The euro disaster

The euro has been a failure. Britain is right to stay on the sidelines, says James Ferguson...

The euro may not yet be a sinking ship, but it's certainly taking on water. MEP Daniel Hannan used last weekend's Sunday Telegraph as a platform to call for UK withdrawal from the EU. In June, a member of Italian prime minister Silvio Berlusconi's cabinet labelled the euro "a disaster" and the European model a "failure". Then, last month, Berlusconi told a party rally that "Prodi's euro has screwed us all". Could it really be that Berlusconi is, in the words of Ross Clark in The Sunday Telegraph, "at least considering doing what until very recently would have been considered unthinkable: taking Italy out of the euro"?

This idea is not as preposterous as it may seem. An HSBC report recently argued that not only Italy, but Germany and Holland too would be better off out of the euro. More pertinently, the financial markets are already paying less for Italian government debt than German, implying that many think the possibility of being repaid in lira rather than euros is a real one.

The whole point of currencies is to facilitate the efficient redistribution of resources. If my economy's on the up and I am importing too much of your produce commanding too many of your resources then the ensuing strength of my currency allows you to earn more from your exports to me. Keep this up long enough and I lose whatever competitive advantage I had before and the balance gets redressed in your favour. Free-trading currencies are a fabulously powerful progressive force, not so much levelling the playing field as actually positively discriminating in favour of the loser of the last round.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Take this away and there's no reason why the relatively deprived nation should be any better able to compete next year than this. Add in the free flow of other resources (like labour) and you'll find that all those with skill, education and funds migrate to the prosperous areas, turning everywhere else into sink holes. In short, you get an exaggerated version of Britain's long-standing North-South divide across nations.

Worse, because without free-trading currencies there's no obvious cost advantage to setting up in the more deprived area, costs in the well-off region sky-rocket. This can, of course, be exacerbated by a monetary policy that may be appropriate for neither the prosperous region nor the poor one. Rates will always be too high for the strugglers, condemning them to needless hardship. On the other hand, rates will also always be too accommodative for booming areas, sparking asset bubbles, sky-high property prices and inflation.

All this criticism of a single currency might have been dismissed by pro-Europeans as overly pessimistic doom-mongering not so long ago, but now it is possible to point to European countries with various of these symptoms. Countries such as Spain and Ireland have seen their economic growth takeoff, thanks in part to EU handouts. However, just when domestic monetary policy might have seen rates rise to contain the growth, the ECB has held rates unchanged at 2% for years. Property prices have gone through the roof as a consequence. On the other hand, 2% hasn't been nearly low enough to re-light the fire under Germany's boiler. This once-great economic success story for Europe has anaemic growth, and one in eight of its workforce is now unemployed. No wonder Stern magazine reported last June that the finance minister and the head of the German central bank had already discussed withdrawing from the euro.

Resource migration has also exceeded government expectations. British savings have hiked French and Spanish house prices and labour has migrated from the East to economic hotspots further West. The gap between the haves and the have-nots has grown. Rather than facilitating a united Europe, the absence of currencies accelerates the rifts.

Meanwhile, from Austria to France and from Italy to Holland the perception is that the introduction of the euro has led to inflation. There is always a tendency to round prices up whenever a new currency system comes along and the authorities always attempt to prevent it. In reality, though, it is impossible to monitor everything, especially if people claim that there have been quantity or quality changes too. In 2003, for example, while inflation in Italy was officially just 2.5%, the independent Institute of Political, Economic and Social Studies claimed it was in reality more like 2.9%. And people clearly think that is more likely: real labour costs have risen 20% in Italy since the introduction of the euro. The consequence is chronic recession.

Discarding currencies before properly addressing what they were for and without putting in place workable alternative strategies for re-deploying resources was an enormous risk. It remains to be seen whether Europe's pioneering political leaders can endure the first test, but if it transpires that their hubris has left no scope for a fall-back plan, then they can't be surprised if the experiment, as poorly thought-out as it was, fails. It is often said in entrepreneurial circles: Don't be a pioneer, be a settler. Pioneers just get arrows.' By not joining the euro, the UK gets to see how the experiment pans out without suffering the stress of being a guinea pig. I'd settle for that.

James Ferguson is an economist and stockbroker at Pali International

James Ferguson qualified with an MA (Hons) in economics from Edinburgh University in 1985. For the last 21 years he has had a high-powered career in institutional stock broking, specialising in equities, working for Nomura, Robert Fleming, SBC Warburg, Dresdner Kleinwort Wasserstein and Mitsubishi Securities.