What comfort can the UK extract from what is happening in the Eurozone?
- The Eurozone is not a united place, not in circumstances, causes, consequences, policy options and likely solutions. So one cannot generalize about where it is and where it is going. “One size does not fit all” (and never did) which again underlines the wisdom of the UK staying out of the Eurozone thus far and for the foreseeable future.
- Fiscally, policy is decided by each country separately and virtually everyone is tightening their belts, the Club Med countries because they absolutely have to, most other countries because they need to (France falls into this category) and Germany and the Netherlands because they have decided that it would be prudent if they did. The UK is in the category that ‘has to’ (the current account deficit is a strong conditioning factor here – see below) and, notwithstanding the monetary independence still afforded by keeping sterling, the current government has chosen not to fudge fiscal reform as it would have been so easy to do and – judging on past performance – a Labour Government would have almost certainly done were they still in power, which thankfully they are not.
- Monetarily, Eurozone policy is centrally determined by the ECB. Policy is currently very loose with rates very low (indeed negative in real terms) and the ECB accepting almost any collateral the banks might offer in return for ready cash. It is no secret that it is too loose for Trichet and most in the Bundesbank but thus far the policy cracks between the Southern Doves and the Northern Hawks have been papered over, mostly by compromising in the South’s favour.
- The simple truth is that – notwithstanding high fiscal deficits and low interest rates – without decent (2.5%+) GDP growth, the situation will at best improve at a snail’s pace. Furthermore GDP growth (such as it is) will most likely be jobless. In other words, fudging – as much of especially Southern Europe is currently being allowed to do – is unlikely to be a permanent solution. The North is for now being patient but if the South does not show early signs of coming right, that Northern patience will run out. If it does, the very premise upon which the Eurozone was built – the core economies will help out the peripheral ones in return for expanding the size of a one-currency market – may crumble. But when ‘help out’ becomes permanent ‘bail out’, the core’s subsidy to the periphery will grow too large and that may threaten the Eurozone itself. For now and in the meantime, the Northern countries are using the intervening period to repair and strengthen the balance sheets of their big banks in case the Eurozone does indeed eventually fragment.
- The question now is not so much what more fiscal and monetary policy can do to help but overwhelmingly what can be done to reinvigorate growth that does not rely solely on these fiscal and monetary drugs, “uppers” whose effectiveness now seems to be subject to a form of diminishing returns. The challenge now must be, to paraphrase JFK, to “Ask not what your Government can do for your economy using fiscal and monetary policy; ask what you and your government can do to help stimulate genuine rather than artificial growth.”
- One area of potential Government action is to follow through on the central intent of the Lisbon Accord and liberalise and deregulate the EU economy to a far greater degree than has heretofore been done. Isn’t it ironic that Greece has only begun to do this over the past year in the wake of a near melt-down in its public finances? And doubly ironic that Portugal has thus far paid little heed to the Lisbon directives?
- CRITICAL POINT RARELY NOTED BECAUSE IT IS SEEMINGLY NOT “Economically Correct” TO DO SO. It is no coincidence that the strongest countries of Europe lie in the northern part which almost without exception all run current account surpluses and nearly all border Germany or are in Scandinavia – Germany and its neighbours, Austria, Netherlands, Switzerland, Luxembourg, Hungary plus Scandinavia i.e. Norway, Sweden, Denmark, Finland, and recently even the erstwhile wayward Baltic States of Estonia, Latvia and Lithuania. Some (like the Baltics) have only recently experienced economic problems but have started to address them; others (the rest of Scandinavia) remember the fall-out from the Swedish Banking Crisis of the early 1990s. What distinguishes them from the Club Med countries is that their fiscal belt-tightening is more likely being done out of prudence than immediate necessity though these Northerners also a face medium term demographic crunch. The moral of this story is that, in hard times, countries running current account deficits face harder choices than do current account surpluses.
- On the face of it, in this regard, Britain is more Southern European than Northern European having run a structural current account deficit for decades (as with the US and most other ‘Anglo Saxon’ economies save Canada.) Were Britain part of the Euro Zone, adjusting to the new realities of austerity would be much more painful than it has been thus far and still will be in the future. Part of the adjustment and so pain can and will be borne by Sterling. The Club Med countries by being in the Eurozone are denied this privilege.
- LESSONS FOR BRITAIN:
o Sterling has been a saving grace – given the unavoidable pain that must be endured, an independent currency allows a nation to spread that pain more evenly and THINLY across the whole nation.
o Current account deficits reduce the options of the choices that must be made taken and make them tougher. If Britain reduces its dependence on foreign inflows to balance its external account, it will increase its options and reduce the degree of pain that must be endured as part of the unavoidable adjustment that must be made. This means a more competitive currency might not be a bad thing for Britain.