The euro's demise may be the final chapter of the ERM debacle By poisoning our relationship with Europe almost beyond redemption, it helped save the UK from running headlong into the madness of monetary union. From Black Wednesday onwards, it became politically impossible for Britain to join the euro, despite the later election of a vehemently pro-euro prime minister. The other, often forgotten benefit of the ERM is that it finally exorcised the bogey of Britain's inflationary past. Many will argue with this contention, but there is no disputing the facts. At the time of entering the ERM, UK inflation was at 10.6 per cent and interest rates at 15 per cent. By the time we left, inflation was back down to 3.6 per cent and, but for a blip right at the end when rates were raised in a futile attempt to defend the exchange rate, interest rates were lower, too. Subsequent revisions to the GDP data showed Norman Lamont's much mocked "green shoots" speech was also bang on the money - the UK economy was in fact out of recession by the time it left the ERM. This is not to argue that Britain should have tried to stay the course, or indeed that the same, anti-inflationary policy could not have been achieved outside the straitjacket of the ERM. The point is, as Prof Sir Alan Budd, chief economic adviser to the Treasury at the time, later argued, that membership of the ERM gave us no choice in the matter. It locked in a period of fiscal and monetary austerity in a manner which ultimately stood the UK economy in very good stead. Despite its reputation for incompetence, the Major government established the conditions for more than a decade of low inflation growth. Also forgotten is that back then, the ERM wasn't widely seen in the same way as it is today, as a mere glide path to eventual membership of the euro, though Mrs Thatcher, in her inimitable way, rightly sensed that this was indeed its purpose all along. Many of those who supported membership of the ERM, Nigel Lawson included, were wholly opposed to monetary union. There is a world of a difference between the two. Countries don't easily share currencies, but fixed exchange rate regimes, where individual monetary sovereignty is maintained, were quite commonplace at the time and have been throughout history. For Lawson and many others, the ERM was just another chapter in Britain's long, post-war search for macroeconomic stability. The demand management of the Heath, Wilson and Callaghan governments had failed miserably. By the mid-Seventies, inflation had hit 30 per cent. The monetary targeting championed in the early years of the Thatcher government wasn't much better, with inflation in double digits by the late Eighties. Ironically, this was partly caused by Lawson's policy of shadowing the Deutschemark, an early precursor to membership of the ERM. To stay loyal to the policy, Britain was forced to follow the Bundesbank into a series of interest rate cuts, stoking the latter stages of the Lawson boom. None the less, Lawson remained a convinced "exchange rate monetarist." If you linked yourself to a low inflation economy, he believed, you would get low inflation yourself. Broadly speaking, he was eventually proved right. Full membership of the ERM did the trick, but it went on for too long. The medicine was still being applied long after the cure had succeeded. This brings us back to the contemporary relevance of these events. The immediate cause of the ERM crisis was German reunification, which prompted an inflationary boom in Germany just as everyone else in Europe was plunging into recession. Naively, the UK government believed, right up to the last moment, that out of the goodness of their hearts the Germans would do the opposite of what was needed in their own economy, and to accommodate everyone else, would cut rather than raise interest rates. Even a cursory reading of the German press would have revealed a different story. George Soros took the trouble and bet accordingly. The rest is history. When push comes to shove, Germany cannot be relied on to sacrifice its own national interest to that of the broader whole. Quite right too, you might reasonably argue, but the fact is that even the relatively loose arrangement of a fixed exchange rate regime, let alone the full monty of monetary union, cannot survive unless mutual obligations are recognised. Europe's problem with the single currency is but a reflection of a much deeper and older fault line at the heart of this troubled continent: Germany is both too big and economically dominant to be easily contained, but too small, tainted by history and politically alien, to be trusted with the controls. Perceived national interest prevents Germany from offering the benighted periphery a plausible way out of depression, even though it must if the euro is to survive. Yesterday, the German Constitutional Court seemed to give a qualified thumbs up to Europe's bail-out arrangements, so perhaps there is hope for the euro yet. However, any reading of the detail powerfully suggests otherwise. In fact, this is as close to a thumbs down as you can get without the German court immediately calling time on the whole endeavour. The flexibility needed in German policy to save monetary union is denied by the small print of the ruling. What began with the debacle of the ERM is heading for eventual nemesis in the crisis of the euro.