Revisiting the Eurodebate

This post of P O’Neill’s made me think of something. That is, the British debate on joining the Euro, and on Europe more generally. I was strongly pro-Euro, something which now looks as bad a decision as joining the Liberal Democrats was. It’s hard to avoid the conclusion that had the UK had Eurozone interest rates in the 2000s, we would have had an even huger housing bubble and even more gigantic bank balance sheets, and we would have had to resolve them without being able to use the central bank as lender of last resort, and we would have been unable to devalue the currency as a stimulus mechanism.

Any counter-argument requires that the influence of the Bank of England in ECB policy would have been both powerful and right. The first is debatable, but we have to accept that the Bank didn’t restrain the housing bubble and also failed to respond to the crisis in the real economy in 2008, sitting on its hands and mumbling about inflation while the labour market cliff-dived and the bank regulators across the corridor frantically juggled with Halifax-Bank of Scotland, Lloyds, and Northern Rock. Also, the early 2000s situation of a bubbly periphery and a stagnant core would have been even worse with the London housing market in the Euro, and it’s hard to say how that would have panned out.

But what were we really debating in the 90s?

The arguments in favour, at least the economic ones, were that we might benefit from being fully integrated in a bigger trading bloc, that we would benefit from currency stability, that lower interest rates would be nice to have, and that the Eurozone restrictions would be a force that would require industry to be more competitive (or did they just mean lower wages?). The arguments against, at least the economic ones, were that the Stability & Growth Pact would be an anti-Keynesian force for deflation and that the option of devaluation would be removed.

Then there was a whole lot of other stuff. A lot of the “for” side thought it would make us more European and meant by this that it would make us more social-democratic (or Christian-Democratic, or even Free Democratic), although I don’t think any of them could have articulated a mechanism by which this would happen. I suspect that for a lot of us it was a bit like the Estonian MP who told Tim Garton Ash that “Europa ist…nicht Rußland!”, or in our case, Europe was not-America.

A lot of the “against” side seemed to agree with the idea that joining the Euro meant the triumph of social democracy, because they at least claimed to think that the European Union was an inherently socialist institution. Some of them still think this now, when it has imposed structural adjustment on three European countries in order to avoid the nightmare of fiscal expansion in Germany. Others took the Friedmanite line that currency adjustment was a form of free market competition and therefore desirable. This was at least defensible. And others thought that it was a scheme to redraw the UK’s internal borders or replace the flag or something.

The interesting contradiction here was that the same people who worried that we would be unable to devalue the currency were also fervent austerians who didn’t believe in demand management of any kind. It was as if they believed in hardcore new classicism up to the point where it affected their re-election. How could it happen?

Obviously, whether you felt the SAGP would be useful discipline or an anti-Keynesian straitjacket simply depended on whether you expected the economic problem of the 2000s to be inflation or deflation. But the economic argument that was very rarely discussed was the one that is now fascinating everybody – exactly how the Eurosystem, rather than the Euro, would function in a financial crisis. Apparently this was discussed in specialist circles, but it didn’t make even the best of the national press.

To sum up, I agree that the yes side was wrong about fixing the currency. To be honest, when asked, I always said I was in favour of joining if we could join at a significantly lower exchange rate. The benefits of which Jaguar-Land Rover just demonstrated. But this is a cop-out on my part. On the other hand, I think the Eurosceptics and some of the conservative Europhiles should accept that they were wrong about the SAGP – yes, Virginia, inflation was a phantom menace, and the ghosts of 1929 were not finished with us. And we can all agree that we were all wrong about the banking and financial aspects of the Eurosystem, in that we didn’t even bother to argue about them.

I promised to blame somebody in the last post. Here it comes: the key European politicians, especially the French and the Germans and the European Commission officials, who designed the Euro and the Eurosystem. They created a system that had a structural deflationary bias in an era of deflation, one that delivered rock-bottom interest rates to countries in the grip of land fever, and one that couldn’t cope with a banking crisis although it included the biggest banking system in the world. And then they kept putting up interest rates. What’s worse is that they now have the gall to give lectures about virtuous savers – even when they are the same individuals, like Wolfgang Schäuble, who were in power in the 1990s.

20 thoughts on “Revisiting the Eurodebate

  1. There’s a better “guilty men” book to be written about exactly those “key European officials” who designed the Euro and the Eurosystem. They could do with a bit of healthy mockery and ridicule. Not just the politicians, but e.g. the head of foreign economic policy in the French ministry of finance.

  2. Do they need? Are you sure that the implementation is to blame? Or this the very idea of a currency union the problem?

  3. People had been saying for years before the crash that the Eurosystem and especially the ECB was off-balance in its founding ideology – far too much emphasis on ‘stability’, not enough on ‘growth’. The SGP and associated pleas for ‘virtue’ are hypocrisy worthy of the Catholic church and always have been, and it should have been clear that an ECB set up to keep inflation low at all costs (as opposed to the more nuanced mandates of e.g. the Fed and the BoE) was a disaster waiting to happen. I doubt a hypothetical UK about to join the Euro would have changed the course much, as the cult of stability had at least its fair share of believers in the Major government. (A UK that joined the euro in the middle of Blair’s reign wouldn’t have had much say anyway.) The current Tories are also singing from the same hymn sheet as the CDU when it comes to austerity, so if anything Britain’s politicians would only make things worse for the Eurozone if we were in right now.

    With hindsight, Black Wednesday was probably a blessing in disguise. Imagine if we’d joined the Euro at 3 DM to the pound!

  4. As always however the biggest blame is on voters: German voters who want jobs based on export sales and vote for politicians who approve vendor financing liar loans, Greek voters who want a consumption boom based on public sector sinecures financed by German loans they have no intention to repay.

    The current mess is the result of three different levels of mishap:

    #1 A fundamental long term economic situation that is not favourable to first-world economies or at least their workers.

    #2 Pig-headed insider voters in first-world economies that don’t care about that and just want insiders like themselves to continue to have a good time, one way or another.

    #3 Politicians and elected officials that choose to just pander to those insider voters, tricking them that they can swim against the current by creating bubbles for whatever the voters feel they are entitled to.

    Sure there is in the third part a lack of leadership and honesty from elected politicians and unelected officials, but the main issue is the ferocity of the wishful thinking of pig-headed voters that triggers that. Sure many politicians are corrupt, but often reluctantly; it is voters who tend to be more corrupt than the politicians.

    As to this nothing new. I was doing one of my many rereadings of Gabraith’s “The Great Crash 1929” and that is a book that could be republished today with only a few names changed (some don’t need changing, chapter 4’s title is “In Goldman-Sachs we trust”).

    This is one quote about loans to the Greeks of the time (which included Germany BTW):

    J. K. Galbraith, “The Great Crash 1929”, page 198

    The bank did a large business in Cuban bonds. In contemplating these loans, there was a tendency to pass quickly over anything that might appear to the disadvantage of the creditor. Mr. Victor Shoepperle, a vice-president of the Natioanl City Company with the responsibility for Latin American loans, made the following appraisal of Peru as a credit prospect:

    “Peru: Bad debt record, adverse moral and political risk, bad internal debt situation, trade situation about as satisfactory as that of Chile in the past three years. Natural resources more varied. On economic showing Peru should go ahead rapidly in the next ten years”.

    And here is a quote about meetings of heads of state:

    J. K. Galbraith, “The Great Crash 1929”, page 158

    Yet to suppose that President Hoover was engaged only in further reassurance is to do him a serious injustice. He was also conducting one of the oldest, most important — and, unhappily, one of the last understood — rites in American life. This is the rite of the meeting which is called not to do business but to do no business. It is a rite which is still much practised in our time. It is worth examining for a moment.

    Men meet together for many reasons in the course of business. They need to instruct or persuade each other. The must agree on a course of action. They find thinking in public more productive or less painful than thinking in private. But there are at least as many reasons for meetings to transact no business. Meetings are held because men seek companionship or, at a minimum, want to escape the tedium of solitary duties. They yearn for the prestige which accrues to the man who presides over meetings, and this leads them to convoke assemblages over which they can preside. Finally there is the meeting which is called not because there is business to be done, but because it is necessary to create the impressions that business is being done. Such meetings are more than a substitute for action. They are widely regarded as action.

    Some other quotes:

    J. K. Galbraith, “The Great Crash 1929”, page 28

    Since 1929 we have enacted numerous laws designed to make securities speculation more honest and, it is hoped, more readily restrained. None of these is a perfect safeguard. The signal feature of the mass escape from reality that occurred in 1929 and before — and which has characterized every previous speculative outburst from the South Sea Bubble to the Florida land boom — was that it carried Authority with it. Governments were either bemused as the speculators or they deemed it unwise to be sane at a time when sanity exposed one to ridicule, condemnation for spoiling the game, or the threat of severe political retribution.

    J. K. Galbraith, “The Great Crash 1929”, page 58

    In 1929, a robust denunciation of speculators and speculation by someone in high authority and a warning that the market was too high would almost certainly have broken the spell. It would have brought some people back from the world of make-believe. Those who were planning to stay in the market as ling as possible but still get out (or go short) in time would have gone out or gone short. Their occupational nervousness could readily have been translated into an acute desire to sell. Once the selling started, some more vigorously voiced pessimism could easily have kept it going.

    The very effectiveness of such a measure was the problem. Of all the weapons in the Federal Reserve arsenal, words were the most unpredictable in their consequences. Their effect might be sudden and terrible. Moreover, these consequences could be attributed with the greatest of precision to the person or persons who uttered these words. Retribution would follow. To the more cautious of the Federal Reserve officials in the early part of 1929 silence seemed literally golden.

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  6. «People had been saying for years before the crash that the Eurosystem and especially the ECB was off-balance in its founding ideology – far too much emphasis on ‘stability’, not enough on ‘growth’. The SGP and associated pleas for ‘virtue’ are hypocrisy worthy of the Catholic church and always have been, and it should have been clear that an ECB set up to keep inflation low at all costs (as opposed to the more nuanced mandates of e.g. the Fed and the BoE) was a disaster waiting to happen.»

    All mostly agreeable, but that’s because the whole EU project and the Euro are initiatives that have been set-up on a leap of faith, as starting points, by politicians and administrators who for once would lead the voters as well as pandering to them.

    But pandering still did have to occur, and the above situation with the ECB was largely because otherwise German voters would not have approved switching from the DM to the Euro. And on its merits it was not even a bad idea, except that several EU countries like Greece are kleptocracies and thought that they could continue to be like that only more within the Euro.

    The idea behind the leap of faith was that problems were expected to happen, and when they happened the starting point would have to be developed into something more forced by the pressure of events. Sure not a pretty process, but the reason why the EU politicians on this lead as well as pander is because obviously they think that the alternatives are worse; like being “steered” not so gently by Washington or Moscow like in the 1950s, or having to pay tribute to whichever dynasty is in power in Bejing.

    This would have better chances if the UK were not still deluded of being a great power playing the game of setting the Spanish Empire, the Kingdom of France and the German Federation against each other and coalitions of smaller states; while instead they are a small aging island not far from a small aging continent. But for some the 18th century never ended.

    In an ideal world the best working empires or supranational states are those conquered or created by one country that can run the whole lot. As to this I often wish that the EU had been done by having the ancient kingdom of Denmark (or Sweden) invade the rest of Europe and all other countries offering instant surrender on condition of full annexation.

    Bring back the Norse empire in their modern form sending tourists and cool hifis to other countries instead of raiding and pillaging parties, to be governed by their slightly corrupt but overall fair, efficient and sensible civil servants.

    But given the demented nostalgia of the UK elites for their imperial days, if to get the bloody minded UK to stop undermining their continental cousins it took offering Charles III of Great Britain the title of Charles I of the European Empire, and having to be annexed to the UK and governed by the UK European Empire Office and their annoyingly smarmy, hypocritical, supercilious and elitist mandarins, I’d take it.

    Sometimes the lesser evil is not so evil.

  7. «With hindsight, Black Wednesday was probably a blessing in disguise. Imagine if we’d joined the Euro at 3 DM to the pound!»

    Interesting times, and perhaps certain stupid things like the house price bubble would have exploded even faster and less damagingly.

    But the story of the UK in the past 30 years, and the main reason why it did not join the Euro (same as Norway and same as why Scotland wants to leave the UK itself) is the North Sea oil.

    I often repeat that this graph explains a large chunk of UK politics and economy in the past 30 years:

    http://mazamascience.com/OilExport/output_en/Exports_BP_2011_oil_mtoe_GB_MZM_NONE_auto__.png

    Now that the UK has “invested” the North Sea oil income into housing and debt bubbles, and has become a net oil importer, the attitude towards the EU project may change a bit. Especially if Scotland secedes, as Scotland without England and NI would still be a net oil exporter for quite a while, and England and NI as such have essentially no oil.

  8. Stop the presses, this is the most important quote about the Euro situation, cited by Naked Capitalism:

    http://www.bloomberg.com/news/2011-09-25/merkel-can-t-rule-out-euro-area-sovereign-default-after-esm-fund-in-place.html

    «Merkel rejected Greece leaving the euro area, saying that “we can’t force it, but I don’t believe in that in any case” because it would send a signal to financial markets that attacks on euro-area sovereigns can succeed.

    “Maybe Greece leaves, the next country leaves and then the next country after that,” she said. “They would speculate against all the countries.” A small group of euro countries would be left at the end, deprived of the euro’s advantage as the currency appreciates, she said.»

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  10. I find it interesting that even when defending the arguments supposedly in favour of joining the Euro, you manage to state them in the slippery way that prevented many people from seeing through them. Examples:

    “that we might benefit from being fully integrated in a bigger trading bloc”: spot the begged question, eh? What does “fully integrated” mean, and how has that worked out for Greece, Ireland, Spain, etc? Trade is trade. Calling for “full integration” is just tendentious, because it implies that “full integration” is beneficial without spelling out what it is.

    “that lower interest rates would be nice to have”: Nice to have for whom? For savers getting less on their savings? For people who can bid up house prices to higher levels with lower interest rates? For developers who can build that many more unsold houses with cheaper investment capital.

    “the Eurozone restrictions would be a force that would require industry to be more competitive”: yup, the convergence argument that has worked, well, approximately nowhere in the Euro-zone. It’s a magic wand argument, with a wand that does not work.

    Really, it’s disappointing to see you state the same arguments in the same slippery ways to excuse your own poor choices, instead of coming out and say “Here is what we though the arguments in favour were, and here is why even the way we stated them was ambiguous, incorrect and misleading.”

  11. The other Oliver Says:
    September 26th, 2011 at 8:11 am

    Do they need? Are you sure that the implementation is to blame? Or this the very idea of a currency union the problem?

    Precisely. The riches of modern Europe piled up in an era of small currency areas, something someone might someday actually notice. It’s only right under your collective noses.

  12. It may be that some of the argumentation raised against joining the euro in the UK was flawed.

    But it is also the case that all of the argumentation in favour of joining was flawed.

    As P. O’Niell has said this is a debate that leaves Thatcher, Congdon, Hague, Brown and others massively vindicated Whilst Ken Clark, Heseltine, Blair and Clegg are massively discredited.

  13. Just passing by – it may be that this is reflects the way most political debate goes (we don’t actually listen to the other lot’s arguments, so much as assumes them), but as somebody who was against joining the Euro at the time, you’re offering a strawman.

    For example, your suggestion that those opposed to UK membership don’t believe in active demand management (and therefore should prefer to be in the Euro) misses the point. If you don’t believe active demand management is that effective in practice, then you worry a lot more about being in an optimal currency area – and the inability of markets to integrate because of political, cultural, etc. barriers was a real concern here. (And proof is found in the lack of integration in Euro area banking.)

    The argument about whether you thought inflation or deflation was going to be the problem of the 2000s is also misplaced. The concern about joining the Euro was that it’s a permanent commitment with no exits – and therefore it has to work in all situations, and we never saw that.

    And that brings me on to the main criticism that was regularly pointed out at the time – that economic union without political union would create all kinds of problems of political economy. I’m thinking here especially of criticisms by Charles Goodhart and especially Charles Calomiris.

    These critiques said that even if it was an optimal currency area at creation, an asymmetric shock will run up against serious adjustment barriers at some point. At that point, a single interest rate would be too high for some and too low for others, and without an exchange rate, balancing would have to come through cost deflation.

    The same critiques said that with such large public sectors but no Europe-wide automatic stabilisers, those on the receiving end of such shocks would face extreme fiscal crises. They said that these fiscal crises would be made worse by political strategising as deficit countries dare surplus countries to finance them, or in the end accept monetisation of their deficits, because of their shared economic fates.

    All of these criticisms have now come to pass. Yes, some politicians made fairly silly arguments against the Euro sometimes. But many didn’t, and there were plenty of serious doubts raised which have come true, if Euro advocates had been willing to listen. But they weren’t.

  14. Well if a country has a floating exchange rate with its trading partners, then that will offset shocks without anyone needing to engage in demand management (I take it by demand management you mean any demand management involving conscious decision-making by say central banks or fiscal authorities).

    I don’t think that decisions about whether or not to join the euro in the 1990s should have turned on what anyone expected the economic problem of the 2000s to be deflation or inflation. Economic forecasting does not have a very good track record, I think that any good system should be able to cope with both. (And of course, the eurozone was at least planned to be around permanently, in which case it would have/will run into both deflationary and inflationary pressures in its time).

  15. Well if a country has a floating exchange rate with its trading partners, then that will offset shocks without anyone needing to engage in demand management

    You have been following the UK economy?

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