Bill's Archived Comments

Monday,  7th January 2002

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The first comment page of the year. I'd like to take this opportunity to wish everyone a very happy, peaceful and prosperous 2002.

€-creep, why it won't happen and why Labour is in Such Disarray

Let's clear something up, shall we? I'm broadly pro-European and broadly in favour of the United Kingdom adopting the € as a replacement for the £, preferably sooner rather than later, although I recognise that the process of change could be mishandled badly, so especial care will be needed to ensure it doesn't go pear-shape. Anyway, what I write here has little do do with whether one is pro- or anti- adoption of the €. It's about economics, stoopid(!)

Over the weeks leading upto the appearance of physical €-notes and -coins, and in the week since its first appearance, a lot of idiotic things have been said about how it will affect the United Kingdom, by people with strong views on both sides of the argument. The fact that certain retail outlets will accept €-notes is a detail - such outlets are probably accustomed to dealing with foreign customers regularly and likely accept a wide variety of foreign banknotes already and, to them, the € is just another major foreign currency, as is the $ or ¥.

Other more basic reasons are that the €/£ rate fluctuates, so the idea that a genuine parallel currency situation could develop in a sophisticated economy such as we have here is farcical. There are instances where a foreign currency can be adopted as a quasi-parallel unit of account, even without a fixed exchange rate - so far as I am aware this is usually because the local economy is in a complete shambles and people want to protect the value of what money they do have by converting it to a more stable unit, most frequently the $ - for example, Vietnam, of which I have personal experience. In more sophisticated economies, there would, I contend, have to be a fixed rate or, possibly, a very narrow range of fluctuation permitted around an agreed rate. This might be for economic or political reasons.

As a topical example, Argentina reformed its currency in 1992 by replacing the Peso with the Austral (Arg$) and fixing the new currency against the $ at a ratio of 1:1. The motivation was almost entirely economic, principally to rein-in inflation. For several years, this seemed to achieve the desired objective, but it did not address the fundamental issue of the underlying poor performance of the Argentinian economy against that of the United States, against whose currency the Austral was fixed, nor the continuing borrowing by the Government in order to shore up its social policies. Eventually the link had to be broken, as we have seen recently, with dramatic consequences for the ordinary citizen and for the political stability of the country.

The classic case of a quasi-parallel currency operating in a sophisticated and very successful economy, as a preferred store of value against perceived political uncertainty, is Hong Kong. For almost twenty years, there has been a reference-rate (almost a quasi-fixed rate, but with a complex formula which permits the HK$ rate to hover around the reference rate with, when required to smooth out periods of particular political [and occasional economic] uncertainty, a quite large band of movement.

None of this applies to the United Kingdom; the country is stable politically and pretty stable economically, too. There is little likelihood of a flight from the £ - not since the abolition of exchange controls over twenty years ago has this been more than a remote possibility.

No doubt some Britons will seek to borrow by way of  €-denominated mortgage loans, specially those who are buying properties in €-zone countries - just as such people often borrowed locally in ESP or FRF, in the past. Some people might be tempted to borrow in €s for property purchases in the United Kingdom, but unless there is a source of €-revenue to underwrite this then the borrower will have to carry an exchange risk. Not a very sensible course, however low the interest rate for €-borrowing,  for any but the most sophisticated borrower who understands the risks.

From the little I know about the Chancellor's views on the € (for example, whether he is fundamentally sceptical or 'anti', or whether he is simply very cautious), he at least probably understands the basic issues at stake, whatever his day-to-day political imperatives dictate. Many others in the Labour camp, however, seem to have a very shaky grasp of the issues - Tony Blair and Peter Hain are two who spring to mind, not forgetting Neil Kinnock, a former leader of the Labour Party and now one of the United Kingdom's European Commissioners. Tony Blair seems to have thought, perhaps he still does, that the new physical notes and coins will somehow make joining the €-zone inevitable - the kindest thing which can be said about this is that it is simplistic. If he genuinely does wish us to join, then he is going to have to undertake a policy of explaining to voters, who have been promised a referendum if the Government decides we should join, the benefits of joining and/or the negative consequences if we don't. A dilemma is that the choice of the exchange rate, at which the £ would have to be 'pegged' against the €, is crucial for economic reasons, but may have negative political repercussions which would dissuade people from voting 'yes'. Spin will only carry Labour so far, eventually the Government will have to adopt a position and live with the consequences at a future election.

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Copyright © 2002 William Cameron