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
football This was Kane’s night, even if he played just a small part of it
travel Dreamland Margate, Britain’s oldest amusement park, is set to reopen
Founders James Brown and Tim Southwell with a mock-up of the first ever ‘Loaded’ magazine in 1994
Threlfall says: 'I am a guardian of the reality keys. I think I drive directors nuts'
voices The group has just unveiled a billion dollar plan to help nurse the British countryside back to health
The Westgate, a gay pub in the centre of Gloucester which played host to drag queens, has closed
ebooksA special investigation by Andy McSmith
  • 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: Retirement Coordinator - Financial Services

Negotiable: Recruitment Genius: To provide a prompt, friendly and efficient se...

Recruitment Genius: Annuities / Pensions Administrator

Negotiable: Recruitment Genius: You will be the first point of contact for all...

Ashdown Group: HR, Payroll & Benefits Officer - Altrincham - up to £24,000.

£18000 - £24000 per annum + benefits: Ashdown Group: HR, Payroll & Benefits Of...

Ashdown Group: Learning and Development Programme Manager

£35000 - £38000 per annum + benefits : Ashdown Group: A highly successful, int...

Day In a Page

The saffron censorship that governs India: Why national pride and religious sentiment trump freedom of expression

The saffron censorship that governs India

Zareer Masani reveals why national pride and religious sentiment trump freedom of expression
Prince Charles' 'black spider' letters to be published 'within weeks'

Prince Charles' 'black spider' letters to be published 'within weeks'

Supreme Court rules Dominic Grieve's ministerial veto was invalid
Distressed Zayn Malik fans are cutting themselves - how did fandom get so dark?

How did fandom get so dark?

Grief over Zayn Malik's exit from One Direction seemed amusing until stories of mass 'cutting' emerged. Experts tell Gillian Orr the distress is real, and the girls need support
The galaxy collisions that shed light on unseen parallel Universe

The cosmic collisions that have shed light on unseen parallel Universe

Dark matter study gives scientists insight into mystery of space
The Swedes are adding a gender-neutral pronoun to their dictionary

Swedes introduce gender-neutral pronoun

Why, asks Simon Usborne, must English still struggle awkwardly with the likes of 's/he' and 'they'?
Disney's mega money-making formula: 'Human' remakes of cartoon classics are part of a lucrative, long-term creative plan

Disney's mega money-making formula

'Human' remakes of cartoon classics are part of a lucrative, long-term creative plan
Lobster has gone mainstream with supermarket bargains for £10 or less - but is it any good?

Lobster has gone mainstream

Anthea Gerrie, raised on meaty specimens from the waters around Maine, reveals how to cook up an affordable feast
Easter 2015: 14 best decorations

14 best Easter decorations

Get into the Easter spirit with our pick of accessories, ornaments and tableware
Paul Scholes column: Gareth Bale would be a perfect fit at Manchester United and could turn them into serious title contenders next season

Paul Scholes column

Gareth Bale would be a perfect fit at Manchester United and could turn them into serious title contenders next season
Inside the Kansas greenhouses where Monsanto is 'playing God' with the future of the planet

The future of GM

The greenhouses where Monsanto 'plays God' with the future of the planet
Britain's mild winters could be numbered: why global warming is leaving UK chillier

Britain's mild winters could be numbered

Gulf Stream is slowing down faster than ever, scientists say
Government gives £250,000 to Independent appeal

Government gives £250,000 to Independent appeal

Donation brings total raised by Homeless Veterans campaign to at least £1.25m
Oh dear, the most borrowed book at Bank of England library doesn't inspire confidence

The most borrowed book at Bank of England library? Oh dear

The book's fifth edition is used for Edexcel exams
Cowslips vs honeysuckle: The hunt for the UK’s favourite wildflower

Cowslips vs honeysuckle

It's the hunt for UK’s favourite wildflower
Child abuse scandal: Did a botched blackmail attempt by South African intelligence help Cyril Smith escape justice?

Did a botched blackmail attempt help Cyril Smith escape justice?

A fresh twist reveals the Liberal MP was targeted by the notorious South African intelligence agency Boss