A fork in the road for the Eurozone

By: Declan Curry | Date: 22-07-2015

Tagged as: ArticleGameplanCurrencyMoney Markets


Greece's crisis raises questions over Britain's membership of the European Union, and Scotland's future in the UK, argues business journalist Declan Curry.

About the author

Declan Curry

Journalist, former BBC business broadcaster and Gameplan Live host.

Declan Curry


There's more to currency than just printing banknotes. If you don't believe that, sketch out your own money on some scrap paper the next time you're playing Monopoly and see how far you get. Even a game based on fake finance will draw the line at funny money.

Currency is a promise. Look at any Bank of England note and you'll see the magic words: "I promise to pay the bearer on demand". The note is an IOU. What gives the banknote its value is the trust invested in that promise; the trust that, when you give your fiver to the butcher, who gives it to the baker, who gives it to the energy-efficient lightbulb maker, it will still be worth a fiver at each link of the chain. It's trust that you can take to the bank, quite literally.

It doesn't just apply to national banknotes. Those so-called "local pounds", the unofficial currency issued by some cities, towns and villages to encourage local residents to buy more from local shops, exist only because those residents trust that the shopkeeper will accept them and give them goods of equivalent value in return. The idea has caught on so much, the Mayor of Bristol and the City Council chief executive accept some of their salary in "Bristol Pounds", and some workers at Lambeth Council are paid in "Brixton Pounds".1

Without the trust that these pieces of paper – and, increasingly in the future, pieces of plastic or digits on a magnetic strip – will be worth what they say on their face, and that we will get that value when we demand it – we would revert to alternative forms of payment – like gold, or barter.

In the UK, the trust in Bank of England notes – and also the notes issued by banks in Scotland and Northern Ireland – is buttressed through a complex infrastructure of laws, practices and national institutions. We draw comfort from the reserves that high street banks store with the central bank, to guarantee the note will be honoured. We are reassured by the tax policy that ensures the Government has enough cash to meet the central bank's promises of payment. Of course, the UK is a single currency zone – a Sterling zone – and we share across the four nations a common interest rate, irrespective of regional economic performance; and a common promise to repay national debts. These, in theory, help control and protect the value of the currency.

These are not all things that Europe can boast for its single currency, the Euro. In a grouping of vastly diverse economies, it is the fault line that has shaken the currency for the best part of a decade.

Yes, there is a common interest rate, set by the European Central Bank (ECB) in Frankfurt. But each individual nation using the Euro has its own tax policy, its own spending programme and its own appetite for borrowing. There were guidelines to control these things – the Maastricht criteria2 – but there was no effective enforcement. In theory, there were punishments for nations that breached the rules; until, that is, they were breached in the infancy of the currency by its biggest members, France and Germany, at which point the rules didn't seem to matter very much. And – until very recently – there was no collective sharing of risk, and no mutual promise for all the Euro nations to guarantee the debts of individual countries. (Even now there is only a limited sharing of risk, through bonds issued by the ECB and through the segment of the quantitative easing programme that's also run by the ECB3, rather than the part that's done by the individual national central banks.)

"The crisis demonstrates starkly the importance of currency in the viability of an independent nation."

This set-up, right at the birth of the European single currency, was a fudge; to try to shoehorn the economics into place before the politics was ready for it. And it has cost Europe dearly.

The straightjacket of the common interest rate meant borrowing costs were set to suit Germany, and to blazes with anyone else. Interest rates were kept low to stimulate a German economy knocked flat by the costs of reunification, but were too low for the nations on the outer edge of Europe. That triggered a massive and unsustainable boom in Ireland, Portugal, Spain and Greece. Property prices soared, wages and welfare payments galloped ahead without a rise in productivity to support them, and personal debt exploded. It was fuelled by a flood of cheap credit, accessible to everyone because they were all using the same form of money, and driven by savers in Europe's wealthier nations, looking for big returns in a low interest rate environment.

With pay packets and welfare bills rising, those nations on the periphery found themselves becoming increasingly uncompetitive, but were locked into it without escape by the single currency itself, which stopped them from devaluing their own money – the traditional 'get out of jail free card'. It was great for German businesses exporting to a captive market; horrendous for local businesses trying to compete with them.

When boom turned to bust, as it always does, the central control on interest rates and currency was not mirrored by a central programme to share risk or guarantee debt repayments. Free-running national taxing and spending had left some countries utterly reliant on borrowing when their economy went bust and tax contributions from local companies and workers collapsed.

National governments are responsible for their own budgetary decisions, of course, but without a central guarantee to repay, international lenders that thought they were dealing with a stable currency backed by the might of Frankfurt took fright and cut off their cash. The only option for the near-bankrupt nations was to beg for a bail-out from their neighbours: bail-outs which ruled out the traditional remedy of cancelling old debts; and which prioritised spending cuts over growth plans, plunging Greece into a spiral that has shrunk its economy by more than 25 percent. Quitting the Euro and devaluing was also not offered as an option.

To get out of this crisis, and prevent future ones, Europe is now at a fork in the road. One path is to let troubled nations exit the single currency in future – preferably in an organised, planned manner. That could mean intense economic pain for the departing nation, with soaring inflation and unemployment. It could also mean pain for those nations remaining in the smaller single currency zone, as they may not get back money they've loaned, and they may face a more competitive economic rival in the future. There would also be immense political embarrassment, and fears it could start the unravelling of the entire project, which may see the Euro scaled back to a central core of Germany and the small nations that surround it; these economies are, after all, already in sync with Frankfurt and Berlin. But it would give troubled nations the option of a second chance.

"To get out of this crisis, and prevent future ones, Europe is now at a fork in the road."

The other path out of the European crisis is – more Europe; more control from the centre over national tax, spending and borrowing, and a shared promised that all will repay the debts of one in traumatic times. It would be a centralised fiscal policy to match the existing centralised monetary policy. It would give the European single currency similar laws, practices and institutions to those which underpin the UK's single currency – Sterling.

When we've tried to work out how the crisis over Europe's debt, stagnation and currency affects Britain, we've concentrated on its economic impact. We felt that once before. The last coalition Government argued that the panic at the time of the first wave of European bail-outs hurt the UK's economy, by cutting demand for British goods in our biggest export market and by damaging confidence at home, curbing investment and job creation.

But there is a longer-lasting impact from the Greek tragedy. It could cool Britain's already lukewarm enthusiasm for the wider European project. If the solution to the European crises is ever-greater control from the centre over issues which are at the core of national sovereignty – decisions on how much to tax, spend and borrow – will the UK be willing to stay in the club, and accept that as the price of membership? Could Greece's trauma ultimately make Brexit more likely?

And the crisis demonstrates starkly the importance of currency in the viability of an independent nation. It's not the notes that matter, or what they are called, or where they are printed. What's critical is the infrastructure to maintain trust in the currency – the monetary and fiscal policies that maintain its value, the systems that ensure its liquidity and the reserves that copper-fasten the promise that you, the bearer of the note, will be paid on demand. These arguments were aired during last year's independence referendum in Scotland. At that time, the European crisis had gone away; many may have assumed Europe's problems had been fixed. Now we know it had merely gone quiet. Greece and Europe's trauma this year will surely ensure that currency will be central in any future referendum debate on independence for Scotland.

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