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1 October 2011

Baffling Pigs

Tag(s): Politics & Economics, Foreign Affairs

Some years ago I was called to a meeting in Europe for the heads of Sony’s sales companies around Europe. Such meetings were frequent during my time in Sony. They were usually held in Cologne where our European HQ was situated. This later moved to Berlin. I once calculated that I visited Germany on over 100 occasions during my time at Sony.

This particular meeting was to discuss the implications of the plans for a European currency. The expert who had been brought in to explain these started by asking if any of us knew the significance of Baffling Pigs. I was the only person who did. They were the initials of those member states of the European Union who intended to join the Euro: Belgium, Austria, France, Finland, Luxembourg, Ireland, Netherlands, Germany, Portugal, Italy, Greece and Spain. Some people in the room proceeded to give me a hard time because the United Kingdom had not decided that it wanted to be part of the Euro. The gentleman from Portugal was particularly scathing.

These twelve nations than agreed the convergence criteria that they judged would allow them to form a currency union. They all joined on 1st January 1999 except Greece who joined two years later. We know now that Greece needed the extra two years to cook the books to make it look like they had converged when they clearly had not.

Since then Slovenia joined on 1st January 2007, Cyprus and Malta on 1st January 2008, Slovakia on 1st January 2009, and Estonia on 1st January 2011. Thus 17 countries now form the Eurozone.  Ten countries (Bulgaria, the Czech Republic, Denmark, Hungary, Latvia, Lithuania, Poland, Romania, Sweden, and the United Kingdom) are EU members but do not use the euro. Before joining the Eurozone, a state must spend two years in the European Exchange Rate Mechanism (ERM II). As of 2011, the National Central Banks (NCBs) of Latvia, Lithuania, and Denmark have participated in ERM II.

Denmark and the United Kingdom obtained special opt-outs in the Maastricht Treaty. Both countries are legally exempt from joining the Eurozone unless their governments decide otherwise, either by parliamentary vote or referendum. Sweden gained its opt-out by means of a cunning plan. It is required to join the Eurozone as soon as it fulfils the convergence criteria, which include being part of ERM II for two years but joining ERM II is voluntary. Sweden has so far decided not to join ERM II.

The Euro is also used in countries outside the EU. Three states, Monaco, San Marino, and Vatican City have signed formal agreements with the EU to use the Euro and mint their own coins. Nevertheless, they are not considered part of the Eurozone by the ECB and do not have a seat in the ECB or Euro Group. Andorra reached a monetary agreement with the EU in June 2011 which will allow it to use the Euro as its official currency when ratified. Under the agreement it is intended that Andorra should gain the right to mint its own Euro coins as of 1 July 2013, provided that Andorra implements relevant EU legislation.

Kosovo and Montenegro officially adopted the euro as their sole currency without an agreement and, therefore, have no issuing rights. These states are not considered part of the Eurozone by the ECB. Further unilateral adoption of the Euro by both non-Euro EU and non-EU members is opposed by the ECB and EU.

While the Eurozone is open to all EU member states to join once they meet the criteria, there is no provision in the EU treaties for a state to leave the Eurozone without also leaving the EU as a whole. Likewise there is no provision for a state to be expelled from the Euro.

I don’t need to rehearse here the mess that the Euro is now in. What is surprising is that anyone is surprised.

In any currency union there will be stresses on the currency from the differing levels of productivity in different parts of the union. There are two ways to compensate for these. One is fiscal transfers, i.e. the richer areas transfer capital to the poorer to allow them to compete and thus remain in the union. The other is mobility of labour which has a similar effect. People move to the richer areas to get work and are thus not a drain on the economy of the poorer areas.

It is not often recognised but the sterling area is a currency union and both of these transfers are made on a regular basis. Under the Barnett formula large capital transfers are made from London to Scotland for example to compensate for the lower productivity in Scotland. And within the UK there is considerable labour mobility assisted by a common language and culture. But even here there are stresses. In some parts of the UK employment is full or even higher while in others it is low. In the centre of Cambridge there is negligible unemployment while in the centre of Rochdale unemployment exceeds 70%. One of the horrible consequences of the benefit culture has been the restriction of labour mobility. Thus we are more likely to see immigrants from Poland coming to get jobs in the prosperous south east of England than unemployed but welfare beneficiaries move from the depressed north for those jobs.

The United States of America is also a currency union. The history of the dollar in North America pre-dates US independence. It began with the issuance of Early American currency called the colonial script, whereby the issuance of currency was equal to the goods and services in the economy. Even before the Declaration of Independence, the Continental Congress had authorized the issuance of dollar denominated coins and currency, since the term 'dollar' was in common usage referring to Spanish colonial eight-real coin or Spanish dollar. Though several monetary systems were proposed for the early republic, the dollar was approved by Congress in a largely symbolic resolution on August 8, 1786.

However, during this period and well into the nineteenth century the pound sterling and other European currencies were used widely while several states issued their own. In the Civil War the Confederacy printed its own currency.

With the enactment of the National Banking Act in 1863 during the  Civil War and its later versions that taxed states' bonds and currency out of existence, the dollar became the sole currency of the United States and remains so today. However, the defeated southern states were tied into the dollar at the same time as giving up their slaves. Noone should defend slavery but it stands to reason that if much of the labour is free on one day and paid on the next that a massive reduction in productivity has taken place. Thus it was and the southern states were condemned to poverty for generations.

But despite the stresses of the currency unions of the pound sterling and the US dollar both these nations could manage them through a single fiscal and political structure. No currency union in history has survived without that. The Euro does not have that. The Euro is therefore destined to collapse unless political and fiscal union takes place. I believe the founders of the Euro intended that but thought the Euro was the way to get there. They knew that they could not achieve political union in one go but the EU is committed to ever closer political and economic union.

If Greece is forced to leave the Euro the effects on all of us will still be dramatic. Capital flight from Greece over the past year has already reached 13% and this will accelerate as we approach the endgame. Once Greece is on its own to print the drachma again it will still have its debt denominated in euros and will be even more unable to repay it. If it defaults then the debt stays with European banks including British ones. I have no sympathy for any bank that has lent to Greece knowing the state of its finances. But of course some of these banks have become adept at trading such debt in profitable ways playing a deadly game of pass the parcel and hoping they are not the ones holding the parcel when the balloon goes up.

UBS has forecast that if Greece leaves the Euro the first year effect on its economy will be a decline in GDP of 40-50%, clearly not tenable. Similarly if Germany pops out the top UBS forecast the effect on its economy through the rapid revaluation of the new deutschmark and other costs will be 20-25% of GDP, also not tenable. Therefore none of these things will happen and the inevitable result will be a totally undemocratic political and economic union. While the UK can stay out of this it will be badly affected as the new EU will pass a lot of terrible laws which will be binding on all member states.

The pigs are well and truly baffled.

Copyright David C Pearson 2011 All rights reserved

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