360° Coverage : Three Reasons Why The UK Can Never Join The Euro

2 Updates
Three Reasons Why The UK Can Never Join The Euro
Photo Credit: Forbes Business

Three Reasons Why The UK Can Never Join The Euro

Mar 7 2014, 11:02pm CST | by

There are three reasons why the UK can never join the Euro. They are Ireland, Cyprus and Iceland. Ireland The Irish financial crisis saw the near-failure of its entire banking sector. Ireland bailed...

Filed under: news


25 weeks ago

Three Reasons Why The UK Can Never Join The Euro

Mar 7 2014, 11:02pm CST | by

There are three reasons why the UK can never join the Euro. They are Ireland, Cyprus and Iceland.


The Irish financial crisis saw the near-failure of its entire banking sector. Ireland bailed out its banks, partly at the behest of the European Union, which was concerned that Irish bank failures would destabilize the European banking system. The bailout wrecked the Irish economy and forced the Irish government to accept assistance from the combined European Union and IMF, the price for which has been five years of tax hikes and spending cuts exceeded in severity only by those in Greece. Ireland has now left the EU/IMF “program”, although fiscal austerity continues. But its economy remains depressed, and despite substantial emigration it still has nearly 12% unemployment. And both its banks and its sovereign are still highly indebted and vulnerable to further shocks.

As this paper from the Irish central bank comments (my emphasis),

“Although Ireland has experienced a very traditional banking crisis, in that it was preceded by a credit and asset price boom, it also occurred in the context of a significant global shock. Also, given its membership of the European Monetary Union (EMU), Ireland did not suffer a currency crisis, experiencing instead an internal devaluation. As previously noted, the scale of state support required to deal with the systemic banking crisis, combined with the severe correction in the real economy, eroded confidence in the Irish sovereign. This latter fact differentiates Ireland from the majority of that group of crisis episodes in advanced economies where property played a key role in the propagation of the crisis.”

The UK’s banks were at least as badly damaged as Ireland’s in the financial crisis. But the UK had its own currency and a functioning central bank.  The currency acted as a shock absorber, falling in value as the central bank cut interest rates to historic lows and used extraordinary measures to reflate the economy in the aftermath of the crisis. The UK’s economy still suffered – it has had a very long, slow recovery. But had it been a Euro member, the damage would have been far, far worse. It would have gone down the same road as Ireland – unaffordable bank bailouts, economic collapse, sovereign default and an EU/IMF “program” accompanied by brutal austerity measures.


In April 2013, the two biggest banks in Cyprus collapsed.  Cyprus is a tiny country with – at the time – a financial sector whose assets were 8 times its gdp. The sovereign was too small to bail out its banks, so one bank was allowed to fail with loss of all deposits above the deposit insurance limit, while in the other one a proportion of deposits above the deposit insurance limit were converted to equity – the so-called “haircut”. Cyprus imposed capital controls to prevent depositors removing their money to avoid the haircut: these controls still remain in place nearly a year later, although they are gradually being reduced.

The financial sector was Cyprus’s largest industry, and its collapse ripped the heart out of the economy. Cyprus’s use of capital controls created an implied currency devaluation that protected the economy to some extent, but as with Ireland, membership of the Euro meant there was no functioning central bank that could reflate the economy. Cyprus’s economy shrank by 5.4% in less than a year: the damage was felt directly by Cypriot businesses, households and ultimately by the sovereign because of falling tax revenues. Cyprus was forced to restructure its domestic sovereign debt in 2013 – the second sovereign default in the Euro area (the first was Greece

But Cyprus is actually doing considerably better than the IMF’s prediction of 8% gdp contraction, and far better than Ireland, Greece, Portugal or Spain.  This is no doubt because it forced bank creditors to take losses and used capital controls to protect its economy from damaging capital flight. But although forcing bank creditors to take losses will now form part of the European Bank Resolution Directive, capital controls remain exceptional and – arguably – contrary to the spirit if not the letter of the Lisbon Treaty. It is by no means clear that a Euro member the size and significance of the UK would have been allowed to use capital controls to create an implied devaluation as Cyprus has done. Small countries don’t benefit from the tolerance that, say, Spain has experienced – Spain’s banking system is still teetering on the brink five years after its crisis – but they also get away with actions that larger countries cannot. They simply do not have the same systemic importance.


Prior to the financial crisis of 2008, Iceland’s banks dominated its economy. At the time of their collapse the financial sector’s liabilities were about 9 times Iceland’s gdp, most of it foreign-denominated. And therein lay the problem. Iceland wasn’t a member of the Euro: it had its own currency and its own central bank. But its banks’ foreign liabilities far exceeded the country’s foreign currency reserves. It couldn’t bail them out. In essence, it was in the same position as Ireland or Cyprus – its banking sector had extensive liabilities in a currency it could not control.

But Iceland’s government had a big advantage over Ireland and Cyprus. It had its own currency and full control of monetary and fiscal policy. It could protect its economy. It allowed its banks to fail and refused to honor foreign liabilities: there was legal action against it, of course, but it won. It allowed its currency to devalue by 50% and imposed capital controls, most of which are still in place. And it provided fiscal support to businesses and households. Six years later, Iceland’s economy has recovered fully from its crisis and is expected to grow at a rate of 2.5% over the next year.

Lessons for the UK

Iceland, Ireland and Cyprus were all small open economies with very dominant financial sectors. The UK is much larger than any of them, but it is still a relatively small open economy with a dominant financial sector: despite a 10% contraction in the last six years, the liabilities of the UK’s financial sector still stand at about twice UK gdp. Were the UK to join the Euro, this would have to be significantly reduced. The UK simply could not afford to take the risk that such a dominant financial sector would pose to the economy in the event of another crisis without the protection of its own currency and central bank.

Whether the UK could, or should, cut its financial sector further – and what the economic cost of doing so would be – is an open question. Diversification of the UK economy is desirable, but the financial sector is an important contributor to gdp and an area where the UK has comparative advantage. So far, the government seems keen for the financial sector to retain its global significance.

But the global importance of the financial sector is not the only reason why the UK can never join the Euro. The other reason is the high level of household debt due to residential mortgages, coupled with the relatively high level of sovereign debt and stubborn primary deficit. Even if the UK stopped being a market leader in global finance, it would still be enormously at risk in a financial crisis. It’s worth remembering that although many UK banks were bailed out in the financial crisis, capital markets activity was a significant factor in only one – RBS. The rest were all damaged by excessive risk in residential and commercial property lending. This is also what happened in Ireland and Spain. Both have suffered terrible economic contraction due to being in the Euro straitjacket.

While the UK remains a highly indebted property-owning economy with a large and dominant financial sector, it can never join the Euro.

Source: Forbes Business


3 days ago

Khazanah throws MAS RM6b lifeline

Aug 29 2014 5:01pm CDT | Source: Business Times Singapore

August 30, 2014 1:15 AMKHAZANAH Nasional will inject RM6 billion (SS$2.4 billion) over three years to resuscitate loss-making Malaysia Airlines (MAS) under a recovery plan that includes even an Act of Parliament. Other key moves are migrating its operations, assets and liabilities to a new company (NewCo) and slashing the workforce of 20,000 b ...
Source: Business Times Singapore   Full article at: Business Times Singapore


4 days ago

MAS posts loss of RM307m for Q2

Aug 28 2014 5:00pm CDT | Source: Business Times Singapore

August 29, 2014 1:13 AMMALAYSIA Airlines (MAS) registered a loss of RM307 million (S$122 million) for the second quarter to end-June, but warned of worse to come in the second half when the "full financial impact of the double ...
Source: Business Times Singapore   Full article at: Business Times Singapore


Don't miss ...


<a href="/latest_stories/all/all/30" rel="author">Forbes</a>
Forbes is among the most trusted resources for the world's business and investment leaders, providing them the uncompromising commentary, concise analysis, relevant tools and real-time reporting they need to succeed at work, profit from investing and have fun with the rewards of winning.


blog comments powered by Disqus

Latest stories

Watching action movies makes your waistline grow
New York, Sep 2 (IANS) If your kids love to watch Hollywood action movies, better watch out for their junk food consumption.
Return as India's envoys, Modi to India-bound Japanese youth
Tokyo, Sep 2 (IANS) Prime Minister Narendra Modi Tuesday kicked-off a new initiative on training for Japanese youth started by Tata Consultancy Services (TCS) at its various facilities in India, asking them to return to Japan as India's ambassadors.
Scientists get ready for mock on-site nuclear inspection
Washington, Sep 2 (IANS) Some 40 scientists and technicians from around the world will descend on Jordan in November to take part in a simulated on-site inspection of a suspected nuclear test site on the banks of the Dead Sea.
Russian space 'sex geckos' found dead
Moscow, Sep 2 (IANS) Four female lizards and one male who were sent to space to understand the effects of weightlessness on sexual intercourse have died, the Russian Space Agency said in a statement.

Latest from the Network

Fung targets home success at PGM Sabah Championship
Sabah (Malaysia), Sep 2 (IANS) Reigning Asian Development Tour (ADT) Order of Merit champion Nicholas Fung hopes to recover from a fever in time to contend for the Professional Golf of Malaysia (PGM) Sabah Championship...
Read more on Sport Balla
Watching action movies makes your waistline grow
New York, Sep 2 (IANS) If your kids love to watch Hollywood action movies, better watch out for their junk food consumption. According to a study, viewers who watch action-packed programmes indulge in over-eating. "We...
Read more on Celebrity Balla
Pitch Perfect cast feel 'under pressure' with sequel
Ben Platt says the cast of 'Pitch Perfect' are feeling the pressure ahead of the sequel. The actor, who has starred in the popular Broadway production 'The Book of Mormon', acknowledges that the eagerly-awaited sequel...
Read more on Movie Balla
Imagine Entertainment in talks for 24 movie
Imagine Entertainment want to make a '24' movie. According to TVLine, the production company's chairman, Brian Grazer, has expressed an interest in taking the hit Fox series to the big screen following the end of the...
Read more on Movie Balla
Stan Lee reveals Black Panther movie is in the works
Stan Lee has suggested plans to make a Black Panther movie are still in development. Lee, the former president and chairman of Marvel Comics, says that Marvel Studios will look to make a film based on the first black...
Read more on Movie Balla
Lindsay Lohan uses hypnotherapy to quit smoking
Lindsay Lohan is using hypnotherapy to quit smoking. The 'Mean Girls' actress has reportedly turned to alternative medicine to kick her nicotine addiction before her West End debut on September 24 for David Mamet's play...
Read more on Celebrity Balla
Angelina Jolie and Brad Pitt's kids write wedding vows
Angelina Jolie and Brad Pitt's children helped to write their wedding vows. The Hollywood couple tied the knot in France on August 23 and they enlisted the help of their kids Maddox, 13, Pax, 10, Zahara, nine, Shiloh,...
Read more on Celebrity Balla
Carrie Underwood announces pregnancy
Los Angeles, Sep 2 (IANS) Country star Carrie Underwood and NHL player Mike Fisher have announced that they are expecting their first child. Underwood and Fisher posted the news on their social media accounts Monday,...
Read more on Celebrity Balla
Look at India, Modi tells Japan
Tokyo, Sep 2 (IANS) Prime Minister Narendra Modi Tuesday hoped Japan will follow "Look at India" policy. "Just as India is focusing on Look East policy, we expect Look at India policy from Japan," Modi said, adding...
Read more on Politics Balla