Thursday, May 20, 2010

Is the Euro in Danger ?

Short answer - no, but I'm very glad Britain isn't in it.

The Times headline in large letters accross today's front page reads 'The Euro is in danger'.

After announcing a ban on speculative share trading in Germany’s top financial institutions and the bonds of eurozone countries until next March, the German Chancellor Angela Merkel is quoted as having warned: “This challenge is existential and we have to rise to it. The euro is in danger. If we don’t deal with this danger, then the consequences for us in Europe are incalculable . . . If the euro fails, then Europe fails.”

This kind of hyperbole does not usually help the situation: all too often, as promptly happened in the past 24 hours, it touches off a wave of selling.

Most european countries, including Britain, are in serious economic difficulties because of reasons which have nothing whatsoever to do with whether they are in the single currency or not. It has much more to do with the gross mismanagement of banking policy, with the world recession which has resulted, and with huge and completely unsustainable budget deficits.

It is important to remember that the financial crises in other EU countries, from Greece to Germany, has serious consequences for us, and would whether we were in the Euro or not: they are key trading partners for Britain. Their problems are exacerbating our problems.

It is also important to remember that a shared currency such as the Euro is less vulnerable in the short term to speculators than a linkage between different currencies, such the ERM from which the markets ejected Britain on Black Wednesday. Speculators can push a shared currency up and down, but they can't pull it apart the way they did the ERM.

The Euro will survive its present difficulties. It will continue to deliver both benefits and disadvantages for those countries which take part in it. The huge short-term costs of re-establishing an independent currency, and particularly of doing so in the middle of the present financial difficulties, would be far greater for any of the existing Euro members than any realistic estimate of the disadvantages of Euro membership. So neither Greece, nor any other Euro member, is going to abandon the single currency.

Meanwhile Britain will survive outside the Euro. Anyone with a good understanding of economics will continue to recognise that the benefits of Euro membership would be smaller, and the disadvantages greater, for Britain than for any other major European economy. A few economic illiterates will probably argue that Euro membership would have helped Britain weather the present economic storm, though they might like to consider that it certainly hasn't provided the current members with a magic wand to banish financial turmoil.

Let's not forget why we were forced out of the ERM in 1997. It is often suggested that Britain joined at too high an exchange rate, which is a misleading half-truth. In terms of purchasing power parity between the Pound and the D-Mark, there was nothing wrong with the rate at which we joined: the problem was that the D-Mark was high against the dollar. It was the impact on British trade of the consequent high exchange rate for the pound against the dollar which made the markets decide that the ERM exchange rate for the pound was unsustainably high: and this was a self fulfilling prophecy.

If Britain were in the Euro now we would probably have the opposite problem, which would be both inflationary, and equally disruptive to our trade.

So the Euro is not in danger, but Britain should not and will not join it.

No comments: