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No Brexit for a eurozone Britain

Apr 05,2018 - Last updated at Apr 05,2018

ATHENS — “You can check out any time you like, but you can never leave.” Prior to the 2016 Brexit referendum, I borrowed this line from the Eagles’ 1976 hit “Hotel California” as an argument against Britain exiting the European Union. I told audiences up and down Britain that if they voted to leave the EU, they would end up more entangled with the EU Commission than ever before.

As British Prime Minister Theresa May is finding out, disentangling a member state from the EU is an arduous and complex undertaking. But how much harder would Brexit have been had the United Kingdom adopted the euro back in 2000?

For starters, the people of Britain would never have been consulted on whether they wanted to check out of the EU. In a hypothetical eurozone Britain, the very announcement of a referendum on membership would have triggered a bank run. Given Britain’s chronic trade and current-account deficits, an exit from the euro would have necessarily caused a decline in the international value of UK bank deposits.

Foreseeing this, depositors would have responded to the announcement of a referendum by immediately withdrawing their euros in cash or by wiring them to Frankfurt, Paris, New York, or elsewhere. And, foreseeing that reaction, no British prime minister, not even David Cameron, would have dared announce a Brexit referendum.

Looking further back, what would the effect of 16 years in the eurozone have been on the relative strength of Leavers and Remainers within the Conservative Party? What would Britain’s economic circumstances have been like prior to 2016 had the euro been the UK’s currency? Would the political pressure to hold the referendum in 2016 have been weaker had Britain shared the same currency as Germany, France and Greece?

As with all counterfactuals, we are treading on thin ice here. Nevertheless, it is not difficult to sketch a plausible economic past for a UK that, hypothetically, entered the eurozone in 2000. 

In October 1990, the UK joined the euro’s precursor, the European Exchange Rate Mechanism (ERM), which kept the exchange rates between Europe’s major currencies within tight bands, which were increasingly tightened before locking the various currencies into a single one. The commitment to keep the pound close to the Deutsche Mark impelled the Bank of England (BoE) to keep interest rates high, leading to the 1991 recession.

To continue in the ERM, countries like Britain and Italy would have had to subject their populations to recessionary depths similar to that which Greece plumbed after 2010. In September 1992, on Black Wednesday, the pound sterling and the Italian lira fell out of the ERM as money markets bet against the survival of what the Conservative peer Norman Tebbit once ridiculed as the “eternal recession mechanism”.

Italy, its ruling class determined to exchange the lira for the euro at all costs, immediately returned to a debauched version of the ERM. But the UK government steered clear, with the psychological and political impact of its humiliation proving even more significant than the financial losses incurred by the BoE.

But following Labour’s victory in 1997, prime minister Tony Blair was keen to bring the euro to Britain and was prevented only by chancellor of the exchequer Gordon Brown’s tactical procrastination and eventual refusal to give up the pound. In short, the UK could have ended up a eurozone member state.

If it had, the effects on the British economy would have been minimal for nearly a decade, in contrast to the real effects of its short-lived membership of the ERM in 1990-2. The reason is that, by the mid-1990s, financialisation had gone berserk everywhere at once: in Wall Street, the City of London, Frankfurt and Paris. 

Except for the interlude following the collapse of the dot-com bubble in 2001, growth in the UK and continental Europe was supercharged by the oodles of paper assets, functioning as quasi-money, produced by banks. During that audacious upswing, when even Greece was growing at 5 per cent per year, a euro-denominated UK would have proceeded more or less as it did under the pound all the way to the 2007-2008 financial crisis. It was only then, once the bubble had burst, that the eurozone’s draconian constraints began to bite.

With the BoE at liberty to create as many billions of pounds as it deemed fit to reflate the City and back the government’s bank nationalisation and monetary stabilisation drive, Britain escaped the crisis with a single-year recession (2008-2009) amounting to a loss of 5.15 per cent in national income. Had London found itself in the clasp of the European Central Bank’s (ECB) policies in the 2008-2012 period, Britain’s large trade and budget deficits, in conjunction with massive bailouts for the City, would have made the Greek, Irish, Portuguese and Spanish bailouts look like child’s play. If the EU followed the same playbook in the case of the UK, it would have demanded levels of austerity and bailout loans that would have been politically unacceptable on both sides of the English Channel.

Something would have to give. Either the British government would have, overnight, declared its exit from the euro, without a referendum or even a parliamentary vote, or Germany and France would have had to agree to scrap immediately the ECB’s prohibition of monetary financing.

In both cases, the EU would have become unrecognisable. Either Brexit would have triggered a cascade that would soon cause Germany to withdraw from the euro, leading to the EU’s collapse, or the EU would have become a fiscal union overnight, leading to a political dynamic very different from the one experienced since 2008.

So, had Britain adopted the euro, two things would have happened with certainty: there would be no UK referendum on EU membership, and Greece would not be the domino that fell first. The interesting question is: How would those who support Brexit today feel had Germany and France moved to scrap the current rules and usher in a fully-fledged fiscal union? 

One can only speculate, but one fact remains clear: between 2008-2016 there would be no flood of EU nationals migrating to Britain to take jobs maintained by the BoE’s money creation drive at a time when the ECB was engineering a depression on the continent.

If a fully-fledged fiscal union had emerged in 2008, the absence of EU immigration would have denied the Brexiteers a powerful rallying cry in 2016. By that point, exiting the EU would be as absurd as California striking out on its own today.


Yanis Varoufakis, a former finance minister of Greece, is professor of Economics at the University of Athens. Copyright: Project Syndicate, 2018.

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