Brussels' tan Bor-schette building probably won't be immortalized in eco- nomic history the way New York's Plaza Hotel was after the world's monetary brass sorted out the dollar's fate there in 1985. But perhaps it deserves to be.
It was at the Borschette, a European Community conference center, that the Continent's finance ministers and central bankers finally woke up to reality. In 12 hours of tense negotiations, they cut a deal that all but scuttled Europe's no longer tenable system of regulated exchange rates. France is now free to cut rates without worrying about keeping its currency in line with the overstrong German mark. Germany can concentrate on getting its economy, Europe's largest and, in some ways, sickest, back on track after the shock of unification. The move may well be the Continent's best shot at pulling out of a severe, two-year recession.
NO FREE RIDES. It may also finally quash the ill-conceived efforts to rush ahead with the Maastricht Treaty on political and economic union. Both Maastricht and the Exchange Rate Mechanism tried to enforce economic discipline. But the lesson of the currency crisis is that trying to manage the increasingly complex European economy by edict from Brussels or elsewhere is doomed to fail.
The new economic order that is emerging will rely on market discipline to keep the wayward in line. Politicians who let debt pile up or inflation surge are likely to have their currencies shellacked by global traders. They may be able to get a brief free ride from devalued money, but longer-term, the bill will be paid with higher interest rates and taxes and slower growth.
Europe's major economic achievement of the last decade--the single market--has made it a lot tougher for governments to cut corners. By demolishing exchange controls, Europe, perhaps unwittingly, opened the way for the foreign exchange market to punish out-of-line governments. "The liberalization of capital movements has subjected politicians to much greater market scrutiny," says Thomas Mayer, chief economist at Goldman, Sachs & Co. in Frankfurt.
Business would rather not have exchange-rate volatility; it makes planning and investment more difficult. But business is now well-versed in hedging, and the ERM was no longer workable. Created in 1979, it served its purpose in a simpler time. But the fall of the Berlin wall and the coming of recession put it under too much strain. Once German unification is further along and the Italian, French, and other economies near the end of restructuring, a more closely coordinated system might once again be appropriate. But that may not be necessary. After some short-term buffeting, the currencies could well become more stable--now that freeing them has greatly raised the risk for speculators.
Toppling such a sacred totem has created plenty of worry about Europe's future. No one knows how much damage has been done to the bedrock German-French relationship. But in reality, Europe couldn't continue the way it was heading. The ERM, designed to bring currency stability to the EC, was producing the opposite. The latest currency crisis was the second blowup in less than a year. Britain and Italy dropped out of the system last fall.
Worse yet, the currency structure was ratcheting up political tensions as the high rates imposed by the Bundesbank strangled one European economy after another. Plummeting growth and lengthening unemployment rolls inflamed resentment of the Germans and played into the hands of extremist parties such as German neo-Nazis and France's National Front.
Despite the comments of some European leaders, the ERM is virtually a dead letter. Currencies can now swing a massive 30% against each other. That's more than the free-floating dollar has varied in its roller coaster ride against the mark in the three years since German unification.
A SPARK? While France is the obvious beneficiary of the looser system, Germany is not displeased. The Bundesbank will not have to throw billions away supporting other currencies. And stronger European growth could fuel demand for German exports--giving the economy the spark it badly needs.
It will take some time for Europe's politicians to adjust to the new order. They have invested so much political capital in the ERM and the Maastricht Treaty that it will be hard for them to let go. French Finance Minister Edmond Alphandery is vowing to keep the franc as close to its old fixed rate as possible. But it would be absurd to keep rates at the old recession-perpetuating levels.
One hopes European politicians will absorb the proper lessons from the last year of turmoil. First, forcing an excessive degree of unity on Europe will lead to trouble. Second, despite recession, the single market is working well. Borders are open, costs are dropping, business is becoming more competitive. Europe needs to let market forces act as checks and balances--not try to legislate outcomes from Brussels.