(Title image: The Telegraph)

No, it won’t happen but I’ll humour you anyway.

Introduction

With the establishment of a single trading bloc, the next step in European integration was the creation of a single European currency. The idea is that permanently preventing vast exchange rate fluctuations between different European currencies would improve trade as customers and businesses would be able to determine prices of products across the trading bloc more easily.

The 1992 Maastricht Treaty formalised the process of creating a single European currency – with opt-outs for the UK and Denmark. A new fixed exchange rate mechanism (ERM II) was established to prepare future euro zone member states for the switch, and the European Central Bank (ECB) was established in 1998, eventually basing itself in Frankfurt.

The introduction of the physical euro currency was phased in between 1999-2002 and, as a result, currencies like the franc, Deutschmark, peseta, lira and guilder ceased to be legal tender. As the EU expanded eastwards, more countries adopted the euro including Slovenia (2007), Slovakia (2009) and, more recently, Lithuania (2015). As of 2017, 19 EU member states (and several European micro states) use the euro. Seven other member states are due to join once they meet convergence criteria (outlined later).

The euro has….issues. The biggest one is the sovereign debt crisis affecting Greece in particular but also Portugal, Ireland, Italy and Spain (aka. PIIGS). All of them are members of the eurozone but as they’ve ceded monetary policy controls to the ECB – including a commitment to keep deficits within a reasonable limit – they were unable to use measures like currency devaluation or change to interest rates to deal with massive public spending deficits.

The result has been runaway unemployment and, in Greece, the near-collapse of its financial system and the rise of political extremism. Since then, all of the PIIGS except Greece have recovered and restored confidence. Arguments remain on: whether there can be a currency union without a formal political/fiscal union (i.e. common EU taxes, pension policies, bond issue)? Whether the euro zone will even survive in the longer-term? Whether there should be debt relief?

The Requirements

EU membership – Only full members of the EU are allowed to join the single currency, though the EU does have agreements with non-EU members (like the European microstates) to use the currency, and there’s nothing to prevent Wales adopting the euro as a substitute currency (Part III).

There are also four convergence criteria prospective eurozone members need to meet before they can join:

  1. Inflation Controls – Inflation will need to be no more than 1.5% higher than the three EU member states with the lowest inflation. At the start of 2017, the inflation rate in the eurozone was about 2%, and slightly lower in the UK. It’s unclear what impact Brexit would have on inflation, but if the value of the pound continues to fall then, under usual circumstances, that means inflation rises because you need more currency in circulation to pay for things.
  2. Deficit controls – Prospective eurozone members can’t run deficits higher than 3% of GVA, and a debt-to-GVA ratio of no more than 60%. At the moment the UK runs a deficit of ~5% and a debt ratio of 90.6%. The current figures for Wales are (within the UK) even worse, but in practical terms it means Wales running a public spending deficit of, based on Cardiff University figures from 2016 (pdf), no more than £1.85billion a year.
  3. Interest rate controls – Interest rates are not allowed to be more than 2% higher than the three EU member states with the lowest interest rates. At the moment, interest rates across the Western world are at their lowest recorded levels – including in the euro zone and the UK. It’s likely they’ll start to rise soon, but any move upwards in the eurozone is likely to be matched by the Bank of England.
  4. Membership of the ERM II for two years – Wales would still have to have an intermediate currency for several years before joining the euro. That would presumably be the pound – whether in a formal currency union (Part II) or as a substitute currency (Part III). In the case of the latter, Wales could also go down the Montenegrin route and adopt the euro unilaterally.

So on the face of it, Wales would be unable to meet the membership requirements for two reasons: the budget deficit and Brexit. I doubt the issue of EU membership will be returned to for a generation or more, if ever, but for the sake of argument let’s assume for a moment that it is.

At-a-Glance Assessment

  1. Autonomy – Despite the ECB being the central bank for the eurozone as a whole, Wales would still need to establish its own central bank as a “shareholder” in the ECB and to help formulate monetary policy for the eurozone. So we would have more autonomy than we would by keeping the pound, but the pressure to create a full fiscal union in the eurozone means that might not last in the long term.
  2. Convertibility – The euro is a free-floating currency (like most of the world’s) meaning, like the pound, its exchange rate is determined by market demand. Its value has historically been weaker than the pound which would certainly help Welsh exporters.
  3. Credibility – There are doubts mainly surrounding the necessity of a fiscal union but other than that there are no credibility issues at all. It’s one of the world’s foremost currencies and is here to stay despite what the right-wing press would have you believe.
  4. Stability – This is one of the big issues. Objectively, the euro is incredibly stable and has seen off most major threats, maintaining its value despite the sovereign debt crisis. Those tests remain in the form of Greece, the fiscal union debate, the threat of euro scepticism in other nations than the UK (particularly France).
  5. Foreign trade – Using a different currency to England would probably cause trade issues eastwards, but it would almost certainly boost trade with the eurozone, wider EU and – closer to home – the Republic of Ireland. As about 67% of Welsh exports go to the EU, joining the euro shouldn’t have any negative impact on foreign trade and might lead to more money staying in Wales if we use a different currency to England.
  6. Identity – Banknotes are designed centrally with “pan-European” themes, so no specific identity for individual euro zone members (though they’re marked with a national symbol). The coins, however, do have one face unique to each eurozone nation. Each eurozone member is responsible for minting their own coins and producing their own bank notes with numbers closely monitored by the ECB.
  7. Mobility – Obviously you would be able to use the euro in all eurozone member states, overseas territories etc. This would make going on holiday or a business trip to Spain, Germany or France much less hassle. However, having a different currency to England would mean changing currencies or doing business in different currencies, which would be an inconvenience but happens every day in Northern Ireland.
  8. Synchronicity of economic cycles – There’s a strong argument that the Welsh economy is nowhere near as synchronised with the eurozone as is it with England. There’s no EU-wide deposit protection scheme or banking union, for example, and because we’re physically and culturally attached to England, things like house prices and trade are more likely to fall in line there. However, the same could be said historically for Ireland too and they’ve managed to synchronise with the eurozone very quickly with minimal fuss. There shouldn’t be that much of a problem.

Key Advantages

Sharing a currency with (at the moment) our biggest export market – As mentioned, in 2016 just under 67% of Welsh exports went to the EU (though that’s different to the euro zone). Logically, adopting the same currency as the eurozone would at the very least maintain trade or boost it. Studies have shown that since adopting the euro, trade between eurozone members has increased by around 2% depending on the sector (pdf – p24). This will be down to price convergence across the eurozone (similar things will have similar values) and decreased barriers to trade.

Strength in numbers – The thing that arguably makes the eurozone seem “weak” or “vulnerable” – disparity between different nations and their fiscal policies – is perhaps its greatest strength. If you’re going to share a risk it’s far better to do so with as many partners as possible instead of tying yourself to a single big one. You also increase competition and inward investment from multiple directions, have more transparent prices and eliminate uncertainty over currency exchange rates.

The euro (generally) serves small countries well – The smaller members of the eurozone have generally done well out of it, particularly if their export-oriented and have an openness to trade, which is what Wales could be categorised as. Smaller countries – which might’ve have wildly fluctuating currency values and interest rates prior to adopting the euro – find it easier to trade and are also backed by the eurozone’s powerhouse economies like Germany, France, Spain, Netherlands etc. attracting more inward investment and driving up wages and the value of goods and services produced.

Key Disadvantages

Instability; there’ll have to be a fiscal union eventually – There are clear arguments for and against a fiscal union for the eurozone. It’s not a racing certainty it’ll happen but would mean in practice the prospect of single European taxes, banking regulations, a more formalised role for the European Commission as a “government” and most worryingly of all but unrelated….

Possibly two EU referendums – If Wales wanted to join the euro, we would need to rejoin the EU. It may have escaped your notice but Wales narrowly voted Leave in 2016. So not only would we have to go through all of the arguments over EU membership again, a few years after that we would (probably) also have to go through a referendum on ditching whatever currency we were using at the time to join the euro….and this would presumably happen not long after an independence referendum campaign. The political instability all these hotly-contested votes would cause could (potentially) irreversibly split Welsh society in a way that would make Brexiteers vs Remainers look like a playground scuffle.

For England, see Germany – If England dominates the “pound” (or would dominate any future “pound zone”), then there’s no question Germany anchors the “euro”. As it’s by far and away the largest economy in the single currency, economic shocks in Germany will ripple through the rest of the eurozone and EU. Germany has a reputation for balanced budgets and focus on exports. This is reflected in the ECB’s attitude to sovereign debt – the message from Germany to the rest of the EU is clear: “Don’t spend any money you don’t have”. This is far stricter than the UK’s traditional wastefulness when it comes to public borrowing – PFI and defence spending for example. Would Wales be able to meet the (unofficial) expectations of the Germans? In all likelihood, we’d be seen as a potential future Greece unless big changes were made.

Conclusion

It’s undoubted that Wales would presently fail to meet the convergence criteria to join the euro because of budget deficits and Brexit.

That doesn’t mean Wales couldn’t use the euro as a substitute currency (Part III) if, for whatever reason, we were unable to use the pound. Whether – once Wales’ economic situation improves – we revisit the idea of joining the eurozone (and, as a direct consequence, the EU) is a matter for future generations because I doubt it’ll happen in the lifetimes of everyone reading this.

So we can say with certainty: an independent Wales won’t join the euro, and probably won’t use it as a substitute currency either.

Part V considers the options should Wales establish our own currency “pegged” to a foreign currency.