Eamonn Fitzgerald's Rainy Day

Pundits are expected to have opinions, to say bold things, so here goes: Britain will never give up the pound for the euro. Never, ever. The recent differences with EU partners France and Germany will not be critical, though, it's the contradictions inherent in the common currency that will be decisive.

From the very beginning of the euro project, Marty Feldstein, Harvard professor and president of the US National Bureau of Economic Research, has been pointing out the pitfalls of the single currency and he had a timely piece called "Britain must avoid Germany's mistake" in yesterday's Financial Times. Memorable sentence: "Adopting the euro is a permanent commitment with permanent consequences." Feldstein claims it is the euro and not Germany's structural problems that has raised the country's unemployment rate over the past year to 10.6 per cent. He writes:

"Here are the facts. Germany's gross domestic product rose only 0.5 per cent last year, the lowest of all the leading European countries, and ended the year in decline. Germany also has the lowest inflation rate, just 1.2 per cent. Because the single currency means that all eurozone countries have the same nominal interest rate, Germany's real interest rate is the highest in the eurozone. This is a very dangerous situation in which the high real interest rate weakens the economy and causes inflation to fall further. As the inflation rate falls, the real interest rate rises, creating the potential for a dangerous downward economic spiral.

If the German economy were not constrained by the single currency, natural market forces would cause interest rates to decline, thereby boosting all kinds of interest-sensitive spending. Weak demand in Germany would also cause the D-mark to decline relative to its trading partners, boosting exports and helping producers to compete with imports from the rest of the world. Instead, German manufacturing has been weakened by the sharp rise of the euro over the past year. In addition to these automatic market responses, an independent Bundesbank would probably have responded to the weak economy and declining inflation by temporarily lowering short-term interest rates. This is now impossible. The European Central Bank must make monetary policy for Europe as a whole, an area in which inflation is now above the 2 per cent target ceiling. The Stability and Growth Pact also prevents Germany from using a temporary fiscal stimulus to increase growth and bring down unemployment. Although persistent deficits are harmful in the long term, a temporary rise in the fiscal deficit could in principle provide the stimulus needed to rekindle growth. But the eurozone countries have had to constrain themselves from running deficits because of the potential danger to the common currency."

But why is a single currency good for a large continental economy such as the US and not for Europe? Feldstein's answer:

"First, American employees move within the country when demand is relatively weak in a particular region, facilitated by a common language and a culture that regards moving across the country as perfectly normal. Germans are not leaving Germany in large numbers for areas of Europe with faster growth or lower unemployment. Second, wages are much more flexible in the US than in Europe, reducing the decline in regional employment that occurs when demand falls. And third, the US has a federal fiscal system that directly offsets about 40 per cent of the relative decline in any state's gross domestic product by a lower outflow of taxes to Washington and a higher inflow of transfer payments. European fiscal systems are still largely national."

Feldstein urges Britain not to make the German mistake of opting for the common currency on political rather than economic grounds. Instead of carefully evaluating the costs and benefits of his actions, Helmut Kohl gave up the Deutschemark to create a stronger European political union. He preferred a symbol of solidarity to prosaic notes and coins. Remarkably, his countrymen, who had seen him swap valuable D-marks for worthless Ostmarks in 1990, accepted his decision with barely a murmur of dissent. If the current chancellor goes down in history as the German leader who ruined his country's international stature, his predecessor may enter the annals as the man who pulled down the pillars of an exemplary economy that was built at enormous expense.

So, if Britain stays out of the eurozone will Sweden enter it? Too close to call, that one. Let's see how the year shapes up. One thing is certain, though: the ten countries earmarked to join the EU next year would be crazy to adopt the euro since they would lose their competitive edge inside the union. And by the time their turn to decide on the single currency comes the insuperable problems involved will be obvious for all to see.

Diarist of the day: Count Harry Kessler, 23 April 1929

[Berlin] "In the evening a concert by the young Yehudi Menuhin. The boy is truly marvellous. His playing has the afflatus of genius and the purity of a child. His fantastic virtuosity remains a totally secondary factor, as though it were something to be taken for granted. A wonderful feeling for style, without the slightest suggestion of cheap effects or sentimentality. On the contrary, pure and profound sensibility. He played Beethoven's Romance in F Major (Opus 50) as I have only heard Joseph Joachim render it."