Stephen King: The UK's monetary independence is a blessing for the eurozone
Economic outlook: The devaluation of the pound has had an impact. Oil prices, for example, recently hit a record in sterling terms
Monday 16 May 2011
As the German economy returns to Teutonic strength, the French economy shows a soupçon of economic joie de vivre, and even Greece's economic tragedy temporarily lifts, the UK is in danger of being left behind in the slow lane of European economic growth.
According to Eurostat, Britain's GDP rose 0.5 per cent in the first quarter, while Germany delivered 1.5 per cent, France managed1 per cent and Greece somehow came up with 0.8 per cent.
Admittedly, developments in any one quarter can be weirdly random. It sometimes helps to step back and look at things over a longer time horizon. Over the past 12 months, for example, Greek GDP was down 4.8 per cent so the first quarter bounce – while welcome – still leaves Greece in a thoroughly miserable position.
The UK is doing a lot better, with an overall rise in output over the past year of 1.8 per cent. Whatever the nature of our economic woes, they are nothing like as bad as those confronting Athens. Yet, compared with our main Northern European rivals, our performance is not really up to scratch. The French recovery is already ahead, with its economy delivering an annual gain of 2.2 per cent. Germany, however, is now absolutely dominant, posting a remarkable 4.8 per cent increase over the past year.
The UK seems to find itself stuck somewhere between the renewed dynamism of the Northern European countries and the stagnation in the so-called "peripheral" nations. While Greece grabs the most morbid attention, the Portuguese and Irish economies also find themselves in a sorry state. The economies of Spain and Italy are expanding at only a snail's pace.
The weakness of the peripheral nations is often attributed directly to membership of the euro. Pre-crisis, they became magnets for excess German savings, partly because the Germans believed they could invest down south with absolute safety, given the abolition of exchange rates and, hence, the removal of currency risk. Yet their generosity contributed to the housing booms in Spain and Ireland and, for a while, created the (false) impression that investing in Greece was risk-free.
Post-crisis, it was time to wake up. These countries had borrowed too much and had not delivered the competitive improvements that would allow them to flourish. The combination of high debt and economic stagnation left markets demanding higher risk premia, and it wasn't long before widespread talk about bailouts and defaults.
Yet at least some of these attributes apply to the UK, too. Pre-crisis, international investors poured their savings not only into the peripheral nations but also into Britain. Thanks to their generosity, yields on junk bonds fell dramatically even as official interest rates, as set by the Bank of England, rose. In many investors' eyes, the UK was particularly attractive because, unlike Greece and the others, it had an appreciating exchange rate: at one point, remember, sterling was worth more than $2 despite the UK's widening balance of payments current account deficit.
And like some of the peripheral nations, UK economic growth became increasingly one-dimensional. In our case, job creation depended on only three sectors of the economy: financial services, construction and the public sector. With the first of these in the doghouse, the second in a renewed state of collapse (down 4.7 per cent in the first quarter of 2011) and the third being sliced ever more thinly, it's easy enough to see why the recovery has been less than robust. As the German economy recovers, the British economy remains on its knees.
Yet, unlike the peripheral nations, the UK supposedly has an escape route in the form of an "independent" monetary policy. Back in 2008, sterling collapsed, a process implicitly encouraged by the Bank of England and HM Treasury. The idea was to deliver a rebalancing of the UK economy: less in the way of consumer spending and more in the way of exports. And, if the rebalancing worked, the UK would not have to suffer pain on a peripheral scale.
It sounds neat, but things haven't quite gone according to plan. Whereas the UK, with its huge devaluation, is still struggling to recover, Germany is doing perfectly well without any kind of independent monetary arrangement. And while the UK is doing a lot better than Greece, its performance really isn't hugely better than Spain's. There, GDP has risen modestly for two successive quarters, leaving the annual rate of growth at 0.8 per cent.
So has the UK's monetary independence been of any real assistance? The idea that a big drop in the exchange rate could help rebalance the economy was always, in my view, more than a little suspect. So much of a nation's export success these days rests not on the exchange rate but on its design and marketing skills and its ability to adapt to global economic trends. Germany does this very well, switching its efforts increasingly to the fast-expanding emerging world. Britain, in contrast, has fared badly.
And, whereas inflation is broadly well-behaved elsewhere in Europe, the Bank of England has now admitted that UK inflation could head up towards 5 per cent later in the year. Although there are all sorts of reasons behind the UK's poor recent record – including increases in VAT which are part of the price we now have to pay for earlier excesses – there can be no doubt that sterling's decline has been a factor. Whereas, in euro and dollar terms, oil prices are not yet back to the heady levels seen in the first half of 2008, oil prices in sterling terms recently reached a record high.
And this rise in inflation is, in effect, a tax on growth. Prices are rising but wages are not responding in any kind of meaningful way. Real take-home pay is, thus, under tremendous downward pressure.
Despite, then, the initial benefits of interest rate cuts – at least for those who had big variable-rate mortgages – the subsequent rise in inflation has imposed a form of financial austerity on the UK economy revealing that, like the peripheral nations, there is no easy escape from our earlier excesses.
In truth, the main benefit of the UK's monetary independence has been to stabilise the euro. Just imagine that the UK had been in the euro from day one. It's bad enough asking the Germans and French to bail out the Greeks, Irish and Portuguese, but how might they (and we) have reacted to a bailout of the UK? Could they have offered the funding? Could we have coped with the political humiliation? If not, would the euro have survived?
For those involved in solving the euro's financial crisis, the UK's absence is surely a blessing. Sorting out their remaining economic problems is not going to be easy, particularly when Dominique Strauss-Kahn, the head of the IMF and one of the main protagonists, finds himself hauled off an Air France jet and charged with sexual assault rather than meeting Angela Merkel. Yet, while the euro crisis has been bad enough, with the UK included it would surely have been a lot worse.
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