Misplaced fears over competitive devaluations

COMMENT: `Any suggestion that the outs should be forced to fix their currencies within narrow bands against the euro, with punishments for those who fail to comply, is simply outrageous'

Opponents of economic and monetary union have frequently warned that the premature arrival of a single currency could threaten the unity of the EU. Although these warnings are usually expressed in hyperbolic language, and stem from sources who will seek any opportunity to throw sand in the wheels of integration, they cannot be entirely dismissed. The creation of two separate monetary clubs within a single economic space has never been tried before, and may give rise to problems which will seriously undermine the political coherence of the EU.

Never has this risk been clearer than at the weekend, when finance ministers in Verona started to grapple with the problem of the ``ins and out''. The future EMU ins (notably France but also Germany) apparently agreed to impose a regime on the future outs (notably the UK, but also Italy, Spain and Scandinavia) that Britain sees as unnecessary, authoritarian and unworkable.

This problem was not foreseen when the Maastricht Treaty was drafted, since the belief then was that most countries would be in from the start, or at least that they would mostly be on a smooth glide path to imminent entry. The idea that the outs may be a semi-permanent club, representing at least half of the EU's GDP, only began to dawn last year, and even then the problem would have been largely ignored were it not for the fact that the economic performance of the outs was temporarily rather better than that of the ins. The ins decided that this must be stopped.

Their thinking is this. Membership of the single economic space confers huge advantages in terms of market access, free trade and potential economies of scale. But it also requires certain obligations to be accepted by all. These obligations, according to the ins, involve not only a common regulatory framework and free capital movements,but extend also to the behaviour of the exchange rate. The outs must not be allowed to indulge in ``competitive devaluations'' which bring them an ``unfair'' advantage in the single market.

This means that a new ERM mechanism (``ERM 2'') must be agreed, with the outs accepting that their exchange rates must be directly linked to the euro. There is talk of imposing fines or exclusions from the single market on countries which fail to comply with this obligation. Furthermore, according to Bundesbank president Hans Tietmeyer, the onus for keeping the exchange rates within their new bands against the euro should rest explicitly on the outs, since otherwise the new European Central Bank would have to accept a duty to prop up weak currencies, which could prove inflationary for the ins. In addition, he suggested that the initiation of changes in central parities should come not from the governments concerned, but from a ``supranational authority'', namely the head of the ECB.

Quite apart from inflaming British concerns about national sovereignty, there have been questions about whether any of this is legal. The UK has argued that access to the single market is an inalienable right of all member states, regardless of exchange rate relationships. But the French and others have pointed out that Article 109m of the Maastricht Treaty states that ``each member state shall treat its exchange rate policy as a matter of common interest'', and they claim that this gives legitimacy to their calls for an ERM 2.

The British are surely right about this, but in any case this is not a matter which can be settled in the law courts.The key questions are whether the ins have an economic case, and whether they are strong enough politically to impose their wishes on the outs. On both counts, the outs are on strong ground.

To start with the economics, there is something very odd about the position being adopted by the ins. Here is a group of countries, which conspicuously failed to make ERM 1 work in 1992/93, now seeking to impose ERM 2 on a completely different set of countries. What is more, the ins are simultaneously managing to argue that it is in their own vital interests to give up the right to devalue their currencies, while also maintaining that other countries will secure great national advantage by ``competitively'' devaluing against them. Surely both cannot be true.

Admittedly, this line of argument has been encouraged by the tide of events following the break-up of ERM 1 in 1992. Since then, competitiveness changes triggered by exchange rate devaluations have ``stuck'' for much longer than usual, in the sense that they have not been simply washed away by higher inflation in devaluing countries like the UK and Italy.

This is very unusual by past historical standards, but it will probably prove to be either temporary or an unrepeatable fluke. We have already seen a large rise in the lira this year, eroding much of Italy's earlier competitive gains, while sterling never moved far out of line with its fundamental equilibrium, at least as estimated by Goldman Sachs (see graph). So the old rule that changes in nominal exchange rates within Europe cannot bring about permanent changes in real competitiveness probably still applies.

And in any case, the outs are not staying out because they want to retain the right to devalue. Most will be committed to joining the single currency as soon as they attain the convergence criteria and are allowed in. Competitive devaluations will be the last thing on the minds of these countries.

Britain is in a different situation since, at least under the Tories, this country could well become a permanent out. But the important reason for staying out is not to enjoy the right to devalue the currency on a continuous basis. Instead, it is to maintain the right to adjust monetary policy independently of that being followed on the Continent. Certainly, this may involve the exchange rate going up or down for short periods as interest rates vary in response to economic shocks, but that is very different from seeking a permanent competitive gain from devaluation, even if it were possible.

There is no recent instance of a large nation, never mind the UK, deliberately engaging in a competitive devaluation in order steal export orders from its neighbours. Nor would the suggested ERM 2, at least with narrow bands, be at all likely to work in practice. Unlike ERM 1, where there was in principle a commitment from all countries to intervene as necessary to maintain the bands, the idea now is for the entire onus to be placed on the outs. Since it is obvious from the outset that the UK, among others, does not have the political will to maintain the bands, such a system would be a sitting duck for the currency speculators.

Perhaps something like the present ERM - with theoretical 15 per cent bands that nobody takes very seriously - would be just about an acceptable, though cynical, compromise to keep the ins happy. But any suggestion that the outs should be forced to fix their currencies within narrow bands against the euro, with punishments for those which fail to comply, and with no support from the ins, is simply outrageous. For once, the British government would be fully justified in using its veto to stop this.

Start your day with The Independent, sign up for daily news emails
ebooksAn introduction to the ground rules of British democracy
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

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45K: SThree: SThree were established in 1986....

Recruitment Genius: Compliance Manager

£40000 - £60000 per annum: Recruitment Genius: A Compliance Manager is require...

SThree: Talent Acquisition Consultant

£22500 - £27000 per annum + OTE £45K: SThree: Since our inception in 1986, STh...

Recruitment Genius: Experienced Financial Advisers and Paraplanners

Negotiable: Recruitment Genius: This extremely successful and well-established...

Day In a Page

Seifeddine Rezgui: What motivated a shy student to kill 38 holidaymakers in Tunisia?

Making of a killer

What motivated a shy student to kill 38 holidaymakers in Tunisia?
UK Heatwave: Temperatures on the tube are going to exceed the legal limit for transporting cattle

Just when you thought your commute couldn't get any worse...

Heatwave will see temperatures on the Tube exceed legal limit for transporting cattle
Exclusive - The Real Stories of Migrant Britain: Swapping Bucharest for London

The Real Stories of Migrant Britain

Meet the man who swapped Romania for the UK in a bid to provide for his family, only to discover that the home he left behind wasn't quite what it seemed
Cheaper energy on the way, but it's not all sunshine and rainbows

Cheaper energy on the way, but it's not all sunshine and rainbows

Solar power will help bring down electricity prices over the next five years, according to a new report. But it’s cheap imports of ‘dirty power’ that will lower them the most
Katy Perry prevented from buying California convent for $14.5m after nuns sell to local businesswoman instead

No grace of God for Katy Perry as sisters act to stop her buying convent

Archdiocese sues nuns who turned down star’s $14.5m because they don’t approve of her
Ajmer: The ancient Indian metropolis chosen to be a 'smart city' where residents would just be happy to have power and running water

Residents just want water and power in a city chosen to be a ‘smart’ metropolis

The Indian Government has launched an ambitious plan to transform 100 of its crumbling cities
Michael Fassbender in 'Macbeth': The Scottish play on film, from Welles to Cheggers

Something wicked?

Films of Macbeth don’t always end well - just ask Orson Welles... and Keith Chegwin
10 best sun creams for body

10 best sun creams for body

Make sure you’re protected from head to toe in the heatwave
Wimbledon 2015: Nick Bollettieri - Milos Raonic has ability to get to the top but he must learn to handle pressure in big games

Nick Bollettieri's Wimbledon files

Milos Raonic has ability to get to the top but he must learn to handle pressure in big games
Women's World Cup 2015: How England's semi-final success could do wonders for both sexes

There is more than a shiny trophy to be won by England’s World Cup women

The success of the decidedly non-famous females wearing the Three Lions could do wonders for a ‘man’s game’ riddled with cynicism and greed
How to stop an asteroid hitting Earth: Would people co-operate to face down a global peril?

How to stop an asteroid hitting Earth

Would people cooperate to face a global peril?
Just one day to find €1.6bn: Greece edges nearer euro exit

One day to find €1.6bn

Greece is edging inexorably towards an exit from the euro
New 'Iron Man' augmented reality technology could help surgeons and firefighters, say scientists

'Iron Man' augmented reality technology could become reality

Holographic projections would provide extra information on objects in a person's visual field in real time
Sugary drinks 'are killing 184,000 adults around the world every year'

Sugary drinks are killing 184,000 adults around the world every year

The drinks that should be eliminated from people's diets
Pride of Place: Historians map out untold LGBT histories of locations throughout UK

Historians map out untold LGBT histories

Public are being asked to help improve the map