European monetary reform: pitfalls of central planning.

• Author: Dowd, Ken

ONE OF THE IRONIES of recent years is that, while central planning was being thrown out in Eastern Europe, the countries of the European Community (EC) were going in the opposite direction in a misguided effort to establish a centrally controlled superstate. That culminated in the Maastricht Treaty of 1991, which set out a blueprint to increase significantly the powers of the EC government in Brussels, establish a European central bank, and replace the present national currencies with a new common currency.

The authors of the treaty--the would-be Founding Fathers of a United States of Europe--set out to plan the future of 300,000,000 people, regardless of whether they wanted it or not. Not surprisingly, it provoked a storm of controversy, and the process by which member governments sought to ratify the treaty effectively destroyed whatever legitimacy it might have had.

In Great Britain, calls for a referendum were ignored because polls suggested the English did not want the treaty, and the government managed to get the agreement through Parliament only by the narrowest of majorities and by blackmailing skeptical MPs from its own party. The experience in Denmark was even worse. The government put the treaty to a referendum, and the Danes rejected it.

Rather than accept the result of the referendum, the EC heads of government responded by trying to make the Danish people think that the treaty had been altered to take their concerns into account. They did so by producing a "declaration"--a meaningless piece of paper with no legal standing whatsoever--at the Edinburgh summit of December, 1992. That declaration stated that, while the treaty remained unchanged, Denmark would not be bound by the provisions on European monetary union, common citizenship in the European union, and common defense and security issues. The Danish government then took that legally worthless declaration as an excuse to present the same Maastricht Treaty for a second referendum. It managed to persuade enough voters that the treaty had been altered to meet their concerns, and the pact was accepted in the second referendum.

Still, European governments could not deceive the financial markets, which delivered a devastating verdict against the treaty by destroying the platform--the Exchange Rate Mechanism (ERM)--on which European monetary union was to be built. The treaty calls for the ERM to be expanded and "solidified" into a genuinely fixed exchange rate system, and the final transition to a common currency only can take place once that task has been completed. However, the policies of different governments are fundamentally inconsistent, and market operators were not fooled by attempts to disguise those inconsistencies. There were speculative attacks on the ERM, and, by the summer of 1993, it had effectively been destroyed. Whatever European politicians and bureaucrats may say, and despite the fact that the treaty went into effect without the ERM, the Maastricht Treaty essentially is a dead letter.

The roots of the debacle go back a long way. Most European politicians and civil servants see a "strong" state as necessary to protect "their" citizens, whom they regard as unable to look after themselves. That paternalism in domestic policy goes hand in hand with a mercantilistic view wherein the world economy is a group of mutually antagonistic trading blocs in a state of nearly permanent trade war. That "Fortress Europe" mentality has been associated with the promotion of an artificial sense of European nationalism, the principal characteristic of which is animosity toward the U.S. and Japan.

A second contributing factor is real-politik. The EC originally was built on a bilateral axis between France and Germany, and in recent years the two countries' relationship has become increasingly unbalanced. The French government and the president of the EC Commission, Jacques Delors, became concerned with Germany's renewed assertiveness. If they could not contain Germany indefinitely by themselves, they concluded, they should contain Germany by establishing a federal superstructure above her. They set about to persuade German politicians to accept that superstructure while they still had the influence to do so.

A third factor was dissatisfaction with the German Bundesbank's dominance within the ERM. The ERM had been set up in 1979 to provide a zone of exchange rate stability in Europe, and the Bundesbank's relatively conservative monetary policies had helped reduce inflation in countries such as France and Italy. Despite those benefits, the Bundesbank's dominance within the ERM widely was disliked by politicians in France and, to some extent, the United Kingdom, which saw in it sinister overtones of German hegemony in Europe.

In June, 1988, Delors persuaded the heads of government at their summit in Hanover, Germany, to establish a committee, under his chairmanship, that would put together a program to implement his vision of Europe. In 1989, the Delors Report set...