The Impact of Euro on US Dollar
(A Transcription)
If a continent has made up its mind to develop an internal market, then it
makes sense that one tries to develop an exchange rate that does not frequently
upset all the plans and contracts of the economic agents within this entity by
overnight and sudden changes of exchange rates. It was not a businessman or an
economist who have created EMU, it was farsighted politicians who prepared
ground for that solution. We have to
find out whether this
Europe
is in
line with the conditions Bob Mandel indicated as the underpinning of an optimum
currency area. The reason for the politicians’ acts was that they believed for
good reason that
Europe
never should be adversarial against
each other. It was the political idea to overcome unfriendly action of one
country against the other. In economic terms, an attempt to avoid "backing
my neighbor policies”. It is quite obvious that one exchange rate is the price
of two currencies by definition; and if one partner of the two decides to use
the exchange rate as a national policy instrument, it is very obvious that one
guy, in order to please his citizens and business circles for example, because
of the weak demand devaluating its own currency, by implication appreciates the
currency of the other side. And it is very obvious that this is unwelcome,
especially if both partners are hit by the same shock . If we were hit by a
US
recession, both of us would like to devalue, but if
Italy
devalues DM would appreciate and therefore, it is would be considered an
unfriendly act. Than we are in a situation of benign neglect, and we get into a
spiral of action of retaliation and again reaction. In that sense, I believe, it
was wise to try to overcome adversarial action in between European partners by
considering a different exchange rate regime.
In the early 70s, it was a very inappropriate time for such effort due to
the fact that this time was the time of break- down of Bretton Wood system. We
were embarking upon a floating of the exchange rates between the big currencies.
At that time a different stability culture in
Europe
was
almost impossible. The period between 1973 and 1977 was a period when exchange
rate stability was tried time and again within the European countries but failed
bitterly.
These efforts in
Europe
intensified when Helmut Schmidt took over. He and his state secretary initiated
another round of European exchange rate arrangements at the European Summit in
1978. They were the architects of the next round of the European exchange rate
mechanism. This mechanism was a kind of peg system with a relatively wide band,
and had the intention to move
Europe
towards a converging path in terms of cost and price developments, and tried to
use exchange rates a kind of “corset’. This, however, did not work
particularly because
France
was
not yet ready for policy orientation towards the exchange rates. Even this
arrangement from 1978 until 1982 did not do the trick. Only after
France
found
out that their devaluation policies did not lead to the expected acceleration of
their growth, that they decided to depart from socialism, and pursued policies
oriented towards stability. This was the decisive change in
Europe
.
After that the exchange rate mechanism began to work smoothly, and this
was the time when we were planning to complete the internal market, i.e. the
freedom of movement of goods, services, capital, and labor was established.
As of the middle of 1980s there was a clear move towards identifying the
conditions for a European Monetary Union.
The stability culture was not only a measure in terms of inflation
convergence. Nobody could join the club, if a country didn’t have an inflation
rate that is within ½ per cent of the three most stable countries.
Stability culture should also be measured by the judgment of the
financial market. Therefore, the
second target in the Maastricht Treaty was that long-term interest rates of
candidate countries could not be more than 2 percentage points higher than the
three most stable countries. This reflected the perception in the financial
market, and was a good idea by itself. Another
criteria to join the club was that nobody could join it club has not proven for
two years that one could have a stable exchange rate without tension. One must
be a member of ERM, and this must not be threatening through speculative attacks
for the two years period. Another criteria was fiscal stability which was
measured in two terms. Nobody should have more than 3 per cent deficit to GDP as
government deficit and no country should have a debt to GDP ration of either
above 60 per cent, or not at least close to 60% in the period up to joining the
club. These were the two fiscal criteria identified.
I would have been much more in favor of cyclically adjusted fiscal deficit
rather than the absolute deficit, for example, and, of course, I advised the
government to reconsider it and reformulate it; they rebuffed it. I
suggested one should add the share of government in GDP; it should be an
important guidepost for the orientation of fiscal policy, and they did not
listen. After 10 years of
experience, I must admit that those two simple criteria not only have been the
most relevant political economical guidepost for European policies but also for
worldwide fiscal policies, and, therefore, one must phrase the architects of
this. It is one of the best pieces of advice to correct the fiscal policy that
was very permissive in
Europe
.
The introduction of the Euro:
The European Central Bank and regulators and the private sector is capable
to manage successfully the logistic problems with this very introduction.
What will the introduction of Euro
and introduction of price list in Euro, however, mean?
The ease, with which one can compare the prices across
Europe
, will
increase massively. This is the tome when young generation where they can
compare prices via the Internet. Therefore, the competitiveness in
Europe
will
increase a lot. Comparing prices will be quite natural. The result will be
downward pressure on a number of prices where we had price differentiation until
now. Therefore, we will have a much
milder competitive environment as of now, and this is very helpful for the
consumer, it will squeeze margins of companies and particularly in some places.
By now European is in integrating ever more, and it is very obvious that
a number of European countries headquarted in bigger nation states of
Europe
still
have not made up their minds to become truly Europeans. In many sectors,
particularly in the services sector, the consolidation in
Europe
has
not yet taken place. If we had consolidation of companies, it was basically
consolidation within the nation states rather than across the borders. This has
to do with language and regulatory differences, but now these differences became
less and less important and it become more and more necessary to do in other
sectors what the industry has already done, namely the transnational
integration. I do believe that the Euro will be a catalyst for more
transnational merges and acquisitions. It is very obvious that if the Europeans
would not do it themselves, those who look from outside into
Europe
will
do it for them. Then, basically, American companies would do the Europeanization
of our market.
What will happen to the group of
countries that we don’t call the “outs” but we call the pre-ins”?
We have learned to use diplomatically correct language in order not to
offend people. We call those countries ( 3) that are not members of the EMU.
What will happen to
Denmark
, the
UK
, and
Sweden
? Will
they stay outside or will they join? The crucial country is the
UK
.
We are not yet successful in terms of making the
UK
citizens aware of the economic fact that they are part of
Europe
.
The trade and investment flows show that the most relevant partner to the
UK
is
the EU, not only in terms of level but in terms of the development of the last
thirty years. After September 11,
Tony Blair not only appeared, he acted, like a statesman.
He declared that he would suggest that the
UK
joins
in his second term the EMU, and that he would call for a referendum not later
than 2003. I believe he is very
serious, and joining the EMU for
UK
is
fully underway. However, I believe
it will be a closer call than most people believe, but I consider that 45-55% of
probability that the referendum would be rejected. I believe he is a truly
European and puts his head on the block.
Sweden
has
the same philosophy of the
UK
. In
their case, it is obvious that they don’t benefit from the flexible exchange
rate. The Danish have a completely different philosophy. They fixed their
exchange rate towards the Euro with a very narrow band only and they follow the
interest rate moves of the European Central Bank. They are not interested in
independent policies as the
UK
or
Sweden
.
Their explanation is very difficult to understand. They stay out, they don’t
have the degree of freedom, but the only thing they lose is they cannot support
the decision making process of their own interest rate, because they are
resisting to become a member of ECB. I
cannot understand that. I believe they want to keep their coin as the symbol of
their independence.
Another issue of Euro area of extension is the fact that we are in the
middle of a process of enlarging the European Union, towards Central and
Eastern Europe
, it
may be the case that by the year 2003 a number of these countries are ready to
join. At this juncture, there seems to be a tendency by
Western
Europe
to delay this process but at the end of the day, I
guess, by the end of 2004 between eight and ten out of twelve will be ready to
join. This would imply the earliest possible joining for Euroland would be in
2006. Because one of the conditions to join Euroland is that a country must be a
member of the EU and two years in the European exchange rate mechanism.
Therefore, the earliest possible to join formally and legally to the Euroland
for these new members would be 2006.
I do not believe in the hypothesis
that today’s weak exchange rate of the Euro has to do with the perspective of
the so called ‘weaklings’ from Central and Eastern Europe to join the club.
My fear and prediction is that, with
the introduction of coins and notes, the time for a
correction of exchange rate may have come.