Column: A British Europe

Written by Hugo Dixon | Updated: May 31 2013, 06:32am hrs
Cameron and Draghi should make common cause on FTAs and enhance role of Londons capital markets in Europe

When Mario Draghi was appointed President of the European Central Bank (ECB), the German tabloid Bild gave him a Prussian helmet because it admired his Teutonic anti-inflation credentials. The Sun, Bilds British equivalent, should give him keys to the City of London because of his pro-market credentials.

Draghi likes London. The Italian still has a flat in the city, kept from his time as a Goldman Sachs banker. He is a man with a natural affinity for the markets.

Last week Draghi was in London, the scene of his July 2012 promise to do whatever it takes to preserve the euro. The ECB Presidents message this time was that Europe needs a more European UK as much as the UK needs a more British Europe.

He was careful not to wade directly into the British political swamp and say, for example, that the UK would be crazy to quit the European Union. He confined himself to listing the ways in which Britains economy, and the City in particular, are entwined with the eurozone. But it seems clear that he would prefer the UK to get stuck into Europe than stay on the sidelines (where it has been since Britain decided not to join the euro) let alone quit entirely.

Draghi didnt say what he meant by a more British Europe. But it is interesting to speculate what the eurozone would be like if the UK had decided to join the single currency. For a start, the zones monetary policy would probably have been less German-dominatedand, hence, less obsessed with fighting inflation to the exclusion of other economic objectives.

The ECB has, of course, still managed to innovatein particular, with its bond-buying plan which has taken some of the sting out of the crisis. But it always has to watch its back, given criticism from Germanys Bundesbank and challenges in the countrys constitutional court.

A more British Europe might also now find it easier to adopt a sensible macroprudential policy for managing the flow of credit around the financial system. One of the zones little noticed potential design flaws is a Germanic insistence on Chinese Walls between bank supervision and the conduct of monetary policy, even though both will come under the ECBs aegis.

While such separation makes sense insofar as the supervision of individual banks is concerned, it could be problematic for macroprudential supervision. Take the current situation. With inflation low, the ECB should be pushing interest rates into negative territory or buying government bonds. The snag is that, while such a monetary policy would be right for the eurozone on average, it would be too loose for Germany.

The sensible approach would be to counterbalance such one-size-fits-all monetary policy with tight credit policy focussed on Germany, implemented via extra high bank capital requirements there. Maybe the ECB will eventually get round to such a rational policy mix. But it would be easier if it could operate like the Bank of England, which doesnt have Chinese Walls.

The zones banking system would also, arguably, be in a better shape if it was more British. This is not to deny the UKs massive banking crisis. The point rather is that Britain has done a fairly good job of cleaning up the mess, while the zone has tended to sweep problems under the carpetwhich has debilitated parts of the economy.

The ECB does have a chance to remedy this error. It has already insisted on a rigorous review of bank loan books and a stress test of their solvency before it takes responsibility for supervising them next year. It now needs to get governments to agree to wind down or recapitalise any banks that fail the test.

Another area where a more British Europe might have been beneficial would have been in shooting down the planned Financial Transactions Taxwhich will gum up the markets, in the process disrupting the ECBs monetary policy. Maybe the FTT will prove still-born anyway given lukewarm support from Germany. But this is not guaranteed.

The same goes for the management of the Cyprus crisis, where the somewhat anti-market European Commission insisted on imposing capital controls against the ECBs advice. Again, it may not be too late to mitigate the damage. The controls could, and should, be lifted when the resolution of the countrys two big banks is finished. But it would have been better not to have imposed them in the first place.

To some extent, such speculations are academic. Britain hasnt joined the euro and wont for a long time, if ever. But there are still two main ways in which a more engaged Britain could advance not only its economic interests in Europe, but Europes too.

First, David Camerons push for more competitive marketsprincipally by extending the single market to services and by signing free trade agreements with the United States and Japancould play a role in solving the euro crisis.

Second, the UK could campaign for an enhanced role for Londons capital markets in Europe. The EUs bankcentricityunder which finance is mostly routed through a semi-broken banking system rather than the marketswill be a drag on growth.

Cameron and Draghi should make common cause on such an agenda. Thats a practical way to make the UK more European and Europe more British.

The author is Editor-at-Large, Reuters News