The eurozone currencies were locked together at the beginning of 1998. Euro notes and coins came into circulation at the start of 2001. So far we have therefore had about ten years of experience of the euro. Initially, there were eleven countries in the eurozone and now there are sixteen. The euro has thus had its attractions to some newcomers, no doubt enhanced by the fact that most of the last few years have been a relatively benign economic period, with fairly steady growth and - until recently - no major upsets. Now, however, we are in much rougher water. How is the euro helping or hindering its constituent economies weather the storm and what are the prognostications for its longer term future?
Perhaps, before assessing the contemporary situation in the eurozone, it is worth pausing to consider the typical history of currency unions, of which the euro is the current most prominent example. There have been many attempts in the past to lock currencies together and their histories all conform to a regular pattern. Indeed the EU itself has had significant experience of some variations of them in the form of the Snake from 1969 to 1975 and the Exchange Rate Mechanism from 1979 to 1993. There is an initial period when all goes reasonably well. Strains then set in. Some members have higher rates of inflation than others. The weaker ones start to run balance of payments deficits, while unemployment within their borders increases. The stronger ones become frustrated by the extent to which they increasingly see themselves carrying those who are doing less well. As the divergence increases, so the tensions rise until an incident of some kind suddenly makes the position look untenable to one or more of the currency union members. It is always very hard to predict exactly when this will happen or what the trigger will be, but this is what has always occurred in the past. The union then fractures and some or all of its members go their separate ways.
Currency unions, however, do not always break up. All countries with their own money are currency unions of a sort. Many of these have survived for very long periods. The key characteristic of those which stay the course, however, is that they are unitary states, not federations. They have sufficient authority and tax raising and spending capacity to even out incomes and prosperity within their borders. Generally, countries which maintain their identities with successful currencies for long periods are culturally and linguistically homogeneous, creating a sufficient feeling of common ground and interests to make large scale transfers acceptable.
Against this background, it is not difficult to see the key trends within the eurozone and to make some predictions about what will happen in the future. All the usual divergence is taking place. Germany has kept its costs well under control and has a huge export surplus, much of it to other members of the eurozone. Other countries, notably Ireland, Spain, Italy, Portugal and Greece, are doing much worse. In these countries, inflation is much higher than it is in Germany, so their exports are becoming steadily less competitive. Stagnation and unemployment are the inevitable consequences. In the past, countries with problems like these would have devalued but, of course, within the euro, this is not possible. The only way for competitiveness to be regained is through disinflation, wage cuts and lower living standards. As such policies are political suicide, they are rarely pursued. Instead the deflationary consequences of their current predicament is set to get accentuated as the disparities between their competitiveness and that of Germany and its satellite economies, including Holland and some of Eastern Europe, become more pronounced.
On past performance with currency unions, the outcome of these trends would almost certainly be the break up of the eurozone. This may be what happens. There are already ominous signs. Loans to the German government in euros now attract significantly lower rates of interest than those to the Greek and Italian states. If the economic situation gets much worse than it is at the moment in the weaker eurozone economies - exacerbated by the downturn generally which we are all experiencing - the political pressures for radical changes of policy may become acute. This is likely to take the form of extremist nationalist parties gaining ground. Breaking out of the euro would, however, present policy makers who wanted to do so with substantial problems. There would be no traditional currency left with any kind of credibility to it on which to fall back. Even if this problem was overcome by creating a new currency, there would be very large obligations denominated in euros, which would remain as an exceptionally heavy burden. Defaults, if they were contemplated, would have their own big downsides. There would be no easy answers, therefore, but there would be a way ahead, enabling the economies concerned to regain the competitiveness they desperately need to survive and prosper again.
Some people may think that this scenario is too harshly painted. Is not the whole point of a single currency to stop these kind of choices having to be made? Does it matter if some parts of a single currency area are uncompetitive with others, if they all share the same money? Unfortunately, it does. Just because everyone uses euros, it does not stop the same kind of disparities in economic performance, particularly as regards the balance between exports and imports, materialising exactly as occurred in the old days of Deutschemarks, lire, francs and pesetas. All a single currency does is to rule out one obvious way of adjusting to what has happened - by devaluations and revaluations - forcing the adjustments to be made in other ways - by deflation and unemployment.
It is easy to predict the reaction of Europe's current political leaders to any prospect of the eurozone area breaking up. They will fight tooth and nail to stop it happening. From their perspective, it would be a disaster. There will be enormous pressure put on national governments not to take any steps towards doing anything which might show any sign of their confidence in the euro ebbing away. Even discussing the possibility of the eurozone no longer existing in its present form will almost certainly be taboo. At the same time, the economic difficulties faced by the weaker countries will certainly be used as an excuse for further centralisation of EU institutions. The solution to mounting economic difficulties will be declared to be more co-ordination from the EU centre and not less. Will any of this work? Very probably not. The economic forces at work are much too powerful to be overcome at least by the resources currently available to Brussels. The total amount of money raised and spent by the EU is still only about 1.9% of total EU gross domestic product. Nearly half of this is spent on the Common Agricultural Policy, which shifts far too many resources to countries which do not really deserve them. There simply does not exist the tax and spending base within the EU at the moment to begin to even out the disparities in economic performance which we are likely to see materialising. Of course, there will then be some who will advocate a huge increase in EU taxation and expenditure, to make the EU operate more like the usual nation state. With the EU in its present divided state, however, the chances of any policies along these lines being adopted, within the timescales which would need to be involved, are infinitely small.
Prediction is always dangerous, but some trends look too strong and obvious to be ignored. It is extremely unlikely that the weaker eurozone economies will regain the competitiveness they need while they are in the euro. On the contrary, their relative price competitiveness is much more likely to worsen, with all the consequent increasing unemployment, deflation and government deficits which this will entail. When the present general economic downturn bottoms out, which it will sooner or later, this may mask the scale of the problem for a while. The long term trend, however, is very unlikely to reverse itself. With all the pressure from the centre to avoid a break up, and the difficulties involved in any country leaving the euro, it is improbable that anything like this will happen soon, although it is always extremely difficult to predict what might suddenly cause a change of heart. What does seem nearly inevitable, however, is that the trend towards increasing divergence of economic performance will continue. It is then hard to believe that, sooner or later, the dam will not break. This has been what has happened to all other currency unions in the past and, in the long sweep of history, it does not seem likely that the eurozone will be an exception.
The British public is resolutely opposed to joining the euro and all the available evidence confirms that this perception is well supported by the way events are developing. Of course, the current depreciation of the pound against the euro presents some sections of the population with problems. However painful these may be and however sorry some people may be to see the pound now worth so much less in euros than was the case a year or two ago, it is far better that the British economy should be able to adjust to the economic circumstances in which we now find ourselves. The currency depreciation that the pound has recently experienced may be part of a humiliating process, but it is much less painful than the much higher unemployment, the increasing deflation and the further unravelling of the government's finances than would otherwise have been necessary. Furthermore, with the independence of our currency secure, we are in a position to take on whatever happens in future, in the knowledge that, in the last analysis, we will be able to ensure that we pay our way in the world. This is the precious gift which Ireland, Spain, Portugal, Italy and Greece have given away and which France and some of the newer eurozone countries may soon wish they had never given up.