Thursday 21 May 2020 9:23 am

Protecting the UK from the flaws of the Eurozone

The Eurozone is half-complete. 

Control over the euro currency is centralised, but member state financial arrangements are individualised, creating almost intolerable tensions. That much is well known. What is not so well known is how this set-up operates to the detriment of the UK in three crucial ways. First, the value of the euro is structurally depressed relative to the economies in the northern Eurozone as a result of the over-indebtedness of the southern countries. 

As a result, northern Eurozone exporters are dumping artificially low-priced products on the UK (and around the world), contravening WTO law rules on fair trade. Secondly, the Eurosystem makes available unlimited funding to any Eurozone buyer wanting to buy (predominantly northern) Eurozone products, unfairly subsidising Eurozone manufacturers. And thirdly, the entire set-up creates phenomenal financial risk through EU law’s misapplication of international regulatory rules, failing to recognise that because member states do not control the European Central Bank they are constantly at risk of defaulting on their debts. 

Yet EU law treats the debt of those states as being of sovereign quality, enabling the EU financial system to rely on it for collateral and liquidity purposes and to treat it as though it were riskless (like cash), leaving the risk of member state default unmanaged and exposing the monies of savers and investors. 

The underlying problem is the refusal by the northern Eurozone to assume liability for southern debt, paying for the zone from which they benefit so royally. 

This damages the UK economy by exposing it to unfair competition and the considerable expense of mitigating Eurozone financial risk. Indeed it is only the UK (not the EU or even the US) that addresses this risk, by imposing top-up capital requirements on UK-based banks, mitigating the risk’s impact in the location in which the EU meets the global markets but dampening our competitiveness.

Further borrowings to deal with Covid19 will only exacerbate the situation. The result is southern states may be driven to forced selloffs of their assets to other members or the EU itself – and the degradation of their state’s services leading to dangerously divisive discrepancies in power and wealth within the zone. Will these southern countries accept impoverishment, or will they resist, leading to steps that could end with the breakup of the euro?

It is impossible to forecast the answer to that question. For the UK, though, being outside the EU allows us the advantage of setting our own rules on trade and finance (as one of the only two genuinely global financial centres). It is essential that we protect ourselves from the unfair competition and avoid (as much as possible) any situation where we might be caught by the contagion of whatever negative consequences occur. How do we do that? There are three steps we can take that will help us avoid the worst parts of this calamity. 

First, the UK, citing the artificially lowered euro rate and Eurosystem subsidies, should apply WTO rules and levy tariffs on imports from Eurozone businesses, putting the Eurozone countries back in the position they should be in – without their unfair advantages. Importantly, now the UK has left the EU it is in the position of negotiating a rapid trade deal with the US, providing access to the world-level prices available by way of that vast market. That in turn would offset any negative effects of EU tariffs.  Such a US-UK deal would also pressure Eurozone exporters themselves to absorb the cost of the UK’s new tariffs, reducing their current exorbitant profits in order to cling onto some level of UK sales.

Secondly, the UK should protect itself from the Eurozone’s massive financial risk. The solution is for UK-based financial businesses to sell cross-border to their non-institutional customers in the EU, thus solely under the UK’s protective regime, whilst avoiding exposures to the EU’s risky financial system. Where EU law prevents this and requires services to be provided by EU-based financial middlemen, the UK will need to ensure its financial firms avoid exposure to, or reliance on, those middlemen, given the risk they create. EU financial firms wishing to operate on the ground in the UK should generally be required to do so through subsidiaries here, not through branches. 

Such steps would carry expense for EU businesses and consumers, increasing their cost of funds. However, were the EU to seek to act in its collective self-interest, ignoring the (doomed) aspirations of particular member states seeking to find individual advantage from Brexit, it would accept the UK’s offer for a continuation of the status quo in financial services, whereby the UK would continue to mitigate Eurozone risk. 

This would allow UK-based firms to service EU customers entirely cross-border, without EU middlemen and under UK law, and would be achieved through binding arrangements based on minor enhancements to the existing EU law concept of Equivalence, in the way I have set out. But, frankly, that would require a change in attitude by the EU.

Finally, the UK should avoid the application of any EU law, by replacing the temporary arrangements in the Withdrawal Agreement, including those that impose the EU’s state aid law on the UK. Covid19 has revealed how state aid law is used as an instrument of state, favouring the northern Eurozone, for whose benefit it has instantly been relaxed, and damaging others like the Greeks, whom it forced after the last crisis to sell assets (to northern Eurozone investors) at firesale prices. 

Furthermore, were that state aid law to continue to prevail in the UK, it would cause long-term damage by restricting the UK’s ability to counteract the unfair trading practices embedded in the Eurozone’s structure — particularly as and when the Eurozone’s financial problems explode. 

The UK can help the EU as a sovereign friend, but cannot continue with the EU’s unlevel playing field, nor with the Eurozone’s huge, unmanaged financial risk.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.