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Emu''s cloudy prospects may be a blessing

Now that we have had quite a convincing crash - er, correction - we can have some hope that our western central bankers will get a more balanced view of the world they are in. They can turn their minds more to interest rate cuts and less to 'building counter-inflation credibility' of which there is plenty around, not to say a positive excess by and large. Credibility comes from known policy reflexes, put in place by popular attitudes to inflation. Now people, or more exactly the 'well-informed opinion' that guides them in these arcane areas, realise there are at best temporary gains from inflationary policies at the cost of long-term inflationary pain. So central bankers all over the west have been charged with containing inflation, almost to the exclusion of worrying about the state of output; they have credibility coming out their ears. Fortunately in practice most of them sensibly do worry about output as well; and the most important of them all, Alan Greenspan at the US Federal Reserve, worries a lot. His concern that the Asian crisis would pose a serious threat to western prosperity has been dramatically proved correct; the Fed's hawks are in flight.

That is the significance of the crash, and whatever more of it is in store. There will be some wealth effects from share prices - and from the associated confidence in future prospects that these mirror - onto consumer spending and investment; but provided central bankers are ready and willing to cut interest rates to offset them, they pose no real problem. The difficulties that could arise come from unwilling central bankers, from protectionism as imports cut into industrial jobs in the west and from failure to replenish the world's central bank, the IMF.

The biggest strength in the present situation is the Fed; other elements in the US scene are less reliable, notably Congress which is unwilling to give the President 'fast-track authority' for trade agreements or to replenish the IMF. So far this has not mattered; but now the IMF is running out of money. We have also yet to see whether Representative Gephardt comes up with some amendment trying to cap the US trade deficit, already running at $200 billion. This is already 4% of US national output; and it could easily rise half as much again, with the extra knocking over some sensitive industries like textiles, farming and electronics.

But it is when one turns to Europe that one's doubts escalate. In January we will have the European Central Bank (ECB) presiding over the euro - not the pound, thank goodness. The ECB will be a neophyte bunch with the impossible task of deciding where to set Euro-wide interest rates. Being neophyte it will be obsessed with its credibility. By then, Germany with its high labour costs and its eastern backyard in rout will possibly be in dire shape; already its consumers are zipping up their wallets while its exporters face falling orders not merely now from Asia but also from Russia and its erstwhile satellites. Next after Germany, we should worry about Italy, a big manufacturing nation facing tough competition across the board from an Asia desperate to sell at rock-bottom prices. In both Germany and Italy unemployment is well over 10% and barely falling. Meanwhile France is recovering nicely with something of a consumer boom, so far at least feeling less impact from Asia and with little to do with eastern Europe. Spain, Portugal and Ireland have been booming away for some time now, on the basis of their lower cost 'peripheral' status in the EU.

Forget any talk of some countries not qualifying at this late stage; all have now done so, the decision has been taken. So the ECB will have to decide whether to raise interest rates to cool off the hotter majority or to lower them to deal with the bigger two coping with the global crisis to their east. There is no option to do nothing as interest rates range from 6% in Ireland to 3.5% or so in Germany. And this is no mere technicality. If Germany needs interest rates of 2% and the ECB plumps for an average of 4%, say, then this will be the first time since the war that Germany has a totally inappropriate monetary policy, one that could plunge it deep into prolonged recession - one wished upon them by foreigners to boot. The worst fears of the German people and the Bundesbank about the political drive into the euro will have been justified. This will not be amusing at all. It could lead to Germany's precipitate departure from Emu, well before the 2001 deadline for euro notes and coins being issued to replace existing deutschemarks, francs, etc.

This would be a sort of rerun- admittedly a bit more expensive - of our regular departures from the ERM, real or shadow (1972, 1988, and 1992). Those who talk of EMU 'irreversibility' should remember that what politicians put together politics can always rend asunder. In Germany the politicians after this month's election will almost certainly be a different lot from those who took the Germans into the euro against their will.

These will be agonising times on the continent, just when all were set for a trouble-free euro launch amidst general recovery. Mr. Hague asked for 10 years to provide the euro with a fair test of viability. It may well that thanks to the global crisis that test will come a lot earlier. It is an ill wind. . .

The same agonies will test a lot of other euro-nonsense too: such as the levelling up of tax rates, the general imposition of social burdens and the gold-plating of industrial regulations in the name of harmonisation, the single market and the social dimension. European politicians have gone around like Alice in Economic Wonderland repealing the laws of supply and demand. Good words like competition and free markets are stood on their head in euro directives by these Brussels Humpty-Dumptys. As the Harvard Austrian Joseph Schumpeter observed, bad recessions are the engine of creative destruction in industries - in economic policies too.

It may be the worst of times. But it could also be the best of times, promising the European project a fresh start.

Patrick Minford is professor of economics at Cardiff Business School and visiting professor at Liverpool University.
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