Could the eurozone become a successful economy during the life of this Parliament? That surely is the key question - not the tussle between the Prime Minister and the Chancellor - that will determine whether the Government dares to risk a referendum on British entry.
If the eurozone subsides in deflation, unemployment continues to rise and growth to falter, there is no way that the British would vote to join it. Why cuddle up to a corpse?
On the other hand, were the eurozone to put on a spurt of growth, outpacing both the United States and Britain, then you could see a window of opportunity when the electorate might be persuaded to give the euro-enthusiasts the benefit of the doubt.
So it all turns on whether the superior performance of the British economy can be sustained: whether the record charted in the two graphs is likely to continue.
As you can see, the record on unemployment is unequivocal. On growth the judgement is more mixed. Cumulatively we have done much better, but much of the superior performance was during the middle 1990s when sterling was particularly undervalued.
In addition, we have benefited from getting more people into employment and the extra growth that has stemmed from a consumer boom financed, in part, by additional borrowing.
As far as the eurozone is concerned, the most immediate issue is deflation. The European Central Bank (ECB) will almost certainly cut its interest rates next month, the only issue being whether the cut is a quarter or a half per cent. But even a half per cent cut would only offset a 2-3 per cent rise in the value of the euro, and the euro has risen by about 13 per cent this year.
In any case, the ECB has to set rates for the entire region, and inflation performance has diverged sharply. In the final quarter of 1998, just before the euro was formally launched, the gap between German inflation and the average was only 0.7 per cent. In the first quarter of this year, it was 1.8 per cent.
So whatever the ECB does, it is almost certain to impose rates on Germany that are too high, and it is very hard to see what can be done about this. Deflation in Germany now seems almost certain.
In public relations terms, that will be devastating for euro-enthusiasts, because it highlights the fundamental flaw in the design of the eurozone: that low inflation countries get the highest real interest rates and vice versa.
It is also bad news for the economies most closely tied to the German market, such as the Netherlands and France. But the fringe countries, such as Spain, could continue to do quite well. It is a reasonable question to pose: could the rest of the eurozone perform well enough over the next two years to pull Germany out? If it could, then, it might be possible to make the positive case for the euro a credible one.
A lot depends on the course of the euro and of the dollar. Expect sterling to continue to trade between the two in its usual mid-Atlantic manner, veering closer to one for a few months and then moving a bit closer to the other. If the fall of the dollar becomes really serious and the rate against the euro were to move to, say, $1.30 or beyond, then the eurozone recovery could be set back another couple of years.
That sort of level is perfectly plausible. Indeed. the Merrill Lynch "fair value" calculation puts the euro at $1.31. Merrill reckons that the rise of the euro will knock 1 per cent off the eurozone's nominal growth both this year and next, while adding 2 per cent to nominal growth in the US.
The rise of the euro redistributes both growth and inflation away from Europe and towards the US, and to a lesser extent the UK. The ECB will, in Merrill's view, eventually cut rates sharply, but too late to prevent this redistribution of growth.
Might such a shift lead to serious inflation in the US and UK? This is always a theoretical concern, but there are two reasons why people should be reasonably relaxed about this. One is that right now, at a time when deflation is the greater risk, having a weak currency should not import too much inflation from abroad.
The other is that British experience after sterling's 1992 ejection from the ERM suggests that, provided there is not excessive pressure from demand, imported inflation does not have much impact. That was one of the things that most of us got wrong then: we thought the fall in the pound coupled with the fall in interest rates would lead to a surge in inflation, but it didn't.
For what it is worth, my own concern is that the combination of falling property prices, a sharp slowdown in the growth of consumption, and the rise in taxation that is now coming through will combine to make the UK undershoot the Chancellor's growth forecasts.
Central London is probably in recession already (in the congestion charge zone, business is catastrophic), and there is a danger that this might spread to outer London and beyond. We need the stimulus that a more competitive sterling will bring.
If, on the other hand, the dollar/euro rate does not shift much further, then I don't think we should completely write off the idea of a eurozone recovery next year. This year is going to be pretty dire in Europe, but it won't be great in the UK either as the house price boom fades and people become more cautious about running up yet more consumer debt. Some City economists, for example those at Goldman Sachs, are quite positive about a eurozone recovery next year.
Domestic consumption does seem to be rising again as consumers start to experience a decline in inflation and the initial adverse impact of the euro on confidence starts to evaporate. Latest figures on French demand do slightly support this optimism.
So we will see. The balance of probability must surely be that both this year and next will see a continuation of the superior growth of the US and UK over that of the eurozone.
That would certainly be the view of Don Straszheim, former chief economist for Merrill Lynch and now an independent adviser, who provided the graphs above. His recommendation to the UK is: "Just say no." He thinks that the British economy will outperform the eurozone even more during the next three to five years, and that entry "will make even less sense in a few years than it does now".
If he is right, the window is narrow indeed. But that assumes that the decision is an economic one, not one driven by politics. We shall see.Reuse content