Beleaguered euro may have to bank on international rescue

Experts advised their customers to put money in the euro; as a result, their credibility is shot

If the collapse of the euro prompts a co-ordinated rescue of the currency in the next few months, what will be the long-term consequences?

The overwhelming balance of probability is that there will have to be some sort of internationally co-ordinated rescue. It will have to be co-ordinated because action by the European Central Bank on its own would not be credible.

At a minimum there will have to be a statement of support from the eurozone governments, coupled with assurances of continuing structural reform. But that might not be enough. Ideally, there would be a Group of Seven statement of support coupled with specific new structural reforms. And of course both such actions would have to be supported by co-ordinated central bank intervention on the foreign exchanges and an exemplary rise in eurozone interest rates.

We don't know the timing of this rescue, nor the precise form, but let's assume that it happens. Of course it is always possible that there will be a spontaneous recovery of the euro, but it is hard to imagine a sustained one. A rescue is therefore much more likely.

So what then?

The first point is that the markets will not trust the experts for a long time. None of the large investment or commercial banks forecast this weakness and I don't recall any even suggesting it as a possibility. As the currency weakened last year most of them urged their customers to put money into the euro in anticipation of a recovery. As a result, their credibility is shot.

This is serious. It is more serious than the lack of credibility in the ECB, because the poor old ECB never had any credibility to start with. It takes a while to build up a track record and there simply hadn't been time before the slide got going in earnest.

So for the next few years the euro is likely to be in much the same situation as the pound was in the late 1970s and early 1980s following the IMF rescue in 1976. Sure, people will buy it, but they will buy it for trading purposes rather than as a long-term hold. The result will be that the euro will be volatile, maybe for years to come, rather as sterling was. There will be a euro recovery and maybe quite a sharp one. But do not expect it to last.

Further bouts of weakness will compound the problem of an underlying lack of confidence. It took a full 15 years for the French franc to become regarded as a sound currency after the failed expansionary policies of the early 1980s, and the euro could find itself similarly disadvantaged. The ECB might have to run a tighter monetary policy than it would ideally like - as the French did - just to support the currency.

As far as the UK is concerned there will be profound long-term consequences. The pound is now quite seriously overvalued against the German mark, but it is fairly valued against the dollar. So if you are running an exporting company you will be having a dreadful time exporting to Europe, but a great one exporting to the United States. The US markets have been expanding much quicker anyway. Indeed if you look not just as the faster growth in the US, but also its rising propensity to import over a long period (see graph), any sensible firm would direct its efforts to the US rather than the Continent. You put the effort into selling to the markets where you can make the best profit.

One further effect of the long-term weakness of the euro, then, is likely to be a redirection of British trade away from the Continent and towards the US. The fact that, physically, Europe is nearer matters much less now than even five years ago. The communications revolution has changed all that. It is, after all, cheaper to fly to New York than it is to Rome and cheaper to make a phone call to the US than it is to Belgium. True, bulk transport will remain much cheaper to the Continent, so some industries will remain handicapped by the need for physical proximity to markets; but for most high-value-added industries a new freedom looms.

Also, from a British point of view, expect profound resistance by UK financial institutions to any plans to have British company shares quoted in euros, whatever the plans of the newly-merged London and Frankfurt exchanges. The experience of the past 16 months will have shaken pension-fund managers. The danger of having liabilities in one currency and assets in another has been brought home in the most direct of ways: would you like to have the size of your pension determined by the level of the euro?

As to British attitudes towards the euro - well, a new paper by Goldman Sachs concludes that Britain has achieved greater stability in GDP growth and inflation than any other industrialised country, including the US. One could add that the Bank of England has gained considerable credibility for its handling of monetary policy, certainly by comparison with the European Central Bank. It is quite hard to argue against success: if it ain't broke, why fix it?

Finally, it would be naive to think that there will not be political fall-out across the eurozone from the mismanagement of its currency. There is at the moment no focal point for the genuine concerns that ordinary people will have at seeing their savings devalued in this way. Remember how the phrase about "the pound in your pocket" not being devalued dogged Harold Wilson all his days. Ordinary people like the feeling that their currency is a valuable one: that they are being paid in real money rather than rubbish and that the long-term value of their savings will be preserved. This concern will be particularly strong in Germany.

I don't think it is possible at this stage to predict how this political concern will play out. But German voters in particular must feel misled. They were promised the euro would be as good as the mark. I don't think even the most enthusiastic supporter of the euro would claim that now.