Has the euro failed?

The French show great panache when they say "non". However, the elegance of their style should not make one underestimate the rationality of their decision.

When in the early sixties, for example, De Gaulle said "non" to British entry to the European Common Market, he was deemed to have been motivated to make that unwelcoming gesture out of vengeance against his erstwhile allies, but in truth those who have observed subsequent events must conclude that he was right.

Curiously, his decision was sound not just for Europe, the principles of which British pragmatism would have indubitably destroyed; but it was also particularly good for Britain.

She gained from the flexibility she retained from her isolation and this enabled her to bring about the radical reforms by Mrs Thatcher. These changes could not have been so readily implemented under the bureaucratic regime of the European Commission and most importantly under a freely floating exchange rate.

These sound ideas were almost wrecked, first by Lawson and then by Major, who tried to return to a fixed exchange rate regime under the exchange rate mechanism.

Fortunately, their utter failure to achieve their objectives saved the British economy. Now the French need to do something similar for their colleagues in Europe.

For, although the French "Non" is directly aimed at further integration of the European economies and ostensibly aimed against further enlargement of the community, its real target probably is and certainly should be the single European currency, the euro, which has simply not worked.

In economic terms it is the familiar problem of an inflexible fixed exchange rate regime hampering and constraining the talents of a diverse group of people.

The creators of the euro no doubt hoped that the single currency would assist in wiping out economic differences, but the loss of flexibility has only aggravated the problem.

They wanted not a single currency but a single "European" response to the travails of European economies.

A small clue to what has gone wrong comes from a minor research paper released by the European Central Bank, criticising the unpredictability of the Bank of England's Monetary Policy Committee in comparison with the ECB.

The report condemns the supposed uncertainty caused by the Bank of England communicating different opinions of the members of the Monetary Policy Committee compared with the rock-like solidity of the decisions taken by the European Central Bank.

But the report ignores the appalling inability of the European Central Bank to address the great macroeconomic problem of its important member states.

In its invariant response, the ECB hardly bothers to mention unemployment. And this neglect of such a great social issue has happened in a period where both Germany and France have been suffering unemployment rates exceeding 10 per cent for almost a decade.

The response from the ECB, indeed the only policy that the ECB has evolved during this last decade, is that the central bank should not adopt any monetary or fiscal policies to stimulate growth.

It conceives its task as being to disregard all macroeconomic tools, like reducing interest rates for achieving any growth or reducing unemployment, as outside the scope of its regime.

Indeed, it is deemed almost improper even to raise such social macroeconomic issues as relevant to the debate of sound economic policy.

This deeply conservative attitude of the ECB has discouraged any downward change in European interest rates, when most economists would have thought it justified.

Yet the European Central Bank has chosen to ignore the deteriorating social conditions in favour of neutrality that amounts to indifference to the business cycle.

One should add, however, that the ECB is unlikely to be quite as neutral if prices were rising; for, the ECB would not discourage an upward change in interest rates if inflationary pressures were to develop.

In brief the bias of the policy is deflationary, a common enough approach for sound central banks.

It seems that central banks in the developed world have two different approaches to economic activity: one is an immediate monetary response, and, the other ignores the level of activity in the hope that the business cycle itself will reverse in due course.

In these two separate groups the Anglo-Saxon fall into the former and the Europeans into the latter.

As Anatole Kaletsky of the London Times observes, the "do nothing monetarist dogmatism of the European Central Bank" has not made a monetary move since June 2003.

In the same period the Bank of England has changed interest rates six times in both directions while the American Federal Reserve has changed interest rates nine times.

With such limited action it is no wonder that the ECB is deemed to be so predictable, indeed it is the predictability of eventual death.

Further, the consequences of this lack of action are also inevitable. It eventually leads to economic stagnation and a continuing level of unemployment, which, by virtue of its long-term persistence, acquire the nomenclature of "structural", meaning that there is no set of economic policies that can alter the level of unemployment.

At the most general level, countries have two instruments to manage macroeconomics--exchange rates and interest rates. Independent sovereign states in Europe abandoned the exchange rate or rather surrendered its management to the European Central Bank.

Thus, France cannot make changes to its macro policy by altering the rate of the French franc in relation to the Italian lira. This is now permanently fixed. Indeed, this was done to avoid competitive devaluations, which had often been cited as an argument for introducing the euro.

But the dangers were equally foreseeable. That acute speculator George Soros, with remarkable prescience, wrote in an article in1996:

"In all likelihood the Euro will be introduced in 1999 … People will direct all their anger and resentment over unemployment at the single currency. There may well be a political revolt--particularly in France, notorious for such rebellions--and it would likely take a nationalistic anti-European direction … mounting popular discontent would like to sweep away present policies including the single currency" [George Soros, "Can Europe Work?" Foreign Affairs, volume 75 (5)].

The French by their vote have perhaps begun a rebellion. It may fizzle out, but I do not believe so because the tinder for a wider conflagration is in place; but like all developments the picture of what will emerge is as yet unknown.

Eventually, the euro will break down not because it does not work but because it is basically a bad idea.

The merits of a single currency should not be exaggerated. I remember the derision I received from fellow writers when I had the temerity to suggest that there could be some merit in allowing some of the larger Indian states to print their own currency.

Apart from dismissing the idea as anti-nationalist and anti-patriotic it was generally argued that I was encouraging irresponsible spending by politicians. The general argument is that there are certain invariant laws of economics and they must be adhered to.

It is not a theme I subscribe to. The subtlety of economics is to manage these laws suitably. In that context the single currency euro was a bad idea and we are now beginning to learn how difficult it is to manage it well.