Orchestrating Europe (Text Only). Keith Middlemas
Finally, in stage three, exchange rates would be permanently fixed, under an ECB entirely responsible for the monetary policy of the single currency. There would then be binding conventions on member states’ budgetary deficits, modulated – for example in the Spanish, Portuguese or Greek cases – by new EC cohesion funds.
Little debate took place in Ecofin, which had rarely been a forum for technical monetary matters, and the Spanish Presidency pushed ahead to start stage one on 1 July 1990. The governments of France, Germany, Spain, Italy and Belgium concurred in this timetable (though the Bundesbank held strong reservations); those of Italy, Greece and Portugal were appeased with cohesion promises. Finance ministers from Denmark, Netherlands and Luxembourg argued only over the detailed schedule. British delegates again were isolated. At Madrid, the whole package went through in the wake of Spain’s ERM entry within the 6% bands, (at a surprisingly low rate because Carlos Solchaga, the finance minister, had previously ‘talked the peseta down’). Meanwhile, as Lawson told in his autobiography, he and Howe jointly forced Margaret Thatcher to set out the conditions for British entry, despite her protests up to the last moment of arriving in Madrid.18 The Bundesbank gloomily went its way, raising West German interest rates further to contain domestic inflation.
Then the Berlin Wall came down. Very large numbers of East Germans had already escaped, mainly through Hungary’s unofficially opened border, raising the spectre of mass migration from East to West Germany. The situation could be compared with the strong, demand-led inflation experience before the Wall had been built in 1960–61. Bonn poured huge funds into East Germany to forestall such a threat to the DM, and later promised to exchange one deutschmark for each individual’s now almost worthless ostmark at a rate of one to one, a burden on West Germany which ensured high domestic interest rates for the foreseeable future.
Neither of the logical consequences, an ERM realignment or revaluation against the DM, or very high interest rates for all other member currencies, actually occurred. The first broke on French objections, since the franc fort policy had not yet acquired complete credibility, the second on German political reality. Karl-Otto Pöhl’s outspoken protests against the currency swap were ignored, being politically inconvenient before the crucial autumn elections. He was, in fact, threatened with constitutional revision of the Bank’s statutes if he did not give in. As a direct result, the DM’s credibility was impaired.
ERM partners in 1990, however, concerned themselves more with the effect of rising German interest rates on their own borrowing and their domestic economies, for while the German government expected to bear 80% of unification costs, it was not willing to internalize the consequences for other Community members. The result, if the Bundesbank held to its primary duty of monetary stability, could only be a steady rise in German rates to which the rest would have to adjust. Yet the British government – or rather its chancellor, John Major, fearful of losing the chance should Thatcher change her mind – chose this moment finally to enter the ERM in the narrow bands, on 5 October 1990. It was a bad time, with the dollar still falling and the ERM now nearly rigid, and a worse choice of parity. Yet the British chose not to take the advice of other member states which the ERM’s informal conventions prescribed – and which might perhaps have counselled caution.19
Meanwhile, despite these huge potential sources of tension, member governments concerned above all with passage to EMU went ahead, like Captain McWhirr in Conrad’s Typhoon, hoping to win through the storm to the hypothetical calm beyond. The German government’s price for accepting the principle of EMU in such conditions was to be France’s overt support for reunification and rapid progress to political union, so that the new, larger Germany could cement itself firmly into the Community. This can be read as the second stage of the Franco-German bargain made in 1987.
France’s government could accept this, whatever Mitterrand’s initial doubts about reunification, and whatever the impact on French public opinion, because few wished to unleash visceral images of Germany’s past being propounded at this time by Thatcher herself and Nicholas Ridley (except, that is, in languages such as Dutch and Danish which the international press agencies did not read). On that basis, Kohl and Mitterrand agreed their highly important joint declaration of April 1990. It followed, apparently naturally, that EMU would come about via the ERM-convergence path, and according to Delors’s timetable. Franco-German clarity of aim contrasted with Britain’s disarray at the top as Margaret Thatcher fell from power in November 1990, the result of a palace coup within her own Conservative party.
All this time the Bundesbank was constrained not only by its duty to the currency but by its charter obligation to support the Bonn government’s policy in the last resort. Whatever its Directorate felt about Kohl’s pre-election promise that reunification would cost the West German electorate nothing, the bank could not oppose the chancellor’s direction outright. In due course, with the CDU/CSU triumphant in the elections, Pöhl resigned. His lonely gesture and his subsequent explanation, though cogent, had less general effect on events than the new British prime minister’s tone; for John Major’s talk of bringing Britain to a more pro-EC orientation, and signs that his Conservative party might even align with Kohl’s CDU and the European People’s party parliamentary grouping, seemed remarkable after eleven years of marching in another direction.
It was widely assumed during the IGCs that year that the ERM had become the ‘glide path to Monetary Union’.20 But that this represented a political as well as an economic judgment was not clear until after Maastricht, in spite of the most unwelcome paradox that developed shortly afterwards, when the peseta went to the top of its ERM range and the French franc to the bottom – the exact reverse of what their relative stabilities indicated should happen. France encountered the greatest economic pain, for despite inflation being almost as low as in Germany, interest rates stayed higher and contributed both to slow growth and persistent high unemployment, and to the government’s repeated attempts to reduce rates rather than let the franc rise.21
At the heart of the problem lay the fact that with reunification of Germany costs and prices would eventually rise; unless the Bundesbank permitted higher domestic inflation, France and the other members would pay the price via the ERM. Acceptable though the arrangement might be in 1990–91 while Bérégovoy pursued the franc fort, and while Mitterrand sought to reincorporate Germany coute qui coute, its long term survival could not be taken for granted during the next three years. It also depended entirely on monetary union remaining the agreed end. Yet twelve years of ERM practice offered no precedent for resolving such tension. Any realignment at this stage – even by Britain, now locked into its initial misjudgment – would imperil the ‘glide path’ thesis. As for the Spanish paradox, the others could neither ignore the thesis nor rethink the ERM’s logic. Only the Bundesbank’s council dreamed, as they had since 1987, of a different path to EMU through gradual evolution of a cluster of low-inflation currencies such as the guilder, Belgian franc, Danish krone, and now the French franc, linked to the DM.
Governments across the EC chose to ignore protests from industry and trade unions about high interest rates, and focused primarily on the IGCs. But the French and German finance ministers did induce the Spanish government, against the advice of the Bank of Spain, to depreciate the peseta (contrary to the ERM’s presumed doctrine that the government should not manipulate the exchange rate but content itself with cutting state spending, wages and public consumption). The Spanish government conformed, fearing to antagonize Germany, its main investor, suspecting that if it did not Spain might lose access to the cohesion funds which alone could help its economy fulfil the EMU convergence criteria. The Spanish government’s version of perceived national interests triumphed over its central bank’s fiscal prudence.
In order to bring EMU to the speediest conclusion, the French government and the Banque de France argued during 1990–91 for even more than Delors had: instead of achieving convergence first, according to generally-agreed criteria, a strict timescale should be imposed, pari passu with the IGC at Luxembourg. Margaret Thatcher’s replacement by the relatively inexperienced John Major facilitated this move, which was incorporated in the Commission’s draft treaty on EMU and the ECB’s draft statutes in December 1990. Thereafter, the two IGCs ran in parallel into a maelstrom where raison d’état, economic logic and deductions from very recent history surged inextricably