NEWS ANALYSIS : EC May Need New Path to Currency Union

Amid the shambles of European currency markets this week, one conclusion has stood out with crystal clarity: Many European countries are nowhere near ready to scrap their national currencies in favor of a common European one.

But despite the chaos this week, many European nations--including Germany, whose high interest rates helped precipitate the currency crisis--still want a common currency. That, they say, would boost European economies by eliminating the speculation and volatility in exchange rates that discourage trade and erode investor confidence. Europeans, as well as Americans and others, would find it easier to do business in a Europe with a common currency, proponents say.

“Monetary union is not off the agenda,” said Jim Rollo, director of economics at London’s Royal Institute of International Affairs.

But the European Community, Rollo and other experts said, is going to have to rethink how it should get there. Such rethinking may be needed even if France votes Sunday to approve the so-called Maastricht Treaty that sets terms for a unified currency.

And European nations also are going to have to halt the economic trench warfare that erupted this week, particularly between Britain and Germany. Those two nations do not sound like nations about to sign on to a common currency with each other.

British Chancellor of the Exchequer Norman Lamont warned Friday that Britain will not rejoin Europe’s system of fixed exchange rates until Germany brings down its high interest rates, which are thought to be one cause of the British pound’s troubles.

Germany’s high interest rates are also expected to come under criticism at today’s meeting of the Group of Seven (G-7) leading industrial nations in Washington. In a Washington speech Friday, Treasury Secretary Nicholas F. Brady signaled that the United States intends to take a tough stand with the Germans.

In reply to Lamont, Chancellor Helmut Kohl criticized his remarks as “inappropriate for a minister.”

Kohl later called for a European summit to foster currency cooperation. The next regularly scheduled European Community meeting is set for December in Scotland.

British Prime Minister John Major jumped into the fray, saying, in what aides described as a reference to Germany, that the European currency system should not be “veered toward national interest in any individual country.”

David Roche, a global strategist for the investment house Morgan Stanley International in London, said Germany’s central bank “was taking the position of knocking off other currencies one by one.” At the same time, he said of Britain, “This government’s economic policy is now called saving the government.”

Officials in Germany, when not sniping at the British, said the week’s events demonstrated not the impossibility of a common currency but the need for it. “The speculators who moved billions around (between national currencies) would then have no more chances to do that,” said German Finance Minister Theo Waigel.

For now, Europe’s road to monetary union is mapped out in the treaty initialed by leaders of the 12 EC nations in the Dutch town of Maastricht last December. The Maastricht Treaty would create a common currency in 1999 for those nations whose economies met the treaty’s standards for low inflation, interest rates and budget deficits.

The Maastricht Treaty, already rejected by Danish voters, goes before French voters Sunday. Rejection by France, which along with Germany is one of the EC’s twin pillars, would bury the treaty--and, with it, the timetable for a single currency.

Most of the remaining currencies in Europe came under intense selling pressure Friday as investors grew anxious that France would vote “no” in its referendum. However, the dollar strengthened against most European Community currencies, and gold prices soared, in anticipation of a “no” vote.

But even if the treaty is approved by the French and eventually takes effect, this week’s upheavals may force the drafters of the monetary union provision back to the drawing board. To many analysts, that would be a good thing.

“The EC needs to rethink the rigid Maastricht rules for monetary union,” said Nigel Gault, a senior economist in London for the DRI-McGraw Hill consulting firm. “The rules are clearly too ambitious for some countries, and they are not ambitious enough for others.”

Most of Europe is already partway along the road to a single currency--or at least it was before this week’s upheavals. Of the currencies of the 12 EC members, the values of all but Greece’s were linked to one another, with only a small amount of wiggle room allowed. The idea was to guarantee investors that they would not lose money to currency fluctuations if they moved their money across national borders.

This was the week that the European Monetary System, as this arrangement is called, came unglued. “In a world of mobile capital, fixed exchange rates simply can’t work,” said Graham Bishop, London-based vice president of Salomon Brothers.

Investors yanked their money out of such countries as Britain, Italy and Spain, whose economies are weak, highly indebted and inflationary. They turned instead to the haven of Germany, where high interest rates make investments particularly attractive.

Britain responded by pulling out of the exchange rate system altogether after its best efforts--an increase of five percentage points in interest rates and massive purchases of British pounds on international currency markets--failed to stop investors from fleeing to other currencies.

Italy tried a different course--it devalued the lira by 7%. But when that proved insufficient, it too pulled out of the system. The government proposed a whopping $75 billion worth of deficit reductions Thursday in an effort to put the budget on a more solid footing, but some economists said the deficit would still reach nearly 10% of economic output--more than double the huge U.S. deficit.

Spain tried a 5% devaluation of the peseta on Thursday, but most analysts said that would prove insufficient.

Britain, Italy and Spain are not about to sign on to a common currency--their economies are not up to it.

By contrast, some countries already have all but established a common currency, with the German mark at its center. The Netherlands, Belgium, Luxembourg, Switzerland and Austria set monetary policy so that their currencies’ values deviate slightly or not at all from the mark.

That has brought great advantages: the same low inflation that Germany has long enjoyed. Investors can be confident that if they put their money in any of the smaller countries, it will not be eroded by rising prices or a declining currency.

The trouble is that the smaller countries are forced to adopt Germany’s monetary policy whether they like it or not. With a common currency, administered by a common central bank, the smaller countries at least would have a voice at the decision-making table.

Current circumstances show why that is important. Germany, faced with inflationary pressures from the reunification with the former East Germany, has pushed interest rates high. Its neighbors have had to ratchet up their rates in lock step, lest their currencies lose value against the mark. But for economies less robust than Germany’s (and possibly even for Germany’s), those high rates could trigger recessions.

Times staff writers William Tuohy in London and William D. Montalbano in Rome contributed to this report.

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