Why has no-one in the UK made the link between the introduction of the euro and the UK/European Credit Crunch?

Ten years ago in 1990, interest rates in the UK and across Continental Europe were fantastically divergent. Italy’s short term rates were approximately 18 per cent, France at 10 per cent, 15 per cent in Spain, Germany at 6 per cent and UK at 10 per cent. Six years later in 1996, governments had forced interest rates lower to align with Germany ahead of monetary union and stood at 9 per cent for Italy & Spain, 4 per cent for France and Germany and 6 per cent for the UK. During the same period, in America Fed Funds rates were approx 7 per cent in 1990 and 5.50 in 1999. The then Fed Chairman Alan Greenspan kept US rates low despite the booming asset prices. In October 2008 Greenspan apologised publicly for his error of judgement in the 1990s which created a “madcap” economic system in the mid 1990s.

Final convergence for all 6 founding member countries took place when the euro was introduced and the prevailing interest rate on 2 January 1999 was 3.25 per cent for 3 month Euribor (Euro Interbank Offered Rate). So, to recap: within nine years, in nominal terms rates had fallen by approximately 50 per cent for Italy, 60 per cent for France, 40 per cent for Spain 33 per cent for Germany and by osmosis 40 per cent for the UK – all with no obvious artfully engineered monetary policies in the respective national finance ministries and barely perceptible difference in the Christian Democrat profile of the continental governing classes.

The reason behind this incredible achievement was simple – the political strong-arming of these European governments hell-bent on qualifying for the Maastricht Criteria and inclusion in the euro. The scandalous tales of how EU governments cooked their books is well documented and eyes in Brussels turned blind and so remain.

Massive foreign direct investment ensued, stock markets boomed, house prices soared as did household debt levels. It seemed this ‘free’ money would continue indefinitely – and without watertight legal preconditions for structural reform. What a blessing! Alas, with this phoney low interest rate environment and declining real rates of return, it was right and proper for investment managers, investment banks and particularly Pension Funds trustees to seek out higher rates of return in alternative asset classes. It wasn’t sheer greed. It was sheer necessity.

So ‘structured products’ were developed and became the norm for higher yielding loan assets in which to invest. The traditional ratings agencies such as Moody’s and Standard & Poors were consulted for their analysis of all these highly complex structures and they in time awarded respectable credit ratings based, amongst other things, upon interest coverage ratios and the ability to redeem outstanding loans. And these colourful structured products proved very popular within segments of the investment community – indeed they proliferated. If you could earn 6 per cent plus annually for a loan with an investment credit rating when government bonds were yielding 3 per cent, it was money for old rope. Indeed it was. As every banker and stockbroker knows – rising prices bring buyers. And no-one remembered their parents’ warning to save for a rainy day.

Banks devised highly profitable assets to sell to hungry investors during this times, so everyone wins, everyone’s happy – especially the politicians.

Until the curtain fell. Which it now has – with a vengeance. The economies of the peripheral countries of the EU e.g. Greece and the Baltic States are facing systemic economic meltdown, not forgetting Ireland of course. Being a straitjacketed member of the euro has made things considerably worse. Had these countries only retained their sovereign currencies, they would have been free to exercise their national prerogative and set their own rates and devalue their currencies accordingly.

Europe and UK were not insulated from the US subprime fallout even though it eventually transpired that UK/ European exposure to domestic, subprime credits was far less than America but our crisis was made worse by the greater error of monetary union when interest rates were being push too low to suit ‘one size fits all’ by the European political elite. The message for eurozone countries is this – get out of the euro and revive your economy.