THE ECONOMY
A live-in relationship with the snake
JOCK BRUCE-GARDYNE
Spare a thought, if you will, this weekend, for Mr Robin Leigh-Pemberton. Governor Leigh-Pemberton is the soul of honour: the last man in the world to trifle with a girl's affections, and then leave her in the lurch. And yet when he crossed the Channel earlier this week for one of his regular trysts in Basle, he found himself confronted by his sweetheart's angry French and German parents, demanding to know in no uncertain terms what precisely were his intentions. To which he could only answer, `wait and see.'
The lass in question is, of course, the European exchange rate mechanism. The Governor's predicament is poignant. For the Bank of England has been yearning to give benefit of clergy to the liaison between the pound and its continental neighbours for years, and has never been allowed to do so. What is odd, though, is the eagerness of the French and the Germans for our hand in marriage.
After more than a decade and a half of British membership of the European Com- munity most of our partners, most of the time, sadly concede that General de Gaulle was probably right: that we are not club- able. If we belong to a perpetual awkward squad within the European Community, it takes a suspension of credulity to believe that we would be cosy partners in the currency snake. Yet there is no gainsaying the urgency of the calls from Bonn and Paris.
Hitherto this may have been attributable to a vague sentiment that sterling participa- tion would give the Euro-currency unit, the ecu, added clout, and help to ensure that the continental finance houses would not be left high and dry as London developed its role as one of the three pivotal centres of the global financial market place, along- side New York and Tokyo. But now there is a new dimension. The central banks and finance ministers of France and Germany each look to London as a friend in need.
The European currency system functions most comfortably when, for extraneous reasons, the dollar is strong and the deutschemark weak. As soon as the fun- damentals reassert themselves, and the deutschemark resumes its cyclical climb against the dollar, the lesser partners in the EMS begin to feel the strain. In theory it is symmetrical: in practice, as with all curren- cy blocks, it tends to travel at the pace of the strongest participant, in this case the deutschemark. Certainly the Germans have been obliged, on several occasions, to bow to pressures to upvalue their currency. But betweenwhiles, when the snakeskin has begun to stretch, it is the weaker partners who have found themselves con- strained to raise their interest rates and defend their exchange rates. The French, in particular, want to make the disciplines more evenhanded. Changes agreed in Basle on Tuesday went a little way in that direction.
Nevertheless the French want partners to stand up to German monetary ortho- doxy and believe that we, with our faiblesse for inflation, would be their natu- ral allies. The Germans, on the other hand, reckon that Mr Lawson's commitment to price stability is to be taken at face value, and hence that we should back their stand for monetary discipline. With the dollar threatening to resume its pot-holing activi- ties, the urgency of the invitations to us is, I suppose, understandable. Were we to accept them both the Germans and the French would probably be disappointed, at different times, by our behaviour.
They will, however, remain unanswered. The Prime Minister is having none of it. Mr Lawson — or so it seems to me — has already decided to make the best of a bad job. Oh yes, the Treasury is going through the motions of an in-depth survey of the pros and cons of membership, and perhaps the mandarins cherish hopes that this will convince her. The Chancellor knows bet- ter. So he has settled for cohabitation. For months and months now the sterling- deutschemark parity has fluctuated less than the rules of the exchange rate mechanism would permit, had we been participating members.
The smoothness of this trendy rela- tionship has, however, owed a great deal to the stability of the dollar. Hence the Chancellor's enthusiasm for the so-called 'Louvre Agreement' — the revelation by the top five finance ministers this spring that their currencies were in perfect align- ment, and would be kept there. Once upon a time there were few more scathing critics of central bank intervention in the curren- cy markets than Nigel Lawson: fingers in the dyke, Mrs Partington's besom against the Atlantic, you name it. Today he is a born-again interventionist, glorying in the skill with which we catch the speculators and deprive them of their trousers. Naturally he insists that the Americans are equally enthusiastic. But are they? It certainly wasn't helpful to the cause of exchange rate stability to have US Trade Secretary Clayton Yeutter predicting the other day that the American trade deficit was not on the mend. All right, so Yeutter is a hobbledehoy who simply does not understand the message. It's Treasury Secretary Jim Baker who matters — him and the new Chairman of the US Federal Reserve, Alan Greenspan. And they're as keen to preserve the sanctity of the Louvre accord as anyone.
If so, Alan Greenspan goes a funny way about it. Prior to assuming office he told anyone prepared to listen that the dollar had still some way to fall. Last week he raised the US discount rate by half a point. He could have justified this move by reference to pressures on the dollar. In- stead he referred to the need to 'deal effectively' with 'potential inflationary pressures'. Just like Nigel Lawson, in fact, when he jacked up our interest rates a month ago. But whereas Mr Lawson was skilfully tightening credit conditions when he reckoned he could do so without caus- ing the pound to appreciate, it looks suspiciously as though Mr Greenspan was anxious to ensure that his tightening of interest rates would not stand in the way of the dollar falling. Hence it is likely to take something more than declarations of un- dying loyalty to the Louvre Agreement from the top central bankers gathered in Basle to convince the makers that the dollar is not a 'sell'.
For those of us who believe that ex- change rate flexibility has an essential role to play in correcting trade imbalances without recourse to protectionism, all this is rather comforting. If the dollar does start slithering again, and as a result the strength of the mark makes life difficult within the exchange rate mechanism, then — thanks to the cussedness of the PM — we keep our options open.
We can preserve station with the mark, possibly tightening our credit stance a notch or two to do so. Or we can hop out of our love-nest and move at least some of the way down with the dollar. Preferably the former. But either way it is surely not the moment to take the e.r.m to the altar, however much its parents think it's time we did. Mr Leigh-Pemberton will have to learn to live with their reproaches.
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