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Monday 20 February 1995
It will erode sovereignty, but it's inevitable
Politicians are spilling blood over the decision to join a single European currency. The question, though, is not whether, but how and when Whether or not you favour a common EC currency, what is certain is that Europe is not yet financially stable enough
Kenneth Clarke argued the other day, in a speech that still loudly reverberates, that it was possible for Britain to join a European currency without sacrificing much sovereignty, and without taking a "huge step on the path to a federal Europe". He is logically wrong on both counts. But the practical significance of his mistake is dwindling to the point where he is right to favour a single European currency.
Mr Clarke claimed that Britain had pegged the pound sterling to gold for many years, and subsequently pegged it to the dollar, under the Bretton Woods agreement, without loss of sovereignty. He forgot that sovereignty is the authority of a nation to make choices - even futile ones - not the possession of power. Britain chose to adhere to the gold standard, chose to exploit it to pay for the First World War, chose disastrously to pretend it had not, suffered dire unemployment as a result until it chose a lower standard, financed another war and finally chose to link sterling to the dollar (which then proceeded to go through similar delusions of grandeur itself).
Sovereignty includes the right of a government to fly in the face of reality. Most of the time that right is not worth much. Under normal conditions, political leaders are probably best deprived of tempting options that amount to promises of a free lunch. How reassuring, to offer a whimsical example, that the Conservative government cannot devalue the foot, as a painless way of increasing both its stature and the distance between Britain and the Continent. The foot remains pegged to Napoleon's dastardly metre, and not even George Soros can do anything about it.
But, in extremis, the sovereign right to suspend reality comes into its own. Going to war is the ultimate exercise of sovereignty, one that can require a total mobilisation of a country's resources. The right of a government to issue and debase its own legal tender then becomes a crucial weapon. Seignorage (the revenues from printing money), debasement of that money, and legal tender (the obligation on traders to accept the result), make a powerful trio in war. They offer an unblockable way of drawing upon people's savings and buying their labour for very little.
The scenario may be extreme, but the underlying truth is telling. When and if European countries link currencies and throw away the key, they will, for good or ill, be greatly reducing their individual ability to wage total war. Few things are, at the ragged edge, more sovereignty- sapping than that.
For a less cataclysmic example, take Germany at the time of its unification. Unsure of the future friendliness of Russia, Chancellor Helmut Kohl wanted to sew up the economic merger with East Germany fast. Overriding the Bundesbank, he announced that the D-mark was worth an ostmark. This was lousy economics but a clear exercise of monetary sovereignty. Mr Kohl would have gone purple with frustration had he had to haggle for a valuation of the ostmark in ecus in the European Council of Ministers, and then watch the council persuade the governors of a European central bank to oblige. You may think it would have been better for the rest of Europe had he done so, but you cannot claim Kohl made no use of monetary sovereignty.
What about Mr Clarke's other claim: that one currency need not be a big step towards Euro-federalism? This could be true, but under one hugely demanding condition. If European nation states independently tax, spend and borrow in a common currency, everybody will have to accept that states may mismanage themselves into default, not just on foreign creditors in someone else's currency - like Latin American debtors unable to repay dollars to international banks - but on their own citizens and in their own legal tender. As in the example of war, they will no longer have the option of quietly devaluing their obligations to their own people.
There are precedents. Britain overtly defaulted to holders of its War Loan in 1931, partly because it had struggled to maintain the gold value of sterling. But it is a politically perilous situation, to put it mildly. The turmoil following a large-scale internal default by a European government would put intense pressure on Europe's collective non-government to bail it out as though it were the central government of a superstate. The Bundesbank knows this. It is worried stiff that a financial basket-case such as Italy will glibly denominate its debts in Euro-marks in the implicit expectation that its insolvency will be everybody's problem. That is why the Bundesbank is such a stickler for the "Maastricht conditions" for monetary union.
More of Italy in a minute. Note, so far, two unpalatable truths about monetary union that will have a Europhobe grinning happily. The right to print legal tender is an arch-ingredient of sovereignty when it most matters. And the need to accept an externally managed coinage could demand incredible hard-heartedness from the European authorities that issued it, or else succour from something close to a supranational government.
At the next unpalatable truth, however, the Europhobic smiles fade. The practical value of that monetary sovereignty is fast dwindling, and the obligation of financial solidarity between neighbouring countries is fast growing, whether politicians decide to opt for an EMU or not. This is not because of the automatic Maastricht timetable, but because of what the European Single Market has already achieved in allowing European savings to flow unhindered across frontiers.
These savings are ever less constrained to put their faith in their home currencies. The flow of capital across Europe means the financial markets are constantly judging European governments on the way they run their monetary policies, and charging them high interest for any prospect of inflation or devaluation.
There is a fashion for independent central banks in western Europe. This is not just because of high-minded rigour in Paris or Westminster, but because investors now penalise a currency run by politicians. It is expensive not to have an independent central bank these days, and the only way such a central bank can calm the ups and downs of its currency is to co-operate ever more closely with its colleagues - in other words, to work more with them as a single central bank.
Even without monetary union, Italy is courting internal default. It is already declaring itself unable to pay internal pension obligations. To service and roll-over Italy's existing debt, the government must raise money this year equivalent to half the country's annual GDP; this gross borrowing requirement will peak at 87 per cent of monthly GDP in March. Lombard Street Research, headed by Tim Congdon, is now openly wondering whether Italy will become the next Mexico in the financial markets. The parallel is telling: it has not required a currency union, only a free-trade area, to make Mexico's financial problem become the United States' financial problem.
So the practical utility of monetary sovereignty is steadily dwindling: the in extremis when it matters is becoming ever more extreme. Pan-European enterprises proliferate, running their books in some increasingly arbitrary currency, while their sales are denominated in many moneys. Europe's more mobile consumers, paying with plastic, float through this multi- currency market, unclear of what anything has actually cost them until they see their bank statements. The lack of one European money is going to become steadily more archaic and the question is not whether, but how and when, money joins the growing realm of governance that naturally takes place above the level of the nation state.
This tidal force does not mean the decision on monetary union will make itself. National currencies are clingy, even hopelessly managed ones. The status of legal tender, plus the denomination of tax returns, holds a home currency in place. It is the flip-side of the home currency's sovereign significance that it can be removed only by political fiat. And there is a whole raft of truths that will slow that process down.
The Maastricht treaty had a good stab at pre-ordaining the political decision. The monetary part of it is meant to function like a cuckoo clock that will pop out an ecu when the gears are in the right position. Yet the gears are loose and the nature of what will pop out has not yet even been defined. Salomon Brothers has printed an excellent aide memoire on exactly what the Maastricht treaty says about the conditions for monetary union. It shows how much scope Europe's finance ministers have to bend the ratios. Anyone who is depending on Maastricht's automatic pilot to stop, or push through, monetary union ought to read that fine print.
Even on the all-important Bonn-Paris axis, the political decision is far from pre-ordained. The German parliament has said it wants another say on the matter. The German public is, according to a recent poll in the Financial Times, against the idea. Hans Tietmeyer, head of the Bundesbank, has been playing a connoisseur's game of constructive scepticism. He has emphasised repeatedly how stiff the interpretation of the Maastricht conditions ought to be, and how great the political responsibilities that accompany monetary union will be. And now he is adding rigidity in the French and German labour markets as something that ought to be put right before the great step is taken. Lastly, there is his and the German public's disdain for the ecu: "a basket of European currencies that has lost one-third of its value against the D-mark over the past 20 years".
The prospect for a rapid union is further delayed by the mass of detailed work that there is still to do. The biggest detail is whether the programmed monetary union will actually be one money or not. There are those who would put off the moment of symbolic truth by keeping national currencies "indissolubly linked" under one central bank. If they got their way, the speculators would be itching to dump the lira on the hapless European central bank. A multi-currency EMU would be like a tin of peanuts with a "pull-here-to-open" tab.
Taking account of all those hindrances, it seems unlikely that any national European currencies will vanish this century. So is Mr Clarke wrong to raise the temperature by debating the matter now? Should he follow his leader in uncommitted fence-sitting? No. The moment is right to assert to the rest of Europe that monetary union in Europe is an idea whose time is coming, unstoppably, but not yet come. He should state bravely that he would like Britain to join, but that the whole of western Europe needs another five years, at least, to get its public finances in order and to adjust its labour markets to the new pressures of the post-Cold War world. And that thereafter there would have to be a referendum in Britain to vote on such an important constitutional change, consistent with the realities of open-market Europe that Britain did so much to champion.
The author is the editorial director of the Economist Intelligence Unit.
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