“That’s the only cut this year!” quipped a council member when European Central Bank president Jean-Claude Trichet took the knife to the ECB’s birthday cake in Frankfurt on June 2. The occasion was the tenth anniversary of the Bank’s establishment. Apparently the mood in Frankfurt was of genuine celebration tempered by concern at the conflicting challenges which the Bank currently faces over inflation and growth.
It has been a long journey since June 1998. It’s strange to think that the decisions on who would join the euro zone were taken under British presidency in May ‘98. In the chair was Prime Minister Tony Blair, who had won a landslide election just twelve months earlier. He had to praise the significance of the euro, although he had decided against taking Britain into the new currency, a decision regarded by many people as one of his biggest failures given the strength of his position, and no doubt strongly influenced by Gordon Brown at the Treasury.
The most interesting drama at the time was over the ECB presidency. President Chirac demanded that Trichet, who was then governor of the Bank of France, should be ECB president, whereas Wim Duisenberg from the Netherlands was the consensus candidate.
The crisis was resolved with a classic fudge. I will be far too old to serve two terms as ECB president, said Duisenberg, but any decision to resign “will be my decision alone”. There was, however, an understanding that Trichet would take over once Wim had taken that his solitary decision. Chirac conceded. Relief all round.
When the French president pressed for Trichet’s appointment in 1998 he no doubt hoped that a more relaxed French regime would prevail over Germanic discipline, setting interest rates with an eye to boosting growth. In the event Trichet has staunchly defended ECB independence and its key mission: to fight inflation. Trichet’s own appreciation of the ECB’s role, its record and the tasks ahead was summarised in his Frankfurt birthday speech.
The record of the ECB has surpassed expectations. Its handling of the sub-prime crisis since last August has impressed everyone and the euro continues to strengthen its position in global markets – as well as appreciating in value. It now accounts for around 25 per cent of foreign currency reserves across the globe and we can expect that to rise steadily. China, for one, is keen to increase its euro holdings.
May 1998 marked the creation of the Euro Group of ministers. This group of 11 countries was expected to become a potent force in European politics and it was Britain’s exclusion from the club which many of us thought would be the biggest penalty for not joining the euro zone.
I can’t say it has turned out like that. For a start, total disregard of the Stability and Growth Pact by some of the biggest members caused deep divisions within the group. Not much solidarity there!
There has also been real divergence in the performance of the euro zone economies, both in terms of their growth rates and their inflation. Maybe the interests of the euro zone countries (15 of them now) are so varied that they will never be able to take common decisions on such issues as international exchange rates and the value of the euro, economic management or taxation policy. President Sarkozy, for instance, has called for a cut in certain VAT rates across the EU to put the brake on rising prices, but his finance minister Mme Lagarde got short shrift from colleagues when she put forward the idea at the recent Frankfurt meeting.
On the international front the Euro Group president, Luxembourg’s Juncker, has bemoaned Europe’s failure to speak with one voice in the IMF. The question is, what should the voice say? A high level delegation to China was hyped as a first example of euro diplomacy, but it does not seem to have amounted to much. Maybe that could be a role for the soon-to-be-named Council president – provided he/she comes from a member of the Euro Group.
I see that Slovakia will be the next country to adopt the euro, as of January 1 2009, when it abandons the koruna. It has revalued its currency in advance as an anti-inflationary move. Political opinion in Denmark continues to move in favour of membership. A referendum would of course be needed, and Sweden is publicly stating that a positive Danish vote would open the way for Sweden to consult the people as well, at the earliest in 2011.
Which leaves the United Kingdom. Willem Buiter, former member of the Bank of England’s Monetary Policy Committee is in no doubt. In his view Britain should join now. The FT’s Martin Woolf strongly disagrees.
Buiter refers to the enormous external liabilities of the UK’s financial services industry – €400bn in foreign currencies in his estimate, which is four times the country’s GDP. The Bank of England, he maintains, could never act as lender of last resort for such liabilities. Joining the euro and depending on the resources of the European Central Bank is for him the only way to defend the UK from an Iceland situation, where vast liabilities have accumulated in proportion to the size of the domestic economy.
It’s a bit tough being compared with Iceland, but it does focus on some of the issues raised by the sub-prime banking crisis and the new perceptions of risk that we have to live with. But probably the biggest test for the ECB over the next 10 years will be how far the euro zone can handle its own internal tensions and the divergence of its national economies.