FROM THE OFFICE OF PUBLIC AFFAIRS

Good afternoon. It is a pleasure to be here today at this important conference on "EMU and the Changing Face of Europe." As you know, America's relationship with Europe has long been the cornerstone of our economic and foreign policy. Indeed, this year we celebrate the 50th anniversary of the Marshall Plan which together with the Bretton Woods institutions, the OECD, and our military alliance, NATO, helped create the conditions for a half century of peace and prosperity. Today, America's fortunes remain fundamentally linked with Europe's. Clearly, we have a security interest in what happens on the European continent. But we also have a vital economic stake in what happens across the Atlantic.

In 1995, our annual merchandise trade with the European Union exceeded $250 billion while our trade in services reached $115 billion. American direct investment in Europe is worth $360 billion--more than half of America's total foreign direct investment. And although many believe that Europe is old news, and not an economic frontier, in fact, direct American investment in Europe grew at an average annual rate of 11.1% during the 1982-95 period, compared to a growth rate of 9.9% for American direct investment worldwide.

European integration has been a key element of this process. The United States has long supported the broad objectives of European integration and the United States continues to support that objective, although how this process will continue is the decision of Europe.

The proposed economic and monetary union is the latest step in the process of European integration and one of the most complex. It will represent a fundamental change in Europe’s financial structure and macroeconomic policy. Given our stake in Europe's future, it should come as no surprise that we have followed developments on this front closely.

At the same time, however, this is a European matter, for Europeans to decide. Let me be clear at the outset. I will not take any position on "whether there will be or should be an EMU?" "how should EMU be structured?" or "who should join?" These questions are for Europeans to answer for themselves.

I would, however, like to speak to you today about how the project is likely to affect American interests. This afternoon, I will focus my comments on three topics: first, how the creation of a single currency will affect the US economy directly; second, how EMU will affect the international economic and financial system as a whole; and third, how it may affect Europe's role in the world.

The Economic Effects of EMU on the United States

The primary mechanism by which EMU can affect the US economy is through its impact on the economic vitality of Europe. American economic interests are well served when Europe prospers. A more rapidly growing European market is good for our exports, and an economically stronger Europe is a stronger partner for us around the world.

Western European economies have in many respects achieved an enviable economic record--income levels and living standards are high, inflation rates and poverty rates are low. Europe today nonetheless faces a number of economic challenges. Let me take a moment to discuss these, for how EMU interacts with them ultimately will determine its success and its implications for the United States.

High rates of unemployment across much of Europe are the most obvious symptom of Europe's economic challenge. Long-term unemployment has a tremendous cost in foregone output and wasted lives. This is especially true for the young: in several European countries 1 out of 4 people in their early twenties is unemployed. 40-50% of the unemployed have been out of work for more than a year.

European observers have pointed to other challenges as well. The large increase in public sector debt in many European countries over the past 15 years merits serious attention. As a result of the Maastricht Treaty's convergence criteria, many European governments have made important strides in their efforts to control fiscal deficits. This progress has allowed interest rates to decline significantly in recent years, and lower interest rates in Europe help to keep interest rates in the United States low as well. Nonetheless, most European countries, as well as the United States, face ongoing challenges due to ageing populations and the associated burden of public pensions and medical care. We all know how difficult it can be politically to address these problems, particularly when they involve entitlement reform.

The governments of Europe know what needs to be done, and they have repeatedly indicated that they intend to enact the long-term structural reforms needed to address high unemployment and looming fiscal pressures.

Yet, achieving a political consensus to deal with these problems has proven quite difficult because the necessary reforms go to the heart of the social democratic consensus in Europe.

The paradox is that EMU’s success depends on finding strategies to address these challenges, but that EMU itself does not directly address them.

As members of the monetary union, countries will lose the capacity to pursue independent interest and exchange rate policies that provide the freedom to respond to country-specific economic disturbances. This is particularly significant in the present context, because until deficits and debt stocks have been reduced to more manageable levels, the ability of countries to use fiscal policy as a counter cyclical tool will be severely restricted. In such an environment, EMU makes structural labor market and long-term fiscal reforms even more essential to combating unemployment and achieving robust growth.

To the extent that EMU provides an impetus to achieving the economic and structural reforms that Europe needs to undertake, then it will clearly be beneficial. However, if the process surrounding monetary union distracts Europe from some of its economic and structural challenges, then it will carry an opportunity cost in terms of economic growth foregone.

A successful transition to EMU has the potential to increase Europe’s ability to address the important economic challenges it faces. The United States would welcome an EMU that establishes a credible, growth-oriented macroeconomic policy framework in Europe, and that is associated with significant progress on the microeconomic barriers to faster growth.

EMU and the Global Monetary System

Let me now turn to how European monetary union would be likely to affect the global monetary system. EMU promises to be the most dramatic change in the international monetary system since the breakdown of the Bretton-Woods system over 20 years ago. It is an extraordinary endeavor in the field of monetary innovations. With minor exceptions, there has historically been a one-to-one relationship between countries and currencies.

There has been an extraordinary amount of speculation about the impact of EMU on the level of the dollar and on the dollars role in the system. I am not in a position to resolve any of that speculation for you today. We generally do not speculate about the future values of existing currencies, be they our own or others. This humility certainly extends to future trends in the values of currencies that do not yet exist. With these general qualifications, let me make a few general observations about the likely impact of EMU on the monetary system as a whole.

Fundamentally, I think that the dollar will remain the primary reserve currency for the foreseeable future, and any further erosion in its relative position in the system is likely to happen, if it happens, only slowly. It is true that the dollar’s reserve role has declined somewhat over the past two decades. Since 1973, when the dollar constituted about 76% of official currency reserves, its share of total reserves has fallen roughly ten percentage points to around 65 percent. Some believe that this process will accelerate sharply because investors will find the euro to be a more attractive investment instrument than the individual currencies it replaces.

I believe that these predictions are substantially overstated for several reasons.

First, it is likely to take some time for the markets to become comfortable with and confident in the new currency. Credibility normally takes time to establish. And even under the best of circumstances it is reasonable to expect some uncertainty to prevail about how the new monetary policy regime in Europe will operate and whether the political context in which it operates will lead to a commitment to price stability as well established as that demonstrated by the Bundesbank.

Second, the revolution in European financial markets that many expect to follow EMU will not happen overnight. It is true that the immediate effect of EMU will be a substantial expansion in the range of assets denominated in Euros -- perhaps some multiple over those now denominated in the German mark. Yet, there will still be different assessments of the credit risks of the government securities issued by the member states. And the range of instruments available may take some time to match that of the United States capital markets.

And, finally, it is difficult to overstate the power of inertia. Markets may be forward looking and many participants may be confident that they can see with confidence a dramatic eventual shift into the euro from other currencies, but caution is also a powerful force in the face of uncertainty.

There has been a lot of attention to the role central banks might play in all this. It is important to recognize, however, that the actions of the official authorities will be dwarfed by those of private investors. Total official reserves of the United States, the European Union, and Japan are less than five percent of total outstanding government debt and a somewhat smaller percentage of total financial assets. And it is very unclear at this point how governments, even in Europe, will respond to the advent of the Euro.

Some observers in Europe have expressed a desire to gain a dominant reserve role for the euro as a matter of prestige. I think that this view confuses cause and effect. Prestige alone will not create a successful economic outcome. Successful economic outcomes create prestige. Ultimately, it will be the credibility of the new macroeconomic policy regime in Europe and its success in establishing a more dynamic economy, not monetary union per se, that will determine the euro's use as a reserve currency.

For all these reasons, we expect the impact of the euro on the monetary system to be quite limited initially and to occur only gradually over time. The best outcome from an American perspective would be a sound euro--underpinned by sound European macroeconomic policies.

Ultimately, the relative position of the dollar in the system is likely to depend more on developments in the United States than in Europe or Japan. If the United Sates maintains strong and credible policies, the dollar will remain a sound currency. The fate of the dollar is still largely in our own hands.

Europe’s Role in the World

Equally important to EMU's potential economic effects are its potential effects on Europe's role in the world and in international fora.

This is not the place to speculate on the specific changes in the institution of the system that monetary union might ultimately require. There are broader questions about how the G-7 might evolve and how Europe might participate in international fora such as the International Financial Institutions.

These are not questions that need to be addressed immediately. And regardless of the precise formula in which they are addressed, what is critical is that Europe emerge from the process of EMU with the capacity to play an active, constructive role on the world stage with respect to political, monetary and other matters.

Just as it would be unfortunate if EMU distracted policy makers from action on domestic challenges, EMU should not distract Europe from the important international challenges it faces.

Of particular importance in this respect are the eastward expansion of the EU, European leadership in promoting further integration in the world economy as a whole, and Europe’s ability to work effectively with the United States and other countries to address other challenges in the world economy of particular concern.

The European Union is now considering a major expansion and integration of many of the former East Bloc nations. This is an ambitious undertaking and one which the US government hopes will succeed. Although the challenges and costs are great, so are the potential rewards. EU expansion would represent not only an opportunity to transfer technology and capital, but a transfer of democratic and market-oriented institutions and cultures. The fact that this would be a European solution to a European problem means that we should expect it to enjoy viability over the long run.

Looking forward, Europe must continue to open up its markets and strengthen its ties with the global economy. This requires a strong Europe with a decision making process that permits quick and effective action on an international stage. And it requires that Europe not be overly constrained by protracted domestic preoccupation with the political and economic dimensions of building the architecture and refining the plumbing of monetary union.

Conclusion

Let me conclude where I began. Ultimately the decision by the countries of Europe of how to pursue this next stage of integration must be a European decision.

The US has a strong interest in the region's future growth and prosperity. Our interest lies in seeing the development of a robust and healthy European economy that is open to world markets.

The United States will fully support a successful effort that provides Europe with the strength and confidence it needs to move ahead with reform and to continue to integrate its economy more fully with the rest of the world.