Leading Article: Europe needs monetary reform

THIS is not just a crisis for Britain, though it is certainly that; it is also a crisis for Europe. In that sense, what happens in the next few days will be as important as the currency crises of 1931 and 1967. In both the pound was devalued. But, in addition, the first also marked the end of the inter-war attempt to return to the gold standard; the second also signalled that the days of the Bretton Woods fixed exchange rate system were numbered. If one lesson of the whirlwind sweeping across the markets is that any move towards a common European currency will be profoundly difficult, the other is that a common currency is all the more necessary to avoid European financial policy being overly dominated by Germany's internal needs.

The chaos of yesterday makes it important to separate the various issues raised by the collapse of the pound: they are technical, economic and political. At a technical level, it is impossible to defend the handling of the matter. The assertions by both the Prime Minister and the Chancellor that everything necessary would be done to preserve sterling's central rate of DM2.95 sit absurdly with last night's announcement. But the clumsy suggestion on Monday by the Prime Minister's office that Britain would soon have lower interest rates had already undermined the pound's position. That two-stage rise in the Minimum Lending Rate yesterday showed a grave misreading of market psychology: all market management should avoid the 'too little, too late' charge. Meanwhile to spend half the reserves in one day on such futile intervention was a utter nonsense. In all probability nothing could have held the exchange rate, but the methods chosen were absolutely guaranteed to fail.

The markets knew that those 15 per cent interest rates could only be the shortest of short-term measures, for were they to have persisted for more than a few days, the economic damage to an economy in recession would have been quite intolerable. The 12 per cent MLR is barely credible, as it is bound to be damaging to the real economy. Presumably the authorities felt they needed some increase in interest rates to cushion the fall of the pound on the exchanges today, but on any other grounds the 12 per cent rate is a damaging nonsense. Again, the Government achieved the worst of all worlds.

The markets will give their snap verdict on this concoction this morning. In the next few days the extent of the Europe-wide realignment of currencies taking place will also become clear. For the Government, devaluation, however presented, has severe political implications. Both the Prime Minister and the Chancellor nailed their reputations to the mast of the DM2.95 central rate. Suspension from the ERM seems to be presented as a temporary measure: maybe the Government intends to return some day at DM2.95. But just as it is hard to conceive any such arrangement that would be credible, so it is hard to see Norman Lamont continuing in his present office. John Major is gravely damaged.

The reputations of British politicians matter less than the prosperity of Western Europe. There are profoundly important lessons for the whole of the EC in the experience of the past few days. One is that at this stage of the EC's development, when governments have conflicting economic policies, some flexibility of exchange rates is still needed. A second is that it is far better to acknowledge early that exchange rates do have to change while the EC member states follow divergent economic policies: common economic policies may not be a sufficient condition for stable currencies, but they are a necessary one. A third is that Europe needs a monetary policy designed for the entire continent, not one tailored to suit the needs of a newly unified Germany. Of course the Bundesbank will continue to be the most important force shaping European monetary policy, but it should not be the sole one. The overriding message of the crisis is less that sterling, the lira, and other weaker EC currencies needed to be devalued. It is that Europe needs some form of the Maastricht treaty. In its detail it may be flawed; but we urgently need a workable version.