William Keegan

Pay nothing for your euros!' proclaimed the notice in the post office. At last, I thought, a free lunch.

But it was not to be. This was not, after all, an offer of free euros. Had it been so, we could all have forgiven the Post Office for renaming itself Consignia. But it was still offering '0 per cent commission on all foreign currencies - all the year round'.

The cost of changing currencies is frequently quoted as one of the reasons for joining the euro, but it is hardly the overwhelming issue, especially if organisations like the Post Office eliminate such transaction costs. It was partly to focus attention on more important issues that the Chancellor introduced his famous five economic tests. Yet empirical research suggests that the average intelligent person finds it almost as difficult to recite the five tests as to recall the details of the Schleswig-Holstein question of 1863-66.

So here they are, in the Treasury's own words, for you to cut out and keep. One: 'Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis?' Two: 'If problems emerge is there sufficient flexibility to deal with them?' Three: 'Would joining Emu create better conditions for firms making long-term decisions to invest in Britain?' Four: 'What impact would entry into Emu have on the competitive position of the UK's financial services industry, particularly the City's wholesale markets?' Five: 'In summary, will joining Emu promote higher growth, stability and a lasting increase in jobs?'

One of the oddities of the tests is that the only economic sector singled out for special treatment is 'financial services', giving ammunition to those who argue that this country tends historically to be run in the interests of the City, not of manufacturing industry. This calls to mind a story in Richard Roberts & David Kynaston's book City State - How The Markets Came to Rule Our World, (Profile). They tell how, when Paul Reichmann was considering developing Canary Wharf, his banker friends told him that London would continue to be Europe's premier financial capital because 'even the most left-wing government in the UK had always been more beneficial to the financial services industry than the most right- wing in the US'.

Many commentators seem to regard the five tests as being 'as long as a piece of string', without saying whether they measure them in yards or metres. Others regard them as a load of old rope.

The Treasury made it clear in 1997 that the first two were the key ones - the 'convergence' and 'flexibility' tests. These had not been met then. Why the Treasury kept the tests to five is a mystery - perhaps there was a cricketing analogy. My own sixth test is: 'Has the appropriate exchange rate been determined?' And, of course, the seventh test has to be 'Does it look as if a referendum can be won?' An eighth test is: 'Is the European Central Bank going to be reformed in such a way that submission to it can be recommended?' A ninth test is: 'Will there be an evolution towards sensible, coordinated fiscal policies throughout the Eurozone?' A final test is: 'Is the EU ready for the constitutional changes necessary to make it work - for them and us - in the long term?'

The exchange rate test is the sine qua non , and it was surprising that it did not figure directly in the Treasury's five tests. Which brings us to the reported statement by key Treasury official Gus O'Donnell: 'Economics can never be clear and unambiguous. Ultimately it will be a political decision'.

Of course it will. The significance of the reported comments was to blow away the fiction - which was public policy for more than four years - that the decision was economic. But it was Tony Blair, and not the Treasury, who stated that he would recommend entry (and therefore a referendum) only 'if the economic case for doing so is clear and unambiguous'. And it had been obvious for some time that any decent assessment would be unlikely to win the wholehearted approval of extremists on either side.

The Financial Times recently described the long-term economic judgment as striking 'the balance between the benefits of eliminating exchange rate risk' and the benefits of 'domestic monetary autonomy'.

It is worth noting how fashion has altered in five years: New Labour and the FT used to insist that British economic policy had little chance of autonomy in a globalised world; now it has become clear that Britain can indeed pursue domestic monetary autonomy if it so wishes.

The FT sees the question of 'the right exchange rate and how to get there' as a 'transitional problem'. But the right exchange rate is surely a vital longer-term consideration, too. At a seminar last week Lehman Brothers economists expressed the view that the greater the perceived political will to enter the euro, the more likely the markets were to bring the pound down from its current levels.

The ultimate bad joke would be if the markets, having kept sterling so crucifyingly high for so long, were to overreact and produce panic in the other direction. It should never be forgotten that those 'wise' markets took sterling from around $1.70 to $2.45 between the late 1970s and early 1980s, and then back down towards $1.00 in January 1986.

By 1990 the pound was averaging $1.79, and in 2000 its average daily rate was $1.52. Meanwhile the sterling/mark rate has ranged from 3.08 marks in 1989 to 2.26 in 1995 and back up to over 3.20 for most of 2000 and 2001. Even last week, at around 3.17, it was well above the exchange rate mechanism level of 2.95.

Now we all have to think in euros. My tip to readers is to remember that, for all the fuss about its 'weakness', the euro is close to 90 cents - not far short of a dollar. Thus, although fortunes can be won and lost on the finer differences, and business profits and losses hang on small margins, for tourists a rough-and-ready reckoner is now one and a half for both dollars (around $1.44 to the pound last week) and euros (around 1.62 to the pound last week).

Of course, if the financial markets became wildly pessimistic about the pound again, who knows - it could in theory head towards one dollar and one euro.

Even those of us who regard the pound as overvalued would not advocate quite such a change of sentiment, even if it made the mental arithmetic easy. In fact, the implications would be so inflationary that the Bank of England would be raising interest rates to stem the fall well before such a low exchange rate was in sight.

Adapted from Observer: Sunday January 13, 2002