12 July 1985
The European Currency Unit and its contribution to the stability of the international monetary system
Delivered by Monsieur Valery Giscard d’Estaing, President of the French Republic, 1974-81.
Relations between the United States and Europe have been dominated, during the last twenty years, by three main issues: defence, trade and money. Presently there are on defence and trade relations some major on-going debates.
But, as far as money is concerned, we could say that apparently ‘All is quiet on the western front’. There were some academic discussions in Tokyo, last month, between Ministers of Finance of the Group of Ten, the major countries, but no prospect of effective action.
In my judgment, this is a mistake, since people who work, invest and trade will not be convinced that we may enter an era of lasting and safe expansion if they do not perceive some return to monetary stability. Europe, which is a continent in decline, should plan a leading role in this field, building upon the success of the EMS (European Monetary System). A more acute perception of the present weaknesses of the international monetary system, and a better understanding of the present and future role of the ECU (European Currency Unit), would help in defining collectively the proper answers.
I - The weaknesses of the present monetary situation
The present system of international settlements is working better than many would have suspected some years ago. However, there are in it presently three major weaknesses: the excessive imbalances on current account; the excessive volatility of exchange rates and interest rates; the excessive debt burden of some developing countries. The main features of a possible comprehensive action derive from this analysis.
1 - The imbalances on current account:
According to figures just released by the OECD, the US current account deficit will increase from about $100 billion in 1984 to $120 billion in 1985 and $145 billion in 1986. During the same period, the Japanese surplus will increase from $35 billion to $50 billion, and the surplus of OECD European countries from about $10 billion to $30 billion.
The causes of the US imbalance are well known, namely the rapid expansion of 1982-1984 and the present exchange rate of the dollar. Its consequences might prove lasting.
Before the end of the year, and for the first time in modern history, US external liabilities will exceed US external assets, which means that the US economy will be a net debtor. The cumulative effect of interest payments will then start to fuel future current account deficits and the attraction by the US of savings and banking flows throughout the world will remain essential for the functioning of the system. A loss of confidence could well then initiate a rapid decline in the value of the dollar, or at least a period of rapid changes in exchange markets.
The causes of the Japanese imbalance are also well known: an excessive trade surplus resulting on the export side from a permanent under-valuation of the yen, and on the import side from the insufficient openness of the economy.
The European situation is more complex. Basically, the small global surplus of Europe reflects insufficient growth in the present recovery phase. The US economy has been growing by 3.7% in 1983, 6.8% in 1984, and around 3% in 1985, while Japan was registering in 1984 and 1985 growth rates exceeding 5%. By contrast, the growth of European countries has not exceeded 1.5% in 1983, 2.5% in 1984, and will be somewhere between 2% and 2.5% in 1985. (French growth for 1985 will be 0.3%; the British figure somewhat higher). This insufficient rate of growth has obvious adverse consequences on employment, aggravated by excessive labour costs and a lack of flexibility.
In addition there is, within Europe, a contrast between countries which have corrected external and budgetary imbalances, such as Germany and to a lesser degree the United Kingdom, and countries still facing imbalances, such as France and Italy.
2 - The excessive volatility of exchange rates and interest rates:
Everybody is aware of the major upward drift of the dollar in the past five years. The effective exchange rate of the dollar, on a basis of 100 in 1980, stands now at around 135. Against the Deutsche mark, the dollar is back to its 1973 level after massive variations in both directions.
But we should be aware also of the magnitude of monthly variations. To take some examples for the dollar/ D.Mark exchange rate: an increase by 10% in three weeks in September 1984, and a decrease by 14% in the weeks from March 4th to April 19th, 1985.
And now, day-to-day variations of 2% are not uncommon, which is equivalent to the range of variations of the central rate of an EMS currency between two realignments, which means for periods of about 18 months. And let us not forget that under the Bretton Woods agreement, between two devaluations, exchange rate variations were limited to 0.75%.
For interest rates, there is a similar volatility. First, there is a trend towards higher real interest rates, with adverse consequences on future growth. Against an historical trend of around 2%, real long term interest rates in the US have exceeded 5% on average in 1980-1984. Around this trend there are major variations related to the deregulation of the financial sector and the implementation of quantitative monetary policies. Changes in interest rates by more than 5% over one year are not uncommon, and we have seen during the last month interest rate decline in the US by more than 1.5%.
3 - The excessive debt burden of some developing countries:
The ‘case by case’ strategy initiated in 1982, after the Mexican crisis, has been a remarkable success. The successful implementation of the Mexican programme, the steps now initiated in a country like Argentina, the multi-year rescheduling agreements negotiated between banks and some debtor countries bear testimony to this. The global improvement in the current account deficit of non-oil-producing developing countries, which declined from $60 billion in 1982 to about $20 billion in 1984, and the restoration of the trade balance of these countries in 1984, after a deficit of $20 billion in 1983, reflect the results achieved by the necessary adjustment policies.
But problems remain. The adjustment by the developing and poor countries was helped by the rapid increase of US imports, and the slowdown of the US economy will affect the trade balance of debtor countries. There is more fundamentally a need to come back, in developing countries, to a more sustained rate of growth, required for economic, social and political reasons. Finally, there are still risks in the system, in relation to distressed banks, interbank credits and the bunching of maturities in coming years.
Faced with these uncertainties and these problems, the markets themselves have reacted. There was a widespread use of forward operations, of swap transactions, of floating-rate instruments. But, as noted by the BIS (Bank for International Settlement) in its last annual report, these instruments could well fuel added instability in the future if a more stable framework is not defined by governments themselves.
4 - The components of a comprehensive action:
In my judgement, comprehensive action aiming at correcting these weaknesses should be based on four mutual undertakings:- a gradual reduction of imbalance in the US economy: it should be a gradual process, since the economy is slowing down, but with a clear objective. It would imply essentially a reduction of the budget deficit. If the budget deficit is seriously addressed, there will be room for a gradual monetary policy ensuring some easing of interest rates and, therefore, a ‘soft landing’ of the dollar;
- a greater perception by Japan of its international responsibilities. Some action is already being taken towards the internationalization of the yen, the deregulation of the capital market in Japan, and the opening of the economy, but added momentum could be given to this ongoing process;
- renewed efforts in solving debt problems through aid, export credits and interim arrangements;
- and a concerted European action for which the time is ripe, since the US economy is running out of steam, and since there would be therefore a need for sustained growth in Europe.
Hopefully, there will be a better political climate for it in 1986. There are general elections in France in 1986, and if the opposition wins, which is my firm hope, a new economic policy aiming at reducing deficits, cutting taxes, and dismantling state interventions, including exchange controls, will be implemented. Germany will have general elections in 1987 and the German authorities might therefore next year consider positively some expansionary measures in the framework of a concerted action under which countries in deficit would simultaneously restore financial discipline. To this concerted action, a move towards a strengthening of the EMS and the emergence of a common European currency could bring added credibility. It is absolutely clear that fiscal imbalances in major countries or the debt situation of developing countries will not be treated by monetary actions alone. But a more stable monetary system would provide a much needed coherent framework for compatible actions. Past experience shows the instability of a system based on a single currency, namely (at the present time) the dollar, with conflicting domestic and international goals. Hence the need for a bold European move towards a European currency, as a component of an international monetary system based on three poles, the dollar, the ECU and the yen.
II- The contribution of a unified European currency
In contributing to a better functioning of the international monetary system, through the promotion of a unified European currency, governments should keep in mind that they have to rely on market forces.
Past developments of the European Monetary System show us the direction. We created, six years ago, a system operated by central banks, and we have seen the emergence of day-to-day operations in European currency on financial markets.
We should now promote these developments on the markets, and amplify them by some bold actions. 1 - The emergence of a European currency
When we decided in 1979 to launch the European Monetary System, we launched at the same time a new currency unit, the European Currency Unit (the ECU, not by coincidence the name of an old French coin), which stands at the heart of the system since it performs the following functions:
a) It is the so-called ‘numeraire’ of the system, which means that each individual European currency is defined in terms of a certain quantity of ECUs;
b) It is the centre of the grid of mutually agreed exchange rates; participants to the exchange rate system, which means all European countries, with the exception of the United Kingdom, conduct central bank interventions on exchange markets to avoid any move larger than plus or minus 2.25% around the agreed central rate (the only available target for speculation in Europe is the pound sterling; and the pound has fluctuated as a result of this);
c) It is a reserve unit since, through swap agreements, all central banks deposit with the European Monetary Cooperation Fund the equivalent of 20% of their gold and foreign exchange reserves;
d) It is the unit of account of all official EEC budgetary and financial instruments; in particular, a debtor country can consolidate its intra-European debt through the use of a short term facility or of a medium term facility, which provides it with the additional ECUs it may need.
The EMS has proved a remarkable success. The variability of exchange rates has been reduced by one third according to a recent IMF study. The discipline of the system, in terms of corrective actions needed when one currency deviates from the others and when a so-called realignment of parities takes place, has proved effective as shown for instance in 1983 when France had to undertake an abrupt change from over-expansionary policies to a policy of restrained growth.
But the official use of the ECU remained limited, since the bulk of interventions by central banks on the market was conducted in dollars and since other types of borrowing than the EMS facilities were used by debtor countries. Some technical improvements, in terms of interest rates and in terms of acceptance limits, have been made recently to the official ECU, which might however contribute to enhancing its future use.
But the most striking feature has been the rapid development of private transactions in ECUs.
The ECU market already ranks as one of the biggest sectors of the Euro-banking market. If one looks at changes in positions in foreign currencies of European commercial banks, one can see that from the end of 1982 to the end of 1984, at constant exchange-rates, ECU-denominated assets increased by $23 billion against $26 billion for dollar assets, $23 billion for Deutsche mark assets and $22 billion for all other currencies. At current exchange rates, and due to the increase of the value of the dollar, the share of the dollar appears higher, but the ECU remains the main vehicle of bank operations in European currencies.
If we look at long-term securities we can notice the same trend; the first ECU-denominated Eurobond was issued in April 1981. In 1984 the volume of ECU issues amounted to $3 billion, far below dollar issues which exceeded £60 billion, but again in the vicinity of Deutsche mark issues which amounted to $4 billion.
Since it is a recent trend, the share of ECUs in foreign claims of banks or of outstanding Eurobonds is still limited, in a range from 2% to 3%, but in terms of flows and not of stocks the change is dramatic.
To be sure, the ECU market remains predominantly an interbank market. The growth of the ECU banking market has come mainly from its assets side, with nearly three quarters of the borrowing being conducted by Italian and French non-bank entities. Bank deposits have been constituted in significant amounts only by residents of the BENELUX countries. And banks had to ‘generate’ ECUs, by borrowing individual European currencies on the interbank market, mostly in France, Belgium-Luxembourg, Italy and the United Kingdom.
In terms of bonds, some European institutions have played a major role since they accounted for about 30% of total issues to the end of 1984. Among the buyers of such bonds were EEC residents, notably in Belgium, but also Swiss, Japanese and US residents. Recently some ECU issues were made in the US domestic market, the first non-dollar issue ever.
One can see how this trend towards a growing use of the ECU may continue in the future: an expansion of the scope of lending operations beyond Italy and France; a broadening of its non- bank deposits base beyond the BENELUX countries; a perceived stability which implies convergence of price developments among EEC member countries.
2 - The task before us
When we look at the future of the monetary construction of Europe, we should build on the elements of strength, i.e. the private use of the ECU; and correct the elements of weakness, i.e. the limited official use of the ECU.
As the fish needs the sea, a currency needs a market.
As I see it, a full development of the ECU market would imply three major steps:
1. The inclusion of the pound sterling in the exchange rate agreement, an issue to which minds seem to be turning in London, in view of the recent rather erratic movements in the exchange rate;
2. The full acceptance by all EMS members of the ECU as a private instrument of payment and as a genuine domestic asset.
It is basically the problem of Germany, which forbids indexation, namely the reference to anything else than the current value of the Deutsche mark, in domestic contracts. From a lecture given last week in Paris by Mr Pöhl, the chairman of the Bundesbank, I got the impression that the German monetary authorities might reconsider their position if other countries were at the same time initiating the dismantling of their exchange controls. Basically, this difficulty will be overcome if German leaders are convinced that other countries are also adopting anti-inflationary policies, ensuring that the Deutsche mark will not be associated too intimately with weak currencies.
3. The dismantling of exchange controls in France and in Italy; which seems probable, in view of the coming political events in both countries. There will not be a genuine European capital market without such an abolition. It is only if governments fully accept the discipline inherent to a free capital market, which penalises unsound policies, that their adhesion to the goal of stability will achieve a lasting credibility.
While relying on market forces, the monetary construction of Europe implies some institutional changes. We should support the creation of a European central bank, the equivalent of the Federal Reserve system.
It would issue ECUs to national central banks against assets denominated in gold or foreign exchange currencies, thus ensuring some pooling of reserves.
It would also impose a common reserve requirement for national money supplies, which means a ratio between the domestic monetary circulation or the domestic monetary base and assests held with the European Central Bank.
No country could then deviate from the global target set for monetary aggregates and would have to adjust accordingly its economic policy.
As time develops, the European Central Bank could intervene directly on the private ECU market, thus creating central bank money freely transferable from one European bank to another through the network of national central banks.
The integration of the two presently separated functions of the ECU, as a private instrument and as an official means of settlement, would provide a major incentive to invoice, settle, lend and borrow in ECU throughout Europe, an important step in the direction of a single European currency, which is the ultimate goal.
I believe that it would lead to a better functioning of the international monetary system which should in the future be based on three pillars: the dollar, the ECU and the yen.
From my past experience, I know that US governments are interested in discussions on the international monetary system mostly when they see the role of the dollar being fairly challenged. It is up to us, Europeans, to build this fair challenge through bold steps towards the construction of the monetary union of Europe, and the growing use of a common instrument.
Let us give a currency to Europe! We will thus give a new impetus to our common endeavour: how to ensure greater monetary stability in the world at large.
The words of the critics of such a proposal sound like a homily delivered at a wedding - be careful; it will not last; it will be difficult.
We would like to attend another wedding - the wedding of the United Kingdom with the EMS. And, I know it will happen - there will be a single European currency because the daily life of Europe shows the desire and the need for it.