John Redwood

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The European Journal The Euro: The Yaa-Boo of the British Debate

Gordon Brown has asserted endlessly that he is bringing an end to “Tory boom and bust”.  Any analysis of the performance of the British economy in the last twenty years would leave people to conclude that the boom and bust was not so much a Tory one but a European one.  It was only when the United Kingdom decided to shadow the Deutschmark in the interests of European cooperation, and then enter the Exchange Rate Mechanism, that our economic policy really went haywire.  It was a policy recommended by Labour and the Liberal Democrats as well as being wrongly accepted by the majority of the Conservatives in office.  Those of us who argued strongly against were shouted down by the CBI, the TUC, the Labour Party, the big battalions of business, and by most members of the Conservative Government as well.

It is true that there is no more Euro boom and bust in Britain, because this Government very sensibly has stayed out of the Exchange Rate Mechanism and out of the Euro, which became its successor in title.  Both main political parties have learnt the painful lesson of ERM that Britain has a very different economy from those on the continent and would only be harmed if we seek to peg our exchange rate too closely to the continental one and allow others in the continent to make interest decisions on our behalf.

It is one of the paradoxes of Gordon Brown’s reign at the Treasury that his most successful decision, to keep Britain out of the Euro, has received so little applause, but his most questionable soundbite, that creating an independent Bank of England has brought an end to Tory boom and bust, should have been so widely feted.  Who said the power of spin would tie with the passing of Tony Blair?

It is instructive to look at what has happened in Euroland since the introduction of the new currency.  The new currency bloc has been very fortunate that Britain decided to stay outside. If the British economy had been forced into a narrow Euro straightjacket, you would have found out sooner, and more catastrophically, that one interest rate does not suit all and that one size of economic policy would be ill-fitting to the very different economies of Western Europe.  Labour has done the continent a mighty good turn and prolonged the life of the Euro-error by wisely keeping out.

However, the establishment of the Euro-area could not have an easy birth, despite the omission of the most distinctive large economy within the European geographical area.  The needs of the Irish, Spanish and Portugese economies on the one hand, and those of the French, German and Italian economies on the other, are very different.  It has proved extremely awkward for the European Central Bank to find an interest rate which makes sense for such divergent and diverging economies.

The overall result has been an average interest rate which makes sense, genuflecting to the size and power of the German economy has been too much inflation and credit in the peripheral economies like Ireland and Spain, and too little monetary stimulus in the mainstream continental economies, beginning with Germany and now moving on to France.  The overall results of Euro-management have been to create relatively low price inflation, at the price of anaemic rates of growth in Germany in the early years and in France and Italy in the later years of the experiment so far.

The struggle of the German economy at the beginning of the twenty first century led the European Central Bank to set relatively low rates of interest.  This enabled a substantial boom in property and everything else to be stoked up in economies like Ireland and Spain, where people partied on the low interest rates geared to the then trundling German economy rather than the rocketing Irish economy. More recently, the German recovery based on very successful cost-control, downward pressure on wages and great export strength in the capital goods industries, has led the European Central Bank to start tightening credit conditions and start putting interest rates up.  Recently we have seen the immediate impact of this on the Spanish construction and property markets, with a sudden crash in housing and construction-related shares.  We are likely to see further grief in Spain, Portugal and in Ireland as the rocketing price of credit comes home to all those who have borrowed too much.

Meanwhile, back in France, the French are discovering that Euro-discipline, when Germany has revived and rebuilt, is no great fun for the Euroland’s second economy.   In the recent French Presidential election, the main candidates queued up to condemn the European Central Bank for taking too though a line.  Their complaining was in vain, mere political posturing, because France sold the pass on interest rates when she signed up to the idea of a common currency all these years ago.  It may be useful to have a whipping boy in the form of a bank, but that does not create more jobs or stimulate the French economy.

Over its years of existence so far, the ECB has done reasonably well on inflation.  The current rate is 1.8%.  The error has been anaemic growth despite the charging performances of some of the smaller and more peripheral countries and has had ultimately higher unemployment, with the unemployment rate at 7.4% and with many places in the Euroland area having unemployment uncomfortably above 10%.  In the early days the ECB wanted a strong Euro to challenge the mighty dollar.  They looked forward to the days when the Euro would be reserved currency, just like the dollar, and would perhaps surpass the dollar in international use.  This did not happen with the Euro weakening in its early years.  More recently, the Euro has absorbed most of the pressure as people have sought to diversify out of dollars and to sell the dollar down.  Euroland is discovering to its cost the price of running a reserve currency in demand with the higher exchange rate against the dollar now adding to the woes of companies in Italy, France and elsewhere.  Many businesses are caught with the double whammy of rising interest rates and a rising exchange rate cutting into their profits.

Bringing together the disparate and divergent economies of Western Europe too quickly into the Euro area was bound to cause boom and bust.  Exchange rates are very necessary adjustment mechanisms.  When a country is no longer as competitive as it needs to be in world markets, its exchange rate may fall, pricing its companies back into the world market.  When an economy becomes super competitive, climbing too large a trade surplus for its trading partners, it is likely in a free market position that the currency will float up, starting to cut back on the very large surplus.

By whipping out the Exchange Rate Mechanism to make the adjustments between the different economies of Western Europe, the European countries signed up to a scheme which meant that the adjustments had to be much more painful, taken by changes in real wages and real activity rather than by changes in the price of the currency.  France wishes to become more competitive relative to Germany, as she will have to do quite shortly.  She will need either to cut real wages, which is always difficult in a democracy, or to cut back on her more expensive activities by closing factories and sacking people.  To recreate equilibrium between France and Germany, Germany needs to boom and France needs a bust to bring them back into line as they can no longer do it by devaluing or revaluing the Franc or the Deutschmark.

It is difficult to see why people see taking the strain on real wages and jobs is better than taking the strain on the price of money.  The only possible justification for a single currency is the wish to create full political union and a single country.  As the Euro scheme comes under greater pressure, I am sure federalists will argue it proves their case that the centre needs much more power over the peripheral economies within the zone.  In a way they are right.  If you wish to make sense of the single currency area you need to introduce much bigger transfers of money from the more successful to the less successful parts of the union.  You need to unify the rules and regulations of the market, and you need to put it under the direction of a single Government.

It makes me doubly-pleased that those of us who fought strongly against abolishing the Pound and adopting the Euro in Britain were successful.  We can look back in pride on our campaign to save the Pound.  It was an important part of a much broader campaign to keep our country and to strengthen its independence.  It was also a necessary decision to keep Britain out, to give the Euro a longer life.  The fewer the divergences between the economies which are part of the zone the better, from the point of view of the strength and health of the zone.

The battle has moved on from the Euro to the power grab we now see daily, partly under the guise of the European Constitutional Treaty and partly through the endless directives, regulations and court decisions which are the stock in trade of the rampant European Union.  Britain made a blow for her freedom by keeping her currency, but she now needs to do much more to reassert her independence from too much European Government.