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spikegifted - Random thoughts

 

Euros, Pounds, quids

October 8, 2003

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Not into letting brussels control our economy, which is way stronger that mainland europe's..
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Can you enlighten me on how joining the Euro will allow Brussels control more of the UK's economy?

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October 8, 2003

The strength of a currency, like the British pound, can have very negative effects on the national economy. At the same time, a currency that is too week will have different but also negative effects on the economy as a whole.

For a strong currency, it will hurt the exporting potential of an economy. Since we live in a 'globalized economy', products and services from the UK are directly competing against others from across the globe. A strong sterling will mean our products and services become less competitive on international terms. Additionally, even for those British companies that bill their clients in Euros or US$, a strong pound means that the resultant earning in sterling terms will become lower (due to the exchange rates) and the profit made will become lower also. In the end, this will hurt re-investment and tax earnings - which will also lead to short-fall in government revenue, driving up deficits, etc...

With a weak currency, the cost of importing raw materials, products and services will become more expensive in sterling terms which in turn drives up inflation. Higher levels of inflation can have a spiraling effect on wage. Additionally, higher inflation, will mean higher interest rates which mean higher cost of borrowing for the government, companies and individuals, resulting in lower levels of disposable income which drives down growth. Also high cost of import will drive up the cost of living which, at the same time, make people feel 'poorer'.

There is no such thing as magic number for the 'right exchange rate'. It is a fine balance between a currency that is too strong or too weak - either extreme, it can hurt the overall economy. At the same time, the currency is also a reflection of the performance of the country's economic performance and perceived growth potential. Letting one of them go to extreme will have long-lasting devastating effect on the other.

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October 9, 2003

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The loss of direct control over interest rates and public spending levels means that we have much less control over our own economy, having lost the most effective measure for short-term fine-tuning of the economy that currently exists.

Also, interest rates are of VERY direct relevance to the UK because we have a much greater trend towards home ownership in the UK than other major Euro economies, like Germany - therefore interest rate rises will hit Joe Public MUCH harder in the UK than they will in countries where house ownership is not so prevalent.

This underlines that point that the UK and other economies do not work in exactly the same way and that a policy that is perhaps right for Germany and France now may be way wrong for us. If you have any doubts over this, look at the effect (over-heating) Euro membership had on the Irish economy (and housing sector) which was thriving while much of the Euro zone was in the economic doldrums.
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I agree with the points you've raised. However, that's why the Chancellor has set out the 5 economic conditions / hurdles that the UK has to overcome before joining the Euro.

When the economic conditions are right, the UK economy will not be as sensitive to changes to interest rates as it is now, hence the worry about changes will nearly disappear. Additionally, one of 5 conditions is economic convergence with the Eurozone - ie. the UK economy will be 'in phase' with that of the Eurozone with growth and interest rates at comparable levels, so in joining the Euro, the economy will not be subjected to undue shocks.

With regards to the control of interest rate, I'd argue that once UK is part of the Eurozone, conditions in the UK will become a factor in the ECB's interest rate decision making. Don't forget by then, economic conditions in both the UK and the Eurozone (not necessarily directly with France or Germany or Ireland, but the overall Eurozone) will be 'harmonized' and hence interest rate changes will not be such shocks to the system.

The interpretation of the Stability and Growth Pact is of course subject to much debate. The SGP is originally designed as a guideline and some countries, notably France and Germany, have chosen to use it just as such. Hence they’ve no problem with breaking the 3% GDP limit on government deficit. However, the EU commission, ECB and other Eurozone states have chosen to use the 3% as an absolute ceiling, which is exactly what you’ve describe - a fiscal straight jacket. My take on this is that the SGP should be used as a guideline and that national governments will and should have the ability to exercise their fiscal judgments. Since Eurozone countries have already given up the monetary freedom in passing interest rate control over to the ECB, it is only fair that they retain a degree of fiscal flexibility.

The passing of interest rate control over to the ECB should not be seen as an alarming development either. The BoE has been doing a similar job since 1997 and has gone out its business in a similar fashion as the ECB - being given an inflation target and then be allowed to achieve it via interest rate policies.

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October 9, 2003

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Other than interest rates problems there would also be an impossibility of a devaluation which would leave Britain more open to external shocks, there would be a rise in imports which would screw the balance of payments and cause unemployment. The problems of exchange rates wouldn't go away because of other countries outside the Euro zone.

I believe it would be much more beneficial for firms to have a stable economy with steady predictable demand and exchange rates than jumping with both feet into the Euro possibly resulting in recession (e.g. ERM). The only firms which would probably benefit from the Euro are those who manufacture in the UK and export to other areas of Europe and as the UK's manufacturing sector is basically dead anyway I don't see how this is a strong argument.
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Devaluation of a currency is probably one of the worst scenarios that can happen to a country. As I’ve mentioned previously, with a weak currency, inflationary pressure within the economy is due the rising cost of import relative to the home currency. The UK does not have a closed economy; hence we’re dependent on import and export. Yes, I agree that currency devaluation will give this country a temporary advantage over our international competitors, but in the end, the increased cost of import will drive up the cost of our own products, eroding any temporary benefits. However, the resultant inflationary effects on the economy will be with us longer than the temporary advantage we can gain over our competitors. So the overall economic effect of devaluation is negative.

The problem with rising import is a valid one. It has a lot to do with the structure of British economy. Services, particularly banking, insurance, and business services, account by far for the largest proportion of GDP while industry continues to decline in importance. And as you rightly pointed out, the balance of payment deficit is something that needs to be addressed. However, this is one thing that needs to be addressed whether the UK is inside or outside the Eurozone. Particularly, it is important that the government to enact policies that encourage the economy to move to one that is based on higher skills and more value-adding. Additionally, a skilled-based economy cannot be achieved without the young people with the right skill sets - education is the key. The UK’s education system geared towards specialization without the necessary basic skill set, which means that the population may be skilled, but it is not adaptive and this is also reflected in the industries as well.

I agree that it is important for the UK to establish a stable economy, that is true with any economy. However, Europe being a significant trading partner of the UK, it is simply impossible to ignore - the UK exports over 60% of its goods and services to the EU and similarly the EU accounted for over half our imports. With our economy being so heavily focused towards Europe, it is simply shortsightedness that anyone can argue against the adoption of the Euro, given the right economic conditions.

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October 10, 2003

I'm not sure if the tests are a politically motivate smoke screen or they're genuine conditions that the Chancellor is going to stick to. However, IMHO, they're good solid tests that can be employed to find out the UK's readiness to join the Euro.

Granted, the structure of the UK economy is significantly different from countries that are in the Eurozone. However, these structural difference can be address via policies, incentives and penalties. For example, it is up to the government and the financial services industry to move a significant portion of UK mortgages from floating rates to fixed rates.

I agree that it will take years, probably decades, to get the UK economy to become 'in phase' with that of the major economies in the Eurozone. It is not something that can be done over a 18 or 36-month period, or there will be undue stress introduced into the economy. I think realistically speaking, if the BoE and the Treasury get their policies right, we're looking at somewhere between 5 to 7 years, combined with changes to mortgages, before the UK can be at a stage where we can contemplate whether we're actually in phase. Additionally, somehow we need to track the progress of the Eurozone to ensure that we're actually moving in the same direction in the cycle(s).

You're correct in your comment that the Euro is one massive experiment and the system is full of risks and tensions. I think anyone with a reasonable level of understanding in economics will recognize that point (which will probably exclude most politicians ). However, I like to point out that there are risks in not joining the Euro also - exchange rate fluctuation with our major trading partner being one of them. So far, since the introduction of the Euro, the UK has fared better than the Eurozone in terms of economic performance. However, there is no guarantee whether the UK will still outperform the Eurozone come 5 or 10 years down the line.


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