A French remedy for an economic headache

LET US suppose that the French say 'no'. There is a sufficiently large opposition to the Maastricht treaty in France for that to be possible. Any sensible planner, certainly in government but also in business or finance, must consider how the world will develop in the months following the French referendum on 20 September.

Those governments that signed the Maastricht treaty have such a vested interest in a 'yes' vote that they have tended to portray a 'no' as potentially catastrophic. But the more one looks at this possibility, the more it seems a neater solution to Europe's economic tensions than a narrow 'yes'.

A 'no' kills the idea of Europe moving to a common currency before the end of the century. But it does not kill European economic unity: regardless of Maastricht, the European Community economies have been increasing their cross-border trade at an astonishing rate. The evidence is before our eyes, from the label on a yoghurt carton in five languages, to the beer with some improbable German name that is actually brewed in Burton on Trent. Such transnational marketing is fostered by the currency-linking arrangement of the exchange rate mechanism (ERM). If the French say 'no', and there is no prospect of a common currency for a decade or more, the ERM becomes more important, not less.

So the EC governments will fight to strengthen the ERM in its own right: as a way of making business in Europe work more more smoothly, rather than a halfway house to a common currency. By general consent, a no vote would lead to a speedy challenge to the present ERM parities on the foreign exchanges, with the markets pushing for a revaluation of the mark and the lira. Politically, it is embarrassing for ministers to admit that when it comes to determining exchange rates, financial markets are stronger than elected governments. But embarrassment aside, it is in practical terms better for the timing of any change in parities to be chosen by governments, for this denies the banks the enormous profits that can be made at taxpayers' expense from speculation ahead of a currency realignment.

So if it is no, expect a stout defence of the ERM. This will involve changes in interest rates, probably including a rise in British base rates, but there will also be other elements to the package that as yet can only be guessed at.

Expect this defence to fail. It will not fail on day one, but it would probably fall to a second challenge later in the year. A realignment at some stage before the end of next spring is highly likely. The present rates do not reflect the real economic competitiveness of the EC nations: the mark has to go up; the lira has to go down; and the French franc could move with the mark, though it may hold its rate.

And the pound? Both the Prime Minister and the Chancellor have invested a lot of political capital in the DM2.95 central rate. It is quite possible, were the realignment to take place next spring and the British economy was clearly emerging from recession, that this rate could be made credible to the financial markets. The pound is not particularly overvalued against the EC currencies: it is absurd to argue that an average 3 per cent devaluation would transform our export prospects. But the markets are looking for some modest devaluation, and the Government may use the only loophole available: saying that the DM2.95 rate was chosen in the context of the move towards currency unity, and without the Maastricht treaty that policy was no longer relevant. The pound is now below DM2.80, so the new central rate, say DM2.85, could be higher than the current market rate. It could be presented as not a devaluation at all, though in practice it would be one.

Would a modest devaluation mean lower British interest rates? Not necessarily. It is hard to see British short-term interest rates below German ones, whatever happens to currencies, while our long- term rates would stay high because of the fear of further devaluations. Indeed, the main practical argument for trying to hold the DM2.95 central rate is that it would lead to lower, not higher, interest rates. But this might not be possible.

At least a French 'no' vote would reassert the idea that the ERM matters in its own right as a way of stabilising European currencies. A narrow 'yes' vote leaves its status uncertain.

Even if the French say yes, Maastricht will still have to be ratified in Germany in November, and it will still have to be got through Parliament in Britain. Failure at either of these would lead to similar challenges to those that would occur were the French to vote it down. If it does get over all the hurdles there will still be uncertainty over exchange rates, for at some stage in 1993 or in the first half of 1994 there will be a powerful temptation to realign in preparation for currency union. As a result, the ERM will remain under strain: Europe will continue to feel that its monetary policy is determined by German needs.

None of this is to say that 'no' would be a good decision. Europhobes would, of course, cheer. But even supporters of the European ideal should recognise that in purely practical terms it might be a better decision than 'yes'. It would force EC governments to confront a problem they have been pretending does not exist: that at some stage in the next couple of years there has to be a realignment within the ERM. If not now, when?