Germany should jettison the euro

By being outside the euro area, the UK has retained more flexibility than other European countries.

I honed my letter-writing skills recently when, with Professor Marcus Miller and Keynes's biographer Lord Skidelsky, both of Warwick University, I organised a letter from 58 economists to the Financial Times. The purpose was to argue that fiscal consolidation would be necessary to put UK public finances back on a sustainable basis, but the timing of the measures should depend on the strength of the recovery. There was another letter from another group of nine distinguished economists, headed by Lord Layard, arguing similarly.

We must be doing something right if we can get Liam Halligan, chief economist at Prosperity Capital Management and a former economics correspondent for Channel 4 News, to write in his Telegraph column that the arguments presented in the letters were "complacent, ill-judged and display a lack of financial acumen".

I recall that Halligan argued on 15 June 2008, just before oil prices plummeted, that "$100-a-barrel oil isn't a spike, but a sustained reality". And, on 4 October 2008, as the economy was about to fall off a cliff, he argued that "the issue of the moment is the UK economy. I also want to highlight the Bank of England's interest rate decision this Thursday. All and sundry are clamouring for a cut - which I still think would be wrong" (my italics).Wrong as ever, Liam.

The letters made George Osborne's claim that the consensus among experts supports his economic policies look empty-headed. Then Osborne, having been humiliated, announced that he would increase the level of the country's debt through a public offering of Royal Bank of Scotland and Lloyds Banking Group shares, with "special" terms for small investors. I thought bribing voters was illegal.

Greece now, but who next?

Meanwhile, Greece's economic problems continue. First Iceland, then Dubai, then Greece; the concern is who might be next. The governor of the Bank of England, Mervyn King, helpfully argued that the UK's situation was quite unlike that of the Greeks. “I don't think you can compare the UK with Greece," he said. "There are big differences. We have our own currency; there is a clear political consensus to take action to deal with the fiscal position here. We have a very good track record, and, maybe most important of all, the maturity of the government debt in the UK is much longer, so rollover problems of refunding government debt are much smaller." Credit where credit is due: Mervyn is spot on.

Greece's big problem is its debt, which is close to 100 per cent of its gross domestic product; the budget deficit is now around 12.7 per cent
of GDP. There is particular anxiety that the government will struggle to narrow a budget deficit that is more than four times the European Union limit. Greek government bonds have slumped in the past two months, driving yields to their highest in ten years. George Papandreou's government needs to sell €53bn of debt this year, or roughly 20 per cent of GDP. The question is whether it can do so and, if so, at what price. Just as worryingly, billions of euros' worth of borrowing was hidden outside the official statistics.

My former boss at the Massachusetts-based National Bureau of Economic Research, Martin Feldstein of Harvard University, has been cautioning since the euro debuted in 1999 that so many different economies are going to find it difficult to fit under the same umbrella. He argues that there is too much incentive for countries to run up big fiscal deficits, as there is no feedback until such a crisis as this emerges.

In a column in the Financial Times on 17 February he came up with the suggestion that Greece should be allowed to withdraw temporarily from the euro and to re-establish the drachma. It could return after a short holiday at a lower and more competitive exchange rate. The Greeks could leave, he suggests, initially floating the currency at the rate of 1 drachma to €1, and return at, say, 1.3 drachmas to €1. This seems preferable to the options under offer in Greece of stringent public spending cuts, increased taxes and higher unemployment.

Greece is being riven by strikes, not least by customs workers, who have made it clear that they are not going to go away without a fight. Their strike has resulted in fuel shortages. Taxi drivers also went on strike for 24 hours. A general strike is planned, which is likely to bring the country to a standstill. The danger is that labour unrest will spread across the eurozone.

However, another alternative to swingeing cuts in Greece would be for the Germans to help Athens out. One possibility would be for them to come up with financial assistance. A report in Der Spiegel magazine claimed that the Greek finance ministry plans to seek a €25bn aid package from other EU member countries, but principally France and Germany.

Good one, Gordon

Another option, however extreme and unlikely, would be for Germany to quit the euro and re-establish the mark. If it left, the value of its currency could be expected to appreciate against the dollar, the yen and the pound. This would not obviously be the case if the French were to re-establish the franc, say. The re-establishment of the German mark would help not only the Greeks, but also the Irish, the Spaniards and even us, as the pound would probably trade lower against the mark than the euro.

So, if the Germans were to leave at, say, DM1 to €1, the mark would appreciate and, in effect, the remaining euro countries would depreciate, making their products more attractive both as exports and domestically.

The Greek crisis makes Gordon Brown's decision not to join the euro look pretty good these days, even if he apparently joked early this year that he could no longer recall what his once-celebrated five economic tests for entry were. The Centre for Economics and Business Research has estimated that UK output would have dropped by more, and unemployment would be twice as high as it is, if we had joined.

By being outside the euro area, the UK has retained more fiscal flexibility than other European countries, and I can see absolutely no basis for reversing that decision any time soon. Well done, Gordon, for keeping the pound. And if you hadn't, I wouldn't have had to take that dreadful job with the Monetary Policy Committee . . . !

David Blanchflower is Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and the University of Stirling

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