The EMS had been created by decisions of the Council. But the ERM was formally an agreement between central banks (and therefore not part of the Community). Yet it had always had a high political content, whatever its economic effect on the economies of participants; and in that sense was to be compared not with the Gold Standard, as it had operated in Europe in the four decades up to 1914, but with the Gold Standard as governments rather than central banks had manipulated it in the 1920s.
Having been affected principally by movements of the French franc during the frequent realignments of the early 1980s, the ERM had been mistrusted by the Bundesbank for reasons expressed during Otmar Emminger’s tenure of office. But in the years after the French economic grand tournant of 1983, the ERM became a DM zone. Mitterrand and Delors, as his finance minister, took a decision which was politically strategic, as well as economic – a decision followed in due course by the Belgian and Danish governments and rather later by Italy and Ireland. For four years, in what can be seen as its ‘classic period’, the ERM rested on the Bundesbank’s credibility, together with West Germany’s willingness to behave as if the DM were indeed the anchor currency; and it achieved a generally accepted and widely welcomed reduction of inflation and state borrowing among members. It thus served as the monetary agency for what were becoming accepted concepts of prudence and discipline, necessary components of economic restructuring. Whether or not causation actually worked in this sequence is another matter: the gains appeared, at a time of rapid growth, to justify the sacrifices in output and employment that accompanied it.
France’s January 1987 devaluation however, which was forced on an unwilling government by the international markets as the American dollar fell steadily, altered this benign pattern.14 As Bernard Connolly observes, ‘the ERM had become an inescapable symbol of attachment to sound policies. But lack of complete credibility made it economically costly.’ French acceptance of the price for hard currency status was overtaken by a desire not to peg the franc to the DM, like the guilder or krone, which would have been politically unacceptable to French public opinion, but to fence the DM inside an increasingly rigid ERM structure which would lead logically and remorselessly to monetary union and a single currency – and thus to the disappearance of deutschmark primacy. French ministers evidently believed that this could be done, despite the global development of money markets where billions could flow across the exchanges in a matter of hours. They assumed continuation of the climate of opinion that had seen the G7 arrange the Louvre Accord in February 1987, in order to stabilize the dollar and yen against European currencies, whilst promoting world economic growth.
But the Bundesbank objected because of the implications for West Germany, and its criticisms carried great weight so long as the Reagan administration did nothing to remedy the dollar’s fall and the American budget imbalance. Having been pressed by Bonn to loosen its monetary stance, the Bundesbank reacted instead by raising interest rates in early October 1987, an action which helped to precipitate the New York Stock Exchange crash on ‘Black Monday’. The clash between Bonn and Frankfurt did not diminish until Hannover in July 1988, when the heads of government agreed on progressive reduction of interest rates. But this added new pressures to currencies in the ERM, since it had been agreed that capital would become fully mobile in France and Italy by 1990; so that it would cost their governments and central banks more and more, in each year before EMU took effect, to resist currency flows and speculation, particularly by the vast American ‘hedge funds’. Strengthening the ERM’s operations failed to limit these accumulating risks.15
Edouard Balladur had already proposed, in conjunction with Giscard, during the period of cohabitation, that a prototype of the European Central Bank (ECB) should start work before the final move to monetary union; and to plan it, the Committee of Central Bankers, under Delors’s chairmanship, was to be appointed at Hannover. But in the shorter term, two years of overshoot in West German money supply, together with signs of a speculative bubble in Japan, rapid overheating in Britain, and the Netherlands’ government’s unease about shadowing the deutschmark, presaged trouble which the G7’s pardonable overreaction on ‘Black Monday’ did nothing to allay.
With the Bundesbank apparently sulking on the fringe of a political vortex, stubbornly pushing up German and therefore ERM interest rates, the ERM’s deflationary classic phase ended in recrimination between Bonn and Frankfurt, and growing signs of inflation in Britain and Spain. (Denmark, isolated in its own peculiar cycle, experienced both inflation and stagnation, with repercussions on public opinion which were to be of great significance in 1992).
Meanwhile, the Committee of Central Bank governors, chaired by Delors, met between autumn 1988 and April 1989. They took part already having much common ground, both as professionals of a high order with a common discipline and as believers in the ERM’s proven effects on inflation, as well as the likely benefits of lower transaction costs and risks to be gained from monetary union. It is inherently unlikely that they ignored the political effects of a future ECB on members’ national sovereignty; but the possibility of national divergencies was offset by a measure of theoretical agreement: the conceptual ground had been well prepared in economic terms by the Padoa-Schioppa Report.16 This highlighted a basic inconsistency: following the completion of the internal market after 1992, which would be accompanied by full capital mobility and a more or less fixed exchange rates in the ERM, member states would still retain monetary autonomy in their national spheres.
Put simply, Padoa-Schioppa argued that it would not be in the interests of weaker economies to conform and bear the pain; instead they would act as backsliders or deviants, forcing the stronger partners to react, and thus prejudicing the whole. Prudent central bankers, inherently suspicious of what politicians would do to appease their electorates after the experience of the fifteen years since 1974, rated the collective good higher than national sovereignty. The fact that Karl-Otto Pöhl chaired the technical group and both he and Robin Leigh-Pemberton, governor of the Bank of England, signed the Delors Report seemed to indicate that unanimity had been achieved.17
To a large extent it had: all the governors accepted that a prototype ECB should start work, in order to begin the process of inducing equality of discipline and practice in reducing inflation as soon as possible. All could reasonably expect their governments to have accepted by then that no one country could bear the costs of doing this alone especially when taken together with contingent problems, such as wages and other labour market rigidities, and that if collective action were not initiated, at the next recession the EC might lapse into another sauve qui peut like 1974. The differences between them related mainly to highly technical problems. But the political issues of whether this new single currency, provisionally styled the ecu, would be too soft (as the Bundesbank feared) or too hard, as the British government suspected, and whether it would eventually be intended to stand up against the dollar and yen as an equivalent world currency, were not and probably could not be argued out.
The one fundamental disagreement in the Delors Committee concerned the mode of transition to EMU. It was finally concerted between Pohl and de Larosière (Banque de France) with some mediation from Carlo Ciampi, governor of the Banca d’ltalia, and help from the Netherlands and Spanish central banks, in time for Delors to present his report on 19 April 1989, in advance of the Madrid Summit. At that stage, it was sufficiently uncontentious to convince ‘respectable financial opinion’ in the EC, which in Britain included both The Economist and the CBI. But when Delors introduced it later that month to Ecofin, he added a timetable: there should be three stages, the first to begin as soon as possible. All twelve currencies should move within the ERM’s narrow bands by 1 January 1993, the date for completing the internal market. In stage two, exchange rates in the ERM should