The International Role of the Euro - 02.02.2004

EIPAL Conference February 5 2004 (text only)
     

THE INTERNATIONAL ROLE OF THE EURO.
EIPAL - 05/II/2004

1. Expectations 
2. Trends in the international use of the euro (?)
3. Exchange rates with the USD ($)
4. Impact of Economic governance and compliance with the Growth and Stability Pact
5. Impact of the adhesion of 10 new member States in the European Union (EU)
6. Conclusions

Main sources : International Role of the Euro - ECB Special Report December 2003
EIB Weekly Note on Economic and Financial Developments of 12 December 2003.
PROMEURO - Publications and Website : www.promeuro.org (also for Illustrations)

1. EXPECTATIONS

Alain PRATE, Economic Adviser of Charles De Gaule & Vice-President of the EIB :

« One cannot conceive a true reform of the International Monetary System (IMS) if Europe maintains it (then) 11 autonomous currencies » 
« Perspectives de l'Europe financière et monétaire ». Revue Banques, n° 487, octobre 1988

Michel CAMDESSUS, Director General of the International Monetary Fund (IMF):

Among the various causes of hope for a more balanced IMS and hence for a better world, the creation of the ? comes first in line .   Le Monde, 2000

PROMEURO : « The Euro for Europe : from national currencies to the European currency » Batsford 2000.

Twenty years were needed for the  $ to replace the £ as the leading international currency.

As from its origin, the ? was set-up as a parallel currency to the $ and the Special Drawing Rights (SDR) ( Illustration 2c).

QUESTIONS :

1. Is the ? already or can it become an international currency of reference ?

2. If so, under what condition will a bipolar IMS with the ? as the second major  international currency be more stable the IMS resulting from the (failed) Bretton Woods agreements ?


2. INTERNATIONAL USE OF THE ? - PLAN

a. Part of the ? in the  International Trade.

b. Part of the ? in the  Financial Markets. 

i. Structure of the ? markets
ii. Bond Markets
iii. Loan Markets

c. Part of the ? in the  Reserves of Central Banks and in the SDR

2.a. USE OF THE ? IN THE INTERNATIONAL TRADE.

Initially : 60 - 70% of trans-border transactions labelled in $, including within the EU.
Exclusive of intra-community trade, the EU represents 15,2 % of world trade.

Part of the world trade labelled and billed in ? passed from 16.4% in 2001 to 18.7% in 2002. 

Exporters from the ?-zone : more than 50% of transactions with third countries billed in ?
Importers from the  ?- zone: around 30 % of transactions with third countries billed in ?


Japan in 2002 :      54% of exports to the ?-zone labelled in ?. 
UK in 2001 :   36% of exports to the ?-zone labelled in ? (+ 10% from 2000 to 2001).
USA in 2001 :   30% with D and A ; 10% or less with other countries.

Adhesion countries: Variable, Czech Rep. : increasing; Cyprus, Bulgaria, .. :  decreasing

Tourism : ? more and more used in substitution for $ at least in Europe, incl. Russia

Conclusion : - rapidly rising especially since notes are available.
- $ remains dominant
- Local phenomenon (neighbouring countries (exc. Japan).
- Largely determined by exchange rate regimes : out of 151 countries with controlled regime, 41 include reference to ? (incl. through SDR). Russia : ? passed from 20 to 40% of reference basket.
 
2.b. USE OF THE ? ON THE FINANCIAL MARKETS.

2.b.1. STRUCTURE OF THE  ?  MARKETS.

Fragmented markets    : structure in silos (national) : more costly, lacks efficiency.

Equity Markets              : first sector to have entirely switched to the ?.
Some mergers but still too limited : more specialisation desirable.

Venture Capital             : limited, mostly bank/credit financing more conservative and less profitable. 

Savings and Credit       : Savers and credit agencies still give preference to proximity factors. Rigidity of national markets.

Progress             : July 2003, elimination of costs on trans-border bank transfers.
2005 : launching of the Single financial market on the basis of the « Report of the Wise Men (Lamfalusy report).

2.b. 2. BOND MARKET.

- Ecu almost became the third most used issue currency  in 1992.

- ? gives Europe ITS OWN capital market of continental size. Also qualitative changes in the bond market (relatively less banks, more corporations and regional bodies (Illustration 8a)

- Volume of total new issues larger than $ in 1999/2000.  European multinational needed large amounts to invest in the USA. Today, especially Anglo-Saxon investors. Growing interest from the part of Asian investors.

- New net issues in ? implying a partner outside the ?-zone also larger than $
Especially short term issues ; long term issues in ? = those in $. 

- Total issues   :   ? = 24% (1994 EMU currencies = 18%)   $  = 45% (decreasing). 

- Global market still largely dominated by $.

2.b. 3. LOAN MARKET

Loans granted by banks from the ?-zone to borrowers outside the ?-zone :

- Total in Q1 2003, ? 619 billion incl. international organisations (among which the EIB ?) :
- ? = 37% ; $ = 45% .

- Regional allocation  : Industrialised countries : (mainly from USA & UK
? = 30% ; $ =  40%.
Third World Countries : especially Africa, Asia  & Middle East,
Latin America remains basically in $.

- Loans among parties both outside ?-zone :

? represents only 8%, behind the  $ and the Y.

2.b. 3. OFFICIAL RESERVES & SDR.

Officical reserves : Part of the ? in the reserves of central banks  According to new IMF  data.

1994 : 22% 1999 : 11/13%     2000 : 16%   2002 : 19/21%

Since 1994 : $ grew  regularly by 12% per year.
? : reserves in national currencies  originating from ?-zone decreased. 

Since 1999 : ? = + 100 % ; $  = + 28% 
part of the ? from  11/13% in 1999 to 19/21% in   2002).

Initial weakness of the ?/$ exchange rate  masked the increase in volume of reserves held in ?.

Central & Eastern  Europe :  ? = 50%. Russia, increased announced from 20 to 30%.
Asia       : ? = 6%.

Notes and Coins : 10% distributed outside ?-zone.

Conclusion : Globally, $ remains most important currency for reserves
Reserves in ? mainly in countries neighbouring ?-zone.
Effect of rise of ?/$ exchange rate uncertain.

SDR : 

The SDR, a basket currency managed by the IMF, comprises 4 main currencies ($, ?, Y, £) according to the relative weight of their region of influence in the world economy. Its composition is revised every 5 years. The last one took place in January 2001. The ? then replaced the DEM and FRF that represented the economy of continental Europe.

The weight of the ? was then reduced to 29 %, while the two national currencies weighted together 32%.  The weight of the £ was kept at 11 % while the $ climbed from 39 to 45 %, also at the expense of the Y (15 % en 2001).

In 1975, the new  European Unit of Account was created to equal 1 SDR (1.02 $)
In January 2002, 1 ? = 1.1995 SDR.


3. EXCHANGE RATE WITH THE $.

a. A matter of principle : The ?, to become a weak, strong or stable currency ?
b. Trends since 1981
c. Impact of changes in short term interest rates
d. Impact of the relative levels of foreign current accounts. 
e. Criteria : inflation, indicative interest rate, economic growth, employment.


3.a. WEAK, STRONG OR STABLE CURRENCIES?

Taken from "« The Euro for Europe : from national currencies to the European currency » Batsford,  2000.

A currency is called « weak » when it regularly devaluates compared to the other currencies. It offers commercial advantages in the international trade, but it is avoided by savers and long term investors. A currency is called "strong" when it regularly appreciates compared to other currencies. This tend to weaken its enterprises compared to foreign competitors. It is usually associated with price stability (low inflation). Such a currency keeps its intrinsic value and is therefore sought after by savers. A country with a « strong »  currency attracts foreign capital despite lower interest rates.

In the IMS, there can be no « strong » currencies without « weak » currencies. According to this interpretation, even strong currencies characterise an unstable system  with dominant and dependent economies. The EU Treaty does not require the ? to be strong but « stable » within a « market economy, open to free competition ». In a global economy, this supposes an independent central bank, a tight control on inflation and a balanced foreign current account. These two conditions being met for the ?-zone, the initial drop in the ?/$ exchange rate is difficult to explain. 


3.b. TRENDS SINCE  1981.

Period pre-? :  fluctuations of +/- 30% around the reference rate of 1 : 1 ; 10-year cycle.

Period 1999 - 2003 : fluctuations +/- 15% around the reference rate of 1 :1 ; shorter cycles.
(Illustrations 7 b)

HENCE : CURRENT EXCHANGE RATES FALL WITHIN LIMITS OF PAST VARIATIONS .
(No dramatisation by calling current rates : new highs, ceilings, etc...)

Concerted interventions of FED, ECB and Bank of Japan after 11 Septembre 2002 has stabilised the international financial markets. 

Until now  : ? = more stable currency but fluctuations more intense. In the future  ?


3.c. IMPACT OF CHANGES IN SHORT TERM INTEREST RATES.


Close correlation  between the exchange rates of  ?/$ and the short term interest rates of these currencies)  (Illustration 7c).




3.d. IMPACT OF THE RELATIVE LEVELS OF THE FOREIGN CURRENT ACCOUNTS

Zone ? and EU : foreign current account is positive or balanced.
UK and USA : account systematically in deficit.  USA situation on slightly modified by lower exchange rates of $ / ?.  ( Illustration 7 special)


3.e. OTHER CRITERIA : INFLATION, INDICATIVE INTEREST RATE, ECONOMIC GROWTH, EMPLOYMENT.

- Inflation : prices have remained stable during period of economic crisis ; will the ECB manage to control prices during periods of rapid growth : ????  (Illustration 6b)

- Indicative Interest Rate : discrepancies among EU countries remains minimal (Illstration 6c) ;

- Economic Growth : remains way below that of the USA.  Performance of ?-zone is mediocre.  ? may not be sustainable as international currency if no improvement ; (Illustration 7 e & 10c) ;

- Employment : Remains around unsustainable 8% (Illustration 7i)


4. IMPACT OF ECONOMIC GOVERNANCE AND COMPLIANCE WITH GROWTH AND STABILITY PACT

4.a. ECONOMIC GOVERNANCE.

EU TRAETY  : Economy is matter of common interest but remains under national authority..

EURO-GROUP : informal gathering of Ministers of Economy and Finance of the ?-zone without proper authority. Votes only as part of ECOFIN with other EU members. Changed under proposed Constitution. 

National management of economies is largely responsible for persistant obstacles to full implementation of Single Market. Lack of parallelism with federal management of monetary policy is unsustainable. (Illustration 10b)

Convention : No significant changes proposed regarding economic governance. 

4.b. GROWTH AND STABILITY PACT.

-  Public sector of EU represents more than  45% of GDP compared to 34% in the USA and  31% in Japan.

-  Public Finances were regularly in deficit : Growth and Stability Pact aims at achieving balanced public budgets over the economic cycle and limits annual deficits to a maximum of 3%.

-  ECOFIN of November 2003 has  « suspended  the application of the Pact » to allow France and Germany to maintain public deficits over 3% for more than 3 years.

-  Effect on the international position of the ? :

- Influenced negative vote in Sweden on adoption of the ? ;
- No immediate effect on  ?/$ exchange rate because the Pact remains applicable in the long run, and USA public deficit hovers around 5% . Compare respective public debts. 
- Undermines international credibility of European integration.

5. IMPACT OF ADHESION OF 10 NEW MEMBER STATES.

- Conditions of entry into Economic and Monetary Union (EMU) :
o Be part of UE
o Respect the convergence criteria (with adjustments)
- Current regimes  very différent :  (illustration 12b)
o Bulgaria, Estonia, Hungary, Lithuania : currency pegged to the ?
o Romania, Slovakia, Slovenia : controlled regimes partly pegged to the ?
o Cyprus, Poland, Czech Republic, Turkey : convertible currency, free exchange
o Latvia : monnaie rattachée au $
o Malta : opposes the adoption of the ?.

- Two positions :
o R. Mundell wishes entry into EMU as soon as possible
o ECB et al : only once conditions are met (earliest in 2008)

- Global impact probably neutral as was the case when Spain and Portugal entered the ECU. 

- ATTENTION : high (and growing in some countries) levels of corruption (Illustration 10f)

6. CONCLUSIONS.

$ still dominant international currency ; role of ? is growing, mainly around ?-zone. ? is more than the DEM which, together with the JPY were the two crutches of the $. One evolves toward a bipolar monetary world.

Potential of ? is real provided it does not stay « orphan » of an economic governance and genuine federal European government. If economic performance of EU does not improve, Europe will become underdeveloped area and ? will not keep status of international currency. 

Stability of bi-polar IMS will depend on :

· Attitude of European leaders will have to be less hegemonic than that of USA (changing) : (The problem of the $ is your problem, A dollar is a dollar,...)

· The ECB and the FED will need to act in concert to reduce excessive exchange rate fluctuations  (admittedly a residual factor) on international markets (Robert Mundell).
            Jean-jacques SCHUL