² The operative element of the European Monetary System (EMS) is, and always has been, the Exchange Rate Mechanism (ERM). In its origins the EMS was the ERM and vice versa. In this article, when I have employed the abbreviation EMS or the full title the European Monetary System, I am writing about an exchange rate mechanism. Only at the end of the story, when it is decided that the EMS should be something other than just an exchange rate mechanism and that the UK could become a member of the EMS without also joining the ERM, have I specified the ERM as being only a part of the EMS.

³ In this essay, by Germany is meant the Federal Republic of Germany, popularly known at the time as West Germany.

⁴ Mike Blumenthal, the US Secretary to the Treasury, had appeared to welcome the depreciation of the dollar. In the USA there was much criticism of the view that the decline in the dollar was entirely the consequence of the policies and performance of the USA. Robert Solomon of the Brookings Institution drew attention to the ‘extremely slow and halting expansion of economic activity in Europe and Japan …’. He added that ‘the movement of exchange rates was used as a convenient excuse for inadequate economic performance in Europe’. Robert Solomon, ‘An American View of the EMS – Can the Dollar Coexist with It?’ (thereafter Solomon, ‘View’), Financial Times Conference, Frankfurt, 14, 15 Feb. 1979 (thereafter FTC), 44. He might also have referred to US expenditure on European security. But this view ignores other factors such as US oil imports.

⁵ Denis Healey reports on his conversations with Manfred Lahnstein, State Secretary of the German Ministry of Economics. ‘Manfred Lahnstein supported [the EMS] on grounds of Germany's national interest.’ The weaker countries would have to intervene on the currency markets to keep the stronger currencies down. Healey, Denis, The Time of my Life (thereafter Healey, Life) (London: Michael Joseph, 1989), 438.Google Scholar On the other hand, this was not the view of the Bundesbank. Otmar Emminger, President of the Bundesbank, asserted that ‘we in Germany do not consider the EMS as an arrangement for artificially holding the exchange rate of the Dmark down (as has often been imputed to us by foreign observers).’ FTC, 20. Speakers at this conference, which took place shortly before the inauguration of the EMS, included many of those most influential in its creation. It therefore provides an opportunity to examine what they were saying in public at the time about this development. I also spoke but about international trade.

⁶ Later, Schmidt was to discover that he had had an unspoken motive in proposing the EMS. It would help to anchor the FRG in Western Europe. Marsh, David, The Bundesbank: The Bank that Rules Europe (thereafter Marsh, Bundesbank) (London: Heinemann, 1993), 233.Google Scholar Certainly, for many years he had harboured the fear that the FRG might become unanchored from Western Europe. He had mentioned this fear in my presence at a small gathering of German, Dutch and British social democrats as far back as 1966. How much it was in his mind in 1978 is less clear.

⁷ Jenkins, Roy, European Diary 1977–1981 (thereafter Jenkins, Diary) (London: Collins, 1989), 234.Google Scholar

⁸ Financial Times, 20 Oct. 1977. Ortoli had been President of the Commission before Jenkins.

⁹ ‘It is…questionable whether the Community would be right to place such an initiative at the top of its agenda in the coming years. The very idea of a common currency for the whole of Europe does indeed imply a massive central budget to finance the regional and industrial policy that would be needed to support the weak areas unable to stand the strain within a monetary union.’ Times, 28 Oct. 1977.

¹⁰ Jenkins, Diary, 197.

¹¹ Jenkins himself admits that the institutions of the Community were unsuitable for rapid decisions on so momentous an issue and sees the creation of the EMS as justifying Giscard's innovation of the European Council. Ibid., 198.

¹² Couzens was a career Treasury official whose current responsibility was overseas finance.

¹³ Ludlow, Peter, The Making of the European Monetary System: A Case Study of the Politics of the European Community (thereafter Ludlow, System) (London: Butterworth Scientific, 1982), 108–9.Google Scholar Ludlow is also critical of the Treasury‐s wish to have a system that was ‘intellectually satisfying and apparently water tight’ and of its ‘marked impatience’ with those like the French, Germans and Italians who were ready to cut corners for political reasons.

¹⁴ Callaghan was a strong supporter of stable exchange rates. When, on 23 Nov. 1978, the Cabinet discussed a draft Green Paper on the proposed EMS, he insisted that the Green Paper should emphasise British support for the principle of stable exchange rates which was in the interests of the UK as a major trading nation. The Green Paper should leave the way open for a wider and more durable agreement on stabilisation in the currency markets.

¹⁵ ’We may also sometimes overrate the practical significance for trade and capital movements of fixed as compared to flexible exchange rates. It does not perhaps conform to textbook wisdom that over the last three years – i.e. from 1975 to 1978 – German exports to the three major EEC countries with floating rates against the DMark – namely France, Britain and Italy, as a group – increased at a significantly faster rate than German exports to the fixed parity club of the “mini–snake”.’ FTC, 16–17.

¹⁶ Norway did not join the EMS.

¹⁷ NIER, No. 87, Feb. 1979, 12. Eric Hoffmeyer, Governor of the Danish Central Bank, hoped that the EMF could operate a system of ‘negotiated floating’ with the dollar and the yen and thereby stabilise exchange rates with the EMS currencies. ‘The EMS and its Wider World Context’, FTC, 2, 5–6.

¹⁸ Financial Times, 22 Oct. 1977.

¹⁹ In the 1992 General Election, John Major managed without it.

²⁰ Cmnd 7404, par. 39.

²¹ NIER, No. 87, Feb. 1979, 9.

²² NIER, No. 87, Feb. 1979, 10.

²³ At Mogadishu, German troops successfully and dramatically ended an aircraft hijack and rescued the passengers. The rescue did a great deal for Schmidt's reputation.

²⁴ See Dell, Edmund, A Hard Pounding: Politics and Economic Crisis, 1974–76 (Oxford: Oxford University Press, 1991)Google Scholar, and Burk, Kathleen and Cairncross, Alec, ‘Goodbye, Great Britain’: The 1976 IMF Crisis (London and New Haven: Yale University Press, 1992).Google Scholar

²⁵ Willy Brandt had remained Chairman of the SPD despite his resignation as Chancellor in 1974.

²⁶ Marsh, Bundesbank, 194, 327 n.99.

²⁷ Kennedy, Ellen, The Bundesbank: Germany's Central Bank in the International Monetary System (thereafter Kennedy, Bundesbank) (London: Pinter Publishers for the Royal Institute of International Affairs, 1991), 123 n.6.Google Scholar

²⁸ Benn, Tony, Against the Tide, Diaries 1974‐76 (London: Hutchinson, 1989), 624.Google Scholar

²⁹ Ludlow, System, 106–7.

³⁰ Jenkins, Diary, 246.

³¹ See Dell, Edmund, ‘The Report of the Three Wise Men’ (thereafter Dell, ‘Report’), Contemporary European History, Vol. 2, no. 1 (1993).CrossRefGoogle Scholar

³² COREPER is the Committee of Permanent Representatives of the member states to the Community.

³³ Sir Donald MacDougall, a distinguished British economist, had been Head of the UK Government Economic Service and Chief Economic Adviser to the Treasury. Subsequently he was Chief Economic Adviser to the Confederation of British Industry. The official name of the report was ‘The Role of Public Finance in European Integration’.

³⁴ The estimate of 5–7% assumed a well-focused Community budget. Otherwise an even higher percentage of GDP would be necessary.

³⁵ Gordon Richardson, ‘The View of the Central Banker on Monetary Integration’ (thereafter Richardson, ‘View’), FTC, 29.

³⁶ Ortoli shared this view. ‘I am opposed to indiscriminate transfers designed to finance consumption or to mask economic divergences temporarily without tackling their roots. Such transfers, based on the feeling that the rich countries will pay, would mean a net impoverishment for the Community which would sooner or later become intolerable.’ Francois-Xavier Ortoli, ‘The European Community Looks at Monetary Integration’ (thereafter Ortoli, ‘Integration’), FTC, 37. It was also the view expressed by the Three Wise Men. Community policies, we said, ‘certainly should not be advocated as a means of correcting budgetary imbalances in the Community.’ Report on European Institutions (Council of the European Communities, 1980), 79.

³⁷ Ludlow, System, 117.

³⁸ Ortoli, ‘Integration’, 32.

³⁹ Guardian, 21 July 1978.

⁴⁰ Harold Lever was Chancellor of the Duchy of Lancaster and economic adviser to the Prime Minister.

⁴¹ Like the British, the Italians were paying more for their agricultural imports than if they bought them on world markets and yet were a net contributor to the CAP.

⁴² See Dell, ‘Report’.

⁴³ On the other hand Giscard did attempt, in the last stages of the EMS negotiation, to bargain his agreement against a satisfactory resolution for French farmers of problems arising out of the existence of monetary compensation amounts (MCAs). He was unsuccessful, but this delayed the start of the EMS until 12 Mar. 1979.

⁴⁴ There had been a first renegotiation of the UK's terms of entry into the EEC after the formation of the Wilson Government in Mar. 1974.

⁴⁵ The last minute attempt by France to raise the question of MCAs was equally irrelevent and equally unsuccessful. Its action merely illustrated the fact that states do not always worry about consistency when they see a negotiating opportunity.

⁴⁶ The European Council, in creating the EMS, requested the Community institutions and the European Investment Bank to make available to Ireland and Italy, for a period of five years, loans of up to 1000 million EUA per year on special conditions. The loans were to be concentrated on selected infrastructure projects and programmes. The special conditions were to consist of interest subsidies of 3 per cent for these loans. The cost of the subsidies, divided into annual tranches of 200 million EUA each, were not to exceed 1000 million EUA over a period of five years. Twelfth General Report on the Activities of the European Communities, Feb. 1979 (thereafter Report), 77. In the case of Ireland this was supplemented to the extent of about £50 million over two years, principally by Germany.

⁴⁷ Healey, Life, 439.

⁴⁸ It is a matter of speculation how far the depth of Giscard's commitment to an EMS was due to personal pride. He had been Minister of Finance when France was unceremoniously expelled from the snake. That may have been a piece of history that he wished to rewrite.

⁴⁹ The Treaty of Rome stipulated that each member state was to treat its exchange rate as a matter of common concern.

⁵⁰ The ECU was to have the same definition as the European Unit of Account (EUA).

⁵¹ They succeeded. The outturn was ECU 14 billion short-term credit and ECU 11 billion medium-term credit. There was a strong implication in the Bremen Annex that gold would be convertible into ECUs at the market price or close to it. This was obviously a French interest. It was likely to be a sore point with the Americans and the IMF. It subverted the policy of downgrading and eliminating gold in the world monetary system. The Treasury commented that the UK might not, in 1978, feel as strongly about it as its governments had in the past. But the Americans still had strong views. If an EMS was to be established, the British Government wanted the support of the US, not hostility.

⁵² Under the snake, when the exchange rates of any two countries moved apart by more than the permitted margin of 2.25 per cent, both had to intervene to redress the situation. In order to provide the country at the bottom with the necessary currency to intervene, the country at the top would advance very short-term credit which had to be repaid within 30 days of the end of the month in which the intervention took place. In Apr. 1973 the EMCF was set up to allow these debts to be settled on a multilateral basis. In addition there were short- and medium-term credit facilities. The short-term facility could, in 1978, provide up to EUA 4–6 billion in total which was available for 3 months, renewable once. The medium-term facility could provide up to EUA 3.85 billion in total for between 2 and 5 years. The short-term facility (but not the medium-term) was administered by the EMCF.

⁵³ Gordon Richardson agreed. ‘In the perspective of history the intervention arrangements may prove less significant and far reaching than the idea launched in 1978 for the ultimate development of a European Monetary Fund …’. ‘View’, 30.

⁵⁴ Jenkins, Diary, 289.

⁵⁵ Ludlow, System, 139. Zijlstra insisted that it would certainly be necessary to carry out detailed studies on technical feasibility.

⁵⁶ Otmar Emminger argued that ‘It is – contrary to some hard dying superstitions – always the surplus country that bears the burden of financing support of a weaker currency by supplying its own, newly created, money (even if the deficit country finances its support operation by drawing the “strong” currency via the IMF or the future European Fund or through selling SDRs to the strong currency's central bank).’ FTC, 20.

⁵⁷ Ludlow, System, 106–7.

⁵⁸ Ludlow, System, 161.

⁵⁹ The use of the basket ECU as the basis for calculating divergence implied the need for stability in the calculation of currency weights within the ECU. It was eventually decided that there should be a review of currency weights every 5 years though other arrangements might be necessary if the weight of any particular currency changed by a significant amount.

⁶⁰ Report, 77.

⁶¹ Eric Hoffmeyer, ‘The EMS and its wider world context’, FTC, 4.

⁶² Ortoli, ‘Integration‘, 34.

⁶³ Minikin, Robert, The ERM Explained (London: Kogan Page, 1993), 24.Google Scholar

⁶⁴ Ortoli, ‘Integration’, 36. He went on to indicate that what was needed was ‘consultation‘consultation’, ‘a degree of policy integration’ and also ‘mutual frankness, so that each country can take its own decisions in full knowledge of the intentions, objectives and policies of the others’.

⁶⁵ Subsequently Governor of the Bank of France.

⁶⁶ Ludlow, System, 183.

⁶⁷ Italy had, on 30 Nov., not yet decided to join.

⁶⁸ Ludlow, System, 184.

⁶⁹ Jenkins, Diary, 249.

⁷⁰ Jenkins, Diary, 246.

⁷¹ See Peter Jenkins's articles on the EMS in the Guardian during the summer and autumn of 1978.

⁷² Ludlow, System, 220.

⁷³ Healey, Life, 439.

⁷⁴ Richardson, ‘View’, 27.

⁷⁵ Jenkins, Diary, 305.

⁷⁶ Sir Jeremy Morse, Chairman of Lloyds Bank, who supported membership, commented: ‘One of my very reasons for wanting us not to be out of the EMS if and when it is launched, is that I think that we need to be in there fighting our corner on the transfer of resources as well as the CAP and the Fund.’ Ludlow, System, 223.

⁷⁷ Heath had said: ‘If the British government is seeking to destroy the common agricultural policy it will fail and in failing it will ruin Britain's chances of securing other changes it wants to bring about in the proposed EMS…’. Times, 13 July 1978.

⁷⁸ Arguably the discussions at Cabinet on 6 and 13 July on the EMS were rather important. However, in the published version of his diary, Tony Benn makes no reference to them. The absence from his published diary of any mention of the discussion is particularly odd as Benn himself presented a paper.

⁷⁹ ‘I was fairly agnostic until I realised, from long discussions with Lahnstein and others, how [the EMS] was likely to work in practice; then I turned against it.’ Healey, Life, 439.

⁸⁰ Ludlow, System, 219, reports that GEN 136 was chaired by the PM. In fact, he only chaired one meeting of it, though that was the most important.

⁸¹ The Bonn communiqué referred to Schmidt's report on the proposed EMS and added, ‘The meeting welcomed the report and noted that the community would keep the other participants informed’.

⁸² The principal amendment was to remove the reference to consultation regarding changes of reference rates, which might be misunderstood, but instead to emphasise the need for mutual agreement on changes in reference rates rather than mutual consent.

⁸³ Report on Economic and Monetary union in the European Community (Luxembourg, 1989), known as the Delors Report, 12.

⁸⁴ The Nyborg Agreement, otherwise known as the Basle–Nyborg Agreement, was an attempt to correct the asymmetry of the system and to achieve a more equitable distribution of the burden of intervention between the different countries. See Kennedy, Bundesbank, 94, and Tsoukalis, Loukas, The New European Economy: The Politics and Economics of Integration (Oxford: Oxford University Press, 1991), 181–2.Google Scholar

⁸⁵ Ibid., 182–3.

⁸⁶ Robert Solomon of the Brookings Institution was concerned at the asymmetry of the EMS: ‘As is well known, a major defect of the Bretton Woods system was that it failed to contain explicit guidelines for balance of payments adjustment and in particular exchange rate adjustment by member countries. In the absence of such guidelines for adjustment, the system was asymmetrical. The pressures on countries in deficit were more severe than those on countries in surplus. As one reads the communiqués on the EMS, one finds little evidence that these lessons have been learned.’ Solomon, ‘View’, 42–3.

⁸⁷ The CPRS, otherwise known as the ‘think tank’, advised the Cabinet, but particularly the Prime Minister. It was founded by Edward Heath in 1971 and abolished by Margaret Thatcher in 1983.

⁸⁸ The effective rate for sterling is here given as a percentage of its value at the time of the Smithsonian settlement in Dec. 1971. In fact, due probably to the increase in oil prices in 1979, the effective rate for sterling rose by about 50–60 per cent between the middle of 1978 and early 1981. It then fell progressively, reversing about half that rise up to early 1985. Dow, J. C. R. and Saville, J. D., A Critique of Monetary Policy: Theory and the British Experience (Oxford: Clarendon Press, 1990), 88.CrossRefGoogle Scholar

⁸⁹ Otmar Emminger nevertheless thought: ‘In some respects, conditions for undertaking the experiment of the EMS are better now than they have been for several years.’ He based this view on the fact that the external balances of the EEC countries with floating currencies were ‘better now than they have been for several years’ and that the exchange rates of the Italian and French currencies ‘seem to be entirely credible in the market place and so appear well suited as entry rates for the EMS’. This was a view which, at the same Conference, Gordon Richardson, Governor of the Bank of England, appeared to share. FTC, 26.

⁹⁰ The great difference since the world of Bretton Woods was that it had become a multi-reserve world.

⁹¹ Otmar Emminger emphasised the importance to the future of the EMS of the development of the dollar. ‘[I]f there were massive outflows from the dollar, this would reverberate throughout the international monetary system, and would probably not spare the future EMS.’ FTC, 21. He had acquired plenty of experience in dealing with the effects of a switchback dollar on the snake and otherwise during 1978 and before.

⁹² Minford shows that since the EMS was established in 1979, a number of member countries have experienced a substantial and persistent rise in their real exchange rate, the ratio of domestic to foreign prices. Patrick Minford, The Political Economy of the Exchange Rate Mechanism, CEPR Discussion Paper No. 774, Mar. 1993, Fig. 1.

⁹³ SDRs are a reserve asset created by the IMF.

⁹⁴ ‘I am convinced that it is in Europe's interests to help to strengthen the IMF.’ Ortoli, ‘Integration’, 40. One question that had been raised was whether the creation of the ECU as a means of settlement and as a reserve asset might compete with the SDR. During 1978 an increase in IMF quotas and a new allocation of SDRs was approved. This was interpreted as demonstrating that EEC countries had not lost interest in the IMF. More generally, creation of SDRs has been limited by fears of inflation.

⁹⁵ Pegs that crawl are inconceivable outside theories of exchange rate management. In this case exchange rates would be changed by small amounts determined by relevant criteria.

⁹⁶ ‘Edmund Dell spoke. “In the old days, the reason why the world economic system worked was that there was one dominating economy–Britain–with a stable currency. We can't expect that any more. The EMS will not be a substitute for the old pound sterling. Indeed, a full economic and monetary union would be better than an EMS.” He added, “The divergence of the economies is the real problem. I would rather we dealt with the problems ourselves and not go in.”’ Benn, Tony, Conflicts of Interest, Diaries 1977–80 (London: Hutchinson, 1990), 384.Google Scholar In fact I was referring to the earlier dominance of the US dollar, not of sterling.

⁹⁷ Lever presumably meant that monetary instability sometimes had a deflationary and sometimes an inflationary effect on the world economy.

⁹⁸ Healey had indicated that, in the view of the Italians, the scheme as now devised would provide an easier way for them to depreciate their own currency due to support from other members of the Community.

⁹⁹ On I Nov. 1978 President Carter announced a package of support measures for the dollar. The Federal Reserve Board increased the discount rate by 1 per cent to 9.5 per cent and announced supplementary reserve requirements for commercial banks. The US Treasury took action to increase its access to foreign currency reserves to defend the dollar.

¹⁰⁰ Benn was referring to the £650 million over five years requested by the Irish. In fact, the eventual settlement gave the Irish slightly more than one-third of this level of assistance.

¹⁰¹ The main surprise was that Giscard had delayed the initiation of the EMS from 1 Jan. 1979 in an attempt to persuade his farmers that he was seeking the abolition of MCAs.

¹⁰² Ireland in fact did not use a 6 per cent margin. Giscard's domestic difficulties lay principally with his farmers. On their behalf he wanted the Community to start on the road to the abolition of MCAs. On this he did not get his way, but the start of the EMS was delayed until 12 Mar. 1979. Giscard could regard the attitude of the UK as constructive in that, although not joining the ERM, it did join the EMS, which was of some help to France.

¹⁰³ There is one advantage to be derived from devaluations. They make the case with domestic opinion for associated measures. When a currency is simply floating down, that need may be overlooked.

¹⁰⁴ FTC, 21–2. At the same conference, Robert Solomon delivered a warning: ‘We have all observed that some of the smaller members of the snake have several times adopted monetary policy measures that were not particularly suited to the domestic state of their economies in order to hold their exchange rates in line with the Deutsche mark.’ Solomon, ‘View’, 43.

¹⁰⁵ In fact, the irreversibility of the process is called in question both by the refusal of the Bundestag to ratify the Maastricht Treaty unless conceded a further vote before EMU and by the criteria which member countries will have to meet to qualify for EMU.

¹⁰⁶ An American view: ‘It has long been evident that European countries, in contrast to the United States, have a need for external discipline in order to make anti-inflationary policies acceptable to the public.’ Solomon, ‘View’, 43.

¹⁰⁷ Report, 19.

¹⁰⁸ Report, 76.

¹⁰⁹ At Frankfurt on 29 June 1993, Helmut Sclesinger, President of the Bundesbank, said that 75 per cent of transactions in ERM currencies in 1992 were in DM. Financial Times, 30 June 1993.

¹¹⁰ According to OECD, the French since 1975 have had the worst unemployment record of any major industrialised country.

¹¹¹ Healey, Life, 439.

¹¹² If the UK had entered earlier it would, presumably, have been at an even higher exchange rate. Nigel Lawson shadowed the DM at DM 3 to £1.