Monday, June 09, 2008

In for a penny...

The continuing travails of the financial markets, and the developing problems in the real economy is confusing political thinkers across the spectrum.

In particular, there is a real sense of concern in Britain over the financial politics of the Euro.

Many economists argue that the creation of the currency union has already brought about substantial convergence, and there is certainly substantial evidence that many countries using the single currency are moving their cycles into alignment. However, it is also true to say that within the bloc there are also several significant divergences, and the single interest rate has proven very problematic- too high at times for the core economies, but so low that it has created a credit boom in Ireland, Spain and other so-called Club-Med states. The key question is whether the economies in the Euro-Zone are sufficiently convergent to avoid a breakdown in the system. Many, such as Liam Halligan, in this article for the Daily Telegraph, argue that the currency can not survive in its current form. A paper from the University of Hamburg is much less certain, though the balance remains on the negative side. The fact is that, as the Euro-Zone celebrates its first ten years, there is still substantial scepticism about its future.

For the UK, much of this discussion is heated and often crafted in emotive and aggressive language. The decision not to join the Euro-Zone at inception, and then to impose conditions so vague as to be highly unlikely that they could ever be fulfilled has parked the issue for at least another decade. British politicians know what to do in the event of a failure of the single currency, but they have no answers were that currency to be successful, and in fact the currency, for all that is should not work in principle, does in fact work very well in practice. Despite the divergence in government bond yields between the different European states, despite too the fundamental questions of unit labour costs and productivity, the currency has become recognised as a trusted store of value. Indeed the European Central Bank has been praised for its handling of the credit crisis, so far, while the US Federal Reserve and the Bank of England have been rightly criticised for serious policy mistakes.

The high taxes and increasingly over-regulated business environment in the UK has caused a sharp fall-off in confidence, with the result that Sterling is now trading at 1.24 Euros, down from about 1.48 in a matter of a few months. The unit labour costs in the UK also no longer compare well to those of Germany, where great effort has been made to reform the micro economy of the country. In short, the UK has made exactly the same mistakes as the Club Med states. Of course, since the UK has retained Sterling as an independent currency, there is the option of devaluing the currency to retain competitiveness, and that is precisely what has been happening in the markets.

However there is a cost in this: British living standards will also fall, and our economy is weaker compared to our competitors.

This is why I can not share Nick Clegg's professed views in his speech to the Liberal Democrat City Forum. The price of devaluation is not insignificant, and devaluation can only buy time in order to restructure the economy more efficiently. Arguably, this breathing room reduces the pressure for necessary reform- and that reform is already overdue. The price also includes maintaining interests several points higher than those in the Euro-Zone, a brake on competitiveness which is only partially off-set by a weaker currency. The decline of the Pound over decades has not given Britain a more successful nor a richer economy, and it won't this time either. The lesson of the Thatcher years must surely be that governments must not duck the issue of reform, rather than try to devalue their way out of trouble.

Furthermore, the failure to enter the Euro-zone has meant that the British cycle remains out of line with the core economies of the European Union, and thus we are not picking up the benefits that we could have achieved by joining.

It now seems as though the voters of the Republic of Ireland are set to reject the Treaty of Lisbon, and this could prove to be a crisis that shakes up the whole European system. However, if at the end of that crisis the Euro has continued, then sooner or later the confused politics of the UK will need to recognise that the Euro is a permanent feature, and that the costs of being outside it will continue to be significant.

Devaluation of the Pound is a failed policy, but when will we recognise this?

2 comments:

Anonymous said...

Has it occurred to you Cicero the reason we are out of sync is that our Economy is tied as it has been for decades to the US economic cycle. Had we been in the Euro our credit binge in the last few years would have been multiplied many fold. Instead of King raising rates we would as you say have had points several points lower for much longer. As it is the criticism of the Bank is that it did not raise rates years earlier leaving it less scope to cut rates now.

The grinding crash in Spain is an object lesson as is the one to unfold in Ireland. The idea that the Euro is some kind of panacea rather than a currency dominated by the needs of the German economy is fantasy.


Lepidus

Newmania said...

I enjoyed that article; quiet informative .Most people still want to retain the trading relationship we have with the EU whereas as vast majority want political control removed( I expect you saw the survey). This is surely what we should be seeking to negotiate and we can let them go off on their United States of Foreigner experiment on their own. They will be relieved to be rid of us and visa versa


I doubt that the heavily bribed ( with our money ) Irish , will rock the boat but it does put fully in perspective the outrage of denying the people of this country a say in their future by a cheap trick. There is the court case as well which will serve to highlight the non legitimacy of laws passed following Lisbon. I think civil disobedience of the right kind would be warranted myself , the pressure will be enormous on Cameron from the Party now more or less united in loathing of the EU. He is no great fan himself but ...easier to opine than do. Also there is the unchanging law that those in power shall discover they rather like the Brussels super state

Bog all chance of reform with the Unions bankrolling the Labour Party more than ever. I probably should not feel this way but to be honest I`d rather the shit hit the fan than put up with the current regime.

I must say I will be fascinated to see how Baker represents this new low tax Liberal Party you claim exists , after all he has said over the years it will be demonstrably farcical and I wonder how many sitting Liberals will have the same problem. The Conservative party is starting to direct resources at the new marginals and this could be bad news for Liberals despite their ‘ok’ showing. What fascinates me personally is how many more people are prepared to switch from Labour to Conservative than labour to Liberal.I suppose the anti nation anti family , pro crime pro criminal pro teacher anti parent pro foxes anti Liberty stuff that may have ruffled feathers over the years .