We have just passed the euro’s 20th anniversary. I am not going to rehearse the ways in which the euro has been a disaster. Instead, I want to ask why it was formed in the first place and how European elites failed to perceive the pain that it would bring. The answers have important lessons for us now, as we contemplate our future relationship with the EU.
From the beginning, the formation of the euro was seen by the European elites as part of the political project of integration, leading eventually to a federal European state. It was widely believed that sharing a common money, with all its implications for interest rates, fiscal policy and umpteen other things, would be both an expression of European unity and a major force for cementing it.
Once it subsequently became clear that the economy of the eurozone was experiencing considerable difficulties, it was common for European political leaders to claim that, as a political project, it had always been recognised that the formation of the euro would bring serious economic costs.
They argued that these had to be borne in order to achieve the political objective. Indeed, some went further and claimed that without the euro the whole EU edifice might collapse. The implication was that although things might seem pretty grim in a number of eurozone members, this was a necessary price to pay.
But this notion was complete bunkum. Although the primary motive for forming the euro was political, before its formation, key European leaders trumpeted the supposed economic benefits of the single currency. They believed that it would bring significant gains through a reduction of transactions costs and uncertainty, the deepening of financial markets and the imposition of good economic governance.
Where did they go wrong? Right at the beginning. The politicians and officials driving the European project generally understood very little about economics.
Indeed, it has to be said that quite a few of their supporting economists apparently understood little about economics either. The most significant error was to believe that it was the deutschmark that gave Germany its overbearing position in Europe. Take that away and Germany would be cut down to size, and Europe would become more balanced and harmonious.
This was a misconception. In fact, it was precisely the deutschmark that kept Germany in check. Then, as now, Germany had a decided tendency towards tremendous success with its exports, combined with over-saving.
If left unchecked, this would lead to an enormous German current-account surplus, forcing other countries into deficit.
A rising deutschmark was the mechanism that prevented this from happening. The higher German currency both attenuated the strength of German exports and, by keeping down the costs of imports, increased German workers’ real incomes, which they largely spent.
The euro has robbed the European economy of this crucial adjustment mechanism. The result is a German current-account surplus approaching 8pc of GDP, alongside slow growth of German real wages and sluggish growth of consumers’ expenditure. Combined with enforced austerity in the deficit countries, this has imparted a strong deflationary force to the European economy, reminiscent of the Gold Standard in the 1920s and 1930s.
There were three other key misjudgements. First, euro supporters greatly overestimated the gains from reducing transactions costs and uncertainty about currency values. In the modern world, companies are readily able to deal with such costs and uncertainties. So the gains from monetary union have been tiny.
Second, they greatly overestimated the ability and willingness of all eurozone member countries to adjust their price and wage setting and to reform their economic structures to enable them to cope with a fixed exchange rate. So the losses have been huge.
Third, they did not understand the implications of allowing debt ratios to rise significantly in countries which, once they had joined the euro, would no longer be able to issue their own money. As a result, Italy is heading for some sort of financial blow-up and possible default. So the system is seriously unstable.
Yet prior to the euro’s birth in 1999, in the debate in this country about whether Britain should join, most of the establishment – led by Tony Blair, the Prime Minister at the time – was strongly in favour. This group included the CBI, representatives of big business and the City, with support from the BBC, most major media outlets and large parts of the civil service.
They envisaged serious economic decline, or even disaster, if the UK stood aside. We now know that their views were comprehensively wrong.
Does this ring a bell? It should – an alarm bell. Now we stand on the brink of another momentous decision. And the same people are still peddling the same sort of nonsense.
Yesterday’s “transactions costs and uncertainty” is today’s “border frictions and disruptions”. Yesterday’s supposed need for a common currency in order to make the trading union work is today’s supposed need for a “deal” with the EU in order to enable us to trade with it.
And there seems to be a blatant disregard of the facts. Contrary to what the Remainers blithely assume, the EU’s economic performance compared with other developed countries has been poor. This is for a good reason. The EU makes bad decisions.
Its institutions don’t work very well and it pursues a political agenda, either ignorant of the economic costs or oblivious to them. The euro is creaking and the European elites are hurtling towards more disastrous decisions. Meanwhile, the EU falls further behind the rest of the world.
We escaped membership of the euro by the skin of our teeth. We now need to grit those teeth to escape fully and finally from the very entity that conceived of the euro monstrosity in the first place. In case you were in any doubt, Mrs May’s capitulation of a “deal” would bring not a full and final escape, but rather a further entrapment.
Click here to read the piece in full.