December 30, 2001

Euro may do better without Britain

Posted in Sunday Business Post ·
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In England, the fancy French train snails through the Kent countryside at around 80 kilometres an hour, shuddering periodically on second-rate, privatised infrastructure (supplied by the now bankrupt Railtrack).

In France, it rapidly hits its top speed of about 200 kilometres an hour without as much as a ripple on your coffee. And in no time, it glides into the Gare du Nord in Paris from where any number of Metro connections deliver you to your destination.

Cast your mind back to when the Channel Tunnel was being built in the late 1980s and you would be forgiven for suggesting that the opposite should have been the case. At that time, it appeared a safe bet that the British side would work smoothly and chaos would reign once you arrived in Normandy.

The British agonised over cost and plans and ideology dominated arguments about how best to finance the project. Ultimately, the private sector forked out.

In France, the state did not bother with such trivia as cost. The tunnel was a great project for France and it would be built using the best French technology with no expense spared. For the French, this was all about vision and national pride and, as a consequence, it was far too important to be left to bean counters, shareholders or irate residents’ committees. It has ever been thus.

The French, or continental, approach is to conceive the big vision and worry about the details later. In contrast, the British start with the detail and, by allowing themselves to get bogged down in the minutiae, sometimes miss out on the big picture altogether.

Today we see this difference reflected in approaches to the euro. Throughout the 1990s, almost every British commentator, economist, banker and politician said it could not happen. To support their scepticism, they cited all sorts of rational economic arguments.

However, they failed to appreciate the crucial fact that the euro, like the Channel Tunnel, was political. The euro is a ‘vision’ thing for France, Germany and Italy and whether it stands up to economic scrutiny is practically immaterial. Even the European Commission acknowledged that the effect of the euro on the economy, unemployment and wages is likely to be modest at best.

The key point is that the euro is another crucial building block for a closer, more federal Europe. That is something France and Italy certainly want and which until recently appeared to be a cornerstone of German foreign policy.

If that is the case, why is Tony Blair so keen for Britain to join the eurozone? Latest rumours suggest that Britain will have a referendum on the euro in June 2002. And if Britain does join, will this be the final piece in the jigsaw for Ireland?

In Dublin, it has been argued that the euro would only make sense for us if Britain also used the new currency so we would avoid huge exchange rate swings with our second biggest trading partner.

Blair believes his best chance of winning a referendum on the euro is when the Conservative Party is seen as a lunatic right-wing fringe party and, given the failure of William Hague’s ‘Save the pound’ campaign at the last British election, his hunch seems to be right. Unfortunately, this is when the problems begin. For sterling to convert to the euro would be a disaster for the new currency and, by extension, for Ireland.

Popular economic opinion in Ireland contends that the euro will be more credible if sterling joins. The theory is that sterling’s weight as a global currency and London’s pre-eminent position in the financial markets would make the euro more believable. Furthermore, some say the addition of Britain’s economy to the eurozone’s mass would also help.

However, history suggests that the opposite would be the case. Every time Britain has tried to “house-train” its currency in a disciplined exchange rate arrangement, it has failed.

There are two reasons for this. Firstly, the British economic cycle, like the Irish one, moves in tandem with that of the United States, and not with that of Europe. Its currency also does. For example, from 1995 to 2000, sterling and the dollar both rose rapidly against European currencies. Had sterling not risen, the growth in Britain over the past five years would have been much stronger.

The last time Britain tried to peg to a European currency at a time of strong growth, interest rates went too low for too long, leading to the early 1990s property roller-coaster. In Britain, like in Ireland, changes in the monetary regime amplify significantly the peaks and troughs of the business cycle.

The second reason for not having Britain in the eurozone is the peculiar politics of money in Britain. Even if Blair gets his referendum through, the margin is likely to be slight. There will always be a rump ‘little Englander’ constituency in Britain campaigning for Britain to pull out of the euro.

The fortunes of this group will ebb and flow with the economy. In bad times, when interest rates in Britain should be falling but are being held firm by the ECB, the little Englanders would have a field day dredging the depths of British nationalism.

We all know the historical reasons for this continental antipathy, but there are sound modern economic reasons for it as well. Britain is very sensitive to short-term interest rate movements because the average person is quite heavily in debt, usually having borrowed at variable, short-term rates.

In contrast, the average German is not heavily indebted and those who are have borrowed at fixed, 30-year rates. So while the Germans don’t even register a change in short-term interest rates; the Britons read it as headline news on ITN.

Against this background, it is easy to see why sterling would be a highly disruptive force in the euro. Every two-bit by-election in Surrey would be turned into another referendum on Europe. The financial markets would therefore need to build a premium into the currency to cover the possibility of Britain pulling out. This possibility would severely undermine the euro.

If the British commitment is only lukewarm, it would lead to arguments about why the Italians should abide by public spending rules or why Poland, the Czech Republic and Hungary should not engineer huge competitive devaluations before committing in 2010.

These factors would severely weaken the euro against the dollar, causing Europe’s interest rates to be higher than they would normally have to be. More importantly, for those Europeans with federal aspirations, sterling’s presence in the project would undermine the political unity that has been so important in bringing the EU to this juncture.

And so a semi-detached Britain converting to the euro might retard the currency’s development. For Ireland, sterling’s entry could make our commitment to the euro more sensible because a sharp fall in the British currency would still give exporters a rough time.

However, the real problem with sterling is not Ireland’s; it is a bigger European problem.

In many ways, the euro chain is only as strong as its weakest link and, with sterling on board, that weakest link would be the eurosceptic electorate of middle England — which is hardly the foundation of a credible challenge to the dollar.