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Dear Dr Ward,
In request to your committee`s call for representations on the exchange rate implications of entry to the euro, can we submit this statement of our view, with accompanying evidence in the form of some of our most relevant Bulletins, to the Committee on behalf of the Labour Euro Safeguards Committee.
Leaving aside the issues of the timing of any referendum and of fulfilling the five tests, both issues which will be decided by Government, two basic problems on euro membership concern us.
FIRST The euro is primarily a political instrument for building ever closer union and furthering integration. For many this is crucial and more important than the economic consequences. They may well be prepared to accept some economic detriment as the price for political gains. We do not deal with this argument and neither, we hope, will you, much as it might colour views for and against. The decision should be primarily economic and those with a political enthusiasm, for or against, should be quite clear about the economic consequences of their ideological preoccupations.
Nevertheless, the euro does have political consequences for Britain. Control of the two most powerful instruments of economic management, interest and exchange rates, will be transferred from an elected British government accountable to the people to an unaccountable Central Bank in Frankfurt. Decisions will, therefore, be taken not by ministers and institutions like the Bank of England directly responsible or responsive to
British opinion, pressures and economic needs, to become a minority consideration as one part of a Europe-wide canvas in decisions taken by a European institution which is unaccountable to the British people and less responsive to British needs.
The EU is not an optimum currency area. Labour is not mobile. If euro-management decisions have adverse consequences for the British economy there is no redistribution mechanism or flexibility in the system to counteract that. One interest rate can`t cover a range of economic needs. Indeed one British rate can hardly cope with both the pressures generated in the South East and the needs of the manufacturing areas. The consequences of applying one rate to widely different economic conditions is divergence not convergence. It can`t be appropriate to all conditions.
Similarly there is no framework of redistribution in the system which can offset adverse consequences for areas or nations. A nation state has two fifths or more of national GDP flowing through its hands and can redistribute as much as it wants to disadvantaged areas by spending on development, infrastructure, regional aid, benefits, etc. The EU has 1.27% of Europe`s GDP available and all most of that is predicated on agriculture, cohesion or regional funding. The only way that a nation which has lost the monetary weapon can deal with difficulties, therefore, is by over using the fiscal one. For difficulties that means cutting spending or increasing taxation. Most governments have learned the electoral consequences of both through bitter experience.
We are not including in our analysis any consideration of the effects of the Stability and Growth Pact. Properly implemented this must have severe and damaging consequences for countries in economic difficulties which will reduce tax take and increase social spending as unemployment rises and the economy slows. To cope with that by fines, mandatory spending and borrowing cuts defies economic logic. However, since it is currently uncertain whether the Pact will be enforced, scrapped, fudged or changed, we can make little useful comment, though this uncertainty is a strong argument for waiting until firm decisions are taken so Britain can be sure what it is joining and what consequences it may have to face.
SECOND The problem of the entry exchange rate. This is crucial and its importance is clearly indicated by the consequences for Germany of locking in at a rate which was, temporarily, too high against the Franc. Germany has always been happy to make sacrifices for “Europe”. We have more to lose with our different trade patterns, stand to suffer more damage and have always shown a less clear-headed understanding of the importance of a competitive exchange rate, though bitter experience in the ERM and before may have created some understanding of the consequences of fixed rate regimes in which the domestic economy and monetary and fiscal policy have to be managed to maintain a fixed exchange rate.
The crucial problem in respect of the euro is the rate at which we join relative to it. There is a general consensus that the pound is overvalued and has been for some time. Overvaluation has been deeply damaging to manufacturing as it was in the last two manufacturing wind downs of the early Eighties and the early Nineties. It is higher against the (now notional) Dmark than at the 2.95 DM central rate in the ERM - a rate which all agree, retrospectively, was far too high, however strong the Liberal Democrats and other euro-enthusiasts then argued for a move to the narrower bands.
In our view Sterling needs to come down by over thirty percent against the basket of the currencies. To go in at that level of overvaluation, or anything like it, locks Britain into a permanently uncompetitive situation British business will be forced to cut costs and fire workers, British public spending will have to be slashed, just as happened in previous periodical efforts to restore competitiveness when afflicted by an overvalued exchange rate, as in the periods 1964-7, 1979-84, 1990-3. These have never worked in the past because no scale of cuts can be enough to overleap the height of the competitiveness barrier the exchange rate erects.
The pound must come down before we can even envisage going in. If the Treaty is to be believed we will be required to go in at an exchange rate maintained against the (now notional) ERM for two years to prove that the rate is stable and tenable. The rate for the last two years has been disastrous so we clearly can`t go in at that. The euro isn`t going to go up anything like enough to close the gap and in any case a change in the euro rate isn`t enough. So it is vital to ask how are we to go in at a competitive sterling exchange rate. This must be much lower than the present disastrous one?
(1) Neither British Government nor the Bank will embark on a policy of managing the exchange rate down. This could be done but both eschew it and are committed against it. Indeed, the Bank, which has consistently kept British interest rates higher than those in Europe, the US or Japan, would probably feel it necessary to put interest rates up if and when the pound comes down, in the belief that any fall in the exchange rate has future inflationary consequences which it is obliged to counter in advance.
(2) Liberal Democrats and other euro-enthusiast proponents of entry tell us that the pound would come down as soon as the intention to go in is announced. It might not. We can`t make such a massive commitment on a hope and a prayer. The fact is no-one knows. Indeed, if the consequences of going in are as important in building confidence, creating stability and attracting investment, and as beneficial as we are often told, there is every possibility that confidence could put the pound up or at least hold it high. If membership is the key to improving investment flows in Britain then that should put the pound up as soon as the prospect is announced. We don`t believe this analysis but logically euro-advocates must. Certainly to lock into a euro which is appreciating against a dollar which is falling would have disastrous consequences for our trade within the US and get us the worst of all worlds.
(3) The entry rate could be agreed by negotiation. The Treasury Committee has reported a willingness on the part of French officials to consider a lower rate for Sterling entry. However, nothing can be guaranteed. It is unlikely that the British authorities will proclaim and possibly don`t even see the need for a competitive rate, let alone the substantially lower one Britain needs. It is also unlikely that they will negotiate hard for it. Too many people, especially in the financial sector, see an overvalued pound as a national virility symbol and a boost to acquisition of assets overseas. Competitors tend to be more clear headed and it is in the commercial interest of the other members that we should go in at a high exchange rate to improve their prospects in our market and hamper ours in theirs. Their financial and political authorities may not be sufficiently keen to get us in to lean strongly against that vested interest.
This is a competitive game and others will be aware of the effects a competitive British exchange rate making it profitable to produce in this country (in the way it currently isn`t) will have on British producers and on the flow of investment funds to Britain from outside. Certainly if our economy continues to do better than theirs, particularly than Germany`s, because of our higher public spending and our credit explosion, it will be difficult for HMG to argue for soft entry terms. It is not beyond the spinning ability of government to tell the British electorate how well it`s doing while claiming to euro negotiators how badly. Yet some may make cross comparisons.
(4) The world seems to us to be entering a period of uncertainty over exchange rates. A major argument for the euro was that it would give greater stability. In fact up to now the euro has been more unstable than the pound. Yet there are now indications that
(a) The Japanese will want, and get, the yen down to boost their economy.
(b) The dollar will fall as the scale of the US trade deficit and the comparative weakness of the American economy produce their inevitable market effects. These have already begun. The dollar has come down by over 10%, a process which will almost certainly go further. Benign neglect seems to be the American approach.
(c) Sterling has kept up with the dollar but should now come down with it. The growing trade deficit should produce its natural market consequences. However, our interest rates are too high compared to those of the euro, the dollar and the yen, so this is currently counteracted. Even so sterling should eventually fall. That will, in our view, be beneficial.
(d) The euro itself should go up, having fallen too low in the long initial decline. That rise should not, and can`t be, seen as sufficient to close the competitive gap against sterling. The pound needs to come down independently. It is also open to doubt whether the euro rise will be more substantial. The European economies are in trade surplus. That builds confidence. Yet the German economy is depressed which depresses it. No one really wants any more appreciation which all see as damaging to exports and growth. The euro may well rise vis a vis the falling dollar and that could produce the same flow of footloose money into Euroland which Britain has enjoyed. If it is going into the euro it will push up its exchange rate as it has so long done ours.
None of this can be guaranteed or measured. None of it is inevitable. It is merely our best guess at likely processes. What is more certain is that after a long period of currency stability with falling euro, strong dollar and overvalued sterling the certainties are beginning to change and currency instability, even over and undershoots, is likely. This will in turn make it even more difficult to fix an exchange rate against the Euro at which we can be locked in forever. Transient circumstances and the consequence of different economic phases are not a basis for successful locking in.
We have not considered the issues of timing arising from when (and if) the referendum will be held, what the electorate should be told about the entry rate, and whether if there is a `Yes` vote sterling will be locked in at the rate on the referendum day or immediately before entry, or what. All this is important but not so relevant when the economic arguments against going in are so strong, and the consequences, potentially, so damaging. |
