Should we stay or should we go? Former Bank of England governor Mervyn King gives his take in the first of a two-part interview with Merryn Somerset Webb.
MoneyWeek's staff aren't easy to impress. Our interview sofa has had all sorts of fabulous people lounging on it Bernard Connolly, Roger Bootle, Russell Napier, Robert Shiller and the like. But most of the time no one even looks up when they arrive. Not so Mervyn King. Everyone looked up when the former governor of the Bank of England turned up. Better still, when he left, they wanted to know what he had said.
Everyone knows, they told me, what most of my interviewees think (vote Brexit; vote Brexit; vote Brexit and expect a deflationary crash; sell bonds respectively for the lot mentioned above). But central bankers aren't much for telling you what they think when they are in office. So bar those who have already made it through King's new book, The End of Alchemy: Money, Banking and the Future of the Global Economy MoneyWeek was agog. Given King's book reveals him to be one of the biggest beasts in the economic bear camp, I rather think you should be too.
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The curse of fixed exchange rates
We started with the eurozone (it's hard not to at the moment). When I read King's book it seemed to me that he was placing much of the blame for the crisis on fixed exchange rates Asian countries tying their currencies to the US dollar at low rates, in order to keep their exports up. That led to countries such as China ending up with large trade surpluses, and others, such as the US, ending up in massive deficit.
Unfortunately, "the willingness of the former to save outweighed the willingness of the latter to spend". That meant that long-term interest rates across the world's capital markets began to fall (as excess capital from the surplus countries looked for yield abroad).
The immediate effect, says King, is that asset prices and house prices in particular began to rise across the board. And as house prices rose, so did the amount ordinary people needed to borrow to buy them: so between 1986 and 2006, household debt rose from just under 70% of total household income to almost 120% in the US and from 90% to 140% in the UK. Nasty. Floating exchange rates would have nipped this whole thing in the bud but fixed rates just made it worse and worse.
Something very similar has happened inside the euro area. Fixed exchange rates have left some countries with China-style large trade surpluses (Germany) and others with large deficits (those in the south). But as long as the euro holds, "there's no mechanism now for correcting the changing competitiveness which happened in the first decade of the monetary union". The eurozone could break up, I suggest. That would be a mechanism of sorts.
He gives me that one and adds to it "internal devaluation" that is, continuing "with the misery of high unemployment in the south" until wages and prices fall enough to make the exports of deficit countries competitive again. That sounds nasty. And it is as the British should know.
We tried it here, says King, back in the 1920s when we went back on the gold standard at too high a rate so much so that we needed to cut wages and prices by 10%. We couldn't cut that much even back then without serious unrest so we gave up and left the gold standard. So given that the "periphery countries need to do it by more" than 10%, the idea that internal devaluation can work seems a little optimistic.
It's full union or exit but which?
You could, of course, try to do it the other way around forcing a period of high inflation in the countries in surplus, Germany in particular but it is hard to see the Germans welcoming that, given their history of inflationary collapse. The final possibility then is full fiscal union making the EU into a full supra-national organisation sitting above Europe's national governments. King is pretty unconvinced by this one too.
EU governments have, he says, been pretty dishonest with their electorates on the impossibility of a monetary union without a fiscal union. But every time they even try to get anywhere near telling the truth, they come up against serious "popular discontent". No one wants a system whereby the euro area's show is kept on the road with fiscal transfers from the rich to the poor not the countries who would end up sending a large proportion of their income to the south (perhaps more than 5% of their GDP, says King), and interestingly, not the would-be recipient countries either.
"They have no wish to have the conditionality that would be required to persuade Germany to make these payments" and they certainly don't want to accept that "someone in Brussels or Frankfurt is going to set their taxes and spending" (the German and French central banks have been floating the idea of having a finance minister for the euro area who would have the power to set tax and spending for each country).
"Why on earth", asks King, would anyone bother to vote for a government in, say, Spain, "if they can't decide on what are the most important issues facing their country"? The eurozone is a "long long way" from having a political union with any kind of legitimacy.
That seems a fair comment to me. But, I say, if you can't find a way to force political union, surely it is impossible to expect monetary union to hold? That, says King, "is a reasonable conclusion". In the end, either the countries of the eurozone have to make a "clear and abrupt" transfer of political sovereignty to a European government, or they have to "return to national monies and democratic control". They really don't want to do the former (nor will their electorates allow them to), so after a period of "muddling through", odds are they will do the latter.
Existential challenges
OK. So how long does the eurozone have? "It won't necessarily fall apart quickly," says King. Right now governments are working to hold things together and the very high levels of unemployment in the south are helping them out: it means smaller trade deficits, and less need for those countries to borrow. But when that changes again, the trouble will really begin: "I don't think people would voluntarily finance that without the belief that Germany would underwrite those loans, eventually... and that's the thing which Germany has always been resistant to doing in any formal sense."
He isn't, I say, making this EU sound very attractive. The UK might not be in the euro area, but as members of the EU, we are still attached to something that is in big political trouble. King agrees: "there's no doubt that the major problems facing the European Union are the euro area, for one, and, secondly, mass immigration from outside the European Union itself. These are the two existential challenges" facing the EU.
But the real question for the UK is on our own "long-term relationship with the continent of Europe". What is it to be, and what should it be? On this, King is deeply unimpressed with the debate. He isn't interested in "exaggerated claims about either the cost of leaving or the benefits from leaving" (this is a man who knows just how dangerous economic forecasts can be!), nor in "all these letters signed by various people telling us what to do".
These, he says, are all "assertions not arguments". They are also mostly wrong: look back to the 1975 referendum and you will find that nearly all the claims made then were absurdly exaggerated: the reality was that it didn't make a huge difference one way or the other. The same may well be true this time: "the idea that somehow it's either going to be bliss if we leave or a complete disaster... is a gross exaggeration".
I entirely agree with him odds are it won't make that much difference economically one way or another. But if that's the case, what does matter here? For me, the answer is sovereignty. For King, it is seeing a genuine vision for the future of Britain's relationship with Europe from both sides: "after all, we went to war, twice, because of what was happening on the continent of Europe". It isn't too late, he says, for the campaign to turn from assertion to argument. By this point I was wondering, and you will be wondering, whether King might be pro-Brexit.
His public position is clear: he hasn't made up his mind. There are good arguments on both sides and "if the answer was obvious" there would be no need for a referendum. I take his point. But I still reckon that the Remain campaign had better get on with finding some arguments that aren't based on made-up forecasts of lost household income a decade out if they want to have a hope of his vote.
My interview with Lord King was long and wide-ranging, so I am dividing it into two. Next week we will move on to the global economy. Growth is slow. Debt is high. Extreme monetary policy isn't working or has done all that it is possible for it to do already. What next?
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