Euro will not collapse, despite what idiots like Ambrose Evans Pritchard say. It's here to stay. Holding it together, even with the PIGS on board, is far less trouble than the chaos and anarchy which would ensue should they let it fall apart
UK will join, no doubt about it.
Only question is when.
Euro makes Europe's world go round
The single currency may not be universally admired, but its durability has disarmed its opponents, says Jeremy Warner.
By Jeremy Warner
Published: 6:45PM BST 17 Sep 2009
Comments 22 | Comment on this article
The single currency has survived because the line that has been held on the stability and growth pact has been roundly ignored
The annoying thing about economics is that nearly all issues of any importance can convincingly be argued either way. It is only the long passage of time that validates one line of analysis over another, and even then, established orthodoxies get periodically overturned according to the fashion of the age.
So it is with the euro, whose benefits or otherwise for member countries will still be debated by economists years from now.
To attempt monetary union among once warring nations with radically different legal and cultural traditions, and without the common Treasury function that usually stands behind major currencies, would always be a contentious project.
Yet, there is at least one thing to be said in the euro's favour, which is that it is well established as a credible form of exchange. So far, it has withstood both internal and external pressures. What is more, it has achieved reserve currency status.
Many believed it would never get off the ground at all, such were the complexities of the new currency. But thus far it has defied its critics. The single currency's introduction was a masterpiece of Teutonic planning, executed with military precision. Having been proved wrong about its birth, sceptics then turned their attention to the euro's sustainability, roundly declaring that it couldn't possibly last. Eventually, they predicted, it would collapse under the weight of its own contradictions. So far it hasn't.
Yet the reasons for this durability are not what you would expect. Even before the economic crisis, the rules and principles supposed to underpin the euro and provide a modicum of fiscal cement between member states were being routinely compromised. Since the credit crunch broke, it is not so much a coach and horses that have been driven through the stability and growth pact â€“ the rules that are meant to limit the budget deficit of member countries to no more than three per cent of GDP â€“ as the whole train set.
With fiscal deficits around the eurozone spiralling out of control, the pact is toast, or suspended for the duration of the crisis, depending on how charitably you want to view events. Surely this would mark the beginning of the end for the euro? Yet again, it has not.
The single currency has survived because the line that has been held on the stability and growth pact has been roundly ignored. Toleration of unruly behaviour has saved the euro from forced or voluntary withdrawal.
What is more, this catastrophic collapse in internal discipline has not had any noticeable adverse effect on the euro's international stature. To the contrary, the crisis has enhanced the euro's appeal as a reserve currency alternative to the dollar.
I won't argue that the euro remains a benefit to all its members. Some weaker, less competitive states would undoubtedly benefit from a lower exchange rate, just as the core union of Germany and France might arguably be better off without the millstone of Italy, Portugal, Greece and others hanging around its neck.
If Germany and France were on their own, they could better tailor monetary policy to their own needs, while the implicit cross-subsidy from Germany of weaker member countries would disappear. Bond yields in Germany would fall to close to zero and the Bundesbank would be able to follow the Bank of England into quantitative easing.
This is why the clever-clogs' answer to the question "Which country might leave the euro first because of present tensions?" is not Ireland, Spain or others suffering crushing economic contraction and unemployment as a result of the crisis, but Germany, the euro's spiritual and physical centre.
In reality, no one will leave any time soon. Far from the crisis undermining the euro, says Willem Buiter of the London School of Economics, the single currency has proved a bulwark against the crisis. The economic situation among peripheral members of the euro is grave, but just think how much worse it would be if the likes of Ireland, Italy and Spain had floating exchange rates.
Another who thinks the euro has been vindicated by the financial and economic crisis, rather than undermined by it, is Richard Portes, professor of economics at the London Business School. Without the euro, he contends, there would be catastrophic currency crisis in all these countries, on top of the existing financial and economic maelstrom, causing interest rates to sky rocket and the already dramatic contraction to deepen further.
Government deficits in most of these countries would have become virtually impossible to finance, forcing even deeper cuts in public spending than those already being pushed through. Nor would the banking system in these countries have had access to the European Central Bank's virtually limitless lender of last resort facilities. In Ireland, the banks would have gone down much more comprehensively than they have.
Iceland demonstrates just how vulnerable small countries with big financial services industries can be to a sudden loss of international confidence. The country went bust alongside the banking system. Countries that don't enjoy the protection of reserve currency status are highly vulnerable to financial crisis.
Luckily for Britain, sterling retains some reserve currency attributes. Foreigners are still happy to hold sterling, which remains in use extensively in international trade. That has helped protect Britain from some of the worst consequences of the crisis, in the same way as the single currency is shielding smaller members of the eurozone.
According to Prof Portes, devaluation would provide no kind of permanent cure for peripheral eurozone members, for it would rapidly get translated into higher inflation, leading to a further loss of competitiveness.
Foreign exchange chaos would also have had potentially dramatic adverse consequences for intra-European trade, which has grown enormously since the introduction of the euro.
The idea that Germany would gain from leaving the euro is equally ridiculous. No other country has gained as much from the euro as Germany, to the extent that it is sometimes mischievously said that by enslaving the rest of Europe to Germany the single currency has finally succeeded where the Third Reich failed.
Maybe it was planned that way, but in fact Germany has largely earned its own success in this regard by using the euro to improve the competitiveness of its economy and major industries. That this hasn't happened in Italy, for example, has nothing to do with Germany or any supposed flaws in the euro, but is largely down to Italy's dysfunctional political system, which has stood in the way of structural reform.
Germany's growing economic might on the European continent has none the less exposed a weakness common to all fixed exchange rate systems.
When Germany still had its own currency, any improvement in the competitiveness of its industry would be partially countered through an upward adjustment in the exchange rate, making its exports more expensive and imports correspondingly cheaper. This pressure valve is no longer available, with the result that an ever growing trade gap has opened up between Germany and other less successful members of the eurozone, rather like the one that exists between China and the US.
For every trade imbalance, there is an equal capital imbalance, with Germany effectively lending the less competitive deficit nations both within the euro and on its fringes the money they need to buy German goods. Germany has gained substantially from this dynamic, but it is plainly not a sustainable one. Imbalances have a nasty habit of unwinding suddenly, painfully and catastrophically, as we have learned during the global banking crisis.
To date, the relationship between surplus and deficit nations within the eurozone has been largely symbiotic, but it may not remain so. Part of the answer is for deficit countries to raise their game. They must spend less and produce more.
But if the euro is to build on the success it has achieved, Germany has to accept that it too has obligations. It must save less and consume more. As it happens, that's precisely what Germany is doing right now. A very substantial fiscal stimulus has been enacted to counter the recession. But it's temporary, and Germany is itching to return to the old normality, however unsustainable it might be.
None of these issues can or indeed should be addressed in the way commonly assumed, which is for Germany to bail out the more distressed members of the euro.
This is not because such action would be illegal. There are lots of ways around the Maastricht ban on one government guaranteeing the debt of another. Rather it is because it would be politically unacceptable. No German government, even one as apparently unassailable as that of Angela Merkel's, could hope to survive for long if it chose to bail out Ireland or Greece over applying the money at home.
Instead, Germany has to find more effective and permanent ways of boosting domestic demand. If it does not, then it is indeed reasonable to fear for the future of the euro, and indeed European harmony more generally.