After the arms race, the exchange-rate war

AFTER the anticlimactic vote in the French referendum, the Maastricht treaty just survives on a life support system, the rationale for its existence still in doubt.

Despite its other reverses, Britain has in effect won the debate on political union, which now turns out to be a much more qualified process than the visionaries anticipated. Without strict political union, monetary union becomes even more problematic, for how can the financially prudent ensure that it will not simply be a mechanism for subsidising the profligate? Without the promise of monetary union, the existing European Monetary System (EMS) is undermined and there is no obvious mechanism for enforcing a convergence of the Community economies. Without convergence, the political cohesion of the Community will be put under even greater stress.

The easy argument, from those who have always been sceptical, is that all this demonstrates the durability of national differences and why sovereignty is so jealously guarded. But this understates the extraordinary progress made in transcending traditional hostilities, bringing down trade barriers and forging common positions on a variety of issues. The crisis facing the Community is not simply a reflection of a seepage of political will but a function of the transformation in the international system following the collapse of Communism.

The Iron Curtain created a natural boundary for the Community within which it could develop and take root among Europe's most advanced industrial states. Ironically, the one area in which this did not happen was in the defence against Communism because it took one superpower to counter another. For the Community's true believers, this dependence upon the United States denied Western Europe true self-sufficiency: their great ambition was to forge a defence identity to complement the common market.

This was very much a French preoccupation. When the Berlin Wall came down, Paris proclaimed an opportunity for Europeans to take responsibility for the security of their own region.

The Americans did not cling to their leading role, showing themselves, on the contrary, to be loath to let their troops become entangled in messy European squabbles. The Community took the lead in Yugoslavia. Unfortunately, the measures taken were always too little, too late. The fires burnt because member governments were unwilling to commit the resources necessary to douse them. Divergent interests meant that diplomatic initiatives lacked direction and constancy: policy was pushed in one direction by the German eagerness to recognise Croatia and then in another by the Greek refusal to recognise Macedonia. Order could not be restored without major military intervention, which was not feasible without the Americans. Europe was fated to demand a settlement based on principles that it could not enforce. To bicker over which institution should be to the fore seems pointless when there is a dearth of credible policies for any of them to follow. Defence was hardly mentioned in the French debate and is an area where the Danes want the Community to backtrack.

The loss of momentum in the drive towards a common European defence identity has made economic and monetary unity even more vital to any prospect of long-term integration. In this context, for those seeking to shape Community affairs, a strong currency has taken over from a strong army. The 'franc fort' has been the centrepiece of French policy for almost a decade. John Major saw a strong pound as the way to put Britain at the 'heart of Europe'.

But the EMS has been turned into the setting for the monetary equivalent of an arms race against the mark, rather than a mechanism for collective security; exchange rates now shape the regional balance of power. This is again a reflection of the changes in the external environment, in this case the consequence of the hasty marriage of the two Germanies followed by the loss of the east's minimal dowry when the Russian market collapsed.

The Bundesbank - if it is to honour its charter - is constrained to maintain high interest rates in order to pay the bills. The Vietnam war undermined the dollar as a reserve currency - unification may have the same effect on the mark. Those sticking with the mark may claim to be in the 'first tier', but this may be a mixed blessing if the mark zone remains deflationary.

It is striking how much last week's sterling crisis was conducted in military metaphors, with 'big guns' being trained on 'sinking' pounds, 'shell-shocked' ministers and new currency targets entering the 'firing line'. 'The battle of Italy has ended,' intoned one commentator after the first Italian devaluation, 'the battle of Britain is about to begin', as if the 'few' at the Bank of England could be compared to the RAF of 52 years ago. At the end there was a palpable 1940-type relief that we were no longer dependent on unreliable allies and could henceforth fight our own battles as we chose.

This again misstates the problem. In 1992 - as in 1940 - Britain is simply too weak to cope on its own. It needs strong allies, and in the economic sphere it has nowhere to turn but Europe. The real problem is that the severity of the external pressures, combined with the diversity of domestic interests, is making it harder to develop common policies that express more than vague generalities. This is painfully evident in the trade field, where the Community ought to be at its most influential but has minimal room for manoeuvre because of the French refusal to compromise further on agricultural subsidies. At the moment, association agreements offer the new democratic countries of Central Europe access to Community markets, except in those areas where they are best able to export - textiles and

agriculture.

Problems in the Community's internal development are highlighted by its inadequate response to the upheavals around it. Discussions of Russia's catastrophic financial crisis run in parallel to those on Maastricht, as if one had nothing to do with the other. It is not simply a problem in decision-making. Those who sought to 'deepen' the Community before it could 'widen' exaggerated the extent to which West European integration could progress independently of the disintegrative tendencies to the east. It is not hard to imagine further disruption following a major lurch to authoritarianism in Russia or the collapse of the reform process in Poland or a wider Balkan war. The special meeting of the Council of Ministers called by Mr Major for 16 October needs to worry less about long-term goals and more about a short-term capacity to respond to this tumult. This is not an alternative project to an ever closer union, but a precondition.