Five reasons why we will rejoin the ERM

WE ARE out of it, but it won't go away. When we joined Europe's exchange rate mechanism in October 1990 we were told that it would help reduce both our interest rates and our inflation, and so it seemed. Then, less than two years later, we were heaved out by the foreign exchange markets in the dramatic events of Black Wednesday. . Since then we have managed to begin to make the sustained economic recovery neither Germany nor France seems able to achieve.

In the last few days there have been three little reminders that the ERM still looms. First, David Hunt, the new employment secretary, causes a minor stir within the Tory right by suggesting that he is in favour of managed exchange rates in Europe - code for the ERM. Next, the European Commission produces a confidential paper, leaked in the press, saying that we were right to get out when we did. (Well, the Commission denied that that was the conclusion, but unless and until the paper is published, Europhobes will delightedly claim it was.) Third, the Organisation for Economic Co-operation and Development warns that the ERM will face turmoil in the autumn unless Germany cut its interest rates.

While Britain finds itself accused of competitive devaluation, as if it was our choice to leave the ERM, the French and Germans continue running its battered remains - battered because several of the smaller countries keep devaluing, and one big one, Italy, has also left. Yet, under the Maastricht treaty, the whole EC, bar Britain, is committed not just to the ERM but to having a single currency by 1999.

What, then, should the sensible non-ideological person think about the ERM, and British membership in particular? Try these five propositions, and see where they lead.

Proposition One is that the EC has found that by setting grand, long-term political goals it can force countries to bring their economies closer together. Look, for example, at the big idea for 1992, the single market. In the early Eighties European integration had stalled, so the Commission suddenly hit on the idea of setting a date for creating a single market. It was really just a public relations exercise, but it caught people's imagination and has undoubtedly brought down some inter-European barriers that were inhibiting genuine trade.

Another example was the way that membership of the ERM forced the French to control inflation. From the Fifties to the mid-Eighties, the French kept devaluing their currency. How many people now remember that when De Gaulle introduced the new franc it was the same value as the mark? Being in the ERM did not initially stop the periodic devaluations, but the discipline has brought France's inflation below German levels.

So both the ERM and the plan for a common currency should be seen in this light: you cannot lock currencies together, still less have a common currency, unless you have common economic policies. But if you say you are going to have a common currency, you will to some extent force countries to bring in common economic policies. Even if you fail, you will be better off than when you started.

Proposition Two is that Europe is gradually becoming a single economic region. In some areas, such as motor manufacturing, it already is. In other areas, in particular the professions, it is still a series of national markets: you will not find many British doctors practising in France or Germany. But looking at the big picture, the European nations have become remarkably specialised, exporting a very high proportion of their output and importing a very high proportion of their needs. The Netherlands' exports are equivalent to 47 per cent of their output; Britain and France export around 18 per cent, more than double Japan or the US.

This economic integration is happening irrespective of whether countries belong to the ERM or not - Switzerland has a very specialised economy - but obviously the more countries trade with each other the greater the case for reasonable currency stability.

Proposition Three follows on from this: there is an economic case for seeking greater global currency stability. Leaders were so aghast at the way competitive devaluations helped plunge the world into depression in the Thirties that they founded the fixed exchange rate system at the Bretton Woods conference in 1944.

That finally disintegrated in the summer of 1972, but the runaway inflation of the Seventies convinced them that fully floating rates were not the answer either, and the entire Eighties were spent trying to manage floating better. The European Monetary System was one such way, but there were others, in particular the efforts of central bankers to hold the dollar, the yen and the mark within informal bands during the late Eighties.

Proposition Four is that money has long been seen as one of the key elements of nationhood. Most newly independent countries set up their own currencies, along with a national airline; most of the former members of the Soviet Union have done so. Without its own currency, a government cannot in extremis print the stuff to balance the books. Of course this drastic action leads to very rapid inflation, as is happening in Russia, but in the very short run it does mean the army can be paid.

This freedom is more apparent than real, because if there is rapid inflation a country quickly comes to use dollars or marks for any important transaction, while local currencies are simply used as tokens for small items. Latin America manages with very high inflation because everyone thinks in US dollars.

Proposition five is that, whatever one thinks about the ERM, the Maastrich treaty has set Europe on a path to a common currency and at the end of this year a body called the European Monetary Institute will start paving the way for a European central bank.

Put these five propositions together and what do you get? It seems to me that there is a case for trying to hold European currencies together, partly because the EC economies are so integrated and partly because wild fluctuations are destructive anyway.

When the European Monetary Institute starts work on 1 January next year, there will be a central banking body for Europe which is not the German Bundesbank. Under its auspices, a well-managed ERM could be a very good halfway house towards a common currency.

And that is what is going to happen. The ERM may be shot though with holes, but it is extremely nave to think it will go away and die. That is not how Europe works. It will patch together something that operates rather better than the present ERM, and the balance of probability is that within three or four years we will join.