Of course, senior EU politicians daren't even think about it. Most of them still see Europe's future in terms of the Maastricht treaty's objectives. But as I argued in this column last month, it's odds-on
the timetable for European monetary union (Emu) will have to be put back. What happens to Europe then? Is it Armageddon, as German chancellor Helmut Kohl sometimes seems to suggest. I think not.
But my optimism depends on the EU's single market surviving the demise of Emu. The single market is the foundation of internal commerce, designed in the mid-1980s for completion in 1992. There are still many barriers, but they get smaller each year.
Supporters of a single currency say Emu is essential to the single market. True, big swings in real exchange rates in the EU would encourage business in strong-currency countries to press for import controls. But trade flows fairly freely between the US and Canada (and increasingly with Mexico), and these countries have separate currencies. There is a danger that frustrated fans of Maastricht might use the absence of a single currency as an excuse for weakening the single market, but there is no logical reason why they should do so.
With the single market intact, what might happen to Europe's monetary and currency arrangements?
Option 1 The exchange rate mechanism (ERM), or something like it, is recreated with national currencies held in narrow bands against one another, but changeable by agreement (and market pressure). That's the talk of the recent Verona meeting of EU finance ministers.
Probability - unlikely: Option 1 was successful in the 1980s, disastrous in the 1990s. The consensus is that a new version of ERM is not durable. It is an effective crash diet (France in 1983-86, the UK in 1989-91), but not a way of life.
Option 2 A single-currency core involving a few countries is formed, with the rest outside, semi-fixed or floating.
Probability - highly unlikely: it won't work. First, who would want to be in the core? Once the convergence criteria cease to be treated as automatic qualifications for winning the prize of a single currency, governments will probably think very hard before wanting to join the contest at all. Second, the core single currency would not be the Deutschmark, so it would presumably include some of the weaknesses now associated with the other joiners, and would suffer in comparison with the Swiss franc, perhaps with others. Third, unless fiscal transfers are in prospect, non-core countries will be reluctant to join. But if transfers are required, Germany will be leery. Even those that wanted to join at some stage would face transitional dilemmas. And prevarication would increase uncertainty and thus currency instability.
Option 3 All EU currencies float freely, with national central banks and finance ministries following their own policies.
Probability - most likely: as yet, no EU government dares acknowledge this option. National currencies are maintained and governments are free to choose how to manage them. But, for various reasons (anti-inflation, trade harmony, habit), a fair amount of stability is achieved. It's not unlike the EU of the past two or three years, since the narrow ERM bands were suspended in August 1993. The big difference - abandonment of the fiction that Emu is impending.
Some countries would still seek close currency links: the guilder or Belgian franc with the Deutschmark, for example, and the escudo with the peseta. But much else might change. In particular, the French would not be obsessed with maintaining a specific foreign exchange parity or range against the Deutschmark. They might want broad secular stability for the franc, but within that they would operate on the basis of other concerns and policy options. If the EU evolves this way, there will be several broad consequences for Europe.
First, those countries that are not currently struggling to meet convergence criteria would have the least disruption to their currencies. The Deutschmark, guilder, Schilling and sterling would be little affected by the dying of the Emu dream. The lira and French and Belgian francs will all get a bad shock (initially a fall).
Second, Europe's growth rate would pick up as the exchange rate focus faded - good for equities, but generally not for bonds.
Third, a sense of fiscal crisis would break out across Europe. At the moment, governments think their fiscal challenge consists of getting their 1997 budget deficits below 3% of GDP (a Maastricht criterion for Emu). Things are far worse than that. The real European dilemma has never been adequately defined by the Maastricht criteria. It concerns the size of government. The proportion of GDP accounted for by state expenditure is 15% or more higher in EU states than in the US, stifling economic dynamism. A few countries may be good at meeting the longer-term need to curb current spending: Ireland (demographics are favourable), the UK (a tradition of funded pensions) and perhaps Spain. But most face wrenching change in the role of government. They hate the prospect. Their bond markets will reflect the high cost of capital.
Fourth, national cycles would return. In 1993-95 the UK grew twice as fast as Germany, whereas France's growth was almost identical to Germany's. This was not because of trade dependence. It was because British monetary policy could go its own way.
Fifth, despite being freer to inflate, most countries will probably resist the temptation. Just as the US, Japan, Australia, Canada and many others choose to be on a low-inflation tack, so most EU countries would do the same. The real equity winners in Europe will be individual companies that globalize successfully and divorce themselves from their respective national models. They are the ones that make what they produce where it is profitable to do so and sell it where it pays to.
David Roche is president of Independent Strategy, a London based research firm.