The Rt. Hon. John Redwood discussed the problems facing the euro zone, which have been highlighted by the recent financial crisis, and suggested how the monetary union might proceed to over come them.
The Rt. Hon. John Redwood began by commending the founders of the European Union (EU) with the good foresight to design criteria for entry to the union, which would be necessary for a monetary union to be successful. He argued over a decade ago, however, in "Our Currency, Our Country" (1997), that the particular entry criteria and stability pact put in place would not be enough, and that more and more powers would have to become centralised. Without this, he foresaw that some countries would free ride on the common interest rate and borrow too much at relatively low interest rates.
The Euro has been under great pressure in recent months. Certain member states have borrowed so much that, because of the induced hike in interest rates, they can no longer afford their debt. These highly indebted (so-called) peripheral euro zone economies face painful adjustment processes in order to restore their competitiveness. The stronger member states have created expensive loan packages to bailout profligate members but, unfortunately, markets do not seem to have regained confidence.
The Rt. Hon. John Redwood traced back the root of the problem to the formation of the monetary union. In order to join the Euro currency, members are currently required to meet the Euro convergence criteria, agreed upon in the Maastricht treaty in 1992. The speaker observed that only one country, namely Luxembourg, actually satisfied those criteria, and that some countries were far off the mark. For example, Italy, Greece and Belgium had state debts of 100% of National Income, and Portugal and Spain had very large public deficits. He believes that because even the better performing countries, like the Netherlands, Germany and France, did not qualify, they felt that they could not exclude other countries. As a result, there are large disparities in the economies of different member states.
The presenter went on to claim that a currency needs a sovereign, which the founders of the Euro failed to achieve. Sovereignty is required to make decisions on regional policy to deal with differential growth rates and levels of prosperity, fiscal policy, and monetary policy. A currency also needs a united and strong representative for international forums and negotiations. A common regulator of the banking and financial system would also be desirable. The EU currently lacks sovereign functions in several ways: regional policy is too modest, regional disparities are large, control over sovereign borrowing is poor, current institutions like the European Central Bank could be bolder, and more regulation is required. The Rt. Hon. John Redwood pointed to the stress tests of July 2010 that set a generously low hurdle which all of the Irish banks passed just before the Irish crisis occurred.
Faced with weak banks bad state finances, how can the EU get out of this situation? The Rt. Hon. John Redwood proposed three ways in which the European Union could possibly proceed. They were that 1) Germany leaves the union, reestablishing the Deutsche Mark (DM) and allowing the euro to devalue for the rest of the Union; 2) Those countries with the most damaged economies exit the Euro; 3) The strongest economies assist the weaker ones, and the currency is enabled to depreciate for the whole Euro area by printing money.
Despite German pride for the DM (70% of Germans did not want to join the Euro!), the speaker doubted that the first option would happen. He also rejected the second option because it would go against the nature of the Euro as a joint political venture, and it would be problematic to decide where to draw the line over which members should leave. He suggested that the third option is the most likely and he thinks that a large transfer of power is already underway. There do remain arguments, however, over which powers will be conceded to a central institution, and in what way.
In conclusion, the Rt. Hon. John Redwood advised that any action to strengthen the EU as a sovereign, and which enabled the strongest economies to help the weakest, would have to include the following:
1) Banking regulation at a European level needs to be reviewed, weak banks need to be remedied and further stress tests applied;
2) the growth and stability pact needs to be revised; more power needs to be given to the EU to impose and police spending, tax, and borrowing with credible financial penalties;
3) there needs to be a large and institutionalised fund to support member states at risk;
4) the ECB should be active bank in bond markets.
Marloes Nicholls, Seminar Coordinator
John Redwood was an investment analyst, manager and Director for Robert Fleming and for NM Rothschild in the 1970s and 1980s. Since then he has been a Pension trustee, a member of the Investment Committee of an Oxford College, the Chairman of an investment company and a non-executive Director of a hedge fund and an Investment Trust. He was an early advocate of tracker funds to cut the costs of equity investment. He has written extensively on economic and investment subjects, including "Popular Capitalism" (1988, about privatisation and debt swap); "The Global marketplace" (1993, setting out how computers and telecoms innovation would power globalisation); Superpower Struggles (2005, looking at the rise of China); "Freeing Britain to compete" (2007, a study of how to improve competitiveness, as Chairman of a Policy review); and “After the Credit Crunch: no more boom and bust” (2009, an account of the Credit Crunch and the steps needed to improve the UK's competitiveness and speed its recovery). He is currently a Distinguished Fellow of All Souls College, Oxford and a lecturer and commentator on economic and investment matters. He holds a doctorate from Oxford University and the IMC Investment Management qualification.
This seminar was hosted by OXONIA in association with All Souls College. It has been made possible through the generous benefaction of Oxford Economics.