Letters to the editor

Polls and Comment

Library - an archive
of speeches


Economists write

Bibliography of EMU

The Euroland Economy

Links

 

















Survival issues that float around the euro sieve

THEY went to sea in a sieve, they did; in a sieve they went to sea. That was what the Jumblies did, according to Edward Lear. Did the euro-11 do the same?

To the elites of Europe who designed the euro and told us all it would be fine, that question is an insult. But the German people have persistently said, as they did in a recent opinion poll, that they wanted to keep the Deutschemark. To them the mark is still their currency but it has been devalued relentlessly by being attached to a euro that embraces other, less reliable currencies. What may be their reaction when euro notes and coins physically replace the mark sometime in 2002?

We have already seen the popular consternation in Ireland as inflation surges towards 10pc, and the unwillingness of ordinary Danes to join the project at all. Recent fuel tax protests have revealed that elites cannot rely on stealth control; by implication they reveal fault lines in consent to their pet stealth project, the euro.

Alas for the Group of Seven's multilateral intervention in the currency markets to prop up the euro. One can see why none of these governments wants a weaker euro; it has got to the stages of beggar-my-neighbour weakness already. The low euro is propping up struggling German, French and Italian manufacturing firms against merciless competition from the Koreas and Thailands of this world, but the propping is at the expense of struggling American, British and Japanese manufacturers.

Meanwhile, the euro governments are beginning finally to be concerned about the potential inflationary effects of letting the euro fall any further; the European Central Bank has been worried about this for some time, as it has seen inflation ignite in the periphery of euroland - in Ireland and in Spain for example.

But here we hit the nub of the euro's problem. There are signs of weakness in the pace of recovery in Germany and Italy; the euro's devaluation has worked through and delivered more exports and output but this growth trick cannot be turned again without yet another devaluation. The neighbour has been beggared; it was a one-off stimulus.

The hope was that households would feel better off and spend more too, keeping the growth going. But households in Italy and Germany are worried by the lack of dynamism in their economies - rather like their Japanese equivalents. They think they should save more for their old age (their government pension promises seeming rather hollow) and they are worried about job prospects. In Italy 19pc less of the over-16 population look for jobs than in the United States, and if you add them to the jobless the Italian unemployment rate comes out at 37pc; in Germany it would come to 22pc.

Against this background the ECB is terrified of pushing up interest rates, whatever the inflationary or monetary need. Professor Avinash Dixit of Oxford University has suggested why in a paper soon to come out in the Economic Journal: countries such as Germany have the potential to destroy the euro totally by leaving, hence the ECB has to react "politically" - bending to avoid the storm.

But if the ECB will not raise interest rates, how can all that mighty foreign exchange intervention succeed? It is almost a truism in international economics to say that "sterilised intervention" is useless except in the very short term, "sterilised" meaning that the intervention is not allowed to affect interest rates. It is useless because it is the return on money that motivates the movement of portfolios, which is the major determinant of the value of currencies.

If interest rates are not going to back up the intervention, that movement of money will not change direction, a direction away from the euro area. That direction is due partly to the euro area's lack of American-style dynamism. But mainly it is due to the worries about lack of political consent to the whole project and the risks of it therefore unravelling; there is no viable strategy for dealing with those severe economic shocks within the euro area that could upset public opinion.

The current strategy, according to the French presidency, is to go as fast as possible for political integration: more power to the euro-11 council of finance ministers, so that Brussels can redistribute taxpayers' money from lucky to unlucky regions, just as a national government does inside national borders. But it was none other than a key ECB Board member, Professor Otmar Issing, who pointed out recently that this strategy, even if people agreed to it long-term, could not be a reality for decades.

The euro has to survive over the next few months and years. To do so it requires alternative mechanisms of adjustment to replace the lost one of national interest rate and exchange rate movements. The available alternatives are flexible wages and labour mobility; in other words if a country has a bad and prolonged fall in output and employment, wages should fall or people should move elsewhere. Neither is something any euroland politician dare contemplate.

The waves around the euro sieve are every bit as bad as the Cassandras warned. These countries are highly divergent; the gap between highest and lowest unemployment is 8pc, between highest and lowest inflation rate it is 5pc (2pc excluding Ireland). Matters could easily be a lot worse with a really bad shock such as the Asian crisis or the 1970s quadrupling of oil prices.

Since one can be outside the euro and in the EU why should any one people put up with grossly inappropriate interest rates merely for the sake of a paper currency? And if people feel that way, how long before the elite who lumbered them with the euro crumble before a popular backlash?

The unthinkable - the failure of the euro - is far from certain. Like the Jumblies the euro could hit a lucky streak and grow tall in the hills of the Chankly Bore. It all depends on the size of the shocks that lie in store and on where they hit hardest. But with a structure so vulnerable to chance it is surely now a risk that cannot be lightly dismissed.

Patrick Minford is professor of economics at Cardiff Business School  

Patrick Minford's home page
 
Back to the Index of Daily Telegraph articles