5:38 AM Aug 3, 1993

ERM SHAMBLES JEOPARDISE MORE THAN MONETARY UNION

Geneva 2 Aug (Chakravarthi Raghavan) -- The decision of the EC Finance Ministers on Sunday night to allow all EC currencies, except the German mark and Dutch guilder, to float within a 15 percent band spread, has not only virtually ended the Exchange Rate Mechanism (ERM), but has placed in serious jeopardy the EC single market and the vision of a wider European home as well as putting one more obstacle in the way of the Uruguay Round of trade negotiations at the GATT.

The move could enable the hard-pressed European governments to bring down interest rates and focus on employment policies, but if they push interest rates down too fast to jump-start their economies out of recession, it could drive down their currencies -- and make a future ERM even less feasible.

And the longer, the ERM and the monetary system remains in suspension, with each country taking decisions on monetary and economic policy in its own national interest, the more difficult it could be to get them all back under one common policy and discipline, surrendering their own domestic and national goals and agenda.

Perhaps the only gainer, atleast in the short-term is Germany which can continue its path of paying for the costs of unification with high interest rates, a high value mark (that will reduce import prices and thus keep down inflation). While it would hurt its export industries -- whether those exporting to other EC states (and intra-EC trade is a very high proportion of exports of EC members) or outside -- it would also achieve the Bundesbank and finance capital's objective of curbing wage demands.

But the Bundesbank views and statements, echoed by the politicians in Bonn and the media, about looking to Germany's national interests first, could on the political front unleash the old balance of power strategists in Paris and London (already visible and at play in the crisis in former Yugoslavia)

Some of the principal parties -- Theo Waigel, the German Finance Minister and Bundesbank Governor Helmut Schlesinger, EC Commissioner Henning Christophersen, and even French Prime Minister Balladur in Paris -- still speak of the continued goal of ERM and keeping to the target date of 1 January 1994 for its first part to be operational.

For good measure, the IMF head Michael Camedessus has added his voice for a quick return in Europe to stable currency exchange rate system. Ironically, Jacques de Larosiere, who as Camedessus predecessor commissioned and presented a staff study to the GATT (against the EC view) that exchange rate fluctuations don't have any effect on trade, is now heading the French Central Bank where a fluctuating or devaluation of the Franc and its positive and negative effects on the economy (including possible imported inflation), stimulating business activity and thus employment and effects on trade have to be weighed and balanced.

However, there is little conviction in their affirmations and it gets even less credence in the markets.

Until this latest ERM decision, the EC currencies within it were allowed to fluctuate only within a narrow band of 2-1/2 above or below a central rate -- with the Portuguese and Spanish currencies given a six percent margin. Now all EC currencies, except the mark and the guilder, can fluctuate by a 15 percent margin either side or a 30 percent appreciation or depreciation within a year.

The variation in the value of the dollar over the last ten years has been around ten percent, and EC countries have been the loudest in decrying such fluctuations and their effects on trade and need for parallel actions (to the conclusion of the Uruguay Round) on exchange rates and monetary stability.

To appreciate the implications of such wide fluctuations, one has only to look at the details of the recent Quad (US, EC, Japan and Canada) the Uruguay Round market access package now on the table in Geneva. After protracted market negotiations, the Quad just last month with difficulty agreed to harmonise their tariffs on chemicals -- and have provided for a five year period to reduce tariffs by ten percent or less, 10 years for reduction of tariffs between 10.1 to 25 and 15 years where tariffs are above 25 percent.

Now, within Europe, trading without tariff or other barriers and with such gyrating currencies, would produce price variations that would make difficult for any enterprise to make any investment or trading decisions and, even if they can hedge against such currency fluctuations, make their operational costs of trading that much higher.

And it will be even more so outside the European borders.

The serious blow that the exercise has dealt to the Bonn-Paris axis, and the sensitivities of either to their partner's interests, could easily make Paris dig its heels even more on the Uruguay Round deals, atleast in the short-run, and make the tasks of negotiators that much more difficult when they return to Geneva at end of August.

When the negotiations were recessed on 28 July, GATT Director-General Peter Sutherland told the Trade Negotiations Committee that August should be the period of reflexion and assessment in the capitals to enable capital-based negotiators move forward vigorously when they come back to Geneva.

Even those at their desks in August, whether in Paris or elsewhere within the EC member-States or at Brussels, would be paying too much attention to these matters.

The markets and the speculators -- most of whom are the leading banks and various funds in search of short-term gains by moving money -- that have successfully destabilised the ERM won't be taking a holiday, but would continue to test.

On Monday, the dealers have been cautious, with only slight changes in values of the weak currencies. But with general expectations that interest rates could fall soon, there will be renewal of speculative attacks.

In this game, the only way governments could act against the speculators is by making short-term and overnight movements of money and buying and selling of currencies for speculation costly. But the industrialized countries have become prisoners of their dogma of 'market'.

Unless they get out of this and act in concert to make the costs of speculation much higher, while rewarding the risk-taking by the real world of production and trade of goods and services, these turmoils and uncertainties will continue.

Combined IPS reports from Brussels, London and Bonn

In Brussels, Michel Luyckx, foreign exchange dealer with Kredietbank said "The ERM now exists only in theory.. In practice it doesn't mean a thing any more."

Since the sole aim of ERM is to reduce fluctuations to the point where currency exchange rates can be fixed, the allowing of greater fluctuation renders the whole system pointless, other analysts said.

"I call this a floating exchange rate system," said Peter Vanden Houte of Banque Bruxelles Lambert (BBL). "But the EC still calls it the European Monetary System."

After the changes were announced, Bundesbank Governor Helmut Schlesinger said, "We now have a situation which is much more stable in the sense that realignments are not necessary because one has wide bands in which the actual exchange rates can fluctuate."

"The 15 percent fluctuation margin means that a currency can either appreciate or depreciate by 30 percent within a year -- more than the dollar does in 10 years-- and that is a floating system," said Vanden Houte. The goal of a European Monetary Union by end of the decade, the establishment of an EC central bank and a single currency, can no longer be met, he and other dealers said.

"The EC's decision doesn't mean much except that Europe wants to keep some kind of monetary system...and abolishing monetary regulation is out of the question," Luyckx said.

In London, George Soros, the financier most commonly blamed for the two ERM crises that forced first Britain and then France to abandon their exchange rate policies, has called for the creation of a new mechanism. "As a first step," Soros said on Sunday, the European governments should "allow currencies to float and as a second step, create a new currency system."

Even speculators though need some 'fixities' to enable them to attack currencies and speculate. If there is no bottom for the governments and central banks to defend, then the risks are greater.

Former British Chancellor Norman Lamont said the agreement by EC finance ministers marked the end of moves to create a single European currency, while his successor, Kenneth Clarke, said that what was now needed was cooperation to ensure "that the best bits of the system go on" -- a reference, British Treasury sources said, to the need for exchange rate stability and economic growth.

But how this is to be attained was not spelt out. But the demise of ERM I, and efforts to cobble an ERM II would put Britain on a par with France and Germany in trying to shape it, with some British commentators focusing on the revival of the idea of John Major (as British Chancellor) for a 'hard ECU', rather than the ERM and full currency union that the other EC members had favoured in the negotiations for Maastricht.

The ECU, like the IMF's SDR, is now only a basket of currencies and an international accounting unit for inter-governmental financial exchanges. Major had then proposed that ECU denominated notes be issued and allowed to circulate side by side with national currencies.

But mutual suspicions between these three leading members of the EC make it unlikely that they will move fast to create a replacement mechanism which many agree needs to be achieved, though no one is clear how and even less are willing to face: fundamental political and economic issues like these cannot be resolved without countries willing to sacrifice some of their sovereignty, and enabling a supra-authority to act in common good, not merely that of individual nations.

The problem confronting the EC is that for a system to work, it must be geared to the needs of the community as a whole. The ERM in effect collapsed because it was anchored on the German mark and the French franc.

This policy failed when Germany's economic and financial priorities began to differ radically from those of France. Germany's determination not to pay for reunification through increased taxation and its resolution to rely on high interest rates to keep the inflationary effects of reunification in check drove a wedge between Frankfurt and Paris.

France, with minimal inflation, required a substantial reduction in interest rates in order to revitalise the economy, but was unable to reduce them so long as the Bundesbank put German inflation ahead of European of French -- and European -- recovery.

In Bonn, as the European economic policy lay dying on the trading floors of the world's money markets Monday, the chief suspect in its demise denied that reforming the Exchange Rate Mechanism (ERM) meant the death of the European Monetary System.

German Minister of Finance Theo Waigel said the decision was supposed only to deter market speculators and reduce the pressure on EC central banks -- particularly Germany's own Bundesbank -- which have been forced to spend billions on foreign reserves propping up the value of weaker EC currencies on the open market.

"The European Monetary System (EMS) is preserved in its most fundamental elements," Waigel said Monday, asserting that its remaining members were still willing to defend the system and the "progress made in terms of stable policies."

However this was very much in doubt -- with French Ministers in Paris citing France's stand against the German Army in World War One and Britain's ex-Chancellor of Exchequer Lamont saying that the EMS was dead and so was the single European currency it was supposed to herald.

Waigel rejected this view, and said the preconditions of the Maastricht treaty of political and economic union -- requiring two years of minimum exchange rate fluctuation within the ERM as a prelude to the establishment of a single European currency -- would be reapplied as soon as possible. He suggested that the EC would meet to evaluate the situation before Jan. 1, 1994 and possibly restore the narrow band -- ironically, the planned start date of the second stage of the economic union, according to the Maastricht treaty.

But Waigel was frank enough to admit that after spending 41 billion dollars worth of foreign currency trying to prop up fellow ERM members in July alone, that they could do no more. He also conceded that the decision "leaves room for a monetary policy that is tuned to national needs". More specifically, that meant Germany, which is struggling to pay for the costs of reunification without feeding domestic inflation.

In Paris, French Prime Minister Edouard Balladur, who had pledged his entire political future on the 'franc fort' policy, went to great lengths to claim that the value of the franc had been preserved.

This was on the theory that on average, the mark is worth 3.35 francs, even though within new wider ERM bands it could find a value between 2.25 and 3.89 francs to the mark. This new flexibility allowed Balladur to say that Monday's fall to 3.5 francs to the mark was not a devaluation.

Independent analysts were franker. "One of the causes that have led to this devaluation was the lack of government decision, and their contradictory comments on the budget deficit, defence of the currency and decreases in interest rates," said Jean-Marc Daniel, of the French Observatory of Economic Developments.

Most analysts noted how the French government's inability to fight speculation by other means forced Paris to resort to the raising of interest rates in a desperate bid to deter money market speculators from selling francs and crashing prices.

Higher interest rates in France, they say will only further block opportunities to borrow to invest in French job creation -- in a country that with 11.6 of the active population unemployed comes second only to Spain in terms of EC jobless levels.

Even before this, within the French ruling coalition, Jacques Chirac has been speaking in terms suggesting that he wanted more attention to dealing with the employment problems rather than sticking to the 'frank fort' policy.

After Monday's announcement in Brussels, Giscard d'Estaing and former German Chancellor Helmut Schmidt both underlined the need for restoring the ERM and its near fixed rates quickly, for the system to survive and achieve its purpose.