The strength of a currency in the foreign exchange market is not a sign of virility, and should not become a policy aim

The debate on the so-called weak euro has produced many contenders for the prize for economic nonsense. The common fallacy is the assumption that a low value of the euro on the foreign exchange market means that it is a bad currency and that a high value would mean that it is a good currency.

In fact, securing a high level in the foreign exchange markets is no part of the remit of the European Central Bank under the Maastricht treaty. Its task is to preserve the value of the currency, by which is meant its purchasing power over goods and services bought in the 11 member countries. The external value only matters if it poses a threat to internal price stability.

Alarmists worry that the value of the euro has at times fallen close to parity with the dollar, compared to Dollars 1.17 when the euro was launched. But this is sheer superstition. The units into which the euro and the dollar are divided are purely arbitrary - like lines of longitude.

The discussion on how many people should be allowed to express a view on the euro exchange rate borders on the farcical. Some European leaders have suggested that only the president and vice-president of the ECB should be allowed to comment. They can try this tactic if they like. But can one imagine it being observed by other ECB council members? Ernst Welteke, president-elect of the Bundesbank, has already put his oar in with a suggested "reference value", which has had a transitory strengthening effect.

And does anyone think that European finance ministers or heads of government will observe a Trappist restraint? There is more to be said for the British innovation under which individual members of the Monetary Policy Committee are actually required to express their personal opinions.

There is a built-in tension in the Maastricht treaty. This gives the ECB full power over monetary policy, while governments remain responsible for the exchange rate. Here could be a source of conflict, as monetary policy is the principal method of influencing the exchange rate. If political leaders wanted to drive down the currency, and the ECB was unwilling to lower interest rates, this would create tension. So far, however, common sense has prevailed and the issue has been in abeyance.

The exchange rate is a price. Like other prices it needs to move in response to events. It is not a sign of disaster when it falls; nor is it a sign of triumph when it rises. Anyone who thinks otherwise should recall the great efforts the Americans made to reduce the external value of the dollar when it a appeared to be reducing US competitiveness in the mid-1980s, and the resultant fears of protectionism. These efforts led to the Plaza Accord of 1985, which was a deliberate attempt to talk the dollar down, coupled with the threat of intervention.

In any case, the euro is not as weak as recent discussion supposes. Even against the dollar it is at about the same level as the currencies that compose the euro - known to statisticians as the synthetic euro - were in mid-1997. Moreover, the rate against the dollar exaggerates the total movement. The fall in the euro has been combined with a rise in the dollar and, when taken together, the two movements magnify the change that has occured. The trade-weighted index of the euro against major currencies had fallen by last week by 16 per cent since its 1994-95 peak, while the rate against the dollar had fallen by over 25 per cent.

To those who think only in terms of the trade balance or the current payments deficit, the movements might seem perverse. For the euro-zone has a substantial current payment surplus with the rest of the world, while the US is heading for a record current deficit. But there are many other factors involved, which are nowadays more important. US interest rates are higher than European ones and expected to rise, while euro rates could easily fall again.

The currency movements have indeed been useful in boosting the effects of both monetary policies. The high dollar has helped to keep US inflation low in a period of almost unprecedented boom, when the pressures on the labour market are at a level which previously would have been associated with explosive inflation. The core countries of the euro-zone, on the other hand, have been experiencing sluggish growth and high unemployment rates.

The European Central Bank rightly believes that a large part of this unemployment is structural, representing ossified labour markets, excessive tax burdens and over-rigid regulation. But there is also an element reflecting weak demand, and the two elements interact and reinforce each other. Without the relative weakness of the euro, it is doubtful if we would have seen even the faint stirrings of recovery visible in the latest German data.

The criticisms that have been levelled at the euro because of its weakness are as nothing compared to the volley of strictures it would have received from business and union leaders and politicians if it had shot up instead. That would have added to the pressures on output and employment.

Indeed, many economists feared that this was exactly what would happen, as they believed that the ECB would try to maintain its credibility by going for excessively high interest rates. Fortunately, this is not what has occurred. The level of euro interest rates is below that of sterling and the dollar.

The main way in which the exchange rate affects ECB policy is the same as the way in which it affects Bank of England and US Federal Reserve policy. A sufficiently depressed level of the exchange rate will feed through into inflation, both by raising import prices and - less obviously but more fundamentally - in weakening resistance to inflationary pay awards.

But this far from the case at present. One reason is that in the euro-zone as a whole, overseas trade accounts for only about 10 per cent of gross domestic product. This is about a third of the level in the individual members before the euro was formed. But just as important, the impact of the exchange rate on domestic prices is much weaker and slower when domestic demand is depressed, as the UK discovered when it left the Exchange Rate Mechanism in 1992.

Of course, a sufficiently large and persistent downward movement in the euro would be a cause for alarm if it reflected a market view that the ECB had backed away from price stability, or would be pressurised by governments against attaining that goal. But there is absolutely no sign of this now. Fluctuations in the euro's value have been well within the range that major currencies have experienced in the last couple of decades - and much less than the switchback movements experienced by the dollar.

It is of course true that the low euro involves a high sterling exchange rate, which could cause a problem for British entry into European economic and monetary union. But contrary to market belief, the government does not have to take its country into Emu at the prevailing market rate. What is true is that the entry rate would have to be negotiated - in contrast to the unfortunate example of British entry into the ERM in 1990. Officials from euro countries insist that this negotiation will not be a mere formality.

The strength of a currency is not a sign of virility; nor is its weakness a key to everlasting prosperity. Markets can be wrong and are prone to overshooting and undershooting. But not nearly as wrong as politicians and commentators speaking from the sidelines.

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