On 16 September 1992 the EU gave up on the narrow band Exchange Rate Mechanism. Italy was forced out of the narrow bands. Spain, Portugal and others were also unable to hold their currencies against a strengthening DM.
The Euro is the ERM it’s more difficult to get out of. The ERM still left countries free to set their own interest rates and budgets. They had to juggle their policies to try to keep confidence going in their currencies. The failure to do so was pretty comprehensive, as the market ganged up on currency after currency. The ERM was meant to be a dry run for the single currency. Instead it set it back. When they did go ahead they simply ignored the fact that several leading players in the Euro had been unable to remain stable against the DM in the ERM days.
The ERM should have been a warning to the founders of the Euro. If markets could destroy a currency locking device, why did they think markets would leave a single currency untouched? They obviously forgot that the debt markets were still open. Investors and speculators can make their views known through the bond markets, just as they did through the currency markets for the ERM.
I find it sad that some of us have had to spend so much time and effort trying to explain why the ERM would not work, and now trying to explain why the Euro cannot work in its current form. It’s bad enough having to do it once. Having to do it twice is worrying. What part of the ERM experience did they not understand? Why do they think the debt markerts will now behave differently from the currency markets? It is after all at base the same argument. Economies have to be in line with one another for the project to work. If countries become uncompetitive against Germany – as they did and as they are again – there needs to be some way to relieve the pressure in the system.
The G20 is considering an IMF expansion. The IMF usually promotes a programme of budget deficit reduction linked to devaluation and appropriate monetary policy and interest rates, set by the sovereign government it is assisting. Euroland countries do not have the ability to devalue or to set their own money policy. This makes it difficult to see how IMF programmes can work. The IMF does not lend to California or New York, so how can it lend to Greece or Portugal? I would prefer a Euroland fix of what is a Euroland problem.