Weighing the Pound

Funny thing about the British and the euro: polls show that about 60% of them don't want it but a majority expect they'll get it anyway. The orderly switch to the single currency on the Continent last week only added to that sense of inevitability: the pound is beginning to look like just another un-modern, un-European eccentricity, like Morris dancing or driving on the left side of the road.

But that doesn't necessarily mean the euro makes good economic sense for the U.K., now or ever. Tony Blair's squeamishly pro-euro Labour government has set five tests for joining the monetary union ...

1. There can be sustainable convergence between Britain and the economies of a single currency.
2. There is sufficient flexibility to cope with economic change
3. It is good for investment.
4. It is good for the financial services industry.
5. It is good for employment.

Unfortunately, for voters in a future referendum trying to make up their minds about the euro, these tests shed too little light on what's really at stake. (What, exactly, does "sustainable convergence" mean, and why does it matter? Why worry so much about financial services when London already dominates the euro-denominated bond business?) Here are five better questions to ask about the euro:

1. Can Britain join the euro now?

Even if Blair can convince voters to stop worrying and love the euro, Britain still won't be able to join the single currency unless the euro starts showing a little moxie. When the virtual euro was launched in 1999, one euro was worth over 70 British pence. Since then, investors nervous about Europe's economy — let alone the viability of the new currency itself — have driven the the euro down to just under 63 pence. That means that British companies exporting goods to mainland Europe are, in effect, now charging their customers 14% more than they were three years ago, even if they haven't actually raised their prices. That's already made British manufacturers a lot less competitive. But if the U.K. switched to the euro tomorrow, it would only lock in that price difference permanently.

The Confederation of British Industry, the leading business lobbyist, says the majority of its members want to see Britain join the euro — but they also think the exchange rate should be as much as 74 pence per euro. Short of creating inflation by printing money or drastically cutting rates, there's not much Bank of England Governor Edward George can do to make that happen, and he won't. With luck, the success of the new euro notes might prop up the currency's values.

Otherwise, euro supporters are left to depend on the government to, in effect, talk sterling down. "A more forceful political leadership could begin to make people feel [the euro] might happen," says Niall FitzGerald, chairman of washing-soap and ice-cream giant Unilever. "The money markets could then assume it will happen, and a correcting process will take place." So far, though, Blair hasn't been willing to take that kind of political risk for the euro.

2. Will the Euro save factory jobs?

For Londoners, the global economic slowdown still seems quite mild. Unlike Germany and the U.S., Britain has so far avoided slipping into a technical recession. High real estate values haven't cracked yet, and consumer demand is so robust that big retail chains including John Lewis just had an even better Christmas sales season than last years'. Even the stock market is recovering from Sept. 11. But this prosperity is not universal: British manufacturing, and with it many of the better-paying jobs in the Labour heartland in the north of England and Scotland, is in serious decline. That's not simply because Britain has avoided joining the euro, but such solitude hasn't helped.

If sterling can first fall or be brought down — and that's a big "if" — joining the euro would remove a major risk for companies deciding whether to build a plant in Britain or to keep open an existing one. Currency volatility is particularly painful for heavy manufacturers such as automakers, who have to plan production three to four years in advance. Toyota's U.K. business blames most of its $190 million loss in its last reported financial year on nasty exchange-rate surprises. It's keeping its production lines going, but that's about all. "I wouldn't want to ask Toyota Motor for a massive new investment in the United Kingdom," says Bryan Jackson, senior director of Toyota in Britain. "They'd question my judgment."

Britain's manufacturing crisis may be the strongest argument in favor of the euro. So how do the euroskeptics respond? They change the subject. "We export about 30% of our gdp. Slightly more than half of that is manufactures, and slightly more than half of that is exported to Europe," says economist Roger Bootle of Capital Economics in London. "Fine. But what about the rest of it?" (More on "the rest of it" in test number four.)

3. Will the euro mean the end of "rip-off Britain"?

No Frenchman ever took the ferry from Calais to pick up cheap booze and groceries in Dover. Most consumer products just cost more in Britain, and that's no accident, say the europhiles. A recent survey of prices in major European cities by Dresdner Kleinwort Wasserstein found that things cost the most in three cities outside the euro: Zurich, Stockholm and London, with London 16% above the eurozone average. One theory is that since British consumers can't easily compare price tags on their high streets with the ones on the Continent, merchants can simply get away with charging them more.

On the Continent, where many items have been quoted in euros as well as local currency over the past three years, prices have been converging, especially for big-ticket items like washing machines and television sets. Of course, prices can converge up as well as down, and taxes, distribution costs and local economic conditions also contribute to pricetag differences. In an island nation full of rich consumers, a good lunch in London will probably always cost more than a similar meal in Madrid — with or without a euro menu. Tellingly, however, some of the biggest opponents of the euro in the British business community are restaurateurs and retailers.

4. Will the euro mean the "wrong" interest rates?

Giving up the pound means that the Bank of England loses the right to set key interest rates — loosening the money supply when the economy needs more investment and spending, and tightening when inflation threatens. Instead, the U.K. would get the same rates as the rest of Europe, set by the European Central Bank in Frankfurt.

The mainland economy is different from Britain's — among other things, taxes are higher, jobs are harder to find and harder still to lose, and governments have big pension obligations that scare many economists silly. So no matter what you think of ecb president Wim Duisenberg (and many people don't think much of him) it's unlikely he could set interest rates for Britain as deftly as Eddie George could. "I can't defeat [that] argument," says Simon Buckby of the Britain in Europe campaign. "I can only mitigate it." For europhiles like Buckby, the risk of having the wrong interest rate is a fair trade-off for being guaranteed the right exchange rate. Euroskeptics point to the early 1990s, when the Exchange Rate Mechanism kept Britain from cutting rates. In that recession, unemployment shot up.

5. Will the euro make Britain less British?

For most Britons, this is really the only euro debate that matters. Joining the euro will intimately tie the U.K.'s relatively flexible, laissez-faire economy to the social democratic mainland. For many europhiles on the left, that may be the whole point of the exercise. Yet this isn't so straightforward; whether Britain enters the euro or not, as a European Union member it will still be party to debates over labor rules and tax harmonization. Ironically, the European Union is in many ways far more conservative than most Europeans. The Stability and Growth Pact sets tough limits on deficit spending, and the ecb is more hawkish on inflation than any other major central bank. The euro may ultimately transform Britain less than its supporters hope, or the skeptics fear.