Comments by myself in [ ] in the text.
Monday December 14, 1998
Risky trip to dollar rivalry
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Helmut Kohl has succeeded by peaceful means where Napoleon and Hitler tried conquest and failed. In the scale of its ambition, the euro project is staggering. Put aside the fact that for the first three years of its life the infant euro will be a virtual currency, with notes and coins only available from 2002 onwards.
>From day one, the European Central Bank will set a single interest rate for
the entire euro-zone and its 11 currencies will be irrevocably fixed.
Should some find the going tough, they will no longer have the option to
alter borrowing costs or allow their
currencies to take the strain.
The $64,000 question is whether the euro will work. Supporters argue that in an era of global economic forces, only the large and powerful can survive. Mr Kohl's devotion to the project stems from his belief that "the nation state cannot solve the great problems of the 21st century."
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What is true is that the euro will cut transaction costs and, more important, eliminate currency risk. Most big firms hedge against exchange-rate fluctuations, but a lot of smaller enterprises find the cost prohibitive. There are those, like the Confederation of British Industry's Adair Turner, who believe the promise of exchange-rate stability outweighs any loss of interest-rate flexibility.
[CB Note that any left wingers who opposed European integration therefore ought to support the Tobin tax globally to slow down the instability on exchange rates that hurt small businesses relative to large. Note also the prediction of Soros that the pound sterling will be severely pulled between the different dynamics of the dollar zone and the euro zone and he *will* speculate on it. This will oblige the British government to negotiate some global financial settlement linking the euro and the dollar but that will create its own inflexibilities that may get broken in another financial crisis.]
A second possible advantage is that Europe will be able to reap the full benefit of the single market, with greater transparency leading to real gains for consumers. Economies of scale will lead to higher levels of growth.
Third, the experience of the United States suggests that over time the euro will reshape Europe's economic geography. Whereas each European Union member has a presence across the spectrum of industrial products, each country will become reliant on fewer products, in the same way American car production is concentrated in the Great Lake States.
So if all goes according to plan, monetary union will lay the foundations for the renaissance of Europe's economy after 25 years of underperformance, which has seen the EU's growth-rate drop from 3 per cent a year in the 1970s to 2.8 per cent in the 1980s, and 1.8 per cent in the 1990s.
What is more, Europe will be able to challenge the economic and political hegemony of the United States.
The ECB will ensure low inflation. Monetary stability will be buttressed by the Stability Pact, which, by setting rules for deficits, will give governments the wherewithal to run counter-cyclical fiscal policies.
[Is that "Keynesian" deficit spending in downturns of the business cycle?]
Consumers will benefit from lower prices and the single market will unleash improvements that will boost the EU growth rate and eat into its unemployment mountain.
That said, monetary union remains a risk. Less evangelical euro supporters admit they would have preferred the single currency to have been limited to a core of congruent economies. But the belief is that national differences can be overcome, and that fast growth among those on the EU periphery are an example of catch-up which will, in the end, bring about broad convergence across the union.
This is a big assumption, for it is clear the monetary policy needed for the Franco-German core is inappropriate for the Republic of Ireland. Suggestions that the single currency is more about politics than economics tend to be met with determinism, complete with assertions about the inevitabe forces of history.
[It is highly significant that with the Euro deal in the bag, Germany led by Schroeder is becoming very arkward about subsidising development in the rest of Europe to the tune of 13 billion pounds a year. This is about the uneven accumulation of capital in a large capitalist market, which Elliott does not discuss. In western Europe it flowed disproportionately to west Germany. A mechanism to equilibrate economic activity was to pump capital out to the other areas, eg Ireland which has temporarily done very well. But this can only be done so much. In the USA it is done by pork barrel politics. What is unviable for Euroland is if it is not done at all, and with the impending enlargement of the EC all the calculations become much more difficult. It is no wonder that Blair and Schroeder have had to argue in public about budgetary contributions. It is also no wonder that harmonisation of tax rates has come up as an embarrassingly controversial issue.]
There are really three risks - one political, one economic, one practical. The political risk is one of legitimacy. The Bundesbank has political legitimacy, so does the Bank of England. People accept the decisions made on monetary policy by these institutions even when they are unpopular.
The ECB has no such legitamacy. It was set up with the express intention of keeping monetary policy divorced from the people. There will be no chance for parliaments to grill the Bank's governor, Wim Duisenberg, and board members will sit for only one, fixed term. But what will happen in a country such as Spain - which has very high unemployment - when the ECB decides that conditions across Europe warrant higher rates?
The risk is that the single currency fails because it is designed for the challenges of a previous era of inflation.
[This is a separate issue.]
Prices are falling across much of Europe, yet the ECB has an inflation target which is worryingly assymetrical. The Bank of England has an inflation target of 2.5 per cent, and has to explain its actions should the actual rate deviate from that central rate. The ECB has no such safeguard, but is simply required to keep inflation below 2 per cent. Given inflation is set to stay low, this is plain daft.
Recent wrangling about tax harmonisation misses the point. What the new breed of left-leaning finance ministers should be concentrating on is not standardising taxation, but reforming ECB statutes and ensuring fiscal and monetary policy work in tandem.
[Watch the financial services subcommittee of the ECB.]
The deflationary bias of the ECB could lead to poor growth and impatience among politicians. To limit electoral fallout, governments might then take off the fiscal brakes, pushing up public spending. The ECB might respond by keeping rates higher, leaving Europe with a combination of tight monetary and loose fiscal policy - the opposite of what it needs.
The practical problem is how to prevent the euro from becoming too strong, too early. Europe is running a healthy current account surplus and being touted as a rival reserve to the dollar. There will almost certainly be some rebalancing of portfolios internationally, and this will have the effect of weakening a US currency that already looks vulnerable. A strong euro would be good for the credibility of the ECB, but disastrous for growth.
© Copyright Guardian Media Group plc.1998
[The recent coordinated interest rate cut was at least a signal that they would not delay till January, but generally the prejudice is to keep the Euro strong in relation to the dollar, whereas in the USA the politicians and financial managers will err on the side of keeping the dollar low, in order to avoid recession, and the calculation is that they can afford to do this because import prices of raw materials are falling.
The scenario is set for the Euro to move in on the dollar as a second reserve currency even at the expense of growth in Europe, while competition intensifies within Euroland. This conflict need not exactly lead to war in the way dogmatic Leninists would have to argue. But the contention and collusion between Europe and the USA should be watched closely for its effect on the rest of the world.
I predict some deal on dollar Euro links and mutual support within a band, because the big capitalist blocs will have their self-interest under control in bilateral negotiations. I predict they will not grasp the nettle of a truly rational independent world financial system which fetters the arbitrary nature of finance capital, especially turbulent short term capital movements. Progress on this front will be piecemeal, unless the USA and Euroland can build it into their bilateral arrangements, because no country can afford to bring in short term capital controls on their own without great cost. CB]