Yet the ERM has been useful. It has given a much greater measure of currency stability than occurred under fully floating rates, and has thus helped to boost cross-border trade. It has also encouraged governments to bring their economic policies closer together, and in particular to provide a discipline against inflation. In its early phase, between 1979 and 1983, that discipline was loose: when a country inflated faster than the ERM's effective anchor, Germany, it devalued and regained most of the competitiveness it had lost.
Between 1983 and 1987, however, the ERM started to bite. Typically, a country would only regain half the loss of competitiveness by devaluation, so that the exchange rate would exert a continuing pressure on inflation. Then, from 1987 to this month, the ERM took on an even harder edge. The notion that the currencies would never be changed turned the ERM from being a discipline on policy into being a political end in itself. It became an ever-tighter band of currencies, in the jargon a 'glide-path' to currency union.
Such was the political commitment of the EC countries that this fiction was maintained for five years, despite the very different inflation performance of the various members, and although the markets did not really believe it. The currencies might be locked together, but the money and bond markets told a different story: interest rates and bond yields were significantly higher in high inflation economies than they were in low.
It is only this third stage of the ERM's development that has been discredited. The discipline it has provided on governments has proved valuable, and the commercial interest of EC trade and industry is far better served by a stable exchange system than one subject to the alternate approval and opprobrium of the markets.
There are two broad alternatives. One is the three-speed Europe. There would be an inner club of currencies, the mark, the guilder and the Belgian franc, which would move quickly to a single currency based on the DM. Then there would be a middle rank, including the French franc and the Danish krona, which might join at some later stage. Finally there would be the weak EC currencies, sterling, the lira, the peseta, the drachma and so on, which might never join.
Europe may evolve that way, but it would be profoundly unsatisfactory if this were allowed to happen. Europe's currency would in practice become the mark, and be subject to all the tensions of German unification. It would be far better for Europe to set to work to rebuild the ERM on a more balanced basis. In particular, more of the responsibility for policy adjustment should be placed on the country with the strong currency, rather than putting the entire burden on the weak. This was the intention when the ERM was developed. Rebuilding a balanced ERM would be a useful and practical preparation for the Maastricht ideal of a common currency. That currency has to be constructed in such a way as to represent all Europe's interests, not the special needs of the largest country. If we cannot rebuild the ERM, we have no hope of creating a genuine European currency.