I used to be a fan of the Eurozone. A single currency across the continent, the absence of exchange costs, means fluidity of spending and selling: lubricating trade, and easing the lives of many tourists and intra-continental businesses.
That was before I properly understood the effects of monetary policy, and how the value of a currency relates to the strength of an economy.
In basic terms, it goes like this: when a nation’s economy is strong, currency associated with that economy is high in demand as many businesses wish to buy and sell using that currency. When demand of something goes up, the market value of it also goes up, and the strength of the currency increases. This is how a strong UK economy leads to a strong value of the pound. However, a strong currency decreases foreign investment and exports, because investing in this country and buying from this country becomes more expensive. To combat this, governments and national central banks attempt to devalue their currency. They do this by increasing the interest rate, which increases inflation, the devaluation of the currency. This is why in a good economy, interest rates are kept high, to encourage a strong economy to keep going. High interest rates also generally encourage consumers to save more and spend less, somewhat counteracting the tendency for overspending during economic boom years.
Conversely, when an economy is weak, demand for the currency of that economy goes down: the value of that currency drops. This makes the purchase of goods and labour in that country cheap on the international market. Low costs lead to the rise in exports and foreign direct investment, both significant factors in encouraging economic growth. This represents a naturally self-stabilising effect of market economies. Additionally, when the economy is weak, central banks tend to lower interest rates to encourage domestic spending. Spending increases the circulation of money, facilitating domestic business growth. To put it another way: if everyone refuses to spend, nobody will earn, and everybody will starve.
So let’s consider the Euro, why would it be good for the UK, and why is it doing so badly for Greece, Italy, and Spain? And what about Germany?
Let’s first consider Germany. Their industry seems to have done very well in the last decade or so. Normally this means that the value of their currency would go up, and so the central bank would raise interest rate to counteract this. The economy is strong and balanced. Consider also the economies of Greece, Italy, and Spain: They’re not doing as well. Normally this means that the value of their currency would go down, and the national interest rate would also go down. The low interest rates and the low value of their currency will increase domestic spending, increase exports, and attract direct foreign investment, all substantial contributors to economic recovery and growth.
Clearly this hasn’t happened because we know that all the aforementioned countries have a shared currency: the Euro.
Because of the currency of Greece, Italy, and Spain is shared with a massive bloc of many other economies, some very successful ones such as Germany, the value of the Euro hasn’t dropped by as much as the economies of these three countries. This means that the natural effect of economic growth due to a low-value currency is unable to kick in. Thus economy will be extremely slow to recover.
On the other hand, the currency being used by Germany is unnaturally depressed, despite the nation’s massive economic successes. Thus, due to the affordability of the currency, exports are at an all-time high. In an attempt to encourage economic recovery of economically weaker Eurozone countries, the European Central Bank (ECB) has drastically reduced interest rates of the Euro to the current 0% base rate. This ultra-low interest rate, coupled with Germany’s soaring economy, means that Germany’s domestic spending is also much higher than if it was using an independent currency. Basically, Germany’s economy is being kept unnaturally buoyant by the economic woes of other Eurozone countries.
In comparison, although the United Kingdom was hit with its own economic woes during the credit crunch, its currency was able to devalue very quickly in response to the market, and exports eventually went back up, and the country is well on its way to economic recovery and growth.
So why did I state that joining the Euro could be beneficial for Britain?
The United Kingdom is one of the stronger performing economies in the EU. Thus joining the Eurozone would grant it benefits similar to those enjoyed by Germany. It would boost the economy, to the detriment of weaker EU economies. It would be good for the UK, but it won’t be ethical. And the benefits of the single currency I described in the opening paragraph would also apply, but they apply only to specific businesses, not necessarily the whole economy.
But heaven forbid, should the economy of the UK undergo problems whilst in the Eurozone, it would be in the same situation as Greece/Italy/Spain.
This is why I think that the shrewd Germans would readily abandon the Euro were their economy to crash for whatever reason.
Do you think the UK should be in the Eurozone?