euro area is a perfect size and shape. It appears that too many peripheral economies with different economic policies and circumstances have already been allowed in. Whilst in due course the expansionists might want to welcome more in, there is a growing realisation that large economies to west and east are different and could prove destabilising for the young single currency.

After all, sterling wrecked the Exchange Rate Mechanism, the dry run for the single currency. The pound would prove an overmighty subject for the currency area, which has enough problems sorting out the pressures within its large and divergent territory. Successful single currency areas usually have more advanced means of transferring wealth from good performing areas to distressed areas, and have a common price for raising public capital. Euroland does not so far have these, so the poorer performing areas suffer more, and governments pay different prices to borrow. Lenders are still not fully convinced that a single currency is for ever. In the meantime German and French industry will suffer bigger falls from the strength of their currency, whilst the devalued pound should start to help UK manufacturers if they can have the capital and the stamina to exploit the market opportunity.


  1. figurewizard
    January 27, 2009

    The devaluation of Sterling may be described by some as a blessing to exporters but recent history shows that it is nothing more than a short term panacea. One only has to look at what happened in the UK during the second half of the1970s (again under a Labour Government) when the pound was falling almost constantly to see that. At the same time Japan and Germany had the opposite problem; a currency that was almost constantly rising. Their response was to do as you point out as being the only solution for the Euro-bound exporters of the likes of Spain and Italy; they cut costs, developed good quality products and became much more efficient at producing them in order to remain competitive. This is of course a far tougher route to sustainable economic success but it is also the only one that can truly deliver it for the long term.

  2. Monoi
    January 27, 2009

    If only it was that easy.

    Devalue, and back we are exporting and producing. Yeah right.

    The reason the outlying countries (PIGS) are having problems is because they did not behave the way they should have done doing the boom years.

    The UK does not belong to the euro, its experience is not much different from the spanish one as far as I can see when it comes to boom and bust.

    Also, Germany has had an appreciating currency as far as I can remember (30y+), and they still have the largest positive trade balance ahead of China and Japan. You buy a german because it is better than the competition, and you pay more for it because value is more than the cost of producing.

    That said, you are right to say that it is a political project, as it has always been. So if it were to break, which I don’t think it will, it will be due to political factors not economic ones. From a practical point of view, it is not that easy to get out either anyway.

    The consequences of the disparities in yield betwen the euro countries are hard to define.

    But please, stop putting out this devaluation myth. It makes a country poorer, and just lets its politicians off the hook for their bad management. Which PIGS countries have still not learnt.

  3. chris southern
    January 27, 2009

    A single currency can only truly work if the majority of the world takes it up and adjusts their living costs so that they are extremely similar.

    At the moment the countries within the euro suffer from some of the countries under cutting the others, and are able to do so because of the lower cost of living.

    The EU should be scrapped and in it’s place a world wide trade federation formed where each country has one reprasentative.
    It should have no other powers than getting countries to use the same safety standards (making trade easier) as well as sorting out trade disputes.
    No other powers are neccesary, nor are they needed. (any form of corruption should be stamped out hard as well)

  4. Nick
    January 27, 2009

    Devaulation is just the result of a bankrupt political process.

    I’ve moved most of my liquid assets into non-GBP denominated stuff.

  5. A. Sedgwick
    January 27, 2009

    If you equate the EU to a listed company and the Euro to a share in that company, who in their right mind would invest in an organisation that has not had its accounts signed off for 14 years?

  6. Mike Gill
    January 27, 2009

    How could any economically distressed country possibly leave the Euro? It would suffer instant sovereign collapse as its reversion currency failed attract investors, while it’s debts remained in Euros

  7. Tim
    January 27, 2009

    An excellent and thought provoking post, British membership of the euro at this point would give us higher interest rates and less flexibility in adapting to changing economic circumstances. The continuing strength of the swiss franc shows that currencies can remain strong in a European context without remaining in the Euro.

  8. […] State of the Euro […]

  9. Johnny Norfolk
    January 27, 2009

    Countries have had wars to stay independent and live their own lives in their own way. The last thing anyone should want is something that reduces that hard won freedom.

    The Euro does just that.

    The last thing we want is the Euro.

  10. TomTom
    January 27, 2009

    Todays Die Welt has an article on the Euro and the squeeze on the PIGS – Portugal, Ireland, Greece, Spain though Italy seems to be an alternate for Ireland.

    The comments below in the online edition are fascinating – many waiting for the Euro states to be picked off one by one until France finds it has too high a cost base vis-a-vis Germany.

    Whether the Euro cracks or not the interest rate spreads will make its debt markets divergent and that in itself will change the patterns of economic growth

  11. mikestallard
    January 27, 2009

    Looking into the future a little there seem to be two things that are possible in Europe.
    The first is for a superb politician to come in and unite Europe. Maybe a Charlemagne, a Cavour, a Bismarck will appear. Without this, I cannot really see Europe progressing because the ramshackle arrangements at the moment are not going to cut the mustard.
    In order to reform these, however, we need a “staerke mensch”. Bismarck said that Germany would not be unified by words alone, but by “Blood and Iron.” With the current economic situation, I can see that this is a very real possibility, although I cannot see, for instance, Margaret Wallstrom doing it.

    The other thing is that, with no real leadership and no serious discussion of the ideas flooding out of the Commission, sooner or later there is bound to be a serious mistake. We haven’t had that yet. We have had lots of little ones. What we need is a very big one.
    Perhaps the economic crisis will provide it. Something like the Landfill Directive, Carbon Emissions, Immigration Rules are just not enough to tip people into the streets for war.
    But the future of Europe doesn’t look good to me. Better off out. We just do not fit, us Brits.

    January 27, 2009

    It’s all a bit heavy going this past couple of days so we thought we’d take a peek at Guido Fawkes for a larf! We came across this entry which might – with increasing speculation about the PM’s state of mind – be entitled …THE SECRETS OF MY SUCCESS!

    (With due apologies to JR’s more serious contributors)

    “So if I am Brown and I declare I have eradicated ‘boom and bust’ and then fiddle with the ONS statistics to hide a million people in university and extra half million in incapacity benefit then I can claim that my elimination of ‘boom and bust’ is evident in ‘low’ unemployment figures. If I rig all the ONS output so that we now talk about national debt as a percentage of GDP instead of raw numbers then I can say things like ‘Borrowing this year was only 3% of GDP’. Which doesn’t sound like a lot. 3%? That’s not a lot is it? Doesn’t sound like much. Rather than ‘I borrowed and squandered another 40bn quid last year because I’m financially incompetent!!!’ In this way I can double national debt while, paradoxically, lauding myself for ‘balancing the budget over the cycle’. Now, most normal people would interpret this as meaning that if I (say) had national debt at 300bn before the ‘cycle’ I would have national debt of 300bn at the end of the cycle. What Fools!!!!! I’d actually have national debt of 600bn. It’s all about perception you see.

    Same with abolishing ‘boom and bust’. If I believe I have abolished boom and bust. I mean really, really, really, cross-my-heart-and-hope-to-die then hey presto I have abolished ‘boom and bust’. Try it. Works for me. Vote Labour. Taking the tough decisions because it’s the right thing to do.

    The same approach works for budget projections. I decide when I’ll stop borrowing so much cash – say five years into the future and then just get up on budget day (or inter budget day or emergency budget day – same principle) and give it ‘Borrowing this year will be 40bn, next year 35bn, next year 15bn, next year 8bn and neutral five years from now. The numbers don’t really matter. I just make them up. I mean a few billion either way is peanuts. Actually I’m always too optimistic. I always seem to borrow more than I’d planned but hey nobody ever manages to pin me down on it so I just keep doing it.

    Same with this 150bn deficit for 2009/2010. I have no idea what the real deficit will be. For sure it’ll be more than 150bn quid but if I just believe its 150bn quid then that’ll do for me. The rest of you can just work on your own reality. I’m the best Prime Minister ever, me!!

  13. Michael Taylor
    January 27, 2009

    John, I think you may have missed an important aspect: viz, if the end-game for PIGS is eventually to exit from the Euro, then their governments find themselves willy nilly in a Prisoners’ Dilemma, in which the rational choice is to defect – ie, to sell lots and lots and lots of sovereign Euro debt whilst they can.

    This logic is effectively what doomed the Latin Monetary Union back in the late 19th century. Strangely enough, it was a rather similar set of nations back then too. . . .

    Not an exact re-run of the Latin Monetary Union, of course, but then history doesn’t repeat, but it does rhyme.

    January 27, 2009

    Something much cleverer coming from Europe tonight – Germany in this case – than Peter Mandleson’s half-cocked scheme.

    As we blogged at the weekend – “IT’S THE DEMAND STUPID!” – so Germany is offering ITS car industry what we’ve been advocating…incentives for car buyers themselves. This is a time to get many old cars off the road for good and replaced by the new models clogging up storage sites and production pipelines. It won’t be easy with consumers rightly so cautious but it’s the only way to get the industry moving again.
    For trade union leaders to look only at the supply side and factory jobs is plainly ridiculous.

    The same applies to most industries in the doldrums – it’s worth selling pipeline overstocks at cost price or below for the long-term good of the company and their staff. Government support would be better directed in this way than the plethora of navel-gazing schemes that are coming out of Downing Street by the dozen.
    Whatever our understandable qualms about Europe their practical politicians seem far more likely to ‘save the world’ than our bunch of naive theorists!

  15. Ian Jones
    January 28, 2009

    It seems people have very short memories on devaluing ones way to competitiveness!!! The UK tried this over and over in the 20th century and almost bankrupted itself! Its one of the main reasons why an inflation target was set up in the first place to emulate the German success!

    In the short run it is protecting the UK and it is also true the pound was overvalued due to the financial flow of money. However, the UK also needs to slash costs and wages as much as Europe for us to remain credible and not once again lose investment from overseas by the fear of it being devalued away!

    As for the Euro, this is a political tool to integrate Europe. Britain can join and be part of a world power or it can remain outside and become a Switzerland. Its days of glory on its own and well and truly history!

  16. savonarola
    January 28, 2009

    Last year I and a group from HK golfed in Biarritz with a plan to do the same in 2009 in Bordeaux.
    This year we are going to Northern Ireland. 35% cheaper that Kerry taking into account all the offers down South. And magnificant courses.

  17. Roger Thornhill
    January 28, 2009

    The Federasts will have to take Sterling ‘from my cold dead hands’.

    What we need is a stable Sterling and that should have been the role of the BoE, not chasing faux metrics like price inflation, which was deflation due to cheap imports and so masked the currency inflation (as in devaluation) due to too much money – but not value – floating about.

    I consider a Pound Sterling as a contract. The Government’s role is to ensure that contracts are upheld, not conspire to undermine and devalue them. By printing money they devalue the contract that is “to promise to pay the bearer”. To me, that is theft.

  18. Alan Wheatley
    January 28, 2009

    When Labour came to power in 1997 policy was to join the euro. Gordon Brown came up with his tests, all of which had to be passed before Britain could join. I have often wondered just how much Tony Blair knew about the test before Brown announced them as a fait-ac-compli. After all, a key part of the Brown strategy has been that interest rates should be set to control inflation, which would be impossible should Britain adopt the euro.

  19. Thatcher-right
    January 28, 2009

    Would we be allowed to join the Euro at the moment, even if we wanted to? I understood that there were a set of rules to which we would have top conform (government borrowing being one) and I would be amazed if we conformed to them.

  20. John De Corve
    January 29, 2009

    Listening to the various languages on the high street are not Continental shoppers but illegal asylum seekers spending their welfare cheques provided by the British taxpayers like me

  21. […] John Redwood M.P. on the Euro […]

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