Don't let's be beastly to the Germans

On the anniversary of Britain's ERM withdrawal, David Marsh draws some lessons for the future

Black, golden, or simply dim? The diverse cluster of memories of Wednesday 16 September 1992, when the Government was forced to pull sterling out of the European Exchange Rate Mechanism and embarked on what Norman Lamont alleged would be "a British economic policy and a British monetary policy", has started to fade. In its place a rich thicket of folklore has spread its roots.

The episode muddied further the argument about Britain's place in Europe. None the less, it would not be a total surprise if, during the next five years, Britain again sought a monetary policy link with Germany and other EU partners as part of a policy of maintaining growth and low inflation in Europe. The dominant force running this policy would probably be the Bundesbank. In view of this, Britain would be well advised to repair the fences which the German central bank fractured so publicly in 1992, and perhaps to think about how it could be turned into a less German and more European institution.

To learn from past mistakes, and also derive pointers to the future, we need to cast a magnifying glass over the events of three years ago.

Some elements connected with September 1992 are reasonably clear-cut. The subsequent much-needed depreciation of sterling and reductions in UK interest rates have been crucially important in steering Britain out of recession and promoting economic growth above the European average. Answers to other questions, though, are surrounded by confusion and conjecture.

For many Britons, the debate about independence boils down to the question of independence from Germany, Western Europe's biggest power. For those (like former Chancellor Lamont) who believed that by severing the pound's link with the mark, Britain would be able to blaze its own economic trail, the consequences have been perverse. Far from breaking free from German economic influence Britain has, if anything, become more dependent on it.

Since 1992 there has been a sharp build-up of German investment in the UK. The takeovers by German corporations of the Rover car group, the Kleinwort Benson merchant bank, the pharmaceutical activities of Boots and the Lancer Boss fork-lift maker, have been only the most prominent examples of the German rush to "buy British".

Recapitalising a business like Rover with German long-term money is, on the whole, positive for UK companies' workers, managers and suppliers. In a host of industrial settings around the country, Britain and Germany now have an enviable opportunity to learn from each other's best economic and management practices. Yet seeing Britain's last large-scale indigenous car group taken over by BMW was hardly good news for those who wished to wrap the British economy exclusively in the Union Jack.

Still more striking, given the hullabaloo of September 1992, the Bundesbank remains Britain's supreme monetary arbiter. Firm evidence has just been delivered in the shape of the latest meeting between the Chancellor of the Exchequer and the Governor of the Bank of England. After a long hot summer of trying to persuade Kenneth Clarke to put up interest rates, Eddie George has conceded that it is not such a good idea after all. The reason: the 17-man governing council of the Bundesbank at one of its fortnightly Frankfurt meetings at the end of last month decided to cut rates by half a percentage point. The rest of the Western Europe (plus Eddie) has humbly followed their lead.

This year's setbacks for the Bank of England's campaign for greater independence from the Treasury underline how the holes in the heart of Britain's monetary policy remain as gaping as ever. It is not inconceivable that to plug them, Britain may again call on the Bundesbank.

For Britain to resume such a course, however, it would be helpful to have answers to some unresolved questions about the past. Why did the British Government high-handedly disregard advice from the Bundesbank, freely dispensed to John Major (then Chancellor) on the very day that Britain announced it was entering the ERM in October 1990, that sterling was joining at too high an exchange rate? Why were Bundesbank hints in 1992 that the UK should take part in a full realignment of ERM currencies imperiously ignored?

When Helmut Schlesinger, the Bundesbank president at the time, suggested in a newspaper interview on 15 September 1992 that a full-scale realignment was needed, this provided the trigger that brought down the pound and unleashed a torrent of opprobrium from the Treasury. The undiplomatic Schlesinger found it difficult not to tell the truth. Was that not the main reason the British found him awkward?

This history of miscalculation and misunderstanding suggests that Britain will be highly cautious in any attempt to recreate some form of exchange rate link with Germany. However, the Germans themselves in coming years will have an interest in sharing the Bundesbank's monetary power with their partners and neighbours. One important motivation will be the German desire to tone down the overvaluation of the mark which is a substantial factor behind Germany's registered total of 3.6 million people without jobs.

Rather than persisting in the probably ill-starred Maastricht treaty bid to build a new European central bank, other countries would be better advised to engineer a progressive Europeanisation of the Bundesbank. Europeanisation is important to offset the certainty that the Bundesbank's enhanced influence will bring vulnerability - for any national institution is bound to be overstretched if it takes over responsibilities for the rest of the Continent.

A start could be made if the Bundesbank invited individual finance ministers from the other large European countries to attend and seek to exert influence over its policy-making meetings, just as the German finance minister already occasionally takes part in these sessions (without having the right to vote). For good or ill, the "made in Germany" component of Europe's monetary policy looks set to increase. Europeanising the Bundesbank would strengthen the chance that this trend would find acceptance - maybe even a welcome - beyond Germany's borders.

The author is director of European Strategy at Robert Fleming, the London- based investment bank.