Keep floating, stop worrying - Samuel Brittan : Financial Times 28/03/02

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Keep floating, stop worrying Samuel Brittan: Financial Times 28/03/02 The real case for an independent pound has nothing to do with ultra-nationalism or hostility to Europe The opponents of the UK joining the euro at an early date are in danger of shooting themselves in the foot by putting so much emphasis on generalised hostility to continental Europe. The case I wish to make is a positive one, not against the euro - still less against the European Union - but in favour of a floating exchange rate which the UK now enjoys and would not continue to have inside the euro. A fixed rate of exchange produces two problems. The first is the threat of a balance of payments crisis and runs on the currency. It should in all fairness be said that this threat is removed either by a floating exchange rate or by membership of the European Monetary Union. There cannot be a run on the pound if sterling no longer exists. The only run can be on the euro as a whole, which is a pretty far fetched proposition - at least so long as the euro is managed by a conservative and independent European Central Bank. But there is a second problem which would not be removed by joining the euro. That is the possibility of unemployment due to money wages which make British goods uncompetitive compared with those of other countries. An exchange rate adjustment to reduce them is no more possible in the euro area than it would be now for Yorkshire or Lancashire. The foreign exchange crises which bedevilled British economic management through the 1940s, 50s, 60s and 70s are legendary. It would be foolish to argue that the UK has had a smooth ride since the pound floated in 1971. The last of the sterling crises, the "IMF" one of 1976, took place when sterling was already floating. In retrospect this was quite an unnecessary crisis, due to the fact that policymakers had insufficient experience of market-determined exchange rates. There were all kinds of fears that the pound would "go through the floor", whatever that meant. But once the government had taken action to reduce the budget deficit and control money and credit, as it had largely done by the time of the IMF visit, the rest could have been left to the market, which indeed produced in 1977 a bigger "recovery " of sterling than anyone had bargained for. The then Chancellor, Denis Healey, actually used the IMF negotiations to gain support for policies that he in any case favoured. Today the wide divergence of views, both on whether the dollar is overvalued and on the rate at which Britain can safely enter the euro, shows how unsure we are of the correct exchange rate. This makes it hard to say when overshooting is taking place, let alone to take action against it. Many of the businessmen who say they want the UK to join the euro really mean that they want a lower sterling exchange rate. Euro-enthusiasts hope that the announcement of an early euro referendum would soon bring down sterling down with a bang. But supposing that it does not? Voters would have to decide on the basis of an entry rate still to be negotiated with euro partners. But the matter is worse than this. Suppose that Britain were able to negotiate a euro entry rate 5 or 10 per cent below the present market one. There is a common belief that the euro is undervalued. What if the euro itself subsequently staged a vigorous recovery against the dollar. The result could be a net appreciation of sterling. The only way of restoring the competitive position of British industry would then be several years of near-zero increases in nominal wages in the trading sector. There is of course no way of avoiding necessary adjustments in real wages. But there is all the difference in the world between reducing them indirectly via the exchange rate and a pitched battle to bear down on money wages - as Winston Churchill discovered in the 1926 General Strike. A floating exchange rate was one of the first causes that I espoused as an economic journalist. Why then did I suspend my belief? The answer is of general and not just autobiographical interest. It began in the 1980s when the Thatcher Government was trying to follow a monetary approach to reducing inflation, but was thrown off course by divergent movements of different measures of money, none of which appeared to reflect underlying conditions. It then seemed tempting to hitch sterling to the D-mark via the Exchange Rate Mechanism and thus to borrow the Bundesbank's credibility. This was a strategy which was already being used with some success by France and other European countries. At the time the only contending policy targets were for the money supply and the exchange rate. The inflation target had not been invented. It was introduced in New Zealand in 1990 and in Britain only when the country was forced out of the ERM at the end of 1992. It turned out more successful than many of us thought. And although I still do not think it is the last word, it has so far beaten all contenders. Even after 1992 there was still a remaining attraction in joining the looming euro: it seemed the only feasible route to an independent central bank. The surprise establishment and subsequent success of the Bank of England's Monetary Policy Committee by the incoming Labour government deprived me of the second argument; and since then I have drifted back into the floating exchange rate camp. This was brought home to me by the recent Venice Press seminar organised every year by the Italian embassy in London with corporate support. There was a session on the subject of left-right differences. The advent of Berlusconi mercifully spared us the routine denunciations of Thatcher and Reagan; and several of us argued that the terms had largely lost their meaning and mainly stood for rival tribes. But at this point there was a revolt by some British journalists who insisted that there was still a left-wing agenda to be enacted in terms of public spending, union rights and so on. Some of those who spoke regretted that globalisation made an Old Left agenda impractical. This was wrong. Globalisation is an excuse. A country inside the euro such as Italy has indeed to be very careful about anything that risks raising labour costs further. But there is nothing to stop a country like Britain that is still outside from taking these risks, knowing that sterling can take the strain. The argument against the Old Left agenda is that the electorate will not wear it or that in practice it has proved counter-productive. The issue should not be pre-empted by arbitrary currency mechanisms. The argument does not apply only to the left. There are various ideas on the centre and right, such as a payroll tax to pay for an expanded health service. Two weeks ago I argued for an earmarked VAT instead. But there is still no reason why the payroll alternative should be ruled out. Or suppose that there were a serious move to tax energy? Such policies should not be ruled out by the exchange rate regime./ Most of those who spoke for the left in Venice - with one notable exception - pinned their hopes on a European federal structure which could promote their desired social model across the whole continent. But this is many moons away; and any kind of experimentation from any part of the political compass would be extremely risky without the safety valve of a flexible exchange rate. There has been a long and inconclusive debate on what is an optimum currency area. The practical answer is that it is the area covered by whatever political authority is responsible for decisions which affect costs and profitability. This is still individual governmments. By all means let the British Government encourage people to use the euro as a parallel currency, but I can see no early benefit in throwing away the advantages of the present floating pound and MPC regime.
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