Brussels and London in finance face-off

Tensions between the UK and the EU over finance rules seem to be coming to a head this week. No sooner had news broke today that British prime minister Gordon Brown is blocking EU efforts to increase financial regulation of hedge funds and private equity, than word was leaked that tomorrow the UK is going to get a very stern tongue-lashing about the size of its debt. Just two more examples of how when it comes to money, the English Channel is wider than the Atlantic.

Tomorrow the European Commission will tell the British government it must do more to cut its budget deficit, which is as large as that in Greece. Market watchers are growing increasingly concerned that once Greece has hit rock bottom speculators are going to turn to the UK's shaky financial system, hedging against the colossal debt. The UK is not part of the Eurozone therefor the EU has no power to exert control over the UK's plans or punish it, so the communication to come tomorrow could be considered more as "guidance". But it's very public "guidance" that will be humiliating for the Labour party.

Could the Tories Bring the Euro to Britain?

Last night I attended a gathering of economists and politicians at The Center discussing the current situation vis-à-vis Britain and the Euro. Had such an event been held a year ago, you probably would have been lucky to get three people to show up. After all, the debate about Britain joining the Euro had been dead in the water for years. But things are looking very differently recently after the unprecedented collapse in the value of the pound, and the assembled speakers at the session had some surprising things to say about what may be around the corner for Britain.

The pound has lost 30 percent of its value since last summer, the most dramatic drop in the currency's history. It's fallen from $2.00 to one pound in July to $1.39 to one pound today. The pound fell to just €1.02 recently, when it was €1.33 at the beginning of last year. So the situation for the sterling is bleak.

So now a debate which was once thought to be done and dusted is beginning to resurface, although not yet out in the open in Britain. Speaking at the session, former British MEP John Stevens observed, "It's much easier to talk about Britain and the euro outside than inside." Indeed Stevens, who just wrote a report concluding that the best monetary option for Britain is to join the euro, said that his report has received much more attention in the rest of the world than it has in the UK. In Britain, the currency problem remains the issue that dare not speak its name. Opinion polls have consistently shown that a majority of the public opposes joining the euro, and no politician in today's Britain is willing to take a principled stand on an unpopular issue. Both Labour and the Conservatives know that reawakening the euro debate could easily have the effect of spooking British consumers even further. "If the public hears talk about joining the euro, there will be mass fear that Britain is really in trouble," Stevens said, perhaps only half joking. A country's currency has much to do with its national pride, and having to give up the pound would be a massive blow to Britain's self-esteem.

Yet the country may get to a point where it has few other options. Last night's panelists seemed to agree there is a good possibility the pound may have much further to fall, and a full-on run could cause it to be worth drastically less than the euro. Stevens noted that if the UK were to start negotiations for joining the currency now they would be coming from a position of strength. "We wouldn't be coming just as supplicants, we would be bringing something to the table," he noted. "Britain joining the euro would position it as the world currency." At the same time, it would demonstrate to currency speculators that the pound is a safe currecy. On the other hand, waiting until the bottom has truly fallen out from the pound to begin negotiations would be a very weak position indeed.

But how to sell the idea politically? A representative from the British Chambers of Commerce asked how the organisation could make small-and-medium-sized enterprises come around to the idea. Stevens pointed out that SMEs actually benefit disproportionately from a common currency. Large businesses have mechanisms to get around currency barriers which small businesses do not. Studies have shown that SMEs within the Eurozone have been some of the greatest beneficiaries of the common currency, Stevens said.

But does any political party in Britain have the political will to sell the public on an unpopular issue like this? Simon Titley, a consultant who also worked on the report, said the reticence to do so may be a result of the systemic over-dependence on polls in modern British politics. Public opinion polls may show that a majority of the British are opposed to joining the euro, he said, but those same polls also show that they also don't care very much about the issue either. It's what pollsters call a 'soft issue,' something which people are willing to express an opinion on but actually isn't very important to them. "It's not an issue that would decide an election," he said. "Politicians that are in favour of the euro need to come out of the closet and stop caring what Rupert Murdoch's newspapers will say about them."

So what's likely to happen? All the panelists seemed to think that the next government of the UK will likely be the Tories under David Cameron, who just this week has signaled his intention to leave the main centre-right Europarty in the European Parliament to form a fringe Eurosceptic party, a move many have seen as making the Tories into an isolationist party. However, Titley had an interesting prediction for what may be in store for the a Conservative government. "I think a likely scenario is that a UK Tory government will adopt the euro, under the whole 'Nixon going to China' idea," he said. "Sometimes an idea seems so far to the left that only a right-wing government could do it."

These certainly have been unpredictable times, so I would say even the conservatives bringing the UK into the Eurozone wouldn't surprise me these days!

One Letter and Six Months

Following the rioting in Iceland this week resulting from the country's economic collapse, the cruel joke making the rounds in Europe right now is that Ireland, its Atlantic island neighbor, is just one letter and six months away from being Iceland itself.

Once hailed as the "Celtic Tiger" for its economic power performance after joining the EU, Ireland today finds itself in bad economic straights. Yesterday the government announced that it would nationalize Anglo Irish Bank, the country's third largest lender. The government is also considering reducing the pay of public sector workers as it scrambles to find money anywhere, a decision which could lead to massive and possibly violent demonstrations in Dublin. In six months, Ireland could be in the same situation as Iceland.

Of course there is one key difference between the two: Ireland is on the Euro, Iceland is not. Many economists are saying that the fact that Ireland is in the euro zone is the only thing that has enabled the country's economy to stay afloat during these trying times. Though the economy is in big trouble, investors still consider the country safe because it is part of the euro zone, and its credit rating has not been downgraded.

This fact has seemed to make a few Euroskeptics across the Irish sea more than a little defensive. The British pound has virtually collapsed over the past six months, dropping today to its lowest level against the dollar in 23 years. It's fallen from $2.00 to one pound in July to $1.34 to one pound today. And the pound has lost 20 percent of its value against the euro in the same time, with the two currencies now almost equal in value. Today the UK also officially entered a recession, with commentators noting that the fact that 3/4 of the UK's economy is dependent on the services industry (the most harshly affected industry in the current global crisis) means that the country will likely be the hardest hit of any during the global downturn. And without the stability of being part of a larger currency block, it is thought the UK may have to go crawling to the International Monetary Fund begging for money, because it won't be able to finance the massive level of debt it is taking on with its currency so devalued.

This might explain the peculiarly hostile questioning the Irish finance minister received on the UK program Newsnight last night about whether it had been "too early" for the country to join the euro zone. The presenter insisted that the country's "hands are tied" by the Eurozone since it will be unable to set its own interest rates in response to the crisis (interest rates for the euro zone are set centrally by the European Central Bank in Frankfurt). The minister, Brian Lenihan, seemed hardly able to disguise his bemusement at the absurd question, pointing out that before Ireland joined the Euro its currency was pegged to the pound, and since the country has never freely floated its currency it has never been able control its own currency measures anyway. That shut the presenter up. But Lenihan must have taken a bit of satisfaction in then being able to tell the lecturing presenter that the Euro, "is the currency of our trade with many of our European partners. With the United Kingdom of course, we are at some disadvantage now because we're far stronger than sterling." Oh snap! "Small countries which have their own currencies tend to be speculated against," he continued. "We don't want to put our country in that position, so we linked to a stronger currency." Lenihan had cause for the comparison. Although the Irish economy is hurting, in the long run it may be in better shape than the UK ecnomy.

A New UK Euro Debate?

The prospect of the UK joining the Euro has long been dead in the water, but the current situation might revive the idea, particularly now that the pro-Europe Tory politician Ken Clarke has been brought back to the front benches. Rather than defending the British pound, however, British Euroskeptics seem to have fired an opening salvo by attacking the decisions of other countries to join. An opinion piece by Ruth Lea in today's Telegraph calls the euro zone "dysfunctional" and says the 'one size fits all' interest rate policy has been a disaster for smaller economies like Spain, Italy and Greece. She even blames the recent downgrading of Spain's credit rating on the Euro, seeming to suggest the Southern European economies will imminently drop out of the zone in order to devalue their own currencies out of the crisis.

But in reality, the Fitch ratings agency has kept Spain's credit rating as triple A because it's on the Euro. As the Wall Street Journal Europe pointed out today, Fitch affirmed Madrid's triple-A rating partly because "Spain's membership of the euro area supports its rating, as it eliminates the risk of a currency crisis." The Journal also points out that being part of the euro zone has kept these Southern European economies' budget deficits lower than 3 percent of GDP (or at least made them try to do so), making many euro zone countries now in a better position to absorb their rising deficits. Futher, the idea that these countries would suddenly leave the zone doesn't make sense. Aside from the enormous cost involved in converting the bills and the national debts back to the old currency, such a move would lead to massive wage inflation. And the concerns about national defaults would still exist to the same degree, only now the counties wouldn't have the security of being in thre euro zone to protect their credit rating. Perhaps it is just euroskeptic wishful thinking to think the euro zone is about to fall apart.

Celtic Tiger Laid Low

Many have been speculating on what effect the new economic reality in Ireland will have on the re-vote to be held in the country on the ratification of the EU Reform Treaty. Last night Lenihan seemed pretty confident that the crisis has made the Irish realize how much they have benefited from membership in the EU and adoption of the Euro. One of the explanations analysts had given for the no vote last year was that, although Ireland had historically been very pro-Europe, its economic success over the past decade had given the Irish the confidence to spurn the EU, thinking they could go it alone if they needed to. The recent months have certainly been humbling for the tiny country, and perhaps they will be thinking differently this time around when they enter the voting booths. That's the hope in Brussels at least.

Will the US recession spread to Europe?

As Wall Street opens after the Martin Luther King weekend, the world is waiting with baited breath to see what happens after the opening bell. The US traders had the day off yesterday, but rather than relaxing they probably spent it in horror as they watched markets across the globe plunge amid fears of a US recession. Markets in Europe suffered their biggest one-day losses since the September 11th attacks. When trading opened this morning in the East the Asian markets took an absolute nose dive. In response the US Federal Reserve made an emergency rate cut early this morning US time, an eye-popping three-quarters of a percent. It helped the European markets bounce back slightly but it was too late for the close of the Asian markets.

So far it doesn’t seem to have done the trick for this morning’s Wall Street trading, probably the most closely watched in years. The Dow fell immediately after the bell, dropping 441.72 points at one point. The Nasdaq and S & P 500 were down more than 3 percent just in the first half hour.

All of this of course is in response to a panic over the fact that the US is either about to enter a recession or it is already in one, sparked by the subprime loan crisis. But aside from the markets, how vulnerable is the rest of the world to this coming economic crisis in the US? The subject has been the topic of much speculation in Europe over the past week.