The conventional wisdom: The crack-up of the European Monetary System did everyone a favor by freeing the French franc from the tight grip of the German mark. With the franc and other weaker currencies floating downward, many European governments will soon lower interest rates, pump up economic growth, and start creating jobs again. Germany will benefit through increased exports to France and other countries. So will the U.S.
This view is right, but only for the very short term. Unification stresses are bloating Germany's budget deficit to 7.5% of gross national product (compared with 4.5% for the U.S.), keeping rates at Alpine levels. So the foreign exchange markets forced the bureaucrats to acknowledge that Germany cannot lead Europe for the time being. Exporting deflation and driving half the Continent into a long, deep recession to control its own unique inflationary pressures is not acceptable to other Europeans. First, the pound and lira dropped out. Now, the franc. For all practical purposes, the mark and the tight monetary policies that go with it are disengaged.
There is great economic and political danger, however, if the split continues. It wasn't too long ago that Europe was awash in beggar-thy-neighbor competitive currency devaluations. In the 1960s and '70s, governments went their divergent ways on interest-rate policies and trade restrictions. It is easy to forget that the open European capital and goods markets that corporations and banks now take for granted didn't exist a decade ago. Only when France and West Germany set up the EMS in 1979 did fiscal and monetary policies begin to converge, cutting inflation throughout Europe. Nearly all the breakthroughs in opening up markets occurred within a relatively strict monetary union, now torn asunder.
It may very well be that these open markets now have a life of their own and will provide the discipline necessary for economic growth. The liberalization of the capital markets and the end to nearly all foreign exchange controls have made it impossible for central bankers alone to dictate European money policy. With open borders, trade is growing, competition is increasing, and European corporations are restructuring. Economic union is taking place without benefit of heavy-handed edicts from Brussels-based Eurocrats.
The big question is whether it can continue moving forward without the steadying hand of strong German fiscal and monetary leadership. Europe and the U.S. need Germany to get its domestic problems straightened out as quickly as possible and to return to addressing European-wide issues. This is not the time to be otherwise engaged.