THE consensus now is that monetary union in Europe will go ahead. But, while that is the most likely outcome, there is an oft overlooked prospect that the "German dilemma" could scupper the entire project.
Despite protestations from the Bundesbank that only a very strict interpretation of the economic criteria will be allowed, there is a general understanding that the decision on which countries will participate will be political. Key officials from institutions such as the World Bank and the International Monetary Fund say that the criteria will be consulted, but that they will not be the only consideration.
Herein lies the danger. For Germany is set to be pulled between its own desire to ensure a small, stable single currency group and political pressure to include as many as possible in the move to monetary union.
One possible route towards trouble comes from the German constitutional court. It has already ruled that the deutschmark can only be given up if the parliament is satisfied that the euro will be as strong a currency. Crucially, there is also the question of what the German electorate will allow. As one senior official noted: "All the mothers are opposed". It is primarily a project attractive to younger Germans who have no memories of the history of hyperinflation.
By and large, the German people are not willing to lose the deutschemark except for a very good reason. And they want the new euro to be as strong as the D mark. For that to happen, Germany must tie itself in a monetary union to a small, select group.
Until very recently it had been assumed that the initial participants in the single currency would all be northern European. But the "Club Med" group of countries including Spain, Portugal and Italy all want "in" badly. Being allowed into EMU would be the ultimate political accolade for their recent economic policies.
Politically, this leaves the northern European states with a very difficult problem. France wants Spain and Portugal in they are major trading partners and France has worries similar to Ireland's if her closest neighbour to the south remains out and pursues of a policy of competitive devaluation.
But Germany does not want Italy in under any circumstances. German politicians admit that having Italy in will be perceived as a sign that the system and, more importantly, the currency will be weak. That could well mean the parliament would vote against entry in 1998.
The difficulty is that it will be practically impossible to keep the southern EU countries out if Belgium is allowed in. Belgium's participation would require so much of a fudge that no one from the north would be able to say "no" to the southern European group with a straight face, one official noted recently. After all, Belgium's ratio of debt to national output is more than twice the Maastricht reference ratio of 60 per cent. But leaving Belgium out would also hardly be possible; it is one of a core group of countries, including The Netherlands, Austria and Luxembourg, which are already in a virtual monetary union with the Germans.
So the smart money is now on Spain and Portugal making it, with a far more serious question mark hanging over Italy. However, if there is a conviction across markets that Italy will join, it could help to push money into Italian markets, reducing interest rates and thus helping to bring its deficit down.
The Italian announcement this week that it will raise a euro tax which will be repaid in 1999 smacks of real shorttermism. But if the French can cook the books with telecom privatisations, there are few objections which the Commission can legitimately raise. That would leave Germany with a real dilemma. If it allows the Italians in, its own parliament could scupper the entire project. And if it exercises its influence to try to keep Italy out, it could provoke a dangerous diplomatic row.
The real level of political commitment to monetary union from Europe's most powerful state may well be called into question sooner than many imagined.
