At a Brussels joint lunchtime meeting with the European Centre for Advanced Research in Economics (ECARE), Université Libre de Bruxelles, on 22 October, Richard Portes discussed the recent turbulence in European monetary politics and financial markets. Portes is Director of the Centre for Economic Policy Research; Professor of Economics at Birkbeck College, London; and Directeur d'Etudes at the Ecole des Hautes Etudes en Sciences Sociales, Paris. His remarks drew in part on CEPR's series of Annual Reports, Monitoring European Integration, in particular the 1990 Report, The Impact of Eastern Europe, and the 1991 Report, The Making of Monetary Union. The views expressed by Professor Portes were his own, however, not those of ECARE, nor of CEPR, which takes no institutional policy positions.

Portes first noted that the fragility of the `new' (or `hard') EMS without capital controls had been well understood by many economists for at least three years. `Permanently fixed exchange rates' make no sense, since exchange rates they serve no purpose unless they can be changed; the issue is whether they will change in a rational and controlled manner. Since the exchange-rate structure was held together after 1987 only by expectations of progress to EMU, the long transition period and postponement of the `final realignment' were inherently unstable. German unification then presented a unique, highly asymmetrical, and exceptionally large shock, which formed the main underlying pressure for realignment; but this danger was also clearly foreseen, and an immediate upward realignment of the Deutschmark in 1990 was necessary to avert the recent chaos on Europe's currency markets.

Portes argued that the main short-run cause of recent events was the instability of expectations following the Danish referendum. Official claims that the authorities were not prepared for the size of the subsequent speculative capital flows are implausible, since it is well known that foreign exchange trading amounts to some $1,000 billion per day, of which probably less than 5% finances trade in goods and services. Those arguing that raising overnight interest rates sufficiently can always defeat a speculative attack may be `technically' correct, but this merely raises the question of whether the currency or the government falls first. Those blaming `the rush to EMU' for recent events are also mistaken; a faster EMU might have been a solution. Nor can we sensibly blame `the markets': a collection of thousands of individual traders working for competing firms, taking very short-run decisions, can have neither a collective view nor any collective intention. Speculators need not conspire to move so much money across borders so fast; this follows logically from the abolition of capital controls, to let capital flow quickly to its most profitable uses.
Portes maintained that an ERM extending beyond the `core' countries without capital controls would now be even more unstable; but simply restoring the status quo ante may no longer be feasible. A rapid move to a union of most EC member countries, which could deliver sufficient `convergence' to maintain itself, remained the best available solution, but this now appeared most unlikely. `Silent' coordination among central bankers led by the Bundesbank is unlikely to be politically viable, since the coordination would have to be very strong and the other central banks sufficiently independent to follow the German lead.

A smaller group of countries could follow Bundesbank policy while exerting no influence over it, but it is unlikely that France would be willing to do so indefinitely. The Pöhl suggestion to abandon Maastricht and move quickly to a common central bank for Germany, France, Benelux, Austria and Switzerland would amount to forming a `North European monetary club'. This would raise political problems for the Community, even if it involved Maastricht-style power-sharing over the European Central Bank; and France might hesitate to enter such a grouping without the counterweight of the other Latin countries and the UK. The recent further elevation of the Deutschmark into a national symbol also raises doubts about Germany's willingness to share authority over its monetary policy, even with such a `core' group.

Portes noted in conclusion that the exchange rate crisis had drawn out not merely the instability of the `new EMS', but also a wide range of negative attitudes and destructive forces, which are disturbing both in themselves and in the underlying tensions they reveal. These are likely to impede the construction of a `deeper' European Community. They need not, however, seriously disrupt current EC enlargement negotiations, although some aspirants may now be less enthusiastic about joining a Community that has proved so deeply divided.