Both Sides of the Coin

The Introduction of the Euro and the Future of Cash

Anthony Gilbert

Please note that most of this article is based on a members' discussion. Views presented and the conclusions drawn from them are not necessarily those of the author, or of Bexley Coin Club as a whole!

Introduction

The last time Europe had one currency, one tax system, and one defence policy, was under the Romans, though Roman currency displayed more local and regional variations than might have been expected from such an efficiently managed empire. At present, we are not considering one tax system, nor one defence policy, although under the WEU (Western European Union) we are getting close. For the first time since the fall of the Roman Empire, Europe has a single currency for the world's largest trading bloc of some 290 million people.

A previous example of monetary union can be found in Ancient Greece - the Achaean League during the 3rd to 2nd century BC. Also during this period, Alexander the Great's coinage found widespread acceptance beyond Macedonia's borders. A few centuries later, from AD 286-301, the Roman emperor Diocletian's reforms of the coinage can be put forward as the first serious attempt at a single currency. More recently, the proposed Latin Monetary Union, first discussed by twenty countries in 1867, was operated for a few years between France, Italy, Belgium, and Switzerland. It collapsed in 1873, the Franco-Prussian War of 1870 effectively bringing about its demise through conflicting material ambitions and lack of trust between states.

Between 1880 and 1914 most currencies were fixed to gold, thus effectively fixing exchange rates. The British gold sovereign was widely used, accepted, and respected. However, the level of international investment was much greater than today.

Two recent examples of monetary union without political union are Belgium and Luxembourg since 1921, and the UK and Ireland between 1921 and 1979.

In order to examine the issues fully, it is necessary to take account of British cultural baggage - mentally a sea from Europe, like the Russians and the Greeks. Despite this, Britain has always been involved in Europe as traders. Whenever threatened, either by Spain in the 16th century, France in the 18th, or Germany in the 20th, Britain has always entered into coalitions against the rising dominant power.

The irony of UK historical involvement with continental Europe is that there are a set of institutions which we have always sought, yet we approach those institutions with suspicion bordering on paranoia. With the fall of the Berlin Wall in 1989, rival nationalisms were on their own again. In Europe, there is no such thing as linguistically and culturally clear-cut borders, and the threat of communism has gone. There is continuing British suspicion, but history shows that we have joined in the end:

• 1955 - Messina Talks - we did not think that anything would emanate.
• 1957 - original Treaty of Rome.

Britain will repeat the mistake; she will miss today's restructuring talks and rule-making. By joining later, the existing rules will have to be adhered to, as happened with the Common Agricultural Policy (CAP) and the Common Fisheries Policy (CFP). "De Gaulled" again?

The European Monetary System, launched in 1979, again affected the UK, leading to the over-valuation of sterling, then recession. The EMS was formed to squeeze out inflation, but Britain joined at the wrong time after German reunification had put pressure on interest rates. Euroscepticism by Britain has tended to lead to higher costs later.

The introduction of the Euro possibly heralds the beginning of Europe as one country, as people understand it. - the beginning of the end of the nation state in Europe. This would mean a quantum leap in the creation of a common European identity and a single European political and economic entity. In 2002, at last would be created the kind of democratic legitimacy which the European Union has never really had.

The Euro is liable to free Euroland governments to take more economic and political decisions together, whilst still leaving scope for independent policies on taxation, as exists at present in the USA and the provinces of Canada. The advent of a new world currency offers Europeans the advantage of seigneurage - the ability to buy other people's exports and offer them printed banknotes in exchange. It is also almost certain to become a hard currency of choice throughout Eastern Europe, Russia, and most of Asia. Europe, and not just the USA, will enjoy the advantages of having a reserve currency. In short, the single currency is the ultimate completion of the single market.

Members' Discussion

What is the Euro?

The Euro is the single currency that will eventually replace the national currencies that join the European Economic and Monetary Union (EMU). It was adopted on January 1st 1999. At present it is a written, paper, and electronic currency, existing in computer memories. Euro notes and coins will not appear until January 2002, and even then will run alongside the national currencies of the eleven 'first wave' countries. Current notes and coins will circulate at parities fixed now, expressed to six decimal places (they have no separate legal existence, all are different non-decimal sub units of the Euro). By July 2002, euro notes and coins will replace francs, D-marks, guilders, pesetas etc.

• The euro is divided into one hundred euro-cents.
• The coins will portray a map of Europe on one side, and on the other side each country will have its own design.
• The coins will be 1, 2, 5, 10, 20, and 50 euro-cents, and 1 & 2 euros.
• The notes will be 5, 10, 20, 50, 100, 200, and 500 euros.

All the notes will have the same design everywhere. More than 80 billion euro coins will be needed, weighing more than 300,000 tonnes.

Which Countries will be using the Euro?

Eleven countries from the European Union (EU) joined the EMU in January 1999: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. They stretch from Helsinki to Cadiz, and from Sligo to Brindisi. Britain has stayed out of the euro, but the euro is certain not to stay out of Britain!

The next phase countries are: Greece, the Czech Republic, Estonia, Hungary, Poland, and Slovenia.

Efficiency Gains: the case FOR

• One currency replaces eleven. The macro economic effects are important, but the really important effects are on small decisions made by thousands of individual companies. Greater economic mobility is effected in this way - the USA is a good example. There is already freedom of movement of goods and services, but differing currencies is an inhibitor. More business brings more prosperity.
• Fluctuating exchange rates can wipe out a company's profit on a deal; this in turn can affect jobs. Exchange rate uncertainty costs UK companies a 2% premium on the invoice. Forward purchasing of foreign currencies is often made, but this can only be done for up to a year ahead.
• Dynamic gains will be made from capital investment in tooling up for the larger market. This market widening and deepening will improve growth.
• Economic history suggests that big competitive markets breed more successful companies and higher standards of living, for example in the USA.
• Gerrymandering by politicians will not be possible. This sort of thing has been all too frequently evident in the UK post-war economy. Minus balances have led to interest rate rises to maintain the exchange rate.
• The euro allows each member to draw an exchange rate provided by the collectivity. Growth can proceed without resorting to stop-go.
• Joining the euro could benefit the UK, particularly with its history of stop-go economics, balance of payments problems, and sterling crises.
• In a single capital market, much more so than in a national market, 'securitisation' will take off, with companies borrowing by issuing bonds rather than by taking out bank loans. Unified, liquid capital markets will be attractive to investors outside the euro zone. The shift to euro-dominated securities will reduce the cost of capital for euro firms. As a new world currency, the euro would make securitisation more competitive within its area than for the pound sterling in the UK acting outside and alone.

  Easier Price Comparisons

  Price differences, especially on big-ticket consumables such as cars, TVs, and washing machines, will become less sustainable across national borders.

  Lower Interest Rates

• The financial markets will trust the new central bank more than the Bank of England.
• Lower interest rates will mean cheaper capital and finances for business, cheaper borrowing for consumers, and companies will shop around for the best deals within the euro market as a whole.
• Companies will be sectoral rather than national. This in turn will lower inflation, with savers benefitting from greater security and capital gains, produced by the cheaper cost of capital lessening companies' target rate of return, which in turn encourages more investment and the raising of growth. The EMU will, therefore, benefit both savers and investors, and trade will thus respond positively to stability in the currency.

Efficiency Gains: the case AGAINST

It is in the British character to spot small flaws in anything and everything, rather than to pursue the bigger picture with a positive attitude.

The EU is imperfect. It was founded in 1957 to avoid war. Its best achievements have been based on another sort of disarmament - policy disarmament; the transfer of powers to a supra-national body. External trade, state aids, and single market rules seemed individually desirable, but were mutually harmful. Is this now true with the currency?

Regionalism

• If monetary union is inappropriate for Europe, then this argument could also be applied to parts of the UK, East Anglia and Northern Ireland for example. Britain's economy as a whole is more closely aligned with the European average than Northern Ireland is with Britain; regional variations within countries can be just as great as those between countries. There are greater differences within the US economy.
• European economies are slowly becoming ever more naturally integrated with each other, mainly through the activities of international corporations.

  Multi-Ethnicity

  Multi-ethnicity is not a barrier to trade. Within Europe, Switzerland has four language groups and independent cantons. Belgium has three languages and shares a currency union with Luxembourg. India has ten main languages and two language groups as different as the Romance and Teutonic languages in Europe.

  Trade Patterns

  Modern trade is more about trade among businesses in the same industry. Thus the structure of developing economies, particularly Europe, is becoming bore integrated, more similar, and less prone to shocks. Any change in consumer tastes is likely to affect Euroland equally, as with cars for example.

  Nature of Debt

  In the UK the highest consumer debt is mortgages which are highly sensitive to interest rates - but there are more savers than borrowers. The move to EMU is likely to provide incentives to people to borrow at fixed interest rates for longer periods.

  Fiscal Transfers

  EMU has no mechanism whereby funds can be transferred to areas under shock, whereas in the USA, the Federal tax system can do this. Thus the euro restricts countries' ability to carry out regional transfers to smooth out the effects of fiscal shocks.

  Exchange Rate Flexibility and Devaluation

  Devaluations only work if they lead to a fall in the cost of production after allowing for subsequent price rises. Most devaluations in the UK have only worked in the short term. What you gain by devaluation is lost on the inflationary swing.

  The pound has fallen steadily since 1960, and has suffered from the ratchet effect - devaluation, rising import prices, rising inflation, rising wage increases, more devaluation.

  "Winner takes all" governments have used economic levers to secure re-election in the post-war period. Britain's economy is very volatile, however, and the devaluation option tends to be overused.

  Social Costs

• The single currency alone will not make Europe prosperous. France and Germany are inflexible; both have high indirect social taxes which threaten growth, such as the working time directive.
• Higher payroll taxes are inevitable to finance the irresponsible social policies of France and Germany. European factionalism may eventually destroy EMU.
• Some of the UK's advantages - labour market flexibility and low wage costs - have been eroded by government adoption of the social chapter, working time directive, and the national minimum wage.
• The euro is an economic straitjacket which has implications for tax and growth rates. Would Britain abandon the powers of US-style wealth creation for a dubious place in an unreformed European superstate?
• The euro's benefits are not automatic, and can only come about if countries shift from social job protection, high benefits that discourage mobility, and wage inflexibility.
• The worst of all worlds would be if Britain adopted European social costs and then stayed out of the euro. At present, Britain looks like heading down this road, but big brother will gain as the euro combines globalisation with Anglo-Saxon shareholder value ideas to produce world-class companies.

The power to print money, inflate, and boost exports by devaluation, is now being created in the most powerful way possible - by treaty. But the European Currency Board's (1991) single aim - price stability - independent of political interference, cannot bail out profligate governments.

The independence of the European Central Bank replaces ultimately national reserve banks, and is not accountable to the people. Most worryingly, however, the EMU deprives national governments of the ability to use national fiscal policy to counteract recessions - this is not lost altogether, but restrained.

There is a danger that in the event of a sharp recession there will be a political reaction against the EU. In most countries, support for the euro is thin or lukewarm, with a three year period before the public actually gets hold of the notes and coins. The euro is a hostage to fortune!

What next? a successful euro would give a big impulse to political union. Full union, as in the USA, is unlikely, but some form of federalism is more likely, with differing degrees of countries opting in or out. Perversely, could this be seen as the true success of the euro?

The euro zone is much further from being an optimum currency area than the USA. Price disparity is greater, after allowing for exchange rate fluctuations. Labour is not so mobile. The euro will encourage greater economic integration, but there are barriers of language and culture. A perverse consequence of the implementation of the euro is that it will promote a greater level of specialisation, thus increasing the chance of asymmetric shocks.

The live question is whether the diminution if national sovereignty is worth the gains of labour and market flexibility, and low interest rates. Political momentum can dominate good economics, but political ideology should not override economic sense.

Britain's Stance

Foreign Direct Investment (FDI) in Britain is the best of the large EU countries. This is because of:

• comparatively cheap labour
• English language
• golf courses and culture
• seen as part of the core of the EU

The alleged economic benefits are not the driving force anywhere in Europe. Everywhere political commitment is buttressed by some convenient economic arguments. Two things are different in Britain. We are inclined to debate the issue on its economic merits. The political project is more popular in Europe than the UK. There is great division in this country over this issue. Even if all of the benefits outweigh all of the costs, Britain considers that it is much better to improve the existing institutions within Europe first.

Anything that casts doubts would harm Britain's ability to attract foreign investment, especially in the poorer areas, such as south Wales, and the north east and north west of England.

London banks service much of the EU. Conventional wisdom is that the City will continue to be a dominant financial centre whether Britain is in or out of the euro, but the financial services industry as a whole could suffer if it remains out, as there are no transport costs involved - witness the success of the Cayman Islands and Switzerland.

In the 1960s, heavy-handed regulation in New York gave more business to London - the 'eurodollar' was born. If Britain stays out, London will be unable to capitalise on the critical mass of the euro.

Pension reform in France and Germany will substantially increase the size of institutional funds. If the UK if outside of the euro, then it is unlikely to participate in their management - Frankfurt would take over.

The decision to stay outside of the euro area would chip away at London's dominance. If the UK remains outside of the euro, then it is likely to complicate British monetary policy. Only 11% of Euroland's Gross Domestic Product (GDP) is external trade, compared to the UK's 46%. Thus Euroland, like the USA where only 10% of GDP is external trade, will not care about its currency's external value. Movements against the dollar and against the euro will be volatile, and thus interest rates in the UK will tend towards greater and more frequent fluctuation.

Join it or not, the euro will be too big to ignore.

Conclusion

Are the benefits exaggerated? The economic costs understated? The minimum condition of British participation should be the establishment of sound principles of economic and democratic accountability. The EMU is everything that the British do not like - large, dramatic, discontinuous, and radical. The euro is the largest change in international monetary arrangements since the Bretton Woods system after World War II.

The euro is an opportunity, not a threat, and it is the first challenge to the US dollar for over fifty years. It is a good idea launched at a judicious moment. The tragedy is that once again the British political and media establishment has made sure that Britain is not in a vital European project at the beginning. British consensus has been to never get to the starting block. Now the prediction is that it will fall apart or else create high unemployment and low output because of the 'one cap fits all' policy.

And what is the cultural gap that divides us from Europe? We use the same alphabet (except for Greece), read the same Bible, drink the same beer and wine, play in the same Champions League at football, share a common European culture, and share the same values of liberty, equality, and social commitment. In stressful times like these, a common cause is becoming the only solution. We need a check and balance to the USA.

The important point is not whether or not we will lost sovereignty by giving up the pound, but whether we will gain some control over the economic environment. Sovereignty should be used to secure national interests. After all, we pool our defences within NATO.

We could keep the pound, but it would only serve as a delusion and a snare, turning our currency into another sad monument to our short-sightedness over Europe. The world is moving towards a dual-currency system, the US dollar and the euro, where the pound sterling and the yen are residual. Europe is underestimating the enormity of the challenge of introducing the euro. If it works it will be phenomenal, yet any one of combination of the complex cultural, political, and economic factors could shunt it into the sidings.

Britain's final choice could be Europe or NAFTA (North American Free Trade Area) - remember the saying "he who hesitates is lost"?