Hermann Remsperger: The importance of the
European Monetary Union in transatlantic relations
Speech by Professor Hermann Remsperger, Member of the Board of the Deutsche Bundesbank, at the
7th Transatlantic Summer Academy on "Europe facing the 21st century: defining the central issues",
Zentrum für Europäische Integrationsforschung, Rheinische Friedrich-Wilhelms-Universität in Bonn,
on 26 June 2000.
* * *
Ladies and gentlemen, I would like to begin my speech by quoting two of the sharpest critics of EMU.
And you may imagine that I do not agree with these critics.
Before the start of the euro, MIT professor Rudi Dornbusch made the following statement:
"So EMU has gone from being an improbable and bad idea to a bad idea that is about to come true...
The struggle to achieve monetary union under the Maastricht formula may be remembered as one of
the most useless battles in European history. The costs of getting there are large, the economic
benefits minimal, and the prospects for disappointment major."1
Martin Feldstein, the former chairman of the Council of Economic Advisers, went even further and
warned that EMU might increase intra-EU conflicts rather than foster political union. He concluded:
"Although it is impossible to know for certain whether these conflicts would lead to war, it is too real
a possibility to ignore in weighing the potential effects of EMU and the European political integration
that would follow."2
However, there were not only negative or sceptical views on EMU. One of the most prominent
proponents of EMU, Nobel laureate Robert Mundell, describes the benefits of a successful EMU:
"Members of the EMU will get not just a currency on par with the dollar and the right to share in
international seigniorage but also greater influence in the running of the international monetary
system. The rest of the world will get an alternative asset to the dollar to use in international reserves
and a new and stable currency that could be used as the focus for stable exchange rates or currency
boards. The US will get a needed relief from the eventually debilitating overuse of the dollar as an
international currency, a single-currency continent that vastly simplifies trade and investment, and a
strong partner in Europe with an equal stake in constructing an international monetary system
suitable for the 21st century."3
I think Mundell's statement is a very good starting point for my own considerations. In the following,
I would like to discuss the advantages and disadvantages of the euro as an international currency and
evaluate them on the basis of the empirical evidence available. I will then analyse what implications
the broad international use of the euro might have for monetary policy. Finally, I will examine the
possible impact of EMU on relations between Europe and the United States.
Given the limited time available, I will certainly be unable to give full coverage to all aspects of the
subject matter. However, I will be glad to answer any questions at the end of my talk.
A striking feature of the transatlantic relations between "Europe" and the United States was the
dominance of the US dollar in the area of international monetary policy during the second half of the
20th century. This was partly due to the institutional setting. In the post-war monetary system, the US
currency was assigned a prominent role as the anchor currency. This - in addition to other factors
fostered the international use of the dollar. However, even after the end of the Bretton Woods system
of fixed exchange rates at the beginning of the 1970s, the dollar maintained its position as the most
important transaction, investment and reserve currency - and it did so despite its overall depreciation
against staple currencies.
With the euro, market players now have an alternative currency which may become a serious
competitor to the US dollar. Any currency, especially a new one, will only establish itself
internationally - that is to say, outside its own currency area - if it provides its users with specific
advantages over other currencies. Those advantages may be in the form of lower transaction costs,
greater stability or more opportunity for diversification. There are at least four reasons supporting the
argument that the euro could play an important role as an international currency:
- the economic size of the euro area;
- the euro area's close trade and financial ties with countries outside the euro area;
- the favourable changes in the euro area financial markets;
- the institutional arrangements for maintaining price stability in the euro area.
The euro area has about the same economic weight as the United States; both economic areas are well
ahead of Japan. The population of the euro area, at around 290 million, is larger than that of the United
States (270 million) and Japan (125 million).
It is obvious that the size and capacity of an economic area is of importance to its currency: economies
of scale play an important role, especially in the use of money. A large economic area generates a
large "natural constituency" for its own currency. If a currency is widely accepted, this normally
lowers transaction costs, which, in turn, attracts international customers and leads to a further spread
of the currency beyond its domestic area.
The argument of size is important since the euro area is highly integrated into the world economy. The
euro area accounts for one-fifth of world trade excluding trade within the euro area. This is more than
the corresponding ratios for the United States with 15% or Japan, which is just under 9%.
What is more, the end of currency segmentation has led to a dramatic change on the euro area's
financial markets. The range of financial products is expanding, and the markets are becoming more
liquid. The money market, in particular, is now unified. Concerning the European stock exchanges,
mergers are being planned, and greater attention is being paid to the wishes of market participants. All
that tends to have a favourable impact on the efficiency of the euro financial markets, although they
are still lagging behind the US markets in that respect.
Despite the introduction of a single currency and cooperation among the stock exchanges, the financial
markets in the euro area continue to be segmented to a larger extent than those in the United States. In
particular, issuing on the bond market is heavily fragmented; in the euro area, there is no issuer
comparable to the US Treasury. The existence of different securities settlement systems continues to
entail higher costs than in the United States. Finally, purchasing securities across borders in the euro
area is still more expensive than buying them in a particular member state.
The size and openness of the economic area as well as the dynamism and efficiency of the financial
markets are definitely important factors in determining a currency's international success. Ultimately,
however, the euro will hold its own in competition with other currencies only if it can be kept stable
over the long term. The relevant institutional requirements have been met: the ECB is an independent
central bank which is primarily committed to the objective of price stability.
The euro's greatest success to date has been as an issue currency on the international financial
markets. Between January 1999, the start of EMU, and March 2000, 47% of the net issuance in
international debt securities was denominated in euro, compared with a dollar ratio of 45%. It seems
that the large issuers took advantage of the low euro interest rates in order to raise large amounts of
funds in euro. However, it is also apparent that the euro's success in terms of new issues increased its
share of all international debt securities outstanding only slightly compared with its predecessor
currencies, namely from 25% at the end of 1997 to 30% at the end of March 2000. At this reference
date, the share of the dollar stood at 47%.
The euro's share of international banking business is somewhat smaller than on international securities
markets, amounting to 28% in the case of bank assets and 24% in the case of bank liabilities,
compared with a dollar market share of 40% and 42%, respectively. Relative to the share that the
euro's predecessor currencies had previously, the euro comes off much better in international banking
business.4
From the perspective of a central bank, it would be especially interesting to know the euro's share of
the official foreign exchange reserves. It is precisely as a reserve currency that the dollar has
traditionally had the largest lead over all other currencies, with a recent share of more than 60%.
Unfortunately, the corresponding share of the euro cannot currently be quantified reliably, since the
underlying database is decidedly incomplete.
The euro has developed very quickly into an - at least numerically - important international anchor
currency. The ECB has recently listed some 50 countries in whose currency regime the euro is playing
a role. The arrangements stretch from D-Mark or euro-based currency boards (Bosnia-Herzegovina,
Bulgaria, Estonia) and mutual agreements as part of ERM II (Denmark, Greece) to rather informal
exchange rate links, which are geared to baskets that, in addition to the euro, include other currencies,
too.
Two results of my empirical analysis merit particular attention. Firstly, the dollar continues to be the
leading international currency in virtually all functions, even though the euro has reduced the gap here
and there. Secondly, the role that the euro is playing on the international financial markets is now
already clearly more important than that of its predecessor currencies. The weight that the euro area
lends to its currency is evidently greater than the simple sum of the 11 participating countries.
The euro's growing importance on the international financial markets contrasts sharply with its
exchange rate movements until mid-May. Between January 1999 and its trough in May, the single
currency lost around one-quarter of its value against the dollar, and as a weighted average against the
currencies of the euro area's 13 most important trading partners, it did not come off much better either.
How can the euro gain market shares on the international financial markets while losing so much of its
value?
Taking a look back into the past may be helpful in providing an explanation. The dollar has always
been able to maintain its position as the leading world currency despite the ups and downs in the dollar
exchange rate. Apparently, the individual currencies' positions on the international financial markets
are determined, at least to some extent, by factors other than the exchange rate. In addition, the time
horizons underlying decisions on the foreign exchange market and the (long-term) capital market are
probably different as a rule.
If you ask me, Ladies and Gentlemen, what my analysis up to now means for the transatlantic
relations, I would not deny that the exchange rate between the euro and the US dollar will always play
a central role. However, it is essential to add that the external value of the euro cannot nearly be seen
as the sole indicator for the importance of EMU within the transatlantic relationship. I shall return to
this point soon again but from rather an American perspective.
Before I continue, please allow me to emphasise that the expanding international use of the euro could
have far-reaching consequences for monetary policy. Indeed, there is some evidence to suggest that
the capital markets might play an increasing role in the transmission of monetary policy (at the
expense of the banking system). This might enhance the efficiency of monetary policy by reducing the
time lags in the transmission process, since the capital markets usually respond more quickly to
interest rate changes than does the banking system.
The exchange rate channel might likewise lose in importance if other countries, for example future
accession countries, pegged their currencies to the euro. This primary effect would be diminished by
the fact that the Eurosystem's monetary policy would, in that event, have an immediate impact on the
real economy in those countries, which would feed back to the euro area on account of the close trade
links. However, in the light of the small weight of the countries which may be willing to peg their
currencies to the euro, the overall effect should not be overstated.
Another aspect may prove to be very important. The more the euro gains acceptance internationally,
the more difficult it may be in certain circumstances to interpret monetary growth. Transfers of funds
from euro area monetary financial institutions to the banking systems of third countries (and vice
versa) and - from 2002 - the circulation of euro banknotes outside the euro area might prove to be
potential sources of distortions. However, the Bundesbank's past experience suggests that, although
such problems may cause uncertainty in the short run and thus make higher demands on the central
bank's analysis and communication policy, over the longer term they are controllable by monetary
policymakers. Judging from the experience gained from the Bretton Woods system and the EMS,
however, this applies in an environment of generally flexible exchange rates only.
Now, let me take the opportunity to talk about some of the American interests that may be affected by
EMU - interests which are divided into three categories: political, institutional, and economic.5
Regarding the political aspects, the United States is highly interested in stabilising central and eastern
Europe. If EMU paves the way for economic and institutional reforms that will ultimately lead to
higher growth in Europe, then EMU is clearly in the political interest of the United States.
With regard to institutional issues, pragmatic solutions have been found for the question of
representation, with the result that the ECB represents EMU monetary policy in international bodies.
Apart from this, potential changes in the decision-making process in an enlarged European Union have
received attention in the US due to the substantial implications they have on European-American
relations. The US seems to be interested in institutional arrangements within Europe that lead to
greater efficiency in international cooperation.
As regards the economic interests of the United States that might be affected by EMU there are at least
four points that ought to be distinguished:
First, some US economists seem to be anxious that EMU in combination with the Stability and
Growth Pact might be detrimental to growth in Europe. I think the opposite is true. In addition,
structural reform in Europe would stimulate growth in the long run and create positive spill-over
effects in other regions, too. The transformation of the euro area into a "New Economy", characterised
by more flexibility, higher growth rates and low inflation rates would definitely be much appreciated
by our American partners - and not only by them. Whereas some observers expect EMU to increase
the necessity for and the feasibility of structural reform, others argue that an intensified competition in
a currency union might call for more social protection.
Second, the smooth financing of the American current account deficit seems to be an issue of concern
on both sides of the Atlantic. With the euro potentially rivalling the dollar, some economists have been
expecting huge shifts in international portfolios which might limit the ability of the US to finance its
current account deficit. However, in the light of my remarks about international capital flows, I think
that external financing constraints for the United States will not be too narrow as long as a reasonable
economic policy is pursued.
Third, the US is interested in the smooth functioning of the international monetary system. In
principle, US authorities prefer flexible exchange rates. In the case of a crisis, however, the US is
interested in an efficient decision-making process at international level.
Fourth, systemic stability is an objective with high priority for US policy. The question as to whether
the emergence of the euro as an international currency might indirectly contribute to systemic risks has
already been raised. In particular, large and rapid shifts out of the dollar have been seen as
problematic, whereas gradual changes in market shares are not an issue of concern.
In the run-up to monetary union, there was much speculation about how the launch of the euro would
influence volatility on the foreign exchange markets. It was said that the rivalry between a few major
international investment currencies might lead to stronger short-term exchange rate fluctuations, since
changing market sentiments would immediately turn out to the advantage of one currency and
disadvantage of the other. It was further argued that the euro area's degree of openness in foreign trade
would be smaller than that of the individual participating countries prior to their entry into EMU and
that the Eurosystem would therefore probably be more inclined to pursue a policy of benign neglect
than, for example, the Bundesbank had been in the past. Apart from the fact that some of those
theoretical considerations are on shaky ground, the empirical findings argue against them, too. In a
larger and more liquid euro capital market, the reallocation of assets does not necessarily lead to
increased exchange rate fluctuations, and a generally increased exchange rate volatility has not been
observed so far either. On the contrary, measured in terms of the standard deviation of daily
percentage changes, the average volatility of the euro's rate against the US dollar between January
1999 and May 2000 was actually somewhat lower than the volatility of the D-Mark against the
US dollar between 1991 and 1998.
In concluding, I would like to emphasise that although the interests of Europeans and Americans may
differ here and there, I do not see any fundamental differences, at least not in the economic fields that I
have just discussed: smooth balance of payments financing, higher growth rates in Europe, stability of
the financial system and flexible exchange rates between the major currencies. I think most Europeans
would subscribe to these objectives as well.
However, EMU will not automatically help to achieve these objectives. Consequently, major
challenges for European and American policymakers still exist, some of which could be dealt with by
competing for better policies. Others, such as maintaining the stability of the global financial system,
argue in favour of closer cooperation. At many levels - for example, the IMF, the Financial Stability
Forum, the BIS - such cooperation actually takes place without being ultimately hampered by the
complex political structures in Europe.
Competition and cooperation will presumably remain the salient features of transatlantic relations in
the foreseeable future. Interpreted as the struggle for the best solutions and by assuming joint
responsibility, these two guiding principles - competition and cooperation - might complement each
other almost ideally.