Outlook In launching a collection of essays celebrating ten years of the euro yesterday, Peter Sutherland, chairman of BP, Goldman Sachs International and a committed europhile, says he wants to put the case for Britain joining the euro back on the political agenda. He may have quite a wait. Even the LibDems are these days careful to avoid all talk of joining the euro, for fear of frightening the electorate, while the only member of the cabinet known to be wholeheartedly in favour, Lord Mandelson, has been told to keep his mouth tightly shut. The euro is still a definite no no among British politicians.
Yet the fact is the British economy is today more converged with the Continent than at any stage since the euro was launched, while the credit crunch has thrown up some powerful new arguments in favour of being part of a larger currency block.
Virtually all countries in Europe are sinking into recession, which means that the economic cycles are now fully in sync. Both long- and short-term interest rates are, to all intents and purposes the same, and even the pound, though at a level which prompts howls of anguish from impoverished British holiday makers, is close to the sort of level where Britain could reasonably enter without long-term damage to competitiveness.
The famous five tests, allegedly designed by Gordon Brown and his then assistant, Ed Balls, in the back of a cab, are either all satisfied or now irrelevant. Many of the key economic arguments against joining – such as the British economy's peculiar obsession with the housing market – have, moreover, turned out to be completely misguided. When the Treasury last published a formal assessment of the tests, in June 2003, it produced an eloquently argued paper demonstrating that the application of euroland's then much lower short-term interest rates would have produced a housing and consumer boom of devastating proportions. An independently managed monetary policy had by implication kept the lid on things. Yet even if this was true at the time, the analysis has little relevance today.
As we now know, it was the quantity of credit, rather than the cost of it, that was the root cause of the housing bubble, though I guess the consumer boom might have been more extreme still had interest rates been lower. The point is that an independently run monetary policy failed to prevent the excesses of the credit bubble, which was much worse in Britain than most of Europe.
Rather, it was deficiencies in banking and credit regulation, which are not directly linked to the exercise of monetary policy, that allowed the runaway boom to take hold. Indeed, the evidence is that the European Central Bank was better at recognising the dangers inherent in the growth of credit than the Bank of England. Certainly, it is now widely judged to have been more savvy in addressing the banking crisis with early injections of liquidity.
If the supposed negatives of the euro seem largely to have been exploded, it is also now possible to point to some clear-cut positives. The most obvious of these is currency stability. This is a contentious point because conventional wisdom is very much that ability to devalue the currency in an economic downturn gives a competitive advantage and therefore helps stimulate recovery. However, in the synchronised downturn we see today, currency deval-uation may have little effect. The root of the problem is lack of demand, not lack of competitiveness. What's more, as Willem Buiter of the London School of Economics argues in one of the euro essays, a floating exchange rate can also greatly enhance financial instability in nations which have big banking sectors relative to GDP. As Iceland demonstrated, it is possible to have a run on a country, as well as a bank, with devastating macro-economic consequences.
Being part of the euro would provide protection from such attack. Historically, Britons have never voted for Europe except in circumstances where they are able to look across the channel and see that things are noticeably better over there than they are over here. That hasn't been the case for some years now.
Yet the banking crisis has already turned all manner of things on their heads. Members of the Brown government are banned from trying to open up the euro debate. Remember how it tore the Tories apart more than ten years ago? Mr Brown doesn't intend to do his already uncertain electoral prospects unnecessary further damage.
But who knows how the next few years will pan out. Everyone already agrees that we need greater cross-border co-operation on capital flows and financial regulation. Inflation and reckless public spending used to be thought the great enemies of macro-economic stability. Rotten finance is now revealed as an equally menacing enemy. Huddling together for warmth and protection under the umbrella of the euro may have something to be said for it.Reuse content