If The Franc Falls, So Will Europe's Dream Of A Common CurrencyRudi Dornbusch
While Germany runs its tight-money strategy, the rest of Europe is on the receiving end, with one currency after another weakening in the knees and collapsing. Now it's the franc's turn. The French government has vowed not to yield: that however fierce the attack, it will keep the franc glued to the mark.
But other governments have made the same vow, to no avail. Their currencies have gone soft, and so will the franc. And when the franc has gone, those few remaining will be on the line: Denmark's and then Belgium's, until no currency is left in place but a lonely, strong, overvalued mark. Dreams of a common money will be shattered; bitterness and recrimination will take their place.
Few countries have withstood the hard-currency test since exchange-rate turmoil struck in September when the French and the Danes were voting on a common European currency. The lira went down at the slightest probe; the pound sterling fell after $35 billion was lost in a futile defense; and Sweden practiced astronomical interest rates for a few months, then threw in the towel. France will follow suit, before the Mar. 21 election or just after.
The conventional wisdom is that Europe's widening slump and the currency crisis are the fault of the German Bundesbank, known to currency mavens as "Buba." And the immediate reason for the turmoil would seem to be Buba policy. If German interest rates were low, everybody would have low rates--German rates plus a little bit. But since German rates are high, everybody else's are high--Germany's plus quite a bit--and that's too much to take, if it lasts.
'NOT JUST YET.' Now that the currency pressure and high interest rates have been on for almost half a year, everybody wants relief. Nobody has any patience left for the Buba's "not just yet" attitude. As currency defense has become the routine, growth has evaporated. Last year was poor for business, this year is worse. Next year barely promises recovery--and that's the optimistic scenario.
Should we blame the Bundesbank for all this? For some the answer is obvious. After all, it sets interest rates that nobody can match for any length of time, and it has turned its own inflation fight into a Europewide slump. It is the pressure of mounting recession, not the credibility of the central bank, which has brought down recent wage settlements to 3% or just above.
But the 1993 wage round is not over until May. Giving up now would mean that inflation will linger on, as will slow growth. Later in the year, once moderate wage settlements establish a safe prediction of low inflation for 1994, the Buba can declare victory and cut interest rates to 5% from more than 8% and open the doors for growth. Rather than accept a truce, the Bundesbank is right to fight on until inflation is quite dead.
France may understand the German game plan, but it is counterproductive from a French perspective. France feels it can't wait, and it has a point. The French need low rates now, to call off the speculators and the doubters. The franc is not overvalued: Inflation is less than in Germany, the external balance shows a surplus, public finance is sound. But France is a Latin country, and that means the currency is always suspect (speculators like to take a bite, just to see if the coin is solid). And if one speculator hangs around, so will all. And if they all attack a currency, who's to say they can't bring it down?
PREPOSTEROUS PLANS. The answer for Europe is not a premature end to inflation-fighting in Germany. The answer must be an ambitious, joint commitment to currency cooperation. If the finance ministers in Germany and France declared their agreement to defend a fixed parity whatever the cost, the massive deterrence of such an accord would make the franc as good as the mark in a split second.
The blame for the franc crisis cannot be put on the Bundesbank, which has to fight inflation until it is dead. The responsibility must be placed on the politicians in Germany and France, who have been unwilling to say which parities deserve all-out support. The leaders have ignited the speculation by passing absurd monetary-integration schemes linking some currencies with no prospect of stability--those of Italy or Greece, say--to some of the hardest in the world. Maastricht, the European monetary-integration project planned for the end of the decade, has suddenly moved forward and is knocking at the door. If there is to be monetary integration between Germany and France, leaders on both sides must now underwrite the franc.
If the franc is allowed to fall, so will any prospect of monetary union between Germany and France. The French won't forgive the disgrace of the defeat, and the Germans, while they may gloat at having the hardest coin, will have missed the opportunity to create firm Franco-German cooperation. In the 1970s, France's V lery Giscard d'Estaing and Germany's Helmut Schmidt boldly created a scheme of monetary integration that was nothing short of a political masterstroke. In the next few weeks, leaders in these two countries must return to that Franco-German accord for inspiration.