Comment: Do not sound ERM death knell yet

It is probably a bit early to ask what will happen to the European exchange rate mechanism after it breaks up but, considering the speed at which the exchanges can move, it may be less early than many think.

There was talk at the weekend's Group of Seven discussions of a possible German interest rate cut on Thursday, but maybe it was naive to expect more comfort for those who would like the ERM to continue in its present form: there is no general interest among the G7 in sustaining European currency stability, particularly if it has increased the average level of EC interest rates.

Looking ahead, the balance of probability must be that there will be a further rebalancing of ERM parities in the next two or three months. The Danish krone and the Spanish peseta both look over- valued at current levels; the first because of the revaluation that in effect has taken place against the other Nordic currencies; the second because despite the devaluation of last autumn it looks at least 10 per cent overvalued on a purchasing power parity basis. And then there is the French franc.

The cases for and against a franc devaluation have been widely debated. But the academic arguments do not really matter very much if either the markets, or the centre-right coalition that will form the new government, perceive that France needs a devaluation. It is odds-on that the present franc/German mark parity will be broken before the summer is out. Considering the political commitment by France and Germany to that rate, the ERM in its present form will finally have died.


But only in its present form. There are at least three powerful reasons to be confident that some form of ERM will continue. Most important is the fact that the Continental European countries have run some form of currency union for most of the post-war period. After the Bretton Woods fixed exchange rate system finally broke down in 1972 there was a brief period of floating rates, but quite quickly the main EC currencies linked themselves together in the 'snake'. By the end of the decade, this had developed into the ERM. Continental Europe likes currencies to be anchored.

Second, considering the degree of integration of the EC economies, there is a practical reason for trying to do so. For a small EC country close to Germany -

Belgium or the Netherlands - to sell any product to a customer more than 150 miles away will involve a foreign currency transaction. It is as though London was a foreign market to a Manchester-based producer. So the proportion of GDP exported by, say, the Netherlands, is vastly higher than that of France, Germany or Britain, simply because of distances.

Third, whatever happens on the exchanges, the ERM technically continues and, under the Maastricht treaty, develops at the end of this year into stage two of monetary union. The European Monetary Institute, the precursor of a European system of central banks, will be operational. Whether or not one believes that stage three, the move to the single currency, will ever happen, the fact remains that the institution designed to pave the way for a single currency will exist. This is less than a year away.

Let's assume then that the ERM does indeed break up in its present form: what then is likely to happen? In the short run, the existing arrangements of the ERM will continue; the French franc will get a new parity; perhaps the Italian lira will rejoin; and the smaller currencies will be reshuffled. It is just conceivable that sterling will rejoin, though few people expect it. The result will be a new set of ERM parities, which should be credible to the foreign exchanges for some time - 18 months at least.


This calm will give the European Monetary Institute a breathing space to build its influence. It will be helped by the low level of inflation throughout the industrial world, for both the cyclical and the underlying trend of inflation will be firmly downwards for at least three years. The institute's principal mission is to promote price stability, something that is easier to do when price rises seem to be subsiding anyway.

The institute will also be helped by the memory of ERM tensions. If the franc is devalued, that will weaken the influence of the Bank of France and the Bundesbank, just as the devaluation of sterling has weakened the influence of the Bank of England and the Treasury. It is hard to guess at the power of a body that does not yet exist, but if the new institute developed a reputation for being right, it could become very powerful. Something of the Bundesbank's role as custodian of European monetary order could pass to it. It has, under the Maastricht treaty, some technical powers in administering the ERM. By astute public relations, it could develop considerable authority.

It is important to remember that a year from now the European economic scene will look very different. Germany will have just finished a year of recession; France may well have seen recession and certainly will have experienced very little growth.

By contrast, the UK economy will have had a year of reasonable progress, perhaps becoming the fastest-growing of the European countries. If this can be achieved without serious inflationary pressures, it ought to give Britain rather more influence in the new institute than it has at present at EC finance ministers' meetings.

So there will not only be a new power- centre in the EC; it will be one where the influence will be better balanced than it is now in Brussels. The European Monetary Institute may find that it does not take on the task of building a common European currency, because that will become politically unacceptable. But it may prosper in its interim role as manager of a European currency zone. The lower world inflation, (and hence world interest rates) the easier it will be to manage a semi-fixed exchange rate system, for exchange rate changes are largely needed because of differential inflation rates.

It often happens that institutions formed for one purpose end up taking on another. The Bank for International Settlements, in Basle, was originally set up to handle German war debts after the First World War. The Gatt secretariat in Geneva was an interim body, which was supposed to develop into an international trade organisation alongside the IMF and World Bank.

And so it may be with the European Monetary Institute: it may become a much more important body than envisaged. But meanwhile, whatever happens to the ERM in the coming months, European currency links will continue in some form or other. Do not write off the ERM.

Start your day with The Independent, sign up for daily news emails
ebooksA celebration of British elections
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Claims Administrator

£16000 - £18500 per annum: Recruitment Genius: This is an excellent opportunit...

Recruitment Genius: Senior SEO Executive

£24000 - £28000 per annum: Recruitment Genius: A Senior SEO Executive is requi...

Recruitment Genius: Online Customer Service Administrator

£16000 - £18000 per annum: Recruitment Genius: An Online customer Service Admi...

Recruitment Genius: Digital Marketing Executive

£18000 - £22000 per annum: Recruitment Genius: This global, industry leading, ...

Day In a Page

Fishing for votes with Nigel Farage: The Ukip leader shows how he can work an audience as he casts his line to the disaffected of Grimsby

Fishing is on Nigel Farage's mind

Ukip leader casts a line to the disaffected
Who is bombing whom in the Middle East? It's amazing they don't all hit each other

Who is bombing whom in the Middle East?

Robert Fisk untangles the countries and factions
China's influence on fashion: At the top of the game both creatively and commercially

China's influence on fashion

At the top of the game both creatively and commercially
Lord O’Donnell: Former cabinet secretary on the election and life away from the levers of power

The man known as GOD has a reputation for getting the job done

Lord O'Donnell's three principles of rule
Rainbow shades: It's all bright on the night

Rainbow shades

It's all bright on the night
'It was first time I had ever tasted chocolate. I kept a piece, and when Amsterdam was liberated, I gave it to the first Allied soldier I saw'

Bread from heaven

Dutch survivors thank RAF for World War II drop that saved millions
Britain will be 'run for the wealthy and powerful' if Tories retain power - Labour

How 'the Axe' helped Labour

UK will be 'run for the wealthy and powerful' if Tories retain power
Rare and exclusive video shows the horrific price paid by activists for challenging the rule of jihadist extremists in Syria

The price to be paid for challenging the rule of extremists

A revolution now 'consuming its own children'
Welcome to the world of Megagames

Welcome to the world of Megagames

300 players take part in Watch the Skies! board game in London
'Nymphomaniac' actress reveals what it was really like to star in one of the most explicit films ever

Charlotte Gainsbourg on 'Nymphomaniac'

Starring in one of the most explicit films ever
Robert Fisk in Abu Dhabi: The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers

Robert Fisk in Abu Dhabi

The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers
Vince Cable interview: Charging fees for employment tribunals was 'a very bad move'

Vince Cable exclusive interview

Charging fees for employment tribunals was 'a very bad move'
Iwan Rheon interview: Game of Thrones star returns to his Welsh roots to record debut album

Iwan Rheon is returning to his Welsh roots

Rheon is best known for his role as the Bastard of Bolton. It's gruelling playing a sadistic torturer, he tells Craig McLean, but it hasn't stopped him recording an album of Welsh psychedelia
Russell Brand's interview with Ed Miliband has got everyone talking about The Trews

Everyone is talking about The Trews

Russell Brand's 'true news' videos attract millions of viewers. But today's 'Milibrand' interview introduced his resolutely amateurish style to a whole new crowd
Morne Hardenberg interview: Cameraman for BBC's upcoming show Shark on filming the ocean's most dangerous predator

It's time for my close-up

Meet the man who films great whites for a living