From the 1970s onwards, the EU’s political leadership has been bent on locking the currencies of its Member States together, first with the Snake, then with the Exchange Rate Mechanism (the ERM) and now with the euro. Their motives, however, were never driven by economic considerations. The reason why they wanted monetary union was almost entirely concerned with the achievement of their political goals. A Single Currency was always seen as a critically important building block for the European state which they wanted to create. Such economic arguments as ever saw the light of day were generally unconvincing after-thoughts, produced to try to justify decisions which had already been taken on other grounds. Few serious academic attempts were ever made to justify unifying the currencies of the very varied economies making up the EU. Opponents – many of them economists with powerful international reputations – were brushed aside for failing to appreciate the vision for Europe of which the Single Currency was a crucial part. There are, however, few cases of political decisions taken on flawed economics grounds which turn out well. There are even fewer reasons for believing that the establishment of the euro will t urn out to be one of them.
The problems with the EU Single Currency project were evident from the beginning. The failure of both the Snake and the ERM were potent indications of what was likely to follow with the euro. During both the Snake (1969 – 1975) and the ERM (1979 – 1993) periods, the growth rate in participating countries plummeted while unemployment rose. In neither period were exchange rates as stable as they were supposed to be. Instead, necessary adjustments were postponed until the consequent adverse economic consequences – stagnant growth, balance of payments deficits and ever greater job losses – became unbearable. These were precisely the conditions which led to Britain leaving the ERM in 1992 in what may at the time have seemed to be ignominious circumstances, although in fact, compared to most of the rest of the EU, the British economy has boomed ever since then. The problem is that locking currencies - supposedly irrevocably - into the euro and putting exchange rate adjustments out of bounds, has not removed the underlying reasons why they need to be made. The euro economies do not form a natural single currency area. Their economies do not all operate naturally in tandem with each other. Inflation is much higher in some than in others, reflecting very different traditions of financial discipline, competence and probity. There are no adequate mechanisms in place to provide a shield against disruptive changes, such as German reunification which produced much of the instability from which the euro-zone still suffers. For all these reasons, and others, the establishment of the Single Currency was always going to encounter problems which would inevitably become more acute as time passed and the performance of its constituent economies diverged.
Despite all these problems, the Single Currency might have been made to work if, after its establishment, there had been a rapid movement towards the establishment of a powerful, centralised European State, capable of running the whole of the euro-zone as a unified political entity. If massive transfers had then taken place in powers of taxation and expenditure away from the Nation States to Brussels, this might have created a sufficient concentration of political and economic power within the EU to provide enough redistribution of wealth and income to hold the Single Currency together, as happens within all national economic units. Whatever the pretensions of many of the EU’s leaders, however, nothing on anything approaching this scale has occurred. The total EU budget still comprises no more than just over 1% of total EU output. The Constitution is in limbo. As a result the euro is a currency with no effective state to back it. The history of all currency unions in history which do not have a high degree of political unity to back them is that they all fail. Some last longer than others but they all collapse sooner or later.
Unfortunately, the euro-zone countries now exhibit all the usual signs of monetary union coming under strain. The growth rate in the euro-zone since the Single Currency was established has been dismally low – barely 1.4% per annum, compared to 2.4% for countries outside the euro but in the EU, 3.4% for the USA and a world average, including the fast growing economies on the Pacific Rim, of 3.9%. Unemployment in the euro economies has remained stubbornly high, with registered unemployment at 8.8%, although the percentage of the people who would like to work if they could do so at a reasonable wage is much greater. Public expenditure is under attack as country after country has experienced problems in avoiding deficits, most of them year after year. Cutting expenditure when the economy is already depressed, however, simply makes the overall problem more unmanageable. The situation is made worse by the role of the European Central Bank, which has no mandate to deal with growth or unemployment but is charged solely with keeping inflation as low as possible. The result is that a number of the weaker and less disciplined economies in the euro-zone are now in increasingly desperate straits. The Portuguese navy recently had to be recalled to port because there was no money to pay for fuel to keep its ships at sea. Major political parties in Italy are now talking openly about having the lira back as a parallel currency to the euro. The Greek economy, never supported by reliable statistics, is clearly facing fiscal deficits far above those permitted to it. The political consensus which is essential to make the euro work in the long term is clearly fracturing, even in founder-member states such as France and Holland, as the recent votes on the Constitution showed.
Even so, there are many people who do not believe that the euro will ever fragment including, apparently, large numbers involved in trading in the euro in the world’s financial markets. Part of the reason for this is that they cannot see how it would be possible for the existence of the euro to be unwound and for it to be replaced by the former national currencies. Experience all over the world where currency unions of various sorts have come to grief nevertheless suggests that the problems involved in reverting to national currencies, though highly disruptive for a period, are not insuperable. Furthermore, once the pain and unpopularity of working within a Single Currency framework becomes sufficiently great, breaking out of it sooner or later takes on a degree of inevitability as the markets realise that the present situation is simply unsustainable – much as happened in Britain in 1992 over our ERM membership. It does not follow, however, that the Single Currency as a whole will be abandoned. It is much more likely that over a period of time those economies which cannot manage within the system will flake away, leaving a considerably smaller number of countries still using the euro. If this begins to happen, an important consequence is bound to be increasing reluctance among Accession States to become part of the Single Currency, further undermining the development of the unitary European State which establishment of the euro was designed to create.
In the meantime, what are the prospects for the euro-zone as long as the Single Currency remains in being? Both the longstanding economic arguments about the suitability of the euro-zone area for monetary union and current statistical trends indicate that the next few years are likely to see little improvement on what the past decade has produced, with the danger of even worse economic performance materialising. The depressed conditions of most of the Single Currency countries make it difficult for them to adjust to changes in the rest of the world’s economy and the resulting increased competition which they have to face. Manufacturing – the sector of all economies where productivity improvements, which are the source of rising living standards, are most easily secured – is everywhere in relative decline in euro-zone countries. Demographic trends – themselves not wholly disconnected from languishing economic performance – are likely to work heavily against most Member States as a result of declining birth rates and the consequent aging of the population.. Nearly all well informed commentators, including the World Bank and the United Nations, expect the weight of the Single Currency economies within the world as a whole to go into a steep decline over the coming years
What then, should Britain do about the euro? The vast majority of the electorate in the UK now sees that we are far better off outside the Single Currency than being a part of it. There is no prospect within the foreseeable future of a referendum being held on the Single Currency and a positive vote being secured. We need to remember, however, how readily a decision to join might have been taken by Parliament but for the commitment to a referendum in advance of such a step being taken and the growth of a vast amount of grass roots opposition to Britain joining the Single Currency. It was not the leadership of any of the governments which have been in power in Britain in recent years which stopped us joining the euro. It was public opinion which did this – a potent symptom in turn of the fundamental problem with the EU, which is its lack of democratic legitimacy. Would the Single Currency ever have come about if its creation had been the subject of democratic debate and decision? The reality is that there were serious doubts about the merits of the Single Currency across the whole of the EU before it came into being. Its establishment was forced through by the EU’s political elite against the grain of wide swathes of public opinion, though little of it was effectively represented among the dominant political parties anywhere in the EU. Opposition came from elsewhere. To counteract the still strongly centralising bias among all the major EU institutions, the same determination to resist such trends will be just as pressingly important in future as it has been in the past.