A mark of the times
The Exchange Rate Mechanism is dead, and so is the old dream of European
unity. But, says Helen Simons, the economic integration of a new Europe
centred on Germany is only just beginning
When Europe's Exchange Rate Mechanism (ERM) finally cracked in July, it
sent a wave of panic across the continent. After weeks of devaluation pressure
centred on the French franc, Europe's financial chiefs tried to cobble together
a deal to save the system. But when their only solution was to abandon the
cherished notion of exchange rate stability and allow Europe's currencies
to float within bands so wide as to be meaningless, it was clear to all
that the old ERM was dead.
The crisis of the ERM has been accompanied by apocalyptic warnings about
'the end of Europe' and future instability. According to many pundits not
only is the ERM finished, but Maastricht is dead and even the future of
the EC itself is in question. European cooperation, they claim, is now set
to be superseded by a return to the economic nationalism of the 1930s.
Certainly things have changed since the ERM debacle. The trouble is that
any rational explanation for the monetary crisis has been obscured by the
claims and counter-claims flying across the continent, as governments and
economists blame each other for the chaos. As a result many experts have
missed what is really happening within Europe, and the likely future of
The most ludicrous claims about the crisis came from the British government.
The Tories watched the turmoil in Europe's currency markets with barely
disguised glee. John Major's government had been humiliatingly forced out
of the ERM last September. Now ministers claimed that the latest episode
proved that the ERM rather than the British economy had been the problem,
as there were fundamental 'fault-lines' within the system.
Major even seized the opportunity to relaunch his 'hard Ecu' plan which
was laughed out of Europe two years ago. But while Tory ministers may relish
the fact that their European partners have now run into problems, Europe
is not about to take lessons in currency stability from British capitalism.
Britain was forced out of the ERM because its economy is the sick man of
Europe. With most of British industry unable to compete in world markets,
sterling could not maintain its parity with the deutschmark. Sterling collapsed
not because of hidden fault-lines in the ERM, but because of the obvious
fault-lines in the British economy. Far from vindicating its position, the
Major government's reaction to the latest crisis only served to confirm
Britain's isolation within Europe.
The French press argued that 'Anglo-Saxon financial speculators' were the
villains of the piece. The right-wing paper Le Figaro claimed that
these traders set out to break the franc because of their opposition to
fixed exchange rates and their suspicion of France. Former French foreign
minister Roland Dumas even suggested that 'the Anglo-Saxons' were determined
'to see European construction stopped'.
Meanwhile, French premier Edouard Balladur and many French officials blamed
the Germans for holding Europe to ransom by refusing to cut interest rates.
By putting German domestic fears of inflation ahead of Europe's need for
interest rate cuts, the Bundesbank had thrown the continent into crisis.
Since Germany was the problem, some French officials called for Germany
to leave the ERM.
Unlike the British explanations, French claims do have a resonance within
Europe. Journalists, analysts and politicians have targeted the speculators
and many agree that France is paying the price for Germany's post-reunification
problems. But these arguments cannot explain the currency chaos either.
Take the idea that speculators caused the crisis. Speculators, Anglo-Saxon
or otherwise, are not aliens driven by strange and sinister motives. They
are old-fashioned capitalists, motivated only by the drive for profits.
Speculators make their money by anticipating price movements on the world
currency markets. But they have no magical powers to move prices at will.
Price fluctuations are a result of the workings of the entire market system.
Some commentators tried to suggest that the latest ERM crisis had partly
been caused by arch-speculator George Soros 'playing up' the £1 billion
he allegedly made from exploiting the pound's difficulties last year. But
even if Soros had speculated every penny, it would make little overall difference
to a currency market in which $300 billion is traded every day in
It also makes little sense to blame Germany's economic weakness for the
crisis. Suggestions that the ills of the ERM could be solved by Germany
leaving the system are farcical. A European monetary system would mean nothing
without German involvement. The mark is the key currency because Germany
is Europe's key economy.
Because Germany is the number one trading partner for all major European
countries, they all seek currency stability with the mark. The fact that
the ramifications of German interest rate policy are felt across the continent
indicates the strength of the German economy rather than its weakness. The
idea that this 'weak' economy should drop out of the system to ensure stability
is, as BBC economics editor Peter Jay pointed out, a bit like telling the
sun to quit the solar system.
At one point during the eleventh hour talks to save the ERM, Germany did
agree to leave the system and let the rest sort things out. The response
was instructive. First the Netherlands struck a secret deal to leave the
system with the Germans. And then, like rats leaving a sinking ship, Belgium,
Luxembourg and Denmark all declared that they would do the same. This would
have left France in an ERM with Spain and Portugal.
Faced with the stark choice of sticking with the ERM or going with Germany,
all the core economies in Europe wanted to go with the Germans. This demonstrates
that European institutions are only meaningful today insofar as they reflect
the real power relations between the nations of Europe. Instead of blaming
the speculators, the Anglo-Saxons or the Germans for the ERM's downfall,
it is more useful to look at those relations in order to explain why such
an institution should fail.
Exchange rates between nations reflect the relative performance of economies
at a moment in time. If an economy is strong with high productivity it will
tend to be reflected in a strong currency. Investors are always on the look
out for winners. Nations with the competitive advantage of high productivity
and dynamic growth will tend to attract investors. Demand for that currency
will increase and its value on the foreign exchange markets will rise.
The reverse applies to weaker nations. If productivity is low and economic
activity is slow then there will be little to attract investors. Unless
governments create attractive conditions for investors through incentives
such as high interest rates, there will be little demand for the currency.
The result will be a relatively low exchange rate on the money markets.
The ERM was designed to minimise shifts between Europe's currencies. This
was achieved by setting a narrow target range for exchange rates and getting
the monetary authorities to manipulate the foreign exchange markets, through
controlled buying and selling of currencies by the central banks and careful
manipulation of interest rates.
The ERM worked best in the boom years of the late eighties, when the pressures
on the system were minimal. But when the slump caused tensions to rise within
the system, the ERM was unable to buck the market. Last year the system
could not hold either sterling or the Italian lire at their over-inflated
prices. When it reached the point where the only thing preventing a sterling
or lire crisis was massive buying in the market by the central banks, the
mechanism gave way. The pound and the lire crashed and other peripheral
currencies were soon forced to devalue.
This summer's ERM crisis was precipitated by the French government promoting
the franc further than was justified by the strength of its economy. In
May, one French minister demanded that the franc should become the ERM's
anchor currency. The Balladur administration cut interest rates 10 times
in as many weeks, while insisting that the French economy remained strong
enough to support the franc. However, once French interest rates dipped
significantly below German levels, the franc fort beloved of the
Balladur government was vulnerable.
At first the French got away with their bravado in the exchange markets,
as forecasters and investors became preoccupied with what they saw as the
new problem facing Europe - the German recession. With all eyes focused on
the problems of the German economy, French claims to economic strength seemed
reasonable by comparison. Many investors moved out of the mark and put their
money into gold, Japanese yen or even French francs. But the moment investors
took a serious look at French and German future prospects, the hype surrounding
French claims became transparent.
Whatever difficulties Germany faces in the short term, it remains Europe's
strongest economy. German productivity is about 15 per cent above the average
of Europe's other industrial nations. While France can also claim productivity
levels above Europe's industrial average, in key sectors such as car production
and metals Germany beats its French neighbour hands down. Wise investors
will still choose marks over francs every time.
Once the bubble of hype about France's economic strength had been burst,
the franc was left without support. The French government pushed through
a last ditch interest rate hike, and spent all of its foreign currency reserves
defending the franc fort, but in vain. By attempting to challenge
Germany for the economic leadership of Europe, the French authorities had
created the conditions for the franc's downfall.
The collapse of the ERM was a big blow to Franco-German relations. Since
this axis has been the linchpin of the EC, it is not surprising that many
commentators declared that the ERM crisis spelled the end for closer European
cooperation and currency union. But such obituaries are premature.
It should certainly be clear to all by now that the dream of a harmonious,
united Europe of equal partners is a non-starter; but then, in reality,
it always was. On the other hand, the fall-out from the ERM crisis has accelerated
the process of pulling Europe's core economies together under German leadership.
For a start, the summer's events revealed the close links between some of
the core currencies of central Europe - those of Belgium, Luxembourg, Holland
and Denmark - and the German mark. They all pledged allegiance to Germany
rather than the ERM in the midst of the crisis. And within days of the adoption
of wider ERM bands, proposals were being floated for a smaller and tighter
ERM. This would be nearer to a fixed exchange rate - and hence to a single
currency - than anything which Europe has seen so far.
Nor are the economies that are coming together at the centre of Europe restricted
to existing members of the European Community. At the height of the crisis
Hungary announced that in future it would denote its foreign trade in deutschmarks
rather than Ecus. More significantly, the Austrian and Swiss currencies
remained closely tied to the mark throughout the turmoil.
No other option
The restructuring of European economies under the pressures of the slump
is also helping to pull Europe's most important markets and industries into
closer proximity with one another. Mutual investment levels between France
and Germany are now at an all-time high, as are inter-European mergers and
acquisitions. Despite all the political rancour, the European economy is
now more truly integrated than ever before.
The final factor is that none of the other European economies has any serious
alternative to following the Germans. France is the best example. Recent
events have shattered the dreams of French politicians about shaping Europe's
future. No doubt many of them would love to tell the Germans what to do
with their deutschmarks. But while French pride is at rock bottom, France
has no serious foreign policy options other than to hold on to its German
connection. In the end it will have to swallow its pride and be prepared
to be humiliated every time it tries to outflank Germany.
Much has been said about the ERM debacle heralding the end of the old Europe.
Yet few understand that it also symbolises what European capitalism is becoming.
In the months ahead it should become clearer who are the winners and who
are the losers in the new Europe. But there can now be no doubt that Europe
is a German continent, in which the mark can buy and sell the rest.
Reproduced from Living Marxism issue 59, September 1993