The idea of European unity--the transmutation of the European Community from a free trade area to a full-fledged economic union and eventually to a federal political system--has become virtually unstoppable, even in Britain.
Prime Minister Margaret Thatcher wanted to stop the process with trade; she has been an ardent opponent of British entry into the so-called exchange rate mechanism of the European Monetary System, which stabilizes exchange rates within Europe. But she has effectively lost that struggle; Britain is now expected to join the exchange rate mechanism in the very near future.
And this is a more pregnant move than a decision to join five years ago would have been, because the European Monetary System has clearly become a way station on the route to a common European currency. And as the Germans have just reminded us, a currency union is not much different from a political union.
What is ironic is that Thatcher, who gained a reputation for leadership by putting her economy through incredible punishment in the 1980s, now looks weak, foolish and silly for clinging to a position that makes considerable economic sense. On purely economic grounds, the case against a common European currency is actually quite strong.
Why should one ever want to have separate national currencies? Because sometimes it is very helpful to be able to change the value of one currency relative to another.
Suppose, for example, there is a sharp drop in worldwide demand for goods made in Britain. To cope with such a shock, Britain must both make its goods cheaper and attract new industries to replace the shrunken old ones. The only quick way to do this is to reduce British wages, to make its labor more competitive.
But how can all British wages be reduced quickly? In the face of sustained high unemployment, workers might be persuaded to accept lower wages, and the whole wage structure could gradually be squeezed down to a competitive level. But the economic and social cost of reducing wages by, say, 15% would be huge. In contrast, a 15% devaluation of the pound on foreign exchange markets would accomplish the same thing instantly and almost painlessly.
Conversely, imagine a surge in demand for British products. This would bid up the prices of British goods and services, possibly building an inflationary momentum that would later prove hard to stop--unless Britain accommodated the surge by allowing the pound, instead of the price level, to rise.
