And Finally This!
Euro's destiny lies with markets
ANALYSIS / Political wrangling could taint
perception of currency.
Monday, May 4, 1998
By Peter Cook
BRUSSELS -- The final political step in Europe's long march to monetary
independence was concluded over the weekend and it is now up to financial
markets to pass judgment on the venture.
The early verdict will undoubtedly be that the politicians are still in command. A
summit of European leaders to launch the euro, as the new currency will be
known, ended in acrimony as France fought with its partners to get a French head
of the Frankfurt-based European Central Bank (ECB).
During a very long day, two views of the euro's future were on display.
On Saturday morning, the European Parliament was told by Jacques Santer,
European Commission President, that "thanks to the euro, at a single stroke,
Europe will bestride the world's financial and monetary map."
Fifteen hours later, French President Jacques Chirac was being laughed at by the
press for claiming that Wim Duisenberg, the Dutchman who will be the first
central bank president, had decided to stand down in 2002 and make way for
France's Jean-Claude Trichet for personal reasons. "Don't laugh. There's no
reason to laugh," a peeved Mr. Chirac said.
The d‚nouement over the ECB presidency is important because, under the
Maastricht Treaty, the appointment is clearly for an eight-year term, and the bank
is supposed to be free of political interference.
"I would say it is no good at all for the European Bank to start like this," said Jose
Maria Gil-Robles, President of the European Parliament. And local economist
Peter Praet, of Belgium's G‚n‚rale Bank, commented that real damage had been
done.
The European Bank starts existence on July 1, and will have a new currency to
manage as of Jan 1, 1999. That's when exchange rates between the 11
participating countries will be irrevocably fixed, and the euro come into use for
non-cash transactions. In three years, it will be introduced as bank notes and
coins to replace national currencies.
Crucial to the success of the venture is that the euro, under the ECB's
management, should be seen as a hard currency, not a soft one.
Because some banks are going to start forward markets in the currency
immediately, the weekend's events have some importance. A currency that is
subject to political influence is more likely to be judged soft than hard and, in this
case, there are clear differences between France and Germany. The French want
to strengthen political oversight of the ECB and retain their fiscal freedom; the
Germans stress absolute monetary independence and a stability pact that would
penalize governments running large deficits.
As the euro takes shape, it is likely that a more German view will prevail because
the bank's clear mandate is to keep prices stable -- which will be defined as
aiming for a Europe-wide inflation rate of 2 per cent or less.
However, the all-important exchange rate between the euro and the U.S. dollar is
hard to predict in advance. Because growth is strong, both the new ECB and the
U.S. Federal Reserve Board will probably be raising interest rates over the next
18 months.
What is not in doubt is the clout that the euro will wield, both as a currency that
challenges the U.S. dollar for supremacy and as an agent for change within
Europe.
The 11 countries participating in the common currency have a total economy, and
share of world trade, as large as the United States. The four other European
Union countries, Britain, Sweden, Denmark and Greece, plan to join later if the
experiment succeeds.
Provided the euro is recognized as a hard currency, it will begin to eat into the
U.S. dollar's position as the currency used in 80 per cent of international
transactions and making up 56 per cent of central bank foreign exchange reserves.
Flows from the dollar into the euro could ultimately total $800-billion (U.S.), it
has been estimated, but the movement would take place over a number of years.
One recent prediction by Deutsche Bank Research in Frankfurt is that, by 2010,
the euro will be the currency of choice for 35 per cent of trade invoicing, between
30 and 40 per cent of international investment and financing, and between 25 and
30 per cent of central bank reserves.
The countries using the euro will also become much less concerned about its
external value than they are about that of their national currencies. Much of their
trade has been with each other, but will now take place within what is, in effect,
one huge domestic market. Because of this, the importance of foreign trade to
their economies will diminish.
EU business with Canada will be redenominated in the new currency. Canadian
companies will benefit from selling into a single large market and being able to
adopt Europe-wide pricing policies. Canadian trade with the whole EU was worth
$40-billion (Canadian) in 1997, and Canadian companies have invested a little
more than that, $41-billion, in European plants and subsidiaries.
Generally, North American companies are likely to benefit from what is going to
be a more cohesive market for goods, services and investment. This is because it
will be more familiar to them. The scale of it will be similar to the U.S. market, or
an integrated North American free-trade agreement market.
The euro is also expected to create a revolution in European financing and
financial markets. While the government bond market is already large, European
markets for corporate bonds and equities are small, reflecting the division of the
continent into many jurisdictions and differing markets.
The single currency will -- in time, and with regulatory change -- create a single
capital market. As a result, the importance of bank lending as a primary source of
finance to business will be eclipsed by larger, more liquid bond and equity
markets.
More investing will be done across borders, and there is certain to be a surge of
new money coming into capital markets from investments in private pension
funds. |
