Fisking Oliver Kamm
Warning - this is going to be a long post in which I try to explain some basic economic facts of life about currencies. Do not attempt to read it if you are bored by complex arguments about economics, or have rigid views for or against the Euro and do not want to have them challenged.
If I had to name the one subject on which the highest proportion of economically illiterate drivel is written by fanatics on both sides of the argument, it would have to be the single currency.
Both extremes got it wrong on how easy it would be to prepare for the Euro.
When the countries which ultimately joined the Euro were trying to align their economies, hardline opponents of the single currency predicted that it would be impossible, while hardline supporters would have had you believe that the measures taken to harmonise budget deficits were in the interests of all the countries involved, when the truth was that it caused a moderate amount of difficulty.
Both extremes got it wrong about the actual introduction
When it came to the actual issue of the new notes and coin, the antis predicted chaos, the supporters suggested it was all easy, the truth was that it went better than any reasonable person should have dared hope which meant a modest amount of cost and inconvenience.
Both extremes misunderstand the implications of currency fluctuations
When the Euro was very low against the dollar and most other currencies the antis wrongly interpreted this as proof that the Euro was a disastrous failure. When the Euro was very high against the dollar the pro-Euro brigade wrongly interpreted this as proof that the Euro was a brilliant success.
The actual meaning of this was that the Euro had protected companies whose trade was largely within Europe from significant costs caused by currency fluctuations but that the huge rise and fall in the Euro had caused enormous instability and costs for Eurozone companies whose business includes a large amount of trade with the dollar zone. This point was largely lost on both knee-jerk supporters and knee-jerk opponents of the Euro.
The real argument
Ignoring the political and sovereignity issues involved, it astonishes me how many people cannot see that economic case for and against the Euro revolves around your view of the relative importance of two fairly simple advantages and two fairly simple disadvantages
The economic advantages are:
1) Lower transactions costs within the Eurozone (through not having to change currencies)
2) More stable exchange rate, and hence reduced risk, for trade within the Eurozone
The economic disadvantages are:
3) Less stable exchange rate with non-Eurozone countries and currencies, and hence increased currency risk for trade with these countries.
4) Interest rates and monetary policy less likely to fit the needs of an individual country (because they have to average out the needs of the whole of Europe).
A cold-blooded appraisal of these arguments should make clear that many of the countries which joined the Euro had good reason to think they would benefit economically, but for two particular reasons Britain is the least likely country in Europe to benefit from scrapping our own currency, the pound, in favour of the Euro.
These are
1) For a variety of reasons such as a different proportion of flexible rate mortgages compared to fixed rate mortgages in our housing market, Britain's economy is rather more sensitive than many of those on the continent to interest rate changes. We were thus particularly likely to suffer from an unsuitable interest rate if within the Eurozone, which has one central bank and hence one interest rate.
2) Most of the trading world is divided into blocks which have currencies which tend to follow the dollar or which tend to follow the euro. Britain is unique among European countries in that international trade is a much higher proportion of our national income than most of the rest of Europe, and in that we do a very substantial proportion of our trade with each of these blocks.
Therefore Britain is far more dependent than most other European countries on trade with nations outside the Eurozone, trade which scrapping the pound would hinder rather than help. This is the key reason why the advantages to Britain of Euro membership would be much less than for much of the rest of the E.U.
The appropriate set of exchange rates for Britain's currency has to reflect a balance of levels against both the euro-zone and dollar zone currencies.
For instance, the main reason for Britain's humiliating crash on Black Wednesday out of the currency linkage which was the precursor to the Euro was not that the pound was at a silly exchange rate relative to the D-Mark and Franc in isolation. In terms of purchasing power parities (E.g. the amount you could buy with a pound in Britain against what you could buy with the equivalent amount of D-Marks in Germany) it was about right.
The problem was that the D-Mark and Franc were high relative to the dollar, which in turm meant that the apparently reasonable rate at which we had pegged the pound to those currencies resulted in a high and ultimately unsustainable exchange rate for the pound against the dollar zone currencies.
The fact that we were not in the Euro saved us from a similar painful situation in the early years of this decade. When the Euro was low against the dollar, the pound floated down but not as far, so that it was moderately high against the Euro and moderately low against the dollar, but about right overall. When the Euro was high against the dollar, the pound floated up a bit, but not as far, so that it was moderately low against the Euro and moderately high against the dollar, but our balance of payments stayed roughly in balance overall. If we had scrapped the pound in favour of the Euro, this could not have happened and the British economy would have gone totally out of balance.
There is a piece in the Times today by Oliver Kamm who is a supporter of the Euro. You can read his full article here but there follows a little light fisking of some of the points he makes.
"Ignore the doom-mongers. The euro’s end is not nigh
Despite the air of crisis, no country is about to leave the single currency" ...
Right.
and there would be real benefits if Britain joined.
Wrong.
"If you think Britain faces tough economic times, consider Greece...
Greece faces a prolonged squeeze on living standards ...
One thing it cannot do is devalue the currency and inflate the debt burden away. Greece is part of the euro. Its monetary policy is set by the European Central Bank. The pain that Greece will face has led to serious suggestions that it might be the first country to leave the euro, thereby beginning the unravelling of the whole integrationist experiment.
I exaggerate, of course."
Yes, you do.
"There is no difficulty finding commentators offering these predictions but their track record ought to disqualify them from serious discussion ... they confidently await the end of the euro. As the currency sails on regardless, the date of the supposedly inevitable reckoning gets put back.
It’s like the Jehovah’s Witnesses, who predicted Christ’s return in 1874, 1914, 1925 and 1975."
And like those who predicted that Britain's economy would collapse outside the Euro. That hasn't happened either.
Both the doom-mongers who predicted that being outside the Euro would cause disaster for Britain, and those who predicted that being inside it would cause disaster for Europe have been proved wrong. (The current recession was caused by poor banking regulation and had nothing to do with currencies.)
"Every fresh bout of financial turmoil in the eurozone elicits predictions of the implosion of currency union. I’ll offer my own prognosis: it isn’t going to happen."
I'll agree with you on that one.
"By 2020 there will be significantly fewer currencies in Europe than now, because more and more countries will sign up to the euro."
Some might: some might gain from so doing. Others may not and should not be put under pressure to do so.
"It is unlikely that the pound will disappear any time soon,"
I'll agree with you on that one, too.
"but it may do eventually when only the pound and the euro remain as currencies within the EU."
That won't happen in your lifetime or mine unless the country takes leave of its' senses.
"At least we should recognise that the euro has been a success and has provided benefits for its members. Membership would be good for the UK too, in allowing consumers and businesses to benefit fully from the single market."
There have been both benefits and costs: and there are sound economic reasons to judge that for the UK the costs would outweigh the benefits.
"Of course there are huge economic strains for the weaker members of the eurozone ...
There would be superficial attractions in leaving the euro. A currency depreciation might stimulate growth by making their exports cheaper. An autonomous central bank could help to fund the deficit by buying government bonds. But abandoning the euro would just aggravate the problems. It’s not even clear that it would be technically possible to leave.
A recent IMF paper by Barry Eichengreen, the historian of the international monetary system, lucidly explains the position. A heavily indebted country such as Greece would find its debt burden rise, because its overseas borrowings would still be denominated in euros. While there is nothing to stop the Greek parliament from requiring that wage contracts be denominated in the old drachma, it would not — in a democracy — be able to do that overnight and without warning. The stampede of investors trying to get money out of the banking system would cause financial collapse ...
For all practical purposes, adopting the euro is irreversible.
The more thoughtful British opponents of euro membership, such as Sir Malcolm Rifkind, the former Foreign Secretary, cite this as an argument in their favour.
And they are 100% right to do so. When even strong supporters of a policy admit that adopting it is "irreversible" it would be very foolish to do so unless you are absolutely certain that the policy will produce more benefits that costs.
"Yet the case for staying outside the euro has been made weaker by the financial crisis. Last month a think-tank forecast that the pound would fall below parity with the euro. On the face of it, that would imply a boost for British exporters (though at the expense of British holidaymakers travelling abroad). But a volatile exchange rate is far from being an unequivocal economic benefit."
Sigh. When are people like Mr Kamm going to wake up to the fact that joining the Euro does not mean a less volatile exchange rate for the whole of Britain's trade. It means a totally fixed exchange rate for the Euro zone and a MORE volatile exchange rate for the rest of the world.
"If there is one lesson from the banking crisis it is that financial markets are subject to wild swings of mood that can damage the real economy. Being in the euro would mitigate that."
For countries whose trade is primarily within the Eurozone, being in the euro might on balance mitigate the impact of swings in financial markets. For countries who are as dependent on trade outside the Eurozone as Britain, it is equally possible that euro membership might exacerbate those problems rather than mitigate them.
"It would encourage trade with our European partners, as businesses could be more confident about the value of future sales."
And harm trade with the rest of the world as it would have the opposite effect on confidence about value of sales and purchases with those countries.
"It would benefit British consumers, who could directly compare the costs of goods across national boundaries."
It would make it easier to compare the costs of Eurozone goods and harder to compare that of others.
"Eurosceptic commentators will balk at this message, but they’ve been consistently wrong on the most basic question of all about the single currency."
And pro-Euro commentators have also been consistently wrong.
"Like it or loathe it, the euro is a fact of economic life."
So is the dollar, but I don't want to scrap the pound and replace it with the dollar, either.
If I had to name the one subject on which the highest proportion of economically illiterate drivel is written by fanatics on both sides of the argument, it would have to be the single currency.
Both extremes got it wrong on how easy it would be to prepare for the Euro.
When the countries which ultimately joined the Euro were trying to align their economies, hardline opponents of the single currency predicted that it would be impossible, while hardline supporters would have had you believe that the measures taken to harmonise budget deficits were in the interests of all the countries involved, when the truth was that it caused a moderate amount of difficulty.
Both extremes got it wrong about the actual introduction
When it came to the actual issue of the new notes and coin, the antis predicted chaos, the supporters suggested it was all easy, the truth was that it went better than any reasonable person should have dared hope which meant a modest amount of cost and inconvenience.
Both extremes misunderstand the implications of currency fluctuations
When the Euro was very low against the dollar and most other currencies the antis wrongly interpreted this as proof that the Euro was a disastrous failure. When the Euro was very high against the dollar the pro-Euro brigade wrongly interpreted this as proof that the Euro was a brilliant success.
The actual meaning of this was that the Euro had protected companies whose trade was largely within Europe from significant costs caused by currency fluctuations but that the huge rise and fall in the Euro had caused enormous instability and costs for Eurozone companies whose business includes a large amount of trade with the dollar zone. This point was largely lost on both knee-jerk supporters and knee-jerk opponents of the Euro.
The real argument
Ignoring the political and sovereignity issues involved, it astonishes me how many people cannot see that economic case for and against the Euro revolves around your view of the relative importance of two fairly simple advantages and two fairly simple disadvantages
The economic advantages are:
1) Lower transactions costs within the Eurozone (through not having to change currencies)
2) More stable exchange rate, and hence reduced risk, for trade within the Eurozone
The economic disadvantages are:
3) Less stable exchange rate with non-Eurozone countries and currencies, and hence increased currency risk for trade with these countries.
4) Interest rates and monetary policy less likely to fit the needs of an individual country (because they have to average out the needs of the whole of Europe).
A cold-blooded appraisal of these arguments should make clear that many of the countries which joined the Euro had good reason to think they would benefit economically, but for two particular reasons Britain is the least likely country in Europe to benefit from scrapping our own currency, the pound, in favour of the Euro.
These are
1) For a variety of reasons such as a different proportion of flexible rate mortgages compared to fixed rate mortgages in our housing market, Britain's economy is rather more sensitive than many of those on the continent to interest rate changes. We were thus particularly likely to suffer from an unsuitable interest rate if within the Eurozone, which has one central bank and hence one interest rate.
2) Most of the trading world is divided into blocks which have currencies which tend to follow the dollar or which tend to follow the euro. Britain is unique among European countries in that international trade is a much higher proportion of our national income than most of the rest of Europe, and in that we do a very substantial proportion of our trade with each of these blocks.
Therefore Britain is far more dependent than most other European countries on trade with nations outside the Eurozone, trade which scrapping the pound would hinder rather than help. This is the key reason why the advantages to Britain of Euro membership would be much less than for much of the rest of the E.U.
The appropriate set of exchange rates for Britain's currency has to reflect a balance of levels against both the euro-zone and dollar zone currencies.
For instance, the main reason for Britain's humiliating crash on Black Wednesday out of the currency linkage which was the precursor to the Euro was not that the pound was at a silly exchange rate relative to the D-Mark and Franc in isolation. In terms of purchasing power parities (E.g. the amount you could buy with a pound in Britain against what you could buy with the equivalent amount of D-Marks in Germany) it was about right.
The problem was that the D-Mark and Franc were high relative to the dollar, which in turm meant that the apparently reasonable rate at which we had pegged the pound to those currencies resulted in a high and ultimately unsustainable exchange rate for the pound against the dollar zone currencies.
The fact that we were not in the Euro saved us from a similar painful situation in the early years of this decade. When the Euro was low against the dollar, the pound floated down but not as far, so that it was moderately high against the Euro and moderately low against the dollar, but about right overall. When the Euro was high against the dollar, the pound floated up a bit, but not as far, so that it was moderately low against the Euro and moderately high against the dollar, but our balance of payments stayed roughly in balance overall. If we had scrapped the pound in favour of the Euro, this could not have happened and the British economy would have gone totally out of balance.
There is a piece in the Times today by Oliver Kamm who is a supporter of the Euro. You can read his full article here but there follows a little light fisking of some of the points he makes.
"Ignore the doom-mongers. The euro’s end is not nigh
Despite the air of crisis, no country is about to leave the single currency" ...
Right.
and there would be real benefits if Britain joined.
Wrong.
"If you think Britain faces tough economic times, consider Greece...
Greece faces a prolonged squeeze on living standards ...
One thing it cannot do is devalue the currency and inflate the debt burden away. Greece is part of the euro. Its monetary policy is set by the European Central Bank. The pain that Greece will face has led to serious suggestions that it might be the first country to leave the euro, thereby beginning the unravelling of the whole integrationist experiment.
I exaggerate, of course."
Yes, you do.
"There is no difficulty finding commentators offering these predictions but their track record ought to disqualify them from serious discussion ... they confidently await the end of the euro. As the currency sails on regardless, the date of the supposedly inevitable reckoning gets put back.
It’s like the Jehovah’s Witnesses, who predicted Christ’s return in 1874, 1914, 1925 and 1975."
And like those who predicted that Britain's economy would collapse outside the Euro. That hasn't happened either.
Both the doom-mongers who predicted that being outside the Euro would cause disaster for Britain, and those who predicted that being inside it would cause disaster for Europe have been proved wrong. (The current recession was caused by poor banking regulation and had nothing to do with currencies.)
"Every fresh bout of financial turmoil in the eurozone elicits predictions of the implosion of currency union. I’ll offer my own prognosis: it isn’t going to happen."
I'll agree with you on that one.
"By 2020 there will be significantly fewer currencies in Europe than now, because more and more countries will sign up to the euro."
Some might: some might gain from so doing. Others may not and should not be put under pressure to do so.
"It is unlikely that the pound will disappear any time soon,"
I'll agree with you on that one, too.
"but it may do eventually when only the pound and the euro remain as currencies within the EU."
That won't happen in your lifetime or mine unless the country takes leave of its' senses.
"At least we should recognise that the euro has been a success and has provided benefits for its members. Membership would be good for the UK too, in allowing consumers and businesses to benefit fully from the single market."
There have been both benefits and costs: and there are sound economic reasons to judge that for the UK the costs would outweigh the benefits.
"Of course there are huge economic strains for the weaker members of the eurozone ...
There would be superficial attractions in leaving the euro. A currency depreciation might stimulate growth by making their exports cheaper. An autonomous central bank could help to fund the deficit by buying government bonds. But abandoning the euro would just aggravate the problems. It’s not even clear that it would be technically possible to leave.
A recent IMF paper by Barry Eichengreen, the historian of the international monetary system, lucidly explains the position. A heavily indebted country such as Greece would find its debt burden rise, because its overseas borrowings would still be denominated in euros. While there is nothing to stop the Greek parliament from requiring that wage contracts be denominated in the old drachma, it would not — in a democracy — be able to do that overnight and without warning. The stampede of investors trying to get money out of the banking system would cause financial collapse ...
For all practical purposes, adopting the euro is irreversible.
The more thoughtful British opponents of euro membership, such as Sir Malcolm Rifkind, the former Foreign Secretary, cite this as an argument in their favour.
And they are 100% right to do so. When even strong supporters of a policy admit that adopting it is "irreversible" it would be very foolish to do so unless you are absolutely certain that the policy will produce more benefits that costs.
"Yet the case for staying outside the euro has been made weaker by the financial crisis. Last month a think-tank forecast that the pound would fall below parity with the euro. On the face of it, that would imply a boost for British exporters (though at the expense of British holidaymakers travelling abroad). But a volatile exchange rate is far from being an unequivocal economic benefit."
Sigh. When are people like Mr Kamm going to wake up to the fact that joining the Euro does not mean a less volatile exchange rate for the whole of Britain's trade. It means a totally fixed exchange rate for the Euro zone and a MORE volatile exchange rate for the rest of the world.
"If there is one lesson from the banking crisis it is that financial markets are subject to wild swings of mood that can damage the real economy. Being in the euro would mitigate that."
For countries whose trade is primarily within the Eurozone, being in the euro might on balance mitigate the impact of swings in financial markets. For countries who are as dependent on trade outside the Eurozone as Britain, it is equally possible that euro membership might exacerbate those problems rather than mitigate them.
"It would encourage trade with our European partners, as businesses could be more confident about the value of future sales."
And harm trade with the rest of the world as it would have the opposite effect on confidence about value of sales and purchases with those countries.
"It would benefit British consumers, who could directly compare the costs of goods across national boundaries."
It would make it easier to compare the costs of Eurozone goods and harder to compare that of others.
"Eurosceptic commentators will balk at this message, but they’ve been consistently wrong on the most basic question of all about the single currency."
And pro-Euro commentators have also been consistently wrong.
"Like it or loathe it, the euro is a fact of economic life."
So is the dollar, but I don't want to scrap the pound and replace it with the dollar, either.
Comments