Is this the time for Britain to enter the euro?

You need no telling that 2008 (and particularly after the mistaken decision [with 20:20 hindsight] to let Lehman Brothers go bust) was an appalling year for the world economy. Neither is it any secret that 2009 promises to be worse. I think it will also be the year in which the full horror of the impact of recession in the US (and also the UK) on world trade and thus on the net exporters comes clear. Obviously this is of most concern in East Asia – where trade surpluses have been greatest and most persistent. It will however also have an impact amongst those countries of the eurozone, most notably Germany, who have depended on export led growth since the 1950s.

The strength of the euro is one measure of the adjustments that are likely to take place unless there is urgent action to boost domestic demand in the eurozone. And of course this needs to be coordinated within Europe and globally. The global imbalances were a major contributor to this crisis and without the readjustment of these imbalances, the world is condemned to a low-growth/low-employment equilibrium at best; think Japan since 1990 but without the opportunity to export to maintain production because traditional import markets across the world are contracting. What is required is that domestic demand expands to absorb production that has been previously exported and that imports also increase in China and other export led economies in East Asia, Latin America and Europe.

Played right coordinating the response to the crisis is an opportunity to create a truly global approach to managing the world economy. I fear however it also offers the potential for a massive failure in collective action. The anti-trade rhetoric of the Obama camp during the presidential campaign alongside the apparent anti-trade instincts of the Democratic party now dominant in Congress makes the failure of progress in the world trade talks in Geneva no surprise. As I have said before, failure in the WTO has many parents, not just the US or France or India. That makes it worse however in the sense that there is less hope for ‘coalitions of the willing’ going ahead with liberalisation. But it also bodes ill for global collective action on macroeconomic policy co-ordination and/or financial regulation where the institutional and governance structure are much less developed than for trade.

What about Britain and the euro? Do current circumstances argue for a change of policy? Certainly a fix at £1 = €1 has a certain symmetry to it. And after a long weekend of sticker-shock in Flanders and Artois (where the tourist £ bought €0.98) it is obvious to me that UK exports will enjoy a price advantage in eurozone markets that they have lacked for a decade or more. We could begin to see the shift away from services towards manufacturing in the UK economy as it recovers that many have called for down the years. So fixing at such an advantageous rate could have important benefit for the traded sector of the British economy.

There are two obstacles to that scenario. First, we cannot enter the euro at a stroke. We have to meet the convergence (previously the Maastricht) criteria, which is pretty unlikely any time soon based on the UK fiscal outlook until the middle of the next decade at least. Above all we need to fix sterling to the euro within the Exchange Rate Mechanism of the European Monetary System and maintain that central rate for two years, which raises the possibility of the markets ‘shorting’ sterling as Soros did in 1992 (his recent canonization as the acceptable face of finance in the face of vilification of hedge funds and other ‘shorting’ in any financial market is strange to say the least). Given the likely instability in the real economy, fixing sterling looks a risky enterprise.

Second, our potential partners are unlikely to agree to us fixing at a super competitive rate such as 1:1 or better: it looks like a beggar-thy-neighbour exchange rate policy. Joining the euro therefore appears to be a policy option destined for the ‘too difficult’ tray in London and Brussels.

Will the time ever be right on our side or that of the eurozone? I must say that it is hard to see the circumstances for a smooth entry into the euro arising until we all emerge from this crisis and into a period of relatively calm economic weather. Even then it will require a significant change of view in the two main British political parties.

Jim Rollo,
Co-Director, Sussex European Insititute