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October 26, 2006

Kaletsky on the Euro

This won't make for fun reading in Brussels.

The Iraq invasion, disastrous though it has been, may not go down in history as the greatest political blunder of the past decade. That dubious honour will probably belong to an event most people still regard as a triumph: the creation of the euro. What we see today, not only in Italy and Hungary, but also in the other relatively weak economies on the southern and eastern fringes of the EU, is the beginning of the end of the European project. And if the euro project does turn out to be the high-water mark of European unification, then history will judge it a far more important event that anything happening in the Middle East.

As some people have been pointing out for years the euro weas never an economic policy, it was a political one. The economics were deliberately ignored in order to get the political action done.

The various countries within the euro zone simply are not an optimal currency area. You can quite happily argue that the UK itself is too large and diverse to be one as well but the problems of tying most of a continent into one are of course greater than the one we have here.

The coming breakdown that Kaletsky describes is simply a restatement of that old truth. You can ignore economics but economics isn't going to ignore you.

At some point the people of Europe will realise that there is something rotten in a political system that leaves them forever in the world economy’s slow lane — and which cannot be changed by any democratic process, regardless of how people vote.

Some of us get it already of course.


October 26, 2006 in European Union | Permalink


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» What has four letters, begins with E and is slowly killing half of Europe? from TruePress
Anatole Kaletsky, the London Timess principal commentator on economic and financial affairs, writes on the state of the Euro.  An excerpt; But what does the euro have to do with the political troubles in Hungary and Italy? And how can I compare... [Read More]

Tracked on Oct 26, 2006 8:10:25 PM


What a strange article. Almost everything he complains about has nothing to do with the euro.

"What Italy needs today is competition, privatisation of grossly inefficient state-sponsored utilities, deregulation of the financial system and changes in labour laws."

Surely he means 'devaluation', or if he doesn't then what does it have to do with the euro? And is it so obvious that Italy would be better off outside?

Posted by: Matthew | Oct 26, 2006 10:40:00 AM

The continuing problem in the EU is that some are a bit tardy on the uptake about economic issues. In February 1998, German academic economists wrote to the Financial Times:

"More than 150 German economics professors have called for an 'orderly postponement' of economic and monetary union because economic conditions in Europe are 'most unsuitable' for the project to start.

"The call to delay Emu 'for a couple of years' is made in a declaration signed by 155 university professors and sent to the Financial Times and the Frankfurter Allgemeine Zeitung newspaper in Germany. It signals intensified opposition to the government's euro policy.

"The declaration was organised by Manfred Neumann, professor of economic policy at Bonn university and chairman of the Bonn economics ministry's council of expert advisers. It signals concern among professional economists about Bonn's determination to begin the single currency on January 1 1999. . ."

Subsequent events after the launch of the Euro in 1999 showed the concerns of the German economists to have been well-founded. The governments of the three largest Eurozone economies have each found it necessary to breach the binding fiscal deficit limits set out in the Stability and Growth Pact for the Eurozone of 1997.

My personal enlightenment about prospective problems from monetary union in Europe came on reading the late Rudi Dornbusch (professor of international economics at the MIT) on: Euro Fantasies, in the issue of Foreign Affairs for September/October 1996:

Walter Eltis, sometime chief economic adviser in the DTI to Michael Heseltine in the early 1990s, is very clear in his book about the inhibiting factors for Britain to consider joining the Eurozone: Britain, Europe and EMU (Palgrave, 2000) chp.9. The huge problem is divergent rates of convergence among the economies of EU countries which means that loss of national autonomy in setting monetary policy instruments, such as interest rates, to address national conditions - an inevitable consequence of joining a monetary union - could make it politically painful to maintain national economic stability. Quoting Eltis:

"An independant committee . . reported in May 1997 that: 'Simulations on macroeconomic models run by national central banks suggest that, for the UK, the impact of an interest rate change on domestic demand after two years is four times the EU average.'" [p.186]

Just consider what would have ben the impact on booming house prices in Britain had interest rates here been cut to the levels set by the ECB for the Eurozone.

According to many claims made even from within the DTI in the mid 1990s, staying outside the Eurozone was bound to have catastrophic consequences for inward investment into Britain. However, in fact:

"The UK received more inward investment than any other country last year, according to newly released internationally-compiled figures. The Organisation of Economic Cooperation and Development (OECD) said foreign direct investment into the UK hit a record $165bn (£91bn) in 2005."

Evidently, Walter Eltis made the correct call about the risks for Britain of joining the Euro.

Posted by: Bob B | Oct 26, 2006 1:16:12 PM

If the reason behind a common currency is trade efficiency, what's wrong with the dollar?

Posted by: furriskey | Oct 26, 2006 6:24:54 PM

Kaletsky is living refutation of Tim's proverb; although he has ignored for the last seven years the fact that he was dead wrong to predict for most of the 1990s that EMU would not, could not possibly happen at all, this economic fact has inexplicably ignored him in career terms.

Posted by: dsquared | Oct 26, 2006 7:25:24 PM

"If the reason behind a common currency is trade efficiency, what's wrong with the dollar?"

The US Dollar was adopted in 1785 as the common currency for the 13 states in the then prospective United States of America when there was hardly any manufacturing there and agriculture was the major economic activity, all of which meant that product prices were highly flexible in response to any local imbalances in supply and demand, a very different situation from that prevailing in the mature national economies of west European countries now.

The American economy has had more than two centuries to adapt to the experience of monetary union and, importantly, the US has in place a federal government and a federal system of automatic fiscal stabilisers to transfer funding from states with buoyant local economies - which generate booming tax revenues for the federal exchequer - to states with depressed economies and depressed tax revenues.

By contrast, monetary union in Europe has only recently started, European economies are already mature, with substantial manufacturing sectors, and the total EU budget is very small relative to the size of constituent national EU economies so the EU budget is incapable of performing any effective function of automatic stabilisation. And, of course, there is no EU federal political control over the fiscal policies of national governments which therefore retain national fiscal autonomy.

As a fact, EU national economies respond very differently to changes in interest rates. Add to that natural barriers to job seeking across national borders in Europe - becauses of differences in languages, cultures and social security systems - with the natural reluctance of European consumers to engage in cross-border shopping and the EU economies don't have similar pressures inducing convergence as have existed in the US for two centuries. The evidence also shows that Americans are far more given to moving long distances in search of jobs than are Europeans even within their own national borders.

The upshot is that EU economies don't yet have the extent of convergence for the smooth functioning of monetary union, which is why the governments of the three largest Eurozone economies have each found it necessary to breach provisions of the Stability and Growth Pact of the Eurozone countries in order to better maintain conditions for internal economic stability.

The sad thing is that too many in this debate in Europe have regarded cheerleading for the Euro as a mark of their personal political commitment to a European identity before they have properly understood the economic implications of monetary union. The evidence of what has happened to EU economies since the launch of the Euro in 1999 clearly shows that the Britain's economic stability has not suffered by being outside the Eurozone - and nor has the economic stability of Denmark and Sweden. Inward investment into Britain has been running at record levels. London has been performing admirably as a global financial centre. The Economist recently noted (subscription):

"Twenty years ago London embarked on a remarkable transformation to become a global financial centre. It now has to keep its lead . . However, the City will be hard to dislodge as a financial hub. Sir David Walker, who worked behind the scenes in the early 1980s to reform the stock exchange and is now a senior adviser to Morgan Stanley, an American bank, gives warning against complacency but says: 'Over time a virtuous circle, supported by sensible regulation, has developed to such an extent that London is more than a network: it's become a knot and it's very difficult to disentangle a knot.'"

The fact is that EU economies are still too diverse to be able to cope with having one interest rate set by the European Central Bank to target the average inflation rate across the whole Eurozone without unacceptable side effects in many cases on national economic growth, national unemployment rates or national inflation rates.

Just what is the point in seeking the greater "trade efficiency" of monetary union if that is at the risk of jeopardising national economic stability. The Canadians - very wisely - show no sign of wanting to give up the Canadian Dollar with Canadian national monetary autonomy for whatever benefits of greater trade efficiency might be yielded by joining a monetary union with the United States. The NAFTA Treaties very sensibly allow the participating countries of the USA, Canada and Mexico to retain exchange rate flexibility. Adjusting national economies to international competitive pressures through changes in exchanges rates is much less socially painful than effecting adjustments to competitive trade pressures through changes in national employment levels.

We really needed to sort out the government and (federal) politics of European integration before embarking on monetary union - as Delors, the EU Commission President at the time of the Maastricht Treaty, clearly did appreciate in an interview with The [London] Times in 2004:

"JACQUES DELORS, the former President of the European Commission, fuelled the controversy over the euro yesterday by admitting that Britain was justified in opting out of the single currency because its launch was flawed.

"In a remarkably frank interview with The Times, the one-time bogeyman of Eurosceptics also predicted that Britain would stay out for years, not least because Gordon Brown was so 'passionate about his contempt for Europe'.

"In another startling admission, the veteran French leftwinger said that the European Union was in a 'state of latent crisis' because of weak leadership. He blamed member state leaders, including President Chirac of France, for putting national interests before the common good. . .

"But his most surprising comments were on the euro. He lamented that EU leaders had failed to heed his warning that monetary union must be matched with close co-ordination of economic policies, and argued that the euro was consequently less attractive than it could have been."

Posted by: Bob B | Oct 26, 2006 8:55:33 PM

I have a very simple take on it really. I do not believe money put into Greece or any of a number of other Euro zone countries will and well managed as money invested in Amsterdam. And when push comes to shove, when the Greek economy inevitably collapses again, the German banks will not bail them out for the sake of the Euro.

Posted by: Beachhutman | Oct 26, 2006 9:39:42 PM

I don't want to worry you unduly but the Netherlands is in the Eurozone.

Posted by: Bob B | Oct 26, 2006 11:07:59 PM