Friday, October 28, 2011

Whatever happened to Euro stability?

I hate to say I told you so but I was looking back over my book “The Last of England” published in 2004 and now out of print.

In a chapter on why it would be disastrous for Britain to join the euro, it says:

The truth is that economically – never mind politically – the euro just will not work….

How is it possible to tie in the various economies of Europe so they are always marching in step and in the same direction? One answer is the imposition of a “stability pact” which forces all the Governments of the eurozone to curb their freedom to tax and spend, in the interests of the common good.

The euro’s supporters will tell anyone worried about the economy of the eurozone, and the single interest rate needed for the euro, to be reassured because this pact sets a ceiling on the level of public deficit allowed, at three per cent of GDP and aims to ensure no country boosts Government spending to a level which would have an impact on the Eurozone interest rate.

We are told … the Eurozone “stability pact” ensures the economies keep on walking at the same pace in the same direction. The pact in effect allows the European Central Bank to control tax levels and public spending in the eurozone countries.

The problem is that the stability pact is being undermined and ignored, even by those who first insisted on it. The IMF has said it is being “wrongly undermined by inadequate policies” in France, Germany and Italy. Romano Prodi, the President of the European Commission, said: “I know very well the stability pact is stupid, like all decisions that are rigid.” No wonder the Bundesbank says the problems are “definitely causing a dangerous situation for monetary union”.

It is no surprise the stability pact is being undermined. Consider what happened in Germany in 2002. Growth was down to half a per cent this year. The German Industrial Association said the economy faced “stagnation”. Germany wasn’t able to meet the stability pact demand for a three per cent limit on its budget deficit. Siemens threatened to cut investment in Germany because of the high taxes demanded by the stability pact. Germany, once the economic powerhouse of Europe, before the advent of the euro, is in a double-dip recession, endures unemployment of at least 4.3 million and, according to some people, 6 million.

It saw 40,000 insolvencies in 2002, the worst since the war, while one of its political historians has declared: “Today’s crisis can be compared to the end of the Weimar republic. There is no Hitler in the wings today but the symptoms of economic and political disaster are the same.”

And why is all this happening? According to the Nobel-prize winning economist Milton Friedman the answer is simple. In an interview in Germany, he said: “If it wasn’t for the euro, then Germany would not have its current problems. A single European monetary policy is not possible for the countries of the Eurozone.”

In France, the Government refused to accept the 0.5 per cent spending cuts required to meet its stability pact obligations and when it tried to cut public spending, there were riots in the streets, as there usually are when the French people dislike what their Government is up to.

In the summer of 2003, President Chirac officially concluded that, for France, the stability pact was a dead duck. He sent his Prime Minister, Jean-Pierre Raffarin, to Brussels to announce that France would not even try to control its budget deficit to keep it below the three per cent limit until 2006 at the earliest.

He argued that this was necessary because France needed to boost state spending as a way of breaking out of the recession which, not coincidentally, had been dragging back the eurozone economies since the creation of the euro itself.

Likewise, Portugal has seen strikes provoked by the spending cuts announced by the Government to stay within the bounds of the stability pact. Italy, too, has taken unilateral action which defies the stability pact agreement.

Meanwhile, even a Labour Chancellor, Gordon Brown, supposedly dedicated to taking Britain into the euro eventually, rejected the idea that he should cut spending to keep in line with the stability pact requirements. “I don’t think the British public want the European Commission to cut £5 billion a year from spending, as is implied by these proposals,” he said at the time – and he is right.

No Chancellor will willingly abandon his freedom to fiddle with the economy and his ability to boost public spending in time for a General Election just to keep in step with the rest of the eurozone.

The truth is that the stability pact is a lovely theory but won’t work in practice.

It is sometimes argued against this that a currency union works perfectly well in the United States, so why shouldn’t it work in Europe? But there are big differences, according to Professor Martin Feldstein, President of the US National Bureau of Economic Research. For instance, the US has a flexible labour market, the EU does not; the US has a mobile labour market, the EU does not; and, crucially, the US has a centralised tax system. Without these things, according to Prof Feldstein, the EU will see “as a minimum” higher cyclical unemployment and “from a strictly economic point of view, they are liable to run into some serious problems ahead”.

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