The last couple of months, since the demise of Lehmans, have been extraordinary, earth-shattering and unprecedented. But, at least, it can be said with some confidence that the worst of the financial crisis has now been contained. (I trust that I am not tempting fate by that remark.) The grip of the credit crunch on the real economy is, however, now intensifying. A painful recession is on the cards - whatever Alistair Darling does next week. GDP will probably continue to fall and unemployment rise well into next year.
Into this economic Slough of Despond, ride the battalions to save us all. So critical and so weak is the pound and so inconsequential is Britain’s economy, they cry, that we must look to salvation in the euro.
Professor Willem Buiter is one of the euro’s chief cheer-leaders. He asserts that Britain, like Iceland, is a “small economy” which has a minor currency for ever at the mercy of cruel and unforgiving markets. May we be damned to perdition for our folly in resisting the seductive allure of the eurozone. Suffice to say that the UK’s economy is many times larger than Iceland’s – which has a population of around 320,000. The population of the London Borough of Barnet, of which I am a resident, has a population of 330,000. The idea that Britain is a “small country” in the same league as Iceland is simply laughable. Another of Professor Buiter’s views is that Britain’s large and, arguably, vulnerable financial sector endangers the country’s fiscal solvency – and thus fatally undermines the currency. But Switzerland also has a large financial sector that has experienced its fair share of financial difficulties in recent months. Yet the Swiss franc remains strong and Switzerland, a much smaller economy than the UK, sees no need for euro, or even EU, membership.
A third notion is that the pound is suffering from an unprecedented collapse in confidence. Granted it has fallen significantly in recent months, but its current low rates are not unprecedented and, as yet, the depreciation is manageable. Of course, the markets have looked at Britain’s economic fundamentals and found them wanting. A nasty recession, coupled with appallingly managed public finances, do not appeal to overseas investors. But let us get sterling’s current valuation in some sort of perspective. At the current rate of around £/$1.50 this is not wildly out of line with fair valuation, despite the recent dramatic fall in the pound against the dollar. At£/$2.10 – the pound was absurdly overvalued. And even £/€1.18 is not unprecedented in historic terms. £/€1.18 is roughly equivalent to £/DM2.36. The pound was significantly weaker than this in the heady post-ERM days. Of course, the pound is weak and the British economy a mess. But let us note the US and the eurozone economies are hardly in the best of health. Suffice to say I am not persuaded by Professor Buiter’s arguments for joining the euro.
In the meantime let us remind ourselves that there are at least two very persuasive economic arguments for staying outside the euro and keeping the pound. The first is, of course, control over our own interest rates. The Bank’s recent reduction of 1.5% in the Bank Rate simply could not have happened if we had been in the euro. And there’ll probably be more British cuts to come. And the fall in the pound should ultimately help the economy rather than hinder it. The sharp reductions in interest rates and the equally sharp depreciation of the pound led to our export-led recovery in 1993 and 1994. The fall in the pound should, therefore, be regarded as a positive rather than a negative development - provided it really does not turn into a “rout”, which I am not expecting unless the Chancellor, egged on by his euphoric semi-messianic next-door neighbour, really blows the public finances even more than he already is doing.
It is clear that the pro-euro battalions are already marshalling their forces for another attack on sterling’s citadel. But they are not the battalions of salvation. If anything, they are the economic equivalent of the four horsemen of the apocalypse.
