The Euro: Was the European citizen cheated?

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Within the French election campaign, the Euro is the butt of numerous declarations making it a convenient scapegoat for the country’s economic poor performance. It is therefore useful to clarify for the citizen a number of questions relating to the single currency. I will discuss in succession the questions of the Euro and inflation, the Euro and exchange rate policy, the ECB and the management of the Euro and finally I shall address the controversial question: “the Euro, can one get out of it?”

Many commentators, mainly politicians, but also some economists, consider the introduction of the single currency as directly responsible for price increases (inflation) considerably in excess of the figures published by statistical agencies such as Eurostat or Insee.

There is, however, no reason to doubt the truthfulness and correctness of the official figures that reflect price developments. Thus, Eurostat calculated that the non recurring direct impact of the introduction of the Euro was around .25% due mainly to rounding factors which were mainly upwards. Thereafter, following the introduction of notes and coins in January 2002, official statistics show that inflation in the Eurozone averages slightly in excess of 2% per annum.

Why then the widespread feeling that these numbers do not reflect the evolution of price as perceived by the citizen? On this question Mrs. Royale is quite correct when she says that indices, as published by the official Statistical Institutes are not representative of the cost of living experienced by some segments of the population and in particular by the less well off. The latter are particularly sensitive to the gap between the indices and their real cost of living. Mrs Royale’s proposal to publish a broader series of indices, reflecting the inflationary impact on different population segments rather than a single number would certainly increase the transparency and the correct understanding of the indices.

Mrs. Royale draws a perfectly logical conclusion that the amounts of social support payments as well as the minimum wage should bet set by reference to the inflation indices relevant to the segment of population living on a low level of income. While it is difficult to contest the equity of such a proposal, one should however consider the budgetary cost of such an adjustment which, I assume, was not included in the costing of €35 billion of the measures proposed by the socialist candidate. I do not have available the means to evaluate the impact of such measures, but I fear that, even if it fits perfectly the criteria of aiming at a “more just France”, its cost would be prohibitive and further undermine the competitivity of the economy.

The second point of contention concerns the insinuation, totally unfounded, that the survival of national currencies would have facilitated the control of inflationary pressures. This position is defended in particular by Mr. de Villiers though is also alluded to by other candidates, only too happy to put the blame on the Euro and its management by the ECB which escapes their “political” control.

Let us be reminded that the official inflation rate of around 2% in Euroland represents an average and is historically low over the period since World War II as well as close to the minimum level needed to ensure a healthy pace of economic growth. Furthermore it is easy to insinuate that the single currency is source of inflation when it is no longer possible to draw a comparison with the level of inflation (certainly above zero) that would have prevailed without the introduction of the Euro.  

Indeed, though not demonstrable, it is far more likely that the rate of inflation would have been higher – in any case in France – without monetary Union, because one of the main factors helping to control inflation is precisely the monetary stability derived from EMU. Without EMU, one of the following scenarios would have prevailed: either periodic exchange rate adjustments between Member States would have lead, for those countries devaluing, to an inflation rate higher than the Union average, either policy measures implemented to defend existing parities would have imposed higher interest rates, impairing commensurately economic growth, as was the case during the years where meeting the “Maastricht criteria” imposed the overriding priority of parity stability.

The Eurozone created a large economic space within which interest rates have been maintained lower and for longer periods than during all phase of preceding economic cycles. Furthermore, the removal of exchange risks covers now 85% of trade against only 70% prior to EMU, reducing substantially the financial risks associated with international trade. Both these factors are particularly significant for SMEs as consistent low interest rates and removal of exchange risks (which in their case covers well over 90% of turnover) represent far greater advantages than any financial support programme designed by national and European authorities.

The inescapable conclusion is that, whatever the real inflation rate has been in Euroland, the Euro has been an important factor in stabilising its scope compared with the situation that prevailed prior to its introduction.

The management of the Euro’s exchange rate is in part linked to the previous question. It has been entrusted to the ECB, but all Member States maintain a direct interest in this matter which is expressed mainly through Ecofin and the Eurogroup.

Within the context of the French election campaign, one has been bombarded with complaints of a “strong Euro” supposed to undermine the competitivity of Euroland. There follows repeated calls for direct Government intervention, in clear violation of the Treaty rules guaranteeing the ECB’s independence.

Let us note, in the first place, that there is some incoherence, not to say schizophrenia, in the arguments that are put forward. On the one hand one conveniently overlooks that a strong Euro has several advantages among which one can name: a lower cost for raw materials and in particular for oil; persistence of low interest rates affording economic actors significantly lower financing costs compared with their American and British competitors. On the other hand one should question the direct link between exchange rate and competitivity. The deterioration in the foreign trade balance does not affect equally all Members of EMU. Germany and Belgium, for instance, are showing notable progress while simultaneously the position of France and Italy is deteriorating.

Globally the position of Euroland can be considered as satisfactory in the foreign trade field. The ECB has proven, since the introduction of the single currency at a rate of 1€ = 1.17USD, its ability to manage fluctuations varying from a low of USD 0.83 to a high of 1.36 against the European currency without creating any notable problems. These fluctuations remain well within the exchange rate range of the USD against the strongest of predecessor currencies of the Euro. Let us also be reminded that it is the significant increase of trade within the Eurozone that is the main explanation for this state of affairs, weakening commensurately the argument blaming a strong Euro for mediocre economic performances.

On the other hand, it is also true that some specific sectors, primarily those focussing on big export items are more vulnerable to exchange rate fluctuations. Recent developments at Airbus constitute a prime example but it would be more honest to recognise that the problems encountered are in some measure – if not mainly – to be ascribed to faulty management (delivery delays – overstaffing – political interference in the shareholder makeup) for which the strong Euro acted as a magnifier.

Finally, one should also underline, as far as France is concerned, the contradiction between the accusation that the strong Euro contributes both to inflation (argument refuted here above) and weakens competitiveness. Indeed let us consider France’s €30billion external trade deficit. Happily for France the umbrella provided by the Euro allows the country to proceed with a policy of “benign neglect” for which she used to severely criticise the United States in the years 1980. Indeed, without the Euro, suffering from such a deficit, the country would have been faced with the choice of resorting to a devaluation to restore competitiveness or, alternatively, introduce stringent restrictive budgetary measures together with interest rate hikes, which would have further slowed growth below the Community’s average.

On must therefore conclude that the Euro has efficiently held up the purchasing power of the French consumer for all his spending on Euroland goods (which represent nearly 100% for the great majority of the population). The citizen has therefore benefited directly from a strong Euro contrary to what its detractors purport. It is to the latter, and not to the initiators of the Euro, that should be addressed the reproach of hiding the truth.

The third point deserving clarification concerns the ECB’s management of the currency. Whatever judgement one has concerning the merits of the rules imposed by the Treaty, there is no question that the Bank has carried out its mandate in conformity with the objectives as defined. As a result the Eurozone has enjoyed a controlled inflationary environment and an exchange rate that are adapted to the most important parameters to be taken into account for healthy economic governance. At the same time, Europe is endowed with the second most important internationally traded currency which is progressively asserting itself as a credible alternative to the almighty dollar. Is it not paradoxical that those who are at the vanguard of the criticism of the United States as abusing its unilateral dominant power are also those who criticise a monetary policy by the ECB that strengthens considerably the weight of the European Union in economic and financial negotiations within a globalised world!

As of the setting of exchange rate parities between participating countries, mid 1998, i.e. 6 months prior to the formal launch of the Euro, the ECB has been able to safeguard the Union’s economy of all the international financial crises that have taken place. This state of affairs benefited not only participating countries in the Euro, but all the members of the Union because of the strong and privileged ties that bind them together within the single market. Such a stability of exchange rate parities between European currencies would have been totally inconceivable without EMU during the monetary turbulences that occurred.

Furthermore, the ECB has had to carry out its unified monetary policy in very difficult circumstances being faced with economic policies that remain under the individual control of Member States and cruelly lack coherence. The difficulties surrounding the negotiations on amending the Pact for Stability and Growth underline the handicap from which the Eurozone suffers as compared with countries such as the United States, China, Russia or India which benefit from centralised economic levers which allow more flexibility in monetary policy.

It is therefore appropriate to pay an unreserved tribute to the work carried out by the ECB in particularly difficult circumstances, and to rejoice at the speed with which the Institution has gained recognition and credibility from all market participants. It is clear that the European Union shall be heard all the more forcefully on the world scene that, in addition to a unified monetary policy, it will structure, at Euroland level, coherent economic and fiscal policies (though not necessarily harmonised).

On the question of ECB governance, I should remind the candidates to the French Presidency of a point on which Mr de Villiers insisted heavily during his interview on LCI: as long as a Treaty is not ratified unanimously, it remains void. The converse implies that an existing Treaty, as long as it is neither amended nor denounced (which may indeed be appropriate), it remains in force and one is bound by its terms which, in this case, includes the independence of the ECB. The recurring threats of direct intervention by the elected candidate are not appropriate and constitute at best exhortations liable to mislead the citizen. It would be more honest to suggest a Treaty revision (within the scope of exiting the crisis created by the French and Dutch refusal of the Constitutional Treaty). Considering the arguments put forward, amendments should focus on the strengthening of the coordination of national economic policies which would allow, with no further changes, the ECB to show greater flexibility in the execution of its monetary policy.

Finally, I wish to address squarely the question of the possibility of withdrawing from EMU. There was clearly no dark plot to mislead the citizen on this matter, though there is some justification to regret that the problem was not discussed in a transparent manner at the time of ratification of the membership requirements.

Within the context prevailing at the time, it is understandable that the economic and political actors focussed their attention on EMU implementation. It was a particularly complex project, both from a technical point of view (conversion of payment instruments, adaptation of underlying payment systems, fixing of parities, rounding rules, harmonisation of market conventions, accounting conversion etc.) and a legal point of view (transfer of sovereignty, continuity of contracts etc). Because a currency also embodies, in addition to its objective characteristics, a high emotional content, it is not surprising that the main thrust was directed to underline the positive aspects of EMU and the direct consequences for the citizen so as to convince him that the effort required was worthwhile..

On top of the fact that it is difficult to think about divorce when one is preparing a wedding, it is likely that a thorough debate on withdrawal from EMU would have seriously complicated the outcome, all the more that it was difficult to envisage under what circumstances such a step might be envisaged. Such a blurred situation could have lead to the shelving of the project.

Eight year later one can draw the following conclusions: the technical implementation of EMU was carried out in quasi optimal conditions. One owes a great debt of gratitude to all the actors: to Governments and Legislators for their political vision; to the European Commission for its flawless coordination of all the administrative and technical aspects; to the ECB and the National Central Banks for their technical know-how and, last but not least, to all the actors of the private financial, commercial and industrial sector without whose support it would have been impossible to carry out the project successfully.

The expected positive fall out has been largely realised (monetary and price stability, reduction of exchange rate costs and risks, low interest rate environment, etc.) even if it remains particularly difficult to prove in comparison with an alternative, purely hypothetical, scenario. This alternative scenario does however enjoy a certain amount of credibility, in particular when considering the fairly enviable performance of some countries that remained outside EMU.

Let us take a closer look at these countries; first those benefiting from a derogation under the Maastricht Treaty.

Concerning the United Kingdom, always cited as exemplary, one should give credit for its success to the competence shown by the Blair government in carrying out its economic policy. Following rigorous guidelines and having absolute control over economic and monetary levers, the country benefits all the more from its greater flexibility that its principle overseas market (Euroland and more largely the Union as a whole) is hamstrung by the constraints of the Stability and Growth Pact. However, should EMU not have occurred, the United Kingdom would have been subject to the same turbulences affecting all other Member States. There is nothing that points to believing that Sterling would have escaped its share of speculative attacks by market operators, and there is little doubt that the currency was protected by the stability of the Euro, precisely because the Union is its most important market by a significant margin. Let us also point out that the UK’s independent position has imposed on its economy a consistently higher level of interest rates than in Euroland.

Concerning Denmark, that voluntarily follows a policy of pegging its currency to the Euro, it is difficult to discern any tangible benefits, other than psychological, derived from its derogation. Indeed it is forced to duplicate slavishly Frankfurt’s monetary policy, depriving it from any flexibility with the additional drawback of being absent from all the policy making organs of the ECB. It is not surprising that there is renewed talk about Denmark’s change of heart leading to its joining EMU in the not too distant future.

As to countries that do not benefit from derogations (Sweden and countries belonging to the two latest enlargements) they are bound by the Treaty to prepare themselves to meet over time the Maastricht criteria. The gap between the level of economic development in most of these countries and the conditions prevailing in Euroland, explains the need to grant them sufficient time and flexibility in their domestic monetary and exchange rate policies. Thus,  a faster “catching up” growth policy can be implemented  under optimal conditions without being subject to the constraints imposed by the Stability and Growth Pact on the more developed economies of the Eurozone which would be intolerable for the new participants.

Having attempted to demonstrate the superficial character of many of the arguments put forward to criticise the Euro’s performance, let us take a closer look at the question of withdrawal from EMU.

Let us first recognise that the existing Treaty does not cover this possibility, either at EMU or at Union level. It follows that withdrawal from EMU would most likely take place within the framework of a fundamental upheaval implying probably the disintegration of the Union itself. Though unlikely, such a scenario cannot, however, be excluded.
Why is so difficult to envisage a negotiated withdrawal from EMU within the framework of a surviving EU? The motivation that would underpin such a step would most certainly be based on the premise that the country withdrawing from EMU would recover its sovereignty over monetary and foreign exchange policies and would therefore be better equipped to pursue national ambitions in conformity with the wishes of its population.

Let us consider several scenarios:

The first, and easiest to implement, is to exit EMU while simultaneously declaring in a credible manner (which would prove very difficult) that the country undertakes to maintain a one to one parity with the Euro. We are then back to the case of Denmark and the advantages of such a step are questionable.

The second is that the country wishing to exit believes that the policies of the Eurozone are too lax and wishes to extricate itself from such an environment. The implicit consequence of such a posture is that the country wishes to follow policies that would lead to a “revaluation” of its currency in relation to the Euro. This would entail a loss of competitivity for its economy, as its exports become more onerous until such time as a lower inflation rate equilibrates the terms of trade. Given that the present rate of inflation within the Eurozone hovers around 2%, level judged optimal for sustainable economic growth, it is difficult to see what advantage a country would reap from withdrawal considering that it would need to follow disinflationary policies to restore its competitive position.  Such a scenario does not seem to have any relevance under present conditions.

The third – and most probable case – concerns a country who wishes to withdraw from EMU to recover its independence from the budgetary straightjacket imposed by the Stability Pact and recover its freedom in foreign exchange and interest rate matters. This is apparently the goal pursued by some of the Presidential candidates who deliberately overlook the inescapable severe drawbacks of such a path: it is clearly a call for a “devaluation” of the currency to boost the sagging economy through a “weak currency” policy implicit in their criticisms of the “strong Euro”.

Here are some of the consequences: the repayment of the French national debt, amounting to over €1200 billion (as well as all other public or private debts denominated in Euros) will cost the French citizen all the more that the devaluation of the new currency in relation to the Euro is severe. Cascading bankruptcies will follow from which even companies with a pure domestic business will not be immune. Such a phenomenon was observed when several Asian countries were no longer able to maintain their parities with the dollar and found themselves bound to repay in dollars debts that they had converted into local currency.

Unless the country withdrawing from EMU wishes to cut itself off once and for all from access to international capital markets by defaulting on its debts and reintroduces exchange controls that are incompatible with a globalised market economy, it would indeed be inconceivable to impose in the wake of a “negotiated” exit, a “discontinuity of contracts” implied in a compulsory conversion of debts and receipts denominated in Euros into debts and receipts expressed in the new national currency.

There is no doubt possible that, as soon as the possibility of a Referendum concerning a withdrawal from EMU was mooted, the market would react immediately, severely penalising the price levels at which French debt securities are traded. These quotes would be a first indication of the rates of return required by the market to accept the “French” risk and are likely to be at levels that would paralyse both public and private sector activity killing simultaneously any hope of an economic upswing.

The proposal of Mr de Villiers to submit, under certain circumstances, the question of withdrawal from EMU to a Referendum, and which happily is not shared by any of the other serious candidates, should be exposed for its totally irresponsible character, demonstrating, if need be, his incompetence to assume the French Presidency to which he aspires.  

Short of being able to withdraw from EMU under acceptable conditions, it behoves the authorities to focus on ways to improve the economic governance of the Eurozone. As already mentioned, this implies greater coherence in the economic and budgetary policies of its members.



Conclusion:

Those who berate the single currency for political advantage shelter behind short and sharp “catch phrases” that carry with them a certain aura of common sense. As is demonstrated by the length of this essay, explaining such a complex matter with clarity needs the sustained attention of the reader and a minimum level of understanding in order to differentiate between cheap slogans and economic reality.

If one can legitimately regret that a “sin by omission” was committed at the time of the Euro’s launch, one should however accept that the outcome has been extremely positive, even if one has not yet reaped all of the expected benefits.

This does not, however, excuse in any way the misleading diatribes concerning the damaging effects of the single currency. Indeed, such attitudes deliberately perpetuate – rather than alleviate –the disinformation of the citizen whose interests one pretends to protect. The accusation of deceit deserves therefore to be, purely and simply, reversed against its authors.


Paul N. Goldschmidt
Director, European Commission (ret).
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