by Frank Schnittger
Tue Jan 12th, 2010 at 07:04:54 PM EST
Despite his admittedly dismal record of economic forecasting, the Times' Anatole Kaletsky is again engaging in a bit of doom porn over the fate of the Euro in 2010:
Disappointment ahead for UK -- and big test for euro
The world's weakest currency is likely to be the euro as US exporters increase their global market share mainly at the expense of European rivals, while Chinese and Japanese manufacturers divert to Europe many of the goods that they can no longer sell in the US.
Again, this is really an extension of a somewhat premature suggestion I made last year, when I said that the focus of global economic troubles would shift from America to Europe. This did not quite happen in 2009, although the falls in output and industrial production were much steeper in Europe than the US. But German government labour subsidies will soon expire and the financial pressures on Greece, Ireland, Portugal, Spain and Central Europe can only intensify.
I therefore repeat a point I made last year: before this crisis is completely finished, the cohesion of the eurozone will be tested to near-destruction.
Meanwhile, in Ireland, economist David McWilliams has been making the case that Ireland should never have joined the Euro in the first place, and should certainly leave now:
The Post - Breaking news
For a currency union to work for a country, the most important thing is that the country trades overwhelmingly with the other members of the monetary union.
This ensures that all the countries in the union move roughly in the same economic cycle. It is also important that the structures of the respective economies are broadly similar, so that one country doesn't experience a huge boom, while the rest are just motoring along nicely.
Having similar structures in banking and housing, for example, will imply that a country should not suffer a monumental bust, while the others are merely experiencing a normal recession. Equally, it is important that there is significant movement of people within the currency union - like there is in the US between its states - so that, if a country does slump, its citizens can move to find work in another member country.
In general, for a currency union to work, there should also be a single fiscal policy so that, when one area of the currency slumps, the rest of the union's taxes go some way to ease the problems in the region in difficulty. This is how the currency unions in the US, Canada and Australia work.
Guess what? None of these attributes was in place when Ireland joined the EU economic and monetary union (EMU) and the euro. So it is clear that we didn't join for economic reasons. So why did we join? It seems that we were too insecure to behave logically and this national insecurity - particularly among our senior mandarins - prevented us from having a debate.
Could it be that the people who dictate policy in this country are so in awe of the `big boys' in Europe, and so desperate to be in the club, that they signed up for EMU just to be in the big league? Could it be that they didn't have the confidence to question whether they should be in the marriage in the first place?
The reason we should ask these questions is that it is clear the euro has been a disaster for Ireland, and will ensure our slump lasts considerably longer than it has to. When we look at other countries, we see that, of the three entrants into the then EEC in 1973,we are the only ones using the euro. However, we trade less with other eurozone countries than either Denmark or Britain.
The Danes and the British had the confidence to know that they would still be full members of the EU without the euro. They kept their own currencies because they knew they'd need them at times like this. The Swedes made the same decision. They assessed the risks and concluded that monetary union was not for them.
Ireland doesn't belong in the euro. That is abundantly clear from the queues of Irish people who choose to shop in the North. Irish people shop in Newry, not Nuremberg. We are locked into an arrangement which means we have to try to be more competitive than Germany. But no one is more competitive than Germany - it is the world's most successful exporter.
So the question I have for those who rightly suggest that we need to get our wages and prices down by 30 per cent to claw back the competitive losses we suffered since joining the euro is: how are we going to do it? In particular, how are we going to do this without leaving the euro?
What is the alternative to leaving the euro? How high does unemployment have to go for us to be competitive again?
If there is an alternative way to get costs down which doesn't involve changing the currency, and that doesn't involve massive unemployment and job losses in the trading part of our economy, I would love to hear it. Irish wages are not that flexible, despite the spin being put out.
Think about it. Irish wages, on aggregate, rose last year when the economy contracted by 9 per cent. If we can't get wages down when we are in such dire straits, how are we going to grind down wages in the next few years?
I realise that even talking about leaving the euro is heresy to the mainstream in Ireland, who try to dismiss this suggestion as the nuclear option, one which would have dreadful political and economic ramifications for us. To them, the question has to be: what is the alternative?
There are a few points to make about this analysis:
Firstly, membership of the Euro didn't cause our economic collapse - we managed that almost all on our own by irresponsible fiscal policies which encouraged a bubble in property prices and a debt binge fuelled consumer boom. Ireland has some of the lowest property taxes in the EU - for reasons not unconnected to the close nexus between Fianna Fail, property developers, and a peasant culture conditioned determination to own our own property having been tenants and serfs to a semi-feudal imperial power and landlord system for far too long.
Certainly the ECB had a (too low) interest rate policy which was geared to Germany and France rather than Ireland - which was one cause of the uncontrolled, unregulated and irresponsible lending fuelled property boom in the latter years of the Celtic Tiger - and then raised interest rates just as Ireland was getting into real difficulties. But that policy has been unwound, and now the low Eurozone interest rates are just what this country needs to recover.
However it was Irish regulatory and fiscal policy rather than Euro monetary policy which was the prime cause of our boom and bust, and whilst a c. 30% devaluation could be a short cut to restoring our competitiveness, it would also stoke up inflation, greatly increase the gross value and cost of servicing our (largely external) national debt, and result in soaring interest rates to encourage foreign investors to purchase our Government bonds.
I am old enough to remember the chronic instability of the old Irish Pound, or Punt, where I was paying a mortgage with 15% interest rates shortly after I had built our family home. With many more recent home buyers currently in negative equity, and many losing their jobs, a higher interest rate regime is the last thing we need - and reverting to our own independent currency is sure to carry a very high risk premium, particularly with our current Government borrowing requirements of c. 12% of GDP and a gross (public and private) external debt of over 800% of GDP.
Secondly, whilst much of McWilliams' analyses was more or less true in the 1990's when Ireland joined the EMS and then the Euro, it is becoming less and less true as time moves on. Ireland's economy is extremely open and becoming increasingly integrated with the rest of the Eurozone. Increasingly, Irish people DO shop in Europe, and Irish business is critically dependent on Eurozone trade where the absence of exchange fluctuation risk is a major factor underpinning our export sector and attractiveness for foreign direct investment.
Thirdly, despite McWilliam's estimated 30% overvaluation of Irish Goods and services, Irish exports to the Eurozone actually increased by a net 3% in 2009 - even if there were significant declines in the more labour intensive "indigenously owned" sectors of the economy. Thus whilst Government expenditure has been hugely out of line with Government tax receipts - it is the non-traded rather than the traded sector where costs have been most out of line.
Fourthly, despite McWilliam's claim that a devaluation is the only way to get our costs back in line, there is ample evidence that a very rapid readjustment is currently taking place in any case. Government expenditures were reduced by c. 3 Billion in the last budget, Asset prices have collapsed, wage reductions or standstills have been widely implemented throughout the economy, and inflation is currently -6.5%, which will of itself restore competitiveness sooner rather than later.
Finally, it is anything but clear that a 30% devaluation is actually what is required - certainly on an across the board basis. Those sectors of the economy which are least subject to competition and trade have also been those where inflation has been most rampant in the past few years - private medical services, legal fees, and other services controlled by the Irish professional classes who have successfully managed to gouge an ever larger share of national wealth for themselves. Again, the solution has to be an Irish one - Government regulation and price controls on monopoly or near monopoly service provision.
Thus far from blaming our Euro membership, what we really should be doing is putting our own house in order - controlling our national Kleptocracy, increasing our taxes on property, and using our access to relatively cheap Eurozone finance to prevent a total deflation of the economy whilst the transition to more sustainable price levels is completed.
Indeed the Euro could be our greatest asset if we want to compete with the UK for financial services which require access to the Eurozone. Financial businesses can now set up in Dublin far more cheaply than in London because of our much reduced property prices and salary levels - which brings me back to Anatole Kaletsky's analysis for the UK:
Disappointment ahead for UK -- and big test for euro
The year ahead will be disappointing in Britain for several reasons: political uncertainty before an election; an exodus of financial business from London; tax increases already legislated, with more to come in a post-election mini-Budget; and excessive strengthening of sterling.
So contrary to his prediction that Eurozone membership could produce unsustainable strains for countries like Ireland, any overall weakness in the value of the Euro is to be welcomed from our point of view. At least our competitiveness with non-Eurozone countries (like the UK and US) is enhanced. But most of all it is the stability and direct access to a huge market without currency risk that makes the Euro such an attractive proposition for us. It is an advantage that the UK is unlikely to enjoy under a Eurosceptic Tory Government.