Why the mark rose from less than a florin to nearly 50p

Sustained control of inflation has seen the German currency climb inexorably against Britain's. Diane Coyle reports
AT THE end of the Second World War, the pound would buy you more than 12 German marks. Fifty years on, it buys just DM2.27. And some forecasters believe it will not be much longer before we see the 50-pence deutschmark.

Sterling enjoyed a strong bounce at the end of last week, but history suggests it will be temporary. The pound has been in trouble since 1945, when ''funk money'' fled to South Africa to escape the depredations of the new Labour government.

It is more than jingoism to believe that this long-run decline against the currency of our biggest trading partner matters - although to listen to common business complaints you might not think so. A number of prominent German businessmen, particularly car exporters, have recently complained loudly about the strong mark. It has made their products more expensive overseas, forced them to squeeze profit margins and gnawed into their market share.

Meanwhile, British exporters whose goods have become cheaper abroad are whistling cheerfully about strong order books and the opportunity to enhance their margins. But as David McWilliams, an economist at UBS in London, puts it: ''If you could devalue your way to growth, Burkina Faso would be the richest country in the world.''

His Frankfurt colleague, Richard Reid, explains: ''A strong currency encourages companies to become constantly more innovative, more efficient and undertake top-quality investment.''

In Germany, he argues, the business community understands the value of using the exchange rate as a brace. Companies have developed products that sell on their quality and reliability rather than price.

British exchange-rate history, by contrast, is a sorry tale of using devaluations as a spade to tunnel out of the latest economic hole. A swift survey uncovers sterling crises in 1947, 1949, 1964-5, 1966-7, 1968, 1972, 1973, 1976, 1982-3, 1986 and 1992 - and perhaps 1995.

The main explanation of long-term exchange-rate trends is relative inflation rates. The ''purchasing power parity'' theory says that currencies adjust to keep the prices of tradeable goods in different countries roughly competitive.

It would be hard to find an economic indicator that had differed more widely between the two countries. In the 1960s, German inflation averaged 2.75 per cent and British 4 per cent; in the 1970s, it averaged 5.25 per cent versus 13 per cent in the UK; and in the 1980s, 2.75 per cent against 6 per cent.

Keith Edmonds, senior analyst at IBJ International, says: "The Germans just care more about monetary stability." Bitter memories of hyperinflation in the 1920s influenced monetary arrangements after the war.

Britain has tried pretty much every monetary system - from price controls through monetary targets and joining the ERM to today's system of targeting inflation directly. None, so far, has worked - the jury is out on the current arrangements.

The currency markets' view of British politicians is consequently harsh. Every new prime minister since exchange rates floated in 1973 has been greeted with a sharp fall in sterling - with the exception of John Major.

Economists' second explanation for exchange-rate trends is relative economic strength. A country with higher investment and productivity growth will see its currency appreciate. Germany's performance has surpassed Britain's since 1950.

Comments