QUERETARO, Mexico, Jan. 9 (UPI) -- The world appears to be becoming divided--into currency blocs. Most of continental Europe has now adopted the euro. The dollar is the more reliable second currency of Latin America (and the first currency of Panama, Ecuador and El Salvador). The Yen vies with the dollar in Asia. Britain's pound sterling looks lonely.
How much of a disadvantage could this loneliness be? It is clear that Britain's prime minister, Tony Blair, fears a loss of influence, though whether this is more of a political threat (and even a personal one for Blair who wants to be a major player on the international scene) than an economic one for Britain is unclear. But isolation might do economic harm.
It could be that the city of London and Britain's traditionally substantial financial role in the world economy would be damaged by having a minority currency. There could be harm, too, to investment in Britain and to British exports. Foreign investors such as the Japanese may be wary of fluctuations in the pound and the risk this poses. British exports may not fare well because an alternative currency is not necessarily a weak currency. On the contrary, it may be an overly strong one. The lonely pound has gained by 14 percent against the euro since the latter's launch at the beginning of 1999. Production in Britain could prove expensive and difficult to export to the much larger European market. British competitiveness could suffer and British jobs could be lost. Britain's traditional weakness, in the balance of payments, could reappear.
It could be argued, then, that Britain needs to take its fate in its own hands, that the island cannot waver any longer, that sentimental attachments to sterling must be abandoned and that Britain must unite itself, currency and all, with a larger trading block. But should it throw in its lot with the euro, or with the dollar?
The United States is, by a long way, the world's biggest economy and, notwithstanding the current recession, its most dynamic. The United States and the U.S. dollar dominate international markets.
International capital transactions are primarily in dollars. The leading investment banks are American; their predominance in the huge U.S. capital market has been the main reason for their dominance. By abandoning sterling and dollarizing its economy, the U.K. could improve its own access to the U.S. market, especially if, in dollarizing, Britain negotiated the formation of a common market with the United States. That would give Britain access to the world's biggest economy, as well as to Mexico and Canada, and would give those countries a link to Europe's second biggest economy.
There are other reasons for suggesting that Britain's more natural alliance lies with the United States than with Europe. Britain, since the prime ministership of Margaret Thatcher in the 1980s, has become more American in its way of doing business. It tends, American-style, to favor lower tax rates and lower government spending. It has reformed labor laws and eliminated obstacles to doing business far more readily than continental Europe. And it has derived some of the benefits from so doing. Unemployment in the U.K., at 5.1 percent of the workforce, is much lower than the 9.0 percent of France or 9.5 percent of Germany--though it is true these numbers are not directly comparable and overstate Britain's advantage. It might even be argued that Britain has even achieved greater macroeconomic convergence with the United States than with Europe. Britons, like Americans, favor home ownership over renting and are keen consumers, with a relatively low propensity to save.
Another advantage, pace Mark Twain, is that a common language should make it easier for Britain and the United States (and indeed Canada) to work together. Labor mobility in Europe is impeded by language barriers. If the United States and Britain decided to create a single market with one another, workers would be able to move more freely from one country to another. And mobility of capital would be facilitated by joining the two most important financial centers in the world, New York and London, in the common currency area.
These benefits must be compared with the risks of aligning with the euro. One of Europe's reasons for forming a common currency was a desire to counteract euro-sclerosis. That effort has not yet been successful. European growth continues to lag behind growth in the United States and, indeed, in Britain.
What would be the obstacles to dollarization of the British economy? Some of the obstacles that pertain to British adoption of the euro would also pertain. Britain would lose control of its monetary policy. The U.S. Fed Funds Rate, currently at 1.75 percent, is currently less than the equivalent central bank benchmark rate, the Bank of England's repo rate, which is at 4.0 percent. House prices in Britain are sensitive to interest rates. British house prices might soar if the U.S. were to need to persist with very low interest rates. Consumption, too, might rush ahead. Britain might soon find itself with a large current account deficit. Does this matter?
These trends, of soaring consumption and soaring house prices, have already occurred in Ireland since the introduction of the euro brought negative real interest rates--interest rates that are lower than the inflation rate--to the country. A mentor for the euro, Robert Mundell, the Canadian Nobel prize-winning economists, judges rising prices in Ireland a transitional phenomenon, part of Ireland's acquisition of a higher standard of living. But is he right? A study by the Irish central bank concludes that "there has not been a single episode of house price inflation on the scale of Ireland's which did not end in prices falling, in some cases quite dramatically." In other words, bust may follow boom. And will the price inflation--in consumer and asset prices--that Ireland has experienced in the past few years eventually damage its competitiveness? It is difficult to be sure. Currency regimes must stand the test of time. As Argentian's devaluation 10 years after the introduciton of its fixed exchange rate shows, it takes more than a few years to judge the viability of a new currency arrangement.
Let your correspondent emerge from behind the cloak of objectivity. The dangers presented by dollarizing the British economy or of joining the European currency are uncertain. It could be that all would work well but this writer believes monetary policy, like clothing, is best tailored to individuals. Even if convergence grows between economies that share a common currency, adopting a common size monetary policy may be dangerous. Economic performance between countries in the same grouping may differ stubbornly over time. A shared monetary and exchange rate policy leaves only fiscal policy -- a clumsy tool at the best of times -- to ameliorate differences. Pressures may build that eventually lead countries to abandon the euro. Lonely sterling might not be such a handicap at all.
But our exploration of dollarization for Britain throws up something afresh: that Britain has moved west in its economic policy and its performance has drawn apart from that of continental Europe. Even if the dangers of a one-size fits all monetary policy are less great than this writer fears, how wise would it be for Britain to tie itself still more closely to the sluggish economies of Europe? Might an effort to enhance trade links with the United States and the Americas not be wiser?
