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?