Sterling crises can have rather the same feel. It is not yet clear whether the Government is in the eye of the storm, or whether the foreign exchange hurricane has passed on out to sea. My guess is that the Chancellor has now held the line until the French referendum on 20 September (and beyond, if the French vote 'Yes'). But if the French opinion polls begin to show a clear majority against the Maastricht treaty, or if the French vote 'No', British interest rates will have to go up to keep sterling within its ERM bands.
British politicians and industrialists have reacted to this prospect with dismay: a common response is: 'But this is precisely the sort of thing which our exchange rate mechanism membership was meant to stop.' However, it is arguable that we are indeed getting off more lightly than we might have done outside the ERM, as the two graphs suggest.
The first shows what happened to interest rates and the pound against the mark in 1985 and 1986, a period when Margaret Thatcher was Prime Minister and our ERM critics would have us believe that all was right with the world. After all, the pound was allowed to float and interest rates could therefore be tailored to suit our domestic needs. Naturally, they were kept very low to stop a rise in unemployment. (The jobless rate was going up rapidly then, as it is today). Right?
Wrong. There were two occasions in the space of little more than a year when the then Chancellor, Nigel Lawson, had to raise interest rates to stop a run on the pound. Despite the rise in unemployment, bank base rates went up from 10.5 per cent on 13 January 1985 to 14 per cent on 28 January. The interest rate rise was gradually unwound through the year, but Mr Lawson had to backtrack to 12.5 per cent in January 1986.
Both occasions qualified at the time as sterling crises, but they have not gone down in folk memory because the Government was not trying to defend a fixed rate (as in 1967) and did not have to call in the International Monetary Fund (as in 1977). But the point rests: the conflict between the high interest rates needed to stabilise sterling and the low rates needed to foster growth is not confined to our ERM membership.
Indeed, this crisis is surprisingly modest, even though we no longer have exchange controls and are running a balance of payments deficit (against a pounds 4bn surplus in 1985). The flurries of speculation have been beaten off with only pounds 500m or so of support-buying of the pound. Our three-month interest rates are still a mere 3/4 percentage point higher than Germany's, a scant premium against the risk that a French 'No' might lead to the mark rising against sterling. It is also low compared with our historical experience inside or outside the ERM, as the graph shows. The credibility that the ERM bestows is thus worth a good deal.
But surely, the critics cry, it would be folly not to devalue when the evidence is that we entered the ERM at too high a rate and we are running a payments deficit despite the depths of the recession hitting our appetite for imports? Eventually we will be forced to accept reality, as we were in 1967 with a 14 per cent devaluation.
This is an evocative argument for anyone who was educated in economics at the beginning of the 1970s, as I was. We thought we knew that it had been folly for the Labour government not to devalue straight away in 1964, rather than blight three years with an ultimately fruitless struggle. The clever left-wing dons said so: devaluation would allow more spending and import growth without imports outpacing exports. The clever right-wing dons also said so: you only had to target the money supply and let the market decide on the exchange rate.
It was only some years later, when writing a book with the wise Lord (Harold) Lever of Manchester - who was a Treasury minister at the time of the 1967 devaluation - that I was tutored in how strong the arguments against a devaluation were. As is the case today, we were gaining in cost and price competitiveness by means of a lower inflation rate than our trading partners.
Instead of exercising patience, we devalued a rate that had held since 1949. In so doing, we sent two clear signals. The first was to the financial markets: they could expect a British government to devalue again, which meant that the UK had to pay more to borrow money and became more prone to subsequent speculative attacks on sterling. We ran away once. Why should we be expected to fight?
The second message was to the labour market: employers and employees were told that if they behaved irresponsibly, the Government would nevertheless save them from pricing themselves out of world markets by reducing the value of the pound. Why behave responsibly when no one else was likely to do so? It was no wonder that during the oil shocks of the 1970s, the British economy combined some of the worst inflation with the slowest output growth and sterling crises. There is therefore a strong argument against a devaluation now that the Government has chosen an exchange rate, unless the rate is wildly inappropriate (as it was when we attempted to return to the Gold Standard in the 1920s). But today's evidence for overvaluation is not conclusive.
One way of assessing a reasonable value is to look at the exchange rate that would equate the average price of a basket of tradeable goods with a similar basket overseas - the so- called purchasing power parity.
Goldman Sachs, updating the Organisation for Economic Co-operation and Development's work, suggests that the pound is 7 per cent overvalued on this measure, but the pattern is interesting. The position is largely explained by a near 50 per cent overvaluation against the dollar, offset by a 7 per cent undervaluation against the mark, which is more important for our trade. Since the dollar is likely to correct itself at some point, the argument for changing the ERM rate looks weaker.
Another measure of a currency's fundamental value is the so-called FEER - fundamental equilibrium exchange rate. Developed by John Williamson, this concept uses computer models to try to calculate the exchange rate that would balance trade flows with long-term capital flows and allow the economy to reach full employment. It depends on the computer models used, but the National Institute model suggests that sterling is now about 10 per cent overvalued.
These figures do not justify a devaluation, but that does not mean we need merely wring our hands at the prospect of rising unemployment. As I have argued before and as the Japanese showed on Friday, the Government can and should introduce a fiscal package to aid the recovery. But we should not take the soft option on the pound or interest rates.