Sunday, October 15, 2006
Sterling's lucky escape from the euro
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Tucked away on the Treasury’s website, made available under Freedom of Information, is a rather sad little document. It is the official plan for switching over to the euro in Britain when the time comes.

We learn that, at that time at least, plenty of people were working on the plan, under the government’s “prepare and decide” policy, though many more would be needed when it became “mission critical”.

D-day (for “decision”) would be the cabinet’s recommendation to join, followed a minimum of four months later by R-day (referendum). Twenty months after that, credit card payments would be denominated in euros, and 10 months after that would come E-day, the introduction of euro notes and coins. The favoured date for E-day would be April 6. Two months later sterling would cease to be legal tender, a dead currency.

Set out like that, starkly and clinically, it is easy to ignore the enormity of what was being considered. But had the Treasury’s last assessment of Britain’s readiness for euro entry, in June 2003, come out with a “yes” verdict, then by my calculations euro notes and coins would have been in circulation last April and the pound in your pocket would now be a museum piece.

We know, of course, that the Treasury said “no”. Things could, however, have been different. David Blunkett, in his diaries, says that Tony Blair was ready to ditch Gordon Brown in March 2003, unless the chancellor came out in support of the Iraq war. Had that happened, an a pro-euro chancellor installed in his place, Treasury officials might have been inveigled into saying yes, and sterling would be no more.

It didn’t happen, and that’s why the Treasury document is a sad one. Euro entry, such a hot topic three years ago, has disappeared from the agenda. The prime minister has abandoned hope of achieving it in office and his likely successor, Brown, is not remotely interested. George Osborne, the shadow chancellor, told the Tory conference that his party would never take Britain in. Euro entry is not so much in the long grass as in a distant field.

Nobody will be too distressed by that. If there is a clamour to join out there, it is well hidden. The most basic argument for euro entry, that it would bring currency stability, does not stand up to scrutiny. Sterling has been more stable outside the euro that it would have been inside it. Indeed, it has been more stable than at any time since the Bretton Woods era (of fixed-but-adjustable exchange rates) of the 1950s and 1960s.

What would have happened had we joined? Three years is too short a timescale but we can say what might have happened had Britain gone in at the euro’s inception in 1999. Marchel Alexandrovich of Dresdner Kleinwort, in a simulation, says that there would have been an almighty boom soon after entry, growth reaching nearly 5.5%, followed by a more pronounced boom-bust cycle. The housing market would have risen faster and further, though might by now also have crashed.

Entry would have meant lower interest rates; just 2% much of the time. The Bank of England would have been turned into a branch office of the European Central Bank, relieving its governor of direct responsibility for controlling inflation or writing letters of explanation to the chancellor when the target was missed. But inflation would have been significantly higher, typically 3-4% even on the consumer prices index measure. We had a lucky escape.

What about those who were not so lucky?. Some countries have clearly benefited from membership but for others it has been a struggle. The European economy is in an upturn at present, which is papering over some of the cracks, but those cracks remain.

The Centre for European Reform is not given to alarmism over the European “project”, being very much in favour of it, but a recent paper, Will the Eurozone Crack? by Simon Tilford, set out the dangers clearly.

The failure of European economies to reform themselves is well known. In the case of countries like Italy, its failure to get a grip on its public finances or take action to improve competitiveness is getting dangerous. One consequence has been the adoption of protectionist measures against Chinese clothing and shoe imports - pushed hard by Italy - which hurt consumers across the EU.

The other is that Italy will not be able to keep up with the other euro economies. As Tilford puts it: “What happens in Italy will be crucial for the future of Emu (economic and monetary union). If Italy fails to improve its competitiveness, it could be forced to leave the eurozone. The consequences would be hugely damaging not just for Emu, but for Europe more broadly. It could easily force other countries to leave and could even threaten the single market.”

This chimes in with my view, that the euro will not survive in its present form for the next 10 years. I am glad, despite the irritations, that we are part of the European Union. But when it comes to the euro, it is definitely a case of better off out.

PS Mervyn King has learned to spread his thoughts thinly - he only makes three “major” speeches on the economy a year - which makes them worth reading. One reason is the effort he makes to draw local analogies. Delivering last week’s speech in Winchester’s Great Hall, where what is said to be King Arthur’s Round Table has pride of place, he said the deliberations of the MPC (monetary policy committee) were in the spirit of the Round Table, where “no one person is at a privileged position”. His vote, in other words, counts only as much as the newest MPC member, let alone its Lancelots and Galahads (not forgettig the Guineveres).

That said, King’s words carry extra weight in the markets. The five Bank “insiders” on the MPC - the majority - don’t agree on everything but they do agree on a lot, and the governor is seen to reflect their view.

Last week’s speech had four essential messages. First, while prices in Britain are subject to a range of outside influences, not least the “China effect”, inflation is made at home. Decisions on interest rates, taking into account these influences, will determine whether inflation will be above or below target.

Second, it is no longer likely he will have to write a letter this winter to Gordon Brown explaining why inflation has gone above 3% (I never thought it was). Third, lower oil prices do not, on their own, remove the inflation danger.

And, fourth, the uncertainties are great. Strong growth in money and credit points to higher inflation but low wage growth brought about by rising labour supply (the migration effect) points in the opposite direction. Where does this leave interest rates? King stressed he was offering no clues to next month’s decision. My sense, however, is that like any central banker he’s still keen to take away the punchbowl before the Christmas party gets going.

From The Sunday Times, October 15 2006


Why do you feel "glad, despite the irritations" to be part of the European Union? Perhaps I am spending too much time reading Euro-sceptic sources, but I cannot remember anything that the EU has done that has actually been of benfit to the UK.

Posted by: Abelard at October 15, 2006 06:50 PM

I thought I was the Eurosceptic! Political stability, the bits of the Single Market that work, providing an alternative, albeit not a very effective one, to the United States. But I agree - you have to think about it.

Posted by: David Smith at October 15, 2006 08:47 PM


England doesn't need to join the European Union to find some "alternative" to the United States. Whatever that means. England is free to align, support any political viewpoint and chart any destiny it's elected officials choose to embrace.

You want the benefits of trade, unilaterally eliminate all of your own trade barriers. I only wish the US would adopt those same and sane policies. Enforce contracts between willing parites, get out of the way and watch that freedom create spectactular amounts of wealth.

The Eurpoean Union is a suffocating beast.

Posted by: Gary Bezowsky at October 15, 2006 10:04 PM

re china effect and this is certainly not new but why would the united states trade deficit with china ever be reduced.china offers high quality manufactured goods for low prices and this is not likely to change any time soon.and why would china not accept american ious when there is so much strength in the united states.
last week they took all the science nobels.they are at the cutting edge of science.they are the most advanced technological nation on earth and they are the only economy large enough to accomodate all that surplus cash the world has accumulated.surely they are worth a risk.

Posted by: richard at October 16, 2006 05:49 PM

sorry i forgot the figure of 50 million workers waiting for jobs in china.this populous nation may well say to itself :"better take the ious and give jobs to those in need of employment."
ok so their huge treasuries mountain may diminish through a possible devaluation but the positives outweigh the negatives.

Posted by: richard at October 16, 2006 05:54 PM

Thanks for the response. By "political stability", do you mean in Europe? I can see that that might be a benefit, by not getting the UK entangled in continental wars. I don't see that the EU has helped stabilise UK politics at all.

Posted by: Abelard at October 17, 2006 05:34 AM
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