The euro came into being at the beginning of 1999, when the constituent currencies were locked together, supposedly irrevocably. Notes and coins were introduced at the beginning of 2002. Experience of the Single Currency regime is thus accumulating to a point where preliminary assessments of its strengths and weaknesses can be made. There have been some achievements. Significant euro capital markets are developing. The introduction of notes and coins proceeded without major difficulties. Other things have not gone so well. There have been widespread complaints about inflationary price increases as the switch to euro pricing took place. More seriously, however, the euro-zone economy is still sluggish. Unemployment - at 8.4% - remains very high, not least in Germany and France as well as in other countries such as Spain which have suffered for many years with grievously high numbers of people out of work. The popularity of the euro, as shown by opinion polls, in most participating countries is low. The jury is still out on how successful this huge and risky experiment will turn out to be. The motivation for the euro was always dominated by political considerations - a major step to building a unitary EU state - rather than because establishing it made any sense economically. Ignoring economic considerations for political reasons is a dangerous game.
Part of the reason why most euro-zone economies are still growing slowly, with such high unemployment, is because the euro locked the previously existing currencies together at what are already perceived to have been the wrong rates. The euro is too strong for the German economy, for example, which is why its output is stagnant and the number out of work has steadily increased to a figure now well in excess of 4m. In Portugal, there is a different problem. When the Portuguese joined the euro, interest rates were rapidly reduced to a level which generated an unsustainable boom, which has now broken. Their economy now badly needs a fiscal boost, but this is prohibited by the rule which allows no euro-zone economy to have a deficit of more than 3% of Gross Domestic Product per annum. Even in France, which is currently doing somewhat better than Germany, there is some danger of the 3% limit being exceeded, as is also the case in Italy. The strains involved in trying to run the whole of the euro-zone area within a uniform and strictly applied monetary policy, with no exchange rate flexibility, are therefore already beginning to show through.
There are essentially three medium terms scenarios for the euro. One is that during the next few years, the credibility of the European Union increases to a point where EU electorates are prepared to see large taxation and spending streams shifted from national governments to Brussels. This would stabilise the euro-zone as a whole by making possible major resource transfers to less successful Member States, as happens within all constituent EU countries. The second outcome is that the strains which are already manifesting themselves, as the euro-zone economies get increasingly out of kilter with each other, make better economic performance impossible to achieve, while the momentum towards more centralisation in Brussels falters. This would produce more of the same conditions we have seen over the last twenty five years, with low growth rates, high unemployment and increasing fiscal problems as more and more deflationary policies have to be pursued to maintain the Single Currency regime. The third possible outcome is that the strains involved in holding the euro together prove to be insuperable and at least some countries cease to be members of the Single Currency. Although there are no provisions in the EU Treaties to allow this to happen, the chequered history of all currency unions in the past suggests that this is a far from impossible eventuality.
Predicting the future is always hazardous, but some assessment can be made about the likelihood of each of the three scenarios set out above materialising. In the past, currency unions have tended to last between about five and fifteen years before they have broken up. This indicates that only rapid transfers of major taxation and spending powers to Brussels would provide the centralised political and economic backing which any stable currency needs. Radical changes along these lines, however, would be very widely opposed and it seems extremely unlikely that they will occur. Consequently, the probability of increasing deflationary problems becomes much greater. Whether these problems will be sufficiently large to cause at least some countries to pull out of the Single Currency altogether is impossible to tell, but the risk of this happening, although totally ignored by most commentators - let alone the EU authorities - is certainly there.
As regards timing, much will depend on how stable world economic conditions turn out to be over the coming years. The more tranquil they are, the more likely it is that the Single Currency will avoid a major crisis. The past history of locking EU currencies together provides some guidance. The Snake, set up in 1969, lasted only six years before it broke up in the face of the turbulent financial conditions of the 1970s. The Exchange Rate Mechanism, established in 1979, lasted fourteen years, during which time conditions were relatively calm, before it was finally abandoned in 1993. It is true that inflation was higher during these previous periods than it is now, but this factor was offset by the fact that exchange rate changes took place on an extensive scale during both the Snake and ERM periods, even though they were not supposed to happen. Past history therefore suggests that the Single Currency is not likely to survive for much more than a decade from now without major problems developing.
There are several aspects of the way in which the EU institutions have developed which are likely to increase the chances of euro-zone strains appearing. The European Central Bank, under no democratic control, is charged solely with keeping inflation down to very low levels rather than ensuring that the euro-zone reduces unemployment and achieves a reasonable growth rate. The Stability and Growth Pact, which is designed to subject any euro-zone economy which has more than a 3% fiscal deficit to draconian penalties, is already inhibiting euro-zone countries from using increased public expenditure to stimulate their economies. The Common Agricultural Policy transfers resources between EU economies much of the time in the opposite direction from what is needed to achieve economic stability. It seems unlikely that any of these negative features will change. All will increase the probability that the future of the euro is beset with problems, which may well materialise sooner than many people realise is likely to be the case.
All the problems with the Single Currency are going to be difficult enough to solve with the existing twelve euro-zone Member States. They are going to be made much more intractable if the number of economies in the Single Currency comes close to doubling. The notion that the weaknesses of relatively undeveloped economies can be cured by anchoring their currencies to stronger and more advanced economies is an illusion, as the current condition of Argentina, which tied its currency supposedly irrevocably to the US dollar only to find the strains of doing so impossible to sustain, shows all too clearly. On the contrary, the danger is that the EU applicant countries will also be forced into deflationary policies as the price of joining the euro. This will inevitably mean that their claims for assistance from the richer EU Member States will increase, but at a time when the founder members of the euro-zone are likely to have increasingly serious problems of their own with which to contend.
In economic terms, therefore, the euro is a very risky enterprise. The chances of sufficient reform being achieved for it to lift the EU growth rate and reduce unemployment, look remarkably small. It is much more probable that the euro-zone will continue to perform relatively poorly, with a significant risk of a major crisis looming up sometime in the next decade, leading to at least some euro-zone economies abandoning the Single Currency as the strains of staying within it prove unmanageable. The disruption and dislocation which will materialise if this happens is bound to be substantial and in no-one's interest, but much worse for those inside the euro-zone than for those outside. Why does it make any sense for Britain to get involved in all these risks when it is completely unnecessary for us to do so? Such caution is even more desirable, given Britain's favourable economic performance compared to the euro-zone economies since we left the Exchange Rate Mechanism in 1992.
We always need to remember, too, that joining the euro is not just an economic issue. It is also one with huge constitutional and democratic consequences. The biggest single reason why the Single Currency is likely to fail is that the electorates of EU Member States do not trust the EU to respond to their democratic wishes. This is why major transfers of taxation and spending powers to Brussels are unlikely to occur. Most EU electors would much prefer to have their affairs run at national rather than EU level, where democratic control is stronger. These sentiments are even more powerful in Britain than they are in most other Member States, partly because the British people have a good deal more confidence in their democratic institutions than is the case in much of the rest of the EU. This is why, on the Single Currency, both economic and political arguments point in the same direction. Stay out of the euro.
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