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Should Britain join the euro? No, no, no!

December 2008

By Theo Casey

"Britain is closer than ever before to joining the euro."
- Jose Manuel Barroso, 1 December.

We sincerely hope not.

On 17 November, we raised our concerns that a fresh wave of pro-euro rhetoric would soon be making its way into the mainstream. Two weeks later, the European Commission president put the cat among the pigeons, impishly announcing that unnamed senior British ministers have expressed interest in joining the single currency.

As the value of the pound falls ever lower and the prospects for our economy appear ever gloomier, the euro is being framed as the solution to all our problems.

Except it's not.

Joining the euro would be Gordon Brown's worst call since he lost 2 billion of our money selling the UK's gold reserves at a 20-year low.

Why should we oppose joining the single currency? There are economic, political and practical grounds to steer clear. Even Justice Minister Jack Straw himself has conceded that the euro is not a "piece of magic for the economy". If it were, then Germany, Spain, Italy, Greece and Ireland - all euro members - would not be joining Britain in recession. But they are. Eurozone unemployment is actually worse than the UK, with a 7.7% unemployment rate in the euro zone compared with a 5.8% rate in the UK in November's official reading.

While inflation is marginally lower on the continent, inflation is a diminishing concern going forward.

CPI may have reached 5.2% in September, but it is forecast lower at 3.8% by the year's end. HSBC believe that the UK's inflation will be back below the 2% target by the summer of 2009.

And while the benefit of rising trade sounds tempting on paper, this has not been the universal experience of single currency membership. The three most recent members of the Union have not reported any significant upswing in national growth:

False promise? - New single currency members forecast to decline

(%) 2007   2008   2009  
Cyprus 4.4 3.7 2.9
Malta 3.7 2.4 2.0
Slovenia   6.8 4.4 2.9

Source: Eurostat

The above table maps the GDP figures for the newest three members of the euro. Slovenia and Malta joined 1 January 2007, Cyprus joined on 1 January 2008. What you'll notice is the downward spiral of growth rates for the new members. As a percentage, growth in these three states is expected to fall by average 24% by the end of 2009. It's unfair to say this is bad going. Indeed, it is the common experience around the world and this is exactly the point. We are in a global recession and euro membership cannot stop that.

On top of this, the credit crunch highlights further frailties and new reasons why Britain must stay away. Here are our three main reasons for opposing the single currency:

No. 1: The crippling loss of power at the Bank of England

One of the biggest drawbacks of joining the euro would be in monetary policy, i.e. the ability to set interest rates.

The rate-cutting steps taken by our Bank in the last six months have already helped international trade. Low rates have driven the pound to its lowest levels in 12 years and a weak pound makes exports more attractive to international buyers. This has helped close the UK's trade gap. The Office for National Statistics said the shortfall between goods sold overseas by the UK and those brought into the country narrowed from 8 billion to 7.5 billion - 0.5bn, better than expected.

After all of the bailouts - the asset swaps, the borrowing schemes and the direct recapitalisations - have been exhausted, monetary policy is potentially our last roll of the dice. It is the only lifeline left that our Central Bank can use to stimulate the economy.

The catch-all interest rates set by the European Central Bank for 16 separate countries, by definition, cannot satisfy the demands of each member state. The prospect of being lumped into this group and to be handed an interest rate by a committee that has no interest in the UK could cause havoc to our economy.

Britain's experience in the European Union has demonstrated Britain's unpopularity among its neighbours. Why would we hand over even more power?

Also, as you can see from the chart below, "Hans Six-pack" has not piled on debt the way that we in Britain have.
     One size fits all? - The UK is very different to the dominant euro members
  Source: Bloomberg

One size fits all? - The UK is very different to the dominant euro members

It makes no sense that we should be subjected to interest rates intended for the German or French consumer and that are of benefit to the German and French economies. We are a very different, and unfortunately indebted, animal to either of these countries and would suffer under the policies of the European Central Bank.

No.2: The fatal impact on the banks

The timing of the new wave of interest in the euro beggars belief. We are in a recession.

We cannot seriously consider fiddling with the knobs on the UK banking system's life support machine at a time like this. The Bank of England has set up various support systems in place that financial firms are now reliant upon. If this support were taken away, some firms would fail.

For example, in April, our Bank of England introduced the Special Liquidity Scheme (SLS). This scheme allows for banks to swap their high quality mortgage-backed and other securities for "riskless" UK Treasury Bills.

With demand for these mortgage-backed products almost dead, banks are sitting on billions of pounds worth of assets that they cannot sell or pledge as security to raise funds. With no other options, the banks would have had to take writedowns worth their market capitalisations several times over.

The Bank of England provided the banks a lifeline by allowing banks to swap these illiquid assets for Treasury Bills. This improves their liquidity position and increases confidence in financial markets.

To remove the SLS less than one year in would be fatal for some banks. The confusion and panic that would be raised by a transfer over to separate terms with the ECB would create another wave of solvency fears over the banking sector.

No.3: Conversion criteria - The nail in the coffin to the proposed Keynesian response

Gordon Brown has spoken highly of the plan to spend our way out of recession. Indeed, this Keynesian response to declining growth is being touted all over the world, from America to China.

However, it would be impossible to enact under euro membership. The restrictive criteria set out for new members to adhere to effectively rules out the Keynesian option the government is pursuing. Some of this conversion criteria is unattainable given the UK's current economic outlook and dire state finances.

The budgetary deficit must be lower than 3% of national income. As it is, the UK's deficit is forecast by the Treasury at 8% of GDP in 2008, and rising. Of course, in times of prosperity, it would be considered a good thing to reduce this gap.

But it is difficult to see how the UK would be able to reduce its budget deficit by more than half. It's not possible unless we enact significant cuts in public spending, which would bring about greater unemployment, and huge tax hikes which have their own consequences.

This might well be what the country needs. However, I question whether now is the right time to bring about a move that would surely deepen and lengthen the recession.

Thanks, but no thanks

Britain is in enough turmoil without joining a union that has no regard for our ills and will limit our fiscal and monetary powers. We would be poorer, less independent and our financial sector would be in serious trouble were Britain to cross over into a new regime that the people are not asking for.

This may not be the second coming of the ill-fated Exchange Rate Mechanism - that the UK crashed out of on Black Wednesday 1992 - but neither is it a fix for the economy.

Of course there are now deep problems with the UK economy, and we believe sterling will continue to fall significantly.

However, remember that the faults in the British economy would only be worsened by joining the euro. We would lose the ability to set our own interest rates and our banking sector would be punished in the confusion of implementing literally foreign systems and practices.

While nothing can save us from recession, being a part of the single currency would put Britain even further behind when the recovery eventually does come.