The rise and rise of the power of the Euro

Jul 4 2008 by Nevill Boyd Maunsell

When the Berlin Wall came down, it is said Helmut Kohl and Francois Mitterand made a man-to-man deal. Kohl’s West Germany could have East Germany and Mitterand’s France could have the German Dmark.

It was a huge prize, the lynchpin of West Germany’s astounding economic success in the second half of the 20th century, the currency that weathered the oil-shock inflation of the 1970s and ’80s like no other.

Uniting the two Germanys became a fraught and hugely costly process, while the French, along with the rest of western Europe, ended up with the euro.

The continental currency, with its studiously anaemic banknote designs, seemed a poor exchange for the mighty mark and struggled to inherit the mark’s status as a reserve currency.

Nobody, least of all this column, could believe that a currency could work across what remained to a great extent a string of nation states with disparate economic priorities and policies, not to say tax regimes.

Then last year, as the dollar reeled under the American sub-prime disaster and all that followed, and the pound teetered in its wake, the euro became the world’s currency of choice. That made it too strong for comfort for many European politicians and many European business people.

But the euro is not run by politicians and business people. The European Central Bank, under its second president Jean-Claude Trichet has developed a stroppy independence. If anything it is more inclined to resist political pressure than the old Bundesbank. His stance is that its job is to keep inflation within sight of a two per cent target, not to salvage French jobs, the Spanish construction industry or the Irish housing market.

Anyway, euro-inflation reached four per cent last month and this week the ECB upped its rate to 4.25 per cent from four per cent – 48 hours after President Sarkozy had ordered it to do nothing of the sort.

President Trichet is playing for historic stakes. He is out to make the euro into what it was intended to be, a mega-Dmark. If that means a recession in this country or that, so be it. Heroic stuff.

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The one thing that has gone right for the Bank of England in its struggle with imported inflation is that the dreaded pay explosion it fears could unleash a pay/price spiral has not materialised.

Charlie Bean, the Bank’s newly-named deputy governor, gave some reasons when he appeared before the Commons Treasury committee on Wednesday.

The link between pay deals and the Retail Price Index is much weaker now than it was last time round, in the 1970s and ’80s, he said. This is only partly because of “changes in the structure of wage bargaining” (You don’t taunt Labour MPs about the withering of trade union biceps).

He listed competitive pressures in markets for British products, migrant labour and scope for offshoring. These all make it harder for employees to win pay increases that match the RPI, even if they ask for them.

In the end, Mr Bean suggested, the issue is what employers can afford to pay – and how much they have to pay to recruit and retain the staff they need. With luck he may be right.