THE EURO:

A NEW CURRENCY IN A CHANGING WORLD
 

Prof. Dr. Dr.h.c. mult Hans TIETMEYER
President of the
DEUTSCHE BUNDESBANK

September/1998
Special thanks to:
Foundation Ortega y Gasset &
Prof. Ramón Tamames

In August 1930, José Ortega y Gasset, in what is probably his best-known book, The revolt of the masses, took Europe severely to task. He wrote that Europe had lost heart, like a large bird beating its powerful wings against the bars of its cage, a cage which is formed by the nations of the continent.

Before his call for European integration was heard, however, nearly all Europe had to undergo, yet again, the bitter experience of war. Today, almost 70 years later, we are a good deal closer to his vision of creating better conditions for a united Europe.

After World War Two - in the fifties, to be more precise-six countries established the European Community. The Community then expanded in several stages, becoming the Community of the nine, the 12, and now - in the mid-nineties of the 15. And already negotiations are being held with other countries - particularly in central and eastern Europe - on their accession to the European Union, as the Community is now called.

However, even in the future, Europe is unlikely to become a single state. The goal of an "ever closer union" is enshrined in Article A of the Maastricht Treaty, but the European Union is likely always to remain a union of unity containing diversity.

Over the past few decades ever greater advances have been made not only in this breadth of integration but also in its depth-especially in the economic field.


I

At the end of this year 11 countries are actually going to merge their currencies in a single currency: the euro. The day before yesterday, the inauguration ceremony for the European Central Bank took, place in Frankfurt.

Since 1986 Spain, too, has been taking a direct and active part in the integration process.

Spain will now be participating in monetary union from the outset and will thus belong to the inner core of the Union. Your country is justly proud of that. And we in Germany are pleased that Spain was largely able to fulfil the convergence criteria.

After all, participation in monetary union is the fruit of past efforts. In particular, it reflects the monetary stability that has been achieved and the progress made in consolidating public finance.

However, taking part in monetary union will also present all the participating countries with challenges for the future


II

All the euro countries are hoping that monetary union and the single currency will make it easier to cope in a changing world.

The world has indeed changed considerably over the past few decades, and the process of globalization is continuing at breakneck speed.

In my view, it is fitting that you, Mr. Ferrer, are being awarded the Juan Uad6 Prize not only for your great commitment to promoting culture and research - important and praiseworthy though that commitment is.

Your entrepreneurial activities deserve recognition:

Your made a Catalonian family business fit for global competition and, at the same time, demonstrated that local traditions and ties do not have to be opposed to worldwide expansion.

Many enterprises nowadays are, in fact, already transnational or are becoming so. Today, the value-added chain of a product may be spread over many loations, countries and continents- and that will apply all the more tomorrow. Global economic integration will continue to increase overall.

In part, that is the result of political measures such as the progressive dismantling of barriers to trade in goods, capital and services and of internal deregulation in a large number of countries.

Ultimately, globalization is mainly being driven by enormous technological advances and the accompanying decline in transport costs. Especially as a result of advances in the area of communications and computing, the world has become irreversibly smaller.

Perhaps this is shown most deafly by the globalizes financial markets, investors can switch within seconds from one currency to another and from one financial center to another.

Consequently, flows of foreign exchange and capital have grown much more sharply during the past few decades than the traditional flows of goods.

The free movement of foreign exchange and capital has, at the same time, perceptibly intensified regional competition for capital and investment.

This has meant that the scope of national policy makers to shape events has become narrower. International investors pay greater attention to the soundness and stability of national monetary, fiscal and economic policies.

Anyone who loses 6the confidence of the financial markets as a result of policy decisions may soon be punished nowadays by higher interest rates or tensions in the exchange rate pattern.


III

It is in this setting that the euro, too, will have to hold its own.

Certainly, the euro represents a great step forward in European integration -not only politically but also economically. It can bring significant advantages in international competition.

If only by virtue of the size of the euro area and the use of the euro in trade, the currency will have greater potential than the D-Mark- which has now become the second most important investment and reserve currency in the world.

Whether, however, the euro will one day become a key currency -alongside and comparable with the US dollar - will largely depend on its internal stability.

That is because the euro will gain the confidence of savers and investors worldwide only if it is an enduringly stable currency.

The future monetary policy of the European Central Bank will be important in that. But it will not be sufficient on its own.

The euro will win lasting confidence only if there are no excessive social and political conflicts in the euro area and only it instead, a stability culture develops that is sustained by policy makers, business and society equally in all the participating countries.

On account of its size alone, the euro can then undoubtedly become a useful competitor for the dollar and make a major contribution to the stability of the international financial markets.


IV

However, the stability and soundness of the international financial markets will continue to be decided mainly by local conditions.

The recent crises in East Asia illustrate the importance not only of a sound economic development but also of reliable underlying monetary conditions in the respective financial centers.

Many emerging markets have opposed themselves up very quickly to the outside world, without adapting their monetary, financial and banking systems accordingly.

What has been striking in the respect are:

- the often inadequate efficiency of the internal financial sector,

- the lack of banking supervision and

- the many and varied instances of political influence in private credit relationships.

At the same time, a number of countries were pegging their exchange rates too rigidly, especially to the dollar.

Encouraged by the pegging of the exchange rate and official declarations of loyalty to a policy of stable dollar rates, many investors virtually inundated the East Asian countries with capital and liquidity. In many cases, long-term projects were funded in this way using short-term external resources, thus entailing exposure to considerable risks.

In a number of countries (especially in South-East Asia), this led to a significant Internal expansion of credit and to a liquidity-driven inflation of asset privies.

The hands of national monetary policy makers were tied in most cases however. Given the pegging of the exchange rate, any increase in interest rates would only have made those countries even more attractive to foreign capital.

When investors then began to have increasing doubts about the pegged exchange rates and the markets became more aware of the above-mentioned weaknesses, there ensued massive outflows of capital and depreciation's of the affected currencies.

It is not only explicit or formal exchange rate linkages that are fraught with problems. Even general orientations for exchange rate policy, such as those that might be formulated by the Council vis-a-vis the currencies of third countries, would soon come into conflict with a monetary policy geared to stability.

Given this conflict of alms, the EU heads of state and of government right policy should be formulated only under exceptional circumstances, such as in the event of obvious exchange rate distortions.

A practice of this kind undoubtedly defuses the potential for conflict which exchange rate orientations fundamentally entail, especially as it is expressly laid down in the Maastricht Treaty (Article 109) that such "general orientations" shall be without prejudice to the primary objective to maintain price stability.

For the affected countries in East Asia, a review and modification of their exchange rate arrangements will probably not be enough on their own to restore the confidence of international investors.

What are also needed, above all, are:

- a stability-oriented monetary policy and

- an efficient supervisory body for financial markets and

- banks that complies with international standers.

But the crises in Mexico three years ago, and in East Asia now, also show that generous financial assistance by the international community alone -say, through the IMF- does no more than cure the symptom.

It can easily encourage moral hazard and, at the same lime work as an incentive to lenders to withdraw from comparable countries.

In future, instead of handing out ever larger amounts of IMF aid, it would be better to involve private creditors earlier and to a realer extent in the solution of the crisis than was mostly the case in East Asia.

Anyone making risky investments in order to achieve a higher yield should accept the consequences in the event of loss.

Voluntary rescheduling of debt between private creditors and debtors is a more appropriate course, not the generous provision of public hinds by the international community.

Thus, the IMF, too, should again increase the role it plays as a catalyst in overcoming financial market crises. Affected countries should cope with a crisis mainly through their own efforts and with access to private capital.

Undoubtedly, the international community must also do more to improve crisis prevention.

Particularly necessary are:

- the creation of greater transparency in the financial markets,

- disclosure of the amount and the maturates of individual countries external debt and

- the shortening of existing statistical time-lags.

The internal controls of the financial markets can only function if sufficient information is made available and if the market Players actually pay attention to that information.

V

In the euro area, too, the countries participating in monetary union will have to rely mainly on there own efforts.

With the euro, conditions in Europe will undoubtedly change considerably.

- There will no longer be any internal exchange rates.

- And all participating countries will have to come to terms with a single interest rate level.

At the same time, the euro will intensify competition in the single currency area - not only for the enterprises operating there but also for national policy makers.

Although a stable euro can improve the outlook for growth and employment, national policy makers must prepare the ground for this.

What is needed in a number of countries -not least in Germany, too - is greater flexibility in the national product and labor markets. This will be all the more de case, since the exchange rate and monetary policy will no longer be available at the national level to work as an internal instrument of adjustment.

Each participating country must consciously accept these new and tougher challenges, and

- solve its national structural problems in the area of government budgets,

- make it easier for the business sector to develop its own initiative,

- gear wage developments to productivity, as well as

- strengthen flexibility and mobility in the labor market.
 

There could easily be tensions in the monetary union if these challenges are not met.

In addition to that, closer cooperation by the euro countries in their economic, fiscal and social policies will be essential for strengthening the single policy orientation towards monetary stability.

On the one hand, we shall have a single supranational monetary policy within the euro area. In others words, we shall have the same monetary conditions and largely the same interest rates in all the participating countries.

On the other hand, there are the 11-still largely sovereign- nation states with their differing regulatory, social, legal and tax systems.

Given this asymmetrical construction, it will be important not only for the participating economies to have the necessary internal flexibility, but also for the participating countries to have a sufficiently common basic orientation in their policy.

In the euro economic area there will be no automatic cross-border compensating mechanisms -comparable to those now m the individual nation states - that might cushion regional differences in cyclical trends, growth rates and employment levels.

In order not to place too great a strain on the single monetary policy and in order to avoid conflict, the participating countries have therefore subjected themselves to strict rules on good monetary policy conduct.

Thus, under the Maastricht Treaty, each participating country will retain full responsibility for its debts in future, too. Under the terms of the Treaty, there must be no ball-out at the expense of the Community.

Moreover, with the Stability and Growth Pact, all the participating countries have committed themselves to achieving and safeguarding permanently sustainable position of their government budgets.

I hope that this commitment to rules will have a lasting impact and that the temptation to use Community transfer payments as a substitute for regional adjustment will not prevail.

Even now, the existing transfer payments from the EU budget and the various fluids are increasingly encountering resistance in some countries: that applies, in particular, to me country, which makes by far the largest net contribution.


VI

Europe and the world will continue to change.

We must and cannot shirk this challenge, either by insisting that things remain as they are or by cutting ourselves off from the outside world.

José Ortega y Gasset called on us as Europeans to keep this in mind, when he wrote:

"We are united not by what we were yesterday, but by what we shall jointly become tomorrow". The euro is therefore not the final stage in European integration.

Rather, it is an ambitious project for the future.

The euro must advance the political integration of Europe, too. That also includes the further transfer of national sovereignty at the European level.

The monetary union implies more than technical monetary integration. It is a far-reaching risk-bearing community which -even with all its necessary structuring according to the principle of subsidiary - calls for more far-reaching political ties in the long term.

All those involved now have the responsibility of doing what is necessary to enable the euro actually to become the focal point of European integration and to fulfil the hopes and expectations placed in it.