Hermann Remsperger: Euro markets in a global context
Speech by Professor Hermann Remsperger, Member of the Directorate of the Deutsche Bundesbank,
at the Gulf Euro Summit, held in Dubai, on 8 October 2000.
* * *
I
European economic and monetary union (EMU) has brought about important changes in the
framework for financial markets. This is particularly true of the 11 European countries which have
merged their national currencies into a single currency, the euro, and which have been conducting a
common monetary policy since 1999. However, these changes also apply to market participants in
other countries which maintain economic and financial relations with the countries participating in
EMU. They, too, no longer have to deal with different EMU currencies but only with a single one.
Thus, non-participating states have increasingly perceived the EMU countries as a single area.
Let me start by saying that the euro area represents a relatively large economy. In economic terms, the
euro area comes close to the size of the United States; both economic areas are far larger than Japan.
Measured in terms of world GDP, the US share is about 20.8%. The share of the euro area amounts to
15.5%. It is significantly larger than that of Japan (7.4%). The population of the euro area, at around
290 million, is larger than that of the United States (270 million) and of Japan (125 million).
The size and capacity of an economic area is of significant relevance to its currency and to the
evolution of its financial markets: economies of scale play an important role, especially in determining
the degree to which the money is used. A large economic area generates a large "natural constituency"
for its own currency. If a currency is widely accepted, this normally lowers transaction costs, thus
attracting international customers and spreading the currency even farther beyond its domestic area.
The argument of size is all the more 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 ratio for the United States, which is 15%, or Japan, which is just
under 9%.1
II
If the three large economic regions are examined with respect to their different financing structures
then it quickly becomes apparent that loan-based financing via the banking sector is still important for
the euro area. The volume of credit which euro-area monetary financial institutions have granted to
resident enterprises is, at over 100% of the euro area's GDP, twice as high as the corresponding figure
for the United States (47.5%). In Japan, bank loans, which amount to 92% of GDP, also play a
relatively important role in the financing operations between different economic sectors.2
By contrast, the US economy may be described as a securitised economy; much of the financing is
done not through the banking system but directly on the securities markets. At the end of 1999
outstanding domestic debt securities in the United States were valued at over US$ 15,000 billion, or
161% of GDP. In the euro area they came to around 90% of GDP and in Japan to 131%, although in
the latter case it should be borne in mind that many of the debt securities were issued by the public
sector.
It is also interesting to observe the amount of financing which companies obtain on the capital market.
Whereas euro-area corporates have issued debt securities amounting to only 3.5% of GDP, the
corresponding ratio for Japan is four times as high and for the United States eight times as high. The
figures for equity market capitalisation confirm the initial impression that the securitisation of lending
has an upward potential in the euro area. Expressed as a percentage of GDP, market capitalisation in
the euro area is only about half as large as that in the United States or in Japan.
However, while it is true that the financial system in the euro area is still more oriented towards the
banking industry, bond and equity markets have already begun to play a bigger role. There is also
reason to believe that the presumed dominance of bank loans has been exaggerated and the degree of
equity financing correspondingly underestimated. New data for Germany show that at the end of 1998
the volume of bank loans to non-financial companies exceeded equity financing by a mere 5.3%. In
addition, the aforementioned figures provide only a snapshot at a certain point of time and, as such, do
not reflect changes in their status.
As far as the euro area, in particular, is concerned, the introduction of a single currency has
contributed to a process of adjustment, which tends to promote the securitisation of corporate
financing. Thus the volume of corporate bonds outstanding in the euro area has increased by
approximately one quarter since the start of EMU. This segment of the euro-area capital market, which
started off on a small scale, now presents one of the highest growth rates.3
Meanwhile, the banking sector remains engaged in a process of consolidation, as it has been for some
time now. In 1999 the number of monetary financial institutions in the euro area declined by around
5%. The introduction of the euro, together with technological innovations and the deregulation,
liberalisation and globalisation of financial markets, have led to even fiercer competition among the
banks.
An increasing shift from traditional forms of banking intermediation towards the securitisation of
assets and liabilities does not mean that the "Anglo-Saxon market-oriented model" of a financial
system is principally superior to a bank-oriented system. Both systems have their inherent advantages
and drawbacks. This is why the financial system in a particular economy is not based exclusively on
one model or the other. Only the extent to which one financing alternative is preferred to others differs
from one economy to the next. Even so, it seems to me that the relative advantages also change over
time, depending on the underlying economic and financial conditions. This appears to be precisely
what is happening now in the euro area.
III
The changes on the euro financial markets would seem to suggest - at least at first glance - that
national markets are now converging to form a single market. I would argue, however, that this has
occurred to varying degrees in different market segments.
The greatest degree of integration has been achieved in the euro money market, and within this area it
is best exemplified by uncollateralised inter-bank deposits:4 here the interest-rate differential between
individual euro-area countries is minimal. Cross-border transactions already account for more than
one-half of money market operations. And trade volumes have risen significantly, compared with the
period prior to monetary union.
It was extremely important for the success of monetary policy in the Eurosystem that a single money
market was established right after the introduction of the euro. Only a well-developed money market is
capable of ensuring a smooth distribution of liquidity across the euro area and the efficient
transmission of monetary policy impulses.
The euro bond markets have become "larger" and grown closer together. In order to survive the more
intense competition within the euro area, major issuers (especially the national governments) are
attempting to redesign their debt securities to make them as attractive as possible to potential
investors. Thus some euro-area countries have begun to concentrate their issues on specific maturities
in order to increase their liquidity and achieve benchmark status in certain market segments.
Investors have also adapted quickly to the new market conditions and - if the figures for Germany are
any indication - have invested heavily in the bonds of other euro-area countries. As a result, the
interest-rate differentials for euro-area government bonds have narrowed appreciably. The remaining
small spreads are largely due to differences in liquidity.
The progress that has already been made does not, however, detract from the fact that differences in
the legal systems and settlement systems stand in the way of a more far-reaching integration of the
bond and equity markets. In comparison with the United States, for example, they give rise to
unnecessary transaction costs. Estimates suggest that a better market infrastructure could reduce the
settlement costs involved in cross-border securities transactions so much that they would then be at a
level comparable to that of domestic transactions.
IV
Now I would like to talk about the euro's role among the other major international currencies. Here it
is important to distinguish between two separate issues: the market shares which the euro has captured
as an investment and reserve currency and the movements in the euro's exchange rate.
While it is true that the euro is a new currency, it was able to benefit from the world-wide acceptance
of mainly the DM. This is especially evident in the size of its market shares. The euro is the second
most important international investment and reserve currency, after the dollar, and its market shares
far exceed those of the yen.
Around one-quarter of cross-border bank positions are denominated in euro. The corresponding shares
of the US dollar and the yen amount to somewhat more than 40% and just under 10%, respectively.5
The euro accounts for 30% of the international debt securities outstanding, the US dollar for 48% and
the yen for 10%. If new business alone is taken into account, the euro, since its introduction, has more
or less kept pace with the dollar. If this trend continues, the shares which the euro and the dollar have
in the world-wide market for debt securities outstanding will also converge over the longer term.
The euro's growing importance on the international financial markets contrasted sharply with its
exchange-rate movements. How could the euro gain market shares on the international financial
markets while losing so much of its value? First, it must be borne in mind that the euro as an issue
currency has benefited from low interest rates. Together with a generally falling euro exchange rate,
the low interest rates for the euro, have served to attract issuers from all over the world.
A look at the past may prove helpful in providing a second 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 rates.
Looking for possible causes for the recent weakness of the euro, it will soon become apparent that the
euro's exchange rate reacted asymmetrically to macroeconomic events on each side of the Atlantic.
Thus, the successful passage of the tax reform bill in Germany was barely acknowledged in exchange
rate movements while the surprisingly large growth in US GDP in the second quarter was reflected
rather quickly in a corresponding fall in the euro exchange rate. Apparently, the uncertainties
associated with the euro area received more attention than those affecting the US economy.
Exchange rates do not, however, consistently move in only one direction. Cyclical developments may
revive the diversification argument as a strategic consideration. Moreover, empirical studies support
the view that the composition of foreign exchange reserves to some extent reflects the structure of
external trade and financial ties. If the euro were to become more popular among private market
participants, it might also significantly improve its fortunes as a reserve currency.
The role that the euro has so far played as a reserve currency has been rather modest. Although it also
occupies second place in this segment after the dollar, the gap between the two is large. IMF estimates
have set the volume of foreign reserves held in euro at the end of 1999 at 12.5%, compared with a US
dollar share of 66.2% and a yen share of 5.1%.6 However, one could argue that the euro has held up
well in comparison with its predecessor currencies.
V
At this point, allow me to summarise while at the same time casting a glance towards the future. With
the introduction of the euro, the balance of forces within the international financial system has shifted.
A second currency now exists alongside the dollar which - given the size and economic strength of the
euro area's financial markets - has the potential to become a significant currency with global status.
The extent to which the euro will actually realise this potential also depends on political decisions
taken within the euro area and on the confidence which market participants world-wide place in the
new currency.
Thus the first priority must be to guarantee the internal stability of the euro. This constitutes the
primary objective of the Eurosystem, which has already reacted to imminent inflation risks with
several interest-rate increases. However, economic and fiscal policy makers, who are capable of
accelerating economic momentum in the euro area through the appropriate structural reforms, are also
called upon to act. Much has already been undertaken or set in motion, as in the case of taxation
policy. However, the markets have not (yet) rewarded these efforts.
Important policy initiatives still have to be introduced in the financial markets as well. The
introduction of the euro has succeeded in ending the segmentation into different national currency
zones and in intensifying the competition in individual market areas. Some obstacles to the integration
process only really became apparent once this had been achieved. If one is truly to speak of uniform
financial markets in the euro area, priorities for the future will have to include further improvements in
the infrastructure of the equity and bond markets and a standardisation of legal and administrative
frameworks. Transaction costs between two euro-area countries should not entail higher costs than
those of purely domestic transactions. Moreover, transaction costs within the euro area must not be
higher than the international standard, if the euro is to prosper in international competition with other
currencies.
Let me conclude by emphasising that the financial market trends in the euro area should also be seen
in the light of the developments in the "real" sector of the economy. The financial system not only has
to accommodate the changes in the real sector but it also has to support them. In my view, innovative
financial services - either provided by banks or directly by markets - play a key role in creating a
"New Economy". In this context banks and insurance companies are sometimes portrayed as a part of
the old economy whereas venture capital firms are mentioned as a driving force for a new economy. It
is my opinion, however, that this division between old and new is rather artificial. In Germany last
year 56% of the funds of venture capital investment companies was provided by banks and insurance
companies. Seen in a global context I do believe that the market for venture capital has a big potential
for growth in the euro-area. With this positive outlook on a very special and very important segment of
euro-financial markets I'd like to finish my presentation.