In 1970 the European nations tried narrowing exchange-rate fluctuations. It was to be tried on an experimental basis without any commitment to the other stages. It took for granted fixed exchange rates against the dollar. When the USA effectively floated the dollar from August 1971, the ensuing wave of market instability put upward pressure on the Deutschmark and squashed hopes of tying the Community's currencies more closely together. And the experiment failed.
In March 1972, the Member States created the ‘snake in the tunnel’. This was a mechanism for managing fluctuations of their currencies (the snake) inside narrow limits against the dollar (the tunnel). Hit by oil crises, policy divergence and dollar weakness, within two years the snake had lost many of its component parts and was little more than a German-mark zone comprising Germany, Denmark and the Benelux countries. And the experiment failed.
The quick ‘death’ of the snake did not diminish interest in trying to create an area of currency stability. A new proposal for EMU was put forward in 1977 by the then president of the European Commission, Roy Jenkins. It was taken up in a more limited form and launched as the European Monetary System (EMS) in March 1979, with the participation of all Member States’ currencies except the British pound, which joined later in 1990 but only stayed for two years.
The European Monetary System was built on the concept of stable but adjustable exchange rates defined in relation to the newly created European Currency Unit (ECU) – a currency basket based on a weighted average of EMS currencies. Within the EMS, currency fluctuations were controlled through the Exchange Rate Mechanism (ERM) and kept within ±2.25% of the central rates, with the exception of the Italian lira, the Spanish peseta, the Portuguese escudo and the pound sterling, which were allowed to fluctuate by ±6%. In August 1993, these bands were widened to 15% in order to counter speculative pressures, but by 1996 all currencies had moved back to their original fluctuation margins. And the experiment failed.
Many years of managing large sums of exchange rates hedges and teaching the subject in universities and colleges taught me that large monetary unions, like that of the US, survive if the productivity between the member states is close, very close.
European foreign exchange experiments will continue to fail as long as productivity differentials between member states are so different.
The markets always win. Even in the US monetary union. Sates like Ohio, Michigan, and California are paying dearly because they have become uncompetitive (within the US monetary union) as Greece, Spain, Portugal, and Ireland (within the European monetary union).
George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager
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