Thank you Gordon!

by Ed Bowsher on 28 May 2010  |  14 comments
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Gordon Brown gets a lot of stick but he made one very good economic decision when he was Chancellor.

The euro has been a massive failure. That’s the clear message of the sovereign debt crisis in Greece and other parts of Europe.

Let’s create an imaginary country. We’ll call it Happyland.  Happyland has its own currency which ‘floats’. (In other words, the value of the Happyland currency changes each day just like a share on the stock market.) This means Happyland has much more flexibility if its economy hits trouble.  If the country is in recession and inflation is low, it can reduce interest rates to stimulate an economic recovery.

Lower interest rates will also probably trigger a fall in the value of the currency. As a result, Happyland’s exports will be cheaper and its factories should be busier as a result. Lots of countries have successfully used a falling currency as a tool to create an economic recovery. One good example is Britain in the mid-90s after we left the ERM.

But Greece’s tragedy is that it is part of the euro. This means that it can’t set its interest rates to suit its economic circumstances. Instead Greece has to accept the decision of the European Central Bank (ECB). When the ECB sets its equivalent to our base rate, it doesn’t just look at the Greek economy, it’s looking at the wider economy of the eurozone. So Greece is unlikely to get the right interest rate for its circumstances.

What’s more, Greece can’t benefit from a devaluation or falling currency. Sadly, Greece’s goods and services are too expensive. If the country can’t devalue, its only alternative is to reduce prices and that can only be done if Greek workers are prepared to accept wage cuts – perhaps as much as 20 or 30%. If Greek workers were willing to do that, exports would pick up, the economy would recover and Greek government revenue would rise as the economy grew.

But, of course, Greek workers will never accept those kinds of wage cuts. Devaluation inflicts a ‘hidden wage cut’ on workers but few people will accept a wage cut that shows up in your payslip.

So, sadly, the Greek government now has two options:

-          Leave the Euro

Or

-          Not repay all its debts

Things would be much easier if Greece had never joined the euro and still had the drachma.

What’s this got to do with Gordon Brown?

Back in the early days of the New Labour government, Tony Blair was very keen for Britain to join the Euro.  But Gordon Brown – on the advice of his sidekick Ed Balls – torpedoed Blair’s dream. And I’m so glad he did. Yes, the UK’s economy is in a right old mess but things would be far worse if Blair had taken us into the Euro. The pound has fallen 30% against the dollar over the last three years and that fall has made life easier for British businesses. In fact, without the pound’s fall, I’m in no doubt that the UK economy would still be contracting instead of growing at a very modest rate.

So thank you Gordon! When it came to the biggest economic decision of your time as Chancellor, you got it absolutely right.

PS. Please don’t assume from this post that I’m a supporter of the Labour party. I’m not. In fact, I’ve never voted Labour in a general election in my life.

I also acknowledge that Tony Blair wasn’t the only person who got it wrong on the euro. The Liberal Democrats were fervent supporters of the single currency and now look very silly.