Summary:
Willem Buiter (LSE) says case for Britain adopting the euro has never been stronger. Macroeconomic stability, the defence of London's status as a global financial centre and the political logic of deeper European integration all call for the dumping of sterling and adoption of the euro. (Published: 02/06/08)
Notes:
- case for the UK shedding sterling and adopting the euro has never been clearer
- From a conventional macro-economic perspective, no reasonable argument for a small, highly open economy like Britain's to retain monetary independence
- for economies with a high degree of international financial integration, the exchange rate does not act as a buffer against asymmetric shocks
- i.e. permitting an easier adjustment of international relative prices than under an irrevocably fixed exchange rate.
- instead it becomes a source of unnecessary noise and volatility.
- best way to deal with asymmetric shocks is to smooth national consumption by increased portfolio diversification and cross-border labour mobility
- international portfolio diversification is aided by the reduced exchange rate risk that comes with membership of the euro area.
- joining Schengen, the European border-free travel area, would boost the ability of labour to adjust to economic shocks
- UK's large financial and banking sector conducts much of its activity buying and selling financial instruments denominated in foreign currencies, not in sterling
- UK has massive gross external liabilities and assets
- well over 400 per cent of annual gross domestic product each
- compared with less than 100 per cent for the US and 700 per cent for Iceland
- UK as a giant hedge fund: highly leveraged entity borrowing shorter than it lends and invests
- has a lot of short-maturity foreign-currency-denominated foreign liabilities and illiquid, non-sterling denominated foreign assets
- not a bad way to make a living, but means country needs a lender of last resort and market-maker of last resort
- has one for sterling-denominated financial instruments: Bank of England (after malfunctioning at the onset of the credit crisis in August 2007) now performs this role effectively
- however, B of E cannot print euros, dollars, Swiss francs or yen
- cannot be an effective lender of last resort, or market-maker of last resort, if UK banks find themselves unable to roll over their non-sterling-denominated short-term liabilities or unable to sell their foreign-currency-denominated assets in illiquid international wholesale markets
- to deal with either problem, the Bank would be dependent on the goodwill of other central banks, through swaps and credit lines in foreign currencies
- they would have to be willing to buy sterling when the markets are yelling: "sell it"
- would be possible, but an (unnecessary) risk
- main question is whether the UK is more like the US and euro area or like Iceland
- more like Iceland:
- only the US and the euro area have serious global reserve currencies, with about 63 per cent and 27 per cent of the global stock of reserves respectively.
- Sterling, with about 5 per cent, no longer plays with the big boys and girls
- countries that want a large, internationally active banking sector and financial system need a serious global reserve currency to provide the lender of last resort and market-maker of last resort services required to limit the risk of a bank run or liquidity crunch bringing down their banking system
- it is possible to run a large financial sector with a local currency such as sterling or the Icelandic krona, but it involves taking an unnecessary and costly risk
- sooner or later that risk will be reflected in the cost of capital and render the country uncompetitive
- if London wants to remain the world's financial capital, there is only one choice for the UK: adopt the euro now and wonder why it did not do so in 1999
- political arguments for joining the euro area:
- future of Europe is federal and euro is a symbolic step towards deeper political integration
- UK can continue acting as it has since the European Union (or its predecessor institutions) was created:
- stand on the sidelines, snipe, join late and reluctantly and then moan about how things are turning out
- or it could be at the heart of Europe, shaping its institutions
- UK punches below its weight because it is not a full member of the EU: if you are not in the euro group, you do not count
