A secret member of the ERM?

Every current indicator of Britain's economy suggests sterling is pegged to the mark in preparation for a single currency
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Ever since the Government "withdrew" (or was it thrown out?) from the benighted Exchange Rate Mechanism in September 1992, the economy has blossomed. Every Chancellor and commentator has longed for the British economy to enjoy all the good things we seemed only to see in foreign parts. These were a steady non-inflationary growth, a downward trend in unemployment, export-led growth, moderate wage costs per unit of output, productivity growth, low interest rates, and even no great instability in exchange rates. At last these have been delivered.

Were these goodies simply the result of taking off the Deutschmark strait- jacket? Not entirely, but I think the release from the ERM constraints was perhaps the most important cause of the sustained recovery since 1992.

As an old opponent of the ERM and similar systems, I had published an article in this newspaper, in July 1988, in which I likened the ERM to a roller-coaster. I argued that the ERM, in which we had participated informally from February 1987, was largely responsible for the inflation that had then just appeared on the horizon but was all set to explode. This inflation would be followed inevitably by a massive squeeze, in 1989, to wring inflation out of the system, and so we would have a long recession. This view was condemned by the vast majority of the chattering classes, including professional economists. Indeed, the next day Sarah Hogg, then economics editor of this newspaper, roundly condemned my position and gave her unstinting support to the ERM as the linchpin of stability.

On the whole, however, my predictions of the effects of the ERM and, by implication, the benefits of getting out, have not been discredited by our recent history. But what of the future? Is it likely that we shall re-enter the ERM and have another go on the roller-coaster?

The Government's formal position is equivocal. The mainstream Maastricht conditions call for all those who wish to qualify for the monetary union bus to have been within the narrow (2.25 per cent) bands of the central rate of the ERM for two years (with effect from next July). With his admirable Gaullist-style insouciance, Mr Major negotiated an opt-out clause for Britain. So if the Government intends to invoke the opt-out there is no need for us to join the queue for another ride on the roller-coaster.

No need, perhaps, but will the Government really opt out? Will it stand firm against the emotional claptrap - the "fog-bound island, isolated from expanding Europe", "missing the bus of destiny", "odd man out", "monetary maverick", "little Englander", "subject to temptations in the absence of the discipline of Euro-institutions such as the European Central Bank", etc - that replaces reason and evidence?

A year or so ago I would have suggested that, notwithstanding the opt- out, Mr Major would effectively rejoin the ERM. This would not flow from any point of principle, but because he believed that the majority of the media and, perhaps, most businessmen, were solidly behind the idea of a single currency. Recently, however, opinion is turning against a single currency. From the oldest member, France, with its disastrous franc fort, to the new boy on the Euro-block, Sweden, the strictures and hardships of the strait-jacket are being questioned, increasingly by governments but above all by the people.

Opinion has, I believe, gone through a remarkable change. People have learnt that monetary union is not merely a matter of different banknotes and coin. It involves a massive shift of power out of the hands of the people into the bureaucracies of Brussels and Frankfurt. Even in its embryonic form in the ERM, monetary integration caused a great deal of pain. All over Europe people are beginning to realise that the actual birth of monetary union involves creating a political and fiscal union of immense dimensions.

Of course the Germans have always said that a monetary union must be in parallel with political union - with a concentration of power in the centralised federal parliament and government. Other governments in Europe, notably our own, have never squarely faced these implications. And Mr Major, unlike his predecessor, is not known for grasping nettles.

But this issue of Europe is central to the Government's economic policy and our participation in the Maastricht treaty. As I observe the signs, it seems to me that economic policy will be dominated by the Europhiles' anxiety to qualify for monetary union as a foundation member in 1999.

But, you may say, this cannot be, since one of the main conditions for joining the union is that the exchange rate has been in the narrow bands (2.25 per cent) for two years. And Britain is not in the ERM, so strictly speaking it cannot be a member. But Euro-rules are not made to be obeyed strictly. If Britain could demonstrate that for those years, and perhaps for some years previously, the exchange rate of sterling had been within a whisker of 2.2 marks, how could Britain conceivably be excluded merely on the formality of not being in the ERM? Any red- (or blue-) blooded Chancellor would simply point to this performance, rest his case and patiently await the invitation to the top table in Frankfurt.

I choose this example partly because one observes that sterling has been extraordinarily stable at around 2.2 to 2.3 marks for the past nine months. Of course, it may be just an accident - or perhaps even a reflection of those wonderful conversation-stoppers, "fundamentals" - that is to say deficits, debt, productivity growth, etc. But one's suspicions that sterling is de facto pegged to the German mark at 2.25 are surely aroused by the high interest-rate policy that has been pursued in spite of the evidence of low inflation, declining activity, high unemployment and so on.

Indeed the Governor of the Bank of England was arguing for increased interest rates during the summer - and such a policy would be quite consistent with the need to support sterling in the face of political uncertainty and the increasing probability of a high-spending Labour government. The Chancellor, on that occasion, demurred, partly because he knew that this would spell disaster at the polling booths. And no doubt in the upcoming Budget we shall see at least pounds 3bn of sweeteners scattered around to hold the waning loyalties of Tory constituents. But the British Budget is a minor matter compared with the underlying issue of the aggrandisement of Europe.

If, however, I am right in my conjecture, electoral high jinks aside, we are all much nearer to joining a monetary and political union than most people think. I do not know whether the people of Europe would want such a union. But I strongly believe that this momentous question should not be decided solely by politicians and bureaucrats, or even by prominent persons of one sort or another.

If ever there was a case for a referendum it is the issue of Europe. The people should decide.

Sir Alan Walters was economic adviser to Margaret Thatcher, 1981-89. He intends to stand as a Referendum Party candidate against the Chancellor, Kenneth Clarke, at the next general election.