FROM THE OFFICE OF PUBLIC AFFAIRS
October 21, 1997RR-1999
Good morning. It is a pleasure to be here today. Forty years ago, uniting the economies of Europe under a single currency was the distant goal of a handful of European thinkers. Today, this ambitious project seems close to becoming a reality -- andis attracting serious attention here in the United States.
As you know, European heads of government decided to embark upon thecreation of a single currency in 1992, with the signing of the "Treaty on EuropeanUnion" in Maastricht. This laid down a timetable for achieving European Economic andMonetary Union by the end of this century. Putting these plans into practice has been amajor preoccupation of European leaders ever since.
In a little more than six months’ time, the project is scheduled tobe entering its final stages, with the selection of the initial members of the newcurrency union. A bare six months after that, on January 1, 1999, these countries wouldthen cede control over their monetary policies and the implementation of their exchangerate policies to the new European Central Bank, and the new currency, the euro, would be areality. By 2002, traveling across large parts of Western Europe could involve no moretrips to a foreign exchange bureau than traveling coast to coast in the United States doestoday.
There is a growing and widespread belief in financial markets that EMUwill happen, and it will happen on time. It is thus a very apposite time for thiscommittee -- and for the United States generally -- to take stock.
Let me be clear: at bottom this is a European matter, for Europeans todecide. The Administration has never deemed it appropriate for the United States to enterdebates over whether a single currency is right for Europe or over the details of how itshould be structured -- still less which countries should join. I will not stray from thisapproach today. These questions are for Europeans to answer for themselves. I would,however, like to consider how the single currency project is likely to affect the USeconomy.
Let me focus my remarks on three topics: first, how the creation of asingle currency could affect the European Union as a major economy and internationalpartner of the United States; second, how it might affect the international financialsystem as a whole, and finally, how we are preparing for this change.
I. How EMU will affect Europe -- and itspartners
As you know, America’s relationship with Europe has long been thecornerstone of our economic and foreign policy. We have supported European efforts towardcloser integration since the very beginning. The creation of the European coal and steelcommunity, the common market, the single market, and now plans for further enlargement --these are all things that we have supported and that have been strongly in our interest.
We have the same interest with regard to the creation of a single currencythat we would have with respect to any major development in Europe.
We are wellserved when the region is vibrant economically, and is working to open its markets andstrengthen its ties with the global economy. Europe willprosper from an economic and monetary union that supports these ends -- and if Europeprospers, this will help prosperity in the United States.
1. EMU and European economic growth
When Europe is growing rapidly it is a more dynamic market for our exports-- and a stronger partner for us around the world. Last year our total merchandise tradewith the EU exceeded $270 billion -- an amount second only to Canada. More than half --almost $400 billion -- of our foreign direct investments are in Europe. Nor is this figuredeclining: American investment in Europe grew by roughly 11 percent, on average, between1982 and 1995, somewhat faster than our investments in the rest of the world.
These figures are testament to the many trading and investmentopportunities which have resulted from recent moves toward closer European integration. Itis worth noting that the closer convergence in economic policies, and changing marketexpectations, that have been associated with preparations for EMU have themselves broughtsignificant economic benefits to many countries. In Italy, for example, long term interestrates have fallen by five and a half percentage points since the beginning of 1993, as thegap between Italian and German bond rates has fallen in line with increased expectationsof Italy joining EMU. This increased market confidence in Italian assets has cutgovernment borrowing costs substantially and done much to spur the Italian recovery.
And yet, for all the positive effects that increased integration hasconferred, no one doubts that Europe still faces serious economic challenges -- challengesthat will need to be overcome if EMU is to succeed.
First on the list is Europe’s high rate of unemployment, which hascontinued to rise -- with only brief respites -- since the early 1980s. The averageunemployment rate in the EU last year was more than 11 percent, roughly twice what it wasin 1979. In some countries as many as 1 in 4 people in their early twenties is unemployed,while up to half of those out of work have been so for more than a year.
Partly as a result of these labor market failures, Europe has also hadserious fiscal imbalances to deal with in recent years. The 1992 Maastricht Treaty laiddown criteria for entry into EMU which were intended to ensure all members had broughtthese problems under control before joining the union. These criteria have spurred manygovernments to make significant progress.
The Stability and Growth Pact agreed by European heads in Dublin lastDecember is designed to ensure that countries continue to exercise tight control overpublic borrowing once they are part of EMU. But, as in the United States, every Europeancountry will continue to face an ongoing challenge in coping with the effects of an agingpopulation -- both for pension systems and medical expenditures.
The governments of Europe have repeatedly indicated that they plan tocarry out the structural reforms needed to address both high unemployment and theselooming fiscal pressures. Yet, as we have seen, it has often been difficult to build apolitical consensus to address these issues -- not least because for many, the reformsthat are needed go right to the heart of the social democratic consensus in Europe whichdeveloped through the course of this century.
The advent of EMU will make it more, rather than less vital forgovernments to proceed with these structural reforms if Europe is to enjoy robust growth.Given a shock to domestic demand, individual members of EMU will no longer have anyfreedom to respond by devaluing or revaluing their currency, or cutting or raisinginterest rates. Nor -- given the combined constraints of the fiscal stability pact andexisting debt and deficit levels -- will they able to use fiscal stimuli to supportgrowth.
If coping with the new currency were to distract policy makers from theneed to pursue fundamental reforms, the reduced economic autonomy of the participantscould thus come at the price of forgone growth. This makes it all the more encouraging tohear voices across the European political spectrum acknowledge that EMU requiresstructural reforms to succeed, and that EMU should push policies in that direction. As wehave seen in the recent flood of cross-country mergers and acquisitions, the Europeanprivate sector is already responding to the demands of the new situation. The challengewill be for governments to build on the growing consensus in favor of change -- andchannel it into genuine structural reform.
2. EMU and Europe’s role in theworldeconomy
Just as it would be unfortunate if EMU distracted European policy makersfrom their domestic challenges, it must not distract them from the important internationalchallenges Europe faces. Particularly critical in this context is the expansion of the EUto incorporate several countries of the former Soviet bloc.
This is an ambitious undertaking and one which the United Statesgovernment hopes will succeed. While the difficulties and costs involved may besignificant, so, too, are the potential rewards. Eastward expansion offers chances totransfer not only technology and capital, but democratic and market-oriented institutionsand cultures. All of these would do much to cement these countries’ transition to amarket democracy over the long-term.
More broadly, it will be important in the years after EMU for the EuropeanUnion to dispel any remaining fears about the creation of a "Fortress Europe" bycontinuing to open up its markets and strengthen its ties with the global economy. EMUwill raise issues for the future evolution of the G-7, and the nature of Europe’sparticipation in international organizations such as the International Monetary Fund. Welook forward to engaging with the EU on these matters next year after the selection of thefirst members.
Efforts to resolve these issues must have one vital goal: that Europeemerges out of EMU with the capacity to play an active, constructive role on the worldstage on political, monetary and other matters. The corollary is that European policymakers will have to avoid being overly preoccupied with building and refining thearchitecture of monetary union.
II. The Euro’s Future Role in the Global Financial System
The creation of a new European currency on January 1, 1999 would mark thebiggest change in the international monetary system since the breakdown of theBretton-Woods system in the early 1970s. It would truly be an event without precedent,either in European history or the history of the world. Clearly,the United States will have a major interest in the impact which such an event might haveon the international financial landscape.
There have been two kinds of issues raised in this context: first, theimpact of EMU on the international role of the dollar; and second, the potential effect onshort term trade and exchange rate developments. Let me be clear: we generally do notspeculate about the future values of existing currencies, be they our own or others. Thishumility certainly extends to future trends in the values of currencies that do not yetexist. With these general qualifications, however, I would like to make a few generalobservations about each of these issues.
1. The reserve role of the dollar
Point one to remember is that, ultimately, the dollar’s relativestanding in the international financial system will always depend more on developments inthe United States than on events elsewhere. The buck, you might say, stops -- and starts-- with us. If the United States maintains strong and credible policies, the dollar willremain a sound currency: the fate of the dollar will be largely in our hands.
While the international use of the dollar declined somewhat in the 1970sand 1980s, it has since more than stabilized. Last year, 64 cent of official foreignexchange reserves worldwide were held in dollars, compared to around 57 percent in 1990.Looking forward, the dollar would seem uniquely well-placed to benefit from the definingdevelopment in the global economy of our time, the growth of emerging markets. Mostobviously, a very large fraction of international reserve holdings and cross-bordertransactions in Latin America and Asia are in dollars.
It is difficult to predict with any certainty what the role of the newlycreated euro will be. Those who foresee it growing very rapidly in importance point to thefact that it will be the common currency of countries representing a significant share ofglobal output. Those who are more skeptical point to the fact that the new currency willbe without a proven track record, and to investors’ desire to observe progress towardprice stability before making a commitment.
Even with the clear backing of itsmembers, there are likely to be lingering doubts about the operation of monetary policywithin the new system -- doubts which, ultimately will only be overcome by experienceWhere there is little disagreement is that, barring major policy errors,international currency `holdings do not change at great speed.
In particular,European financial markets are unlikely to transform themselves over night. It is truethat EMU will almost instantaneously bring forth the creation of a very wide range ofassets denominated in euros -- many times more than are presently denominated in theGerman mark. But it will take time before this variety comes close to matching the rangeavailable in the United States; or, given differing perceptions of the creditworthiness ofindividual government securities, the homogeneity of the American market for public debt.Even if there were some movement in this direction in the years after EMU,our financial markets would surely remain the most liquid in the world. Given that, it isvery unlikely that the appearance of the euro will have a significant impact on USborrowing costs in the foreseeable future.
2. Trade and exchange rate fluctuations
The exchange rates of the main Continental European economies have beenfixed among themselves for some time now, with little tendency to fluctuate. In thatsense, European monetary policies have been common for some years.
The general approach each country has taken has shown a recognition thatstrong monetary policies are essential for achieving a healthy environment for investmentand growth -- investment and growth which Europe needs if it is to make a serious dent onunemployment. We welcome the widespread recognition on the part of European nationalgovernments that strong monetary policies need to be supported by a strong financialsystem and sound fiscal policies -- and require the existence of strongly independentcentral banks.
Going forward it will be very important that Europeans recognize -- asmany of them have -- that no nation or region can devalue its way to prosperity. Throughthis century we have learnt that competitive devaluations, in the face of depressedconditions at home, are a poor substitute for concerted efforts to tackle the domesticroots of the problem. The same will hold true in Europe after EMU. This is why it isespecially vital that growth should be based on sound fundamentals -- including solid andbroad-based domestic demand.
Finally, many have expressed concern that during the transition period toEMU financial markets could experience unusually high volatility. Given the magnitude ofthe change involved, this is not an unreasonable concern. However, we do not believe thereis any intrinsic reason why the preparations for a single currency that have hitherto beenannounced should trigger any significant rise in volatility. At any rate, over time anysuch increase should subside as markets become accustomed to the new environment.
Others have suggested that EMU will lead to greater exchange ratevolatility over the longer term, because governments may take a more relaxed attitudetowards exchange rate fluctuations. The reasoning is that exchange rate disturbances aremore disruptive for small, open economies. Europe is composed of
individually smaller economies with higher trade-to GDP ratios than the UnitedStates and therefore has been more interested in dampening exchange market instability.When EMU is launched, however, the member economies will be part of a collective entityroughly the size of the American economy with similar levels of trade. Therefore, theargument runs, European governments will allow greater exchange rate fluctuationsprecisely because it is less of a problem.One might speculate that this would take place, and yet, one could arguethat EMU would actually dampen exchange rate instability by reducing the temptation toengage in counterproductive efforts to control exchange rates.
The very range ofthese predictions suggests grounds for caution.Once again, it is perfectly possible that EMU will be more a force forcontinuity. After all, the external exchange rate policy of the participants in EMU islikely to be quite close to Germany’s present policy, which is also quite similar, tothat of Japan and the United States. There will still be a flexible exchange rate systemamong the major currencies, not targeted at particular levels of exchange rates. And wewill still want to maintain an effective process for cooperation on monetary and exchangepolicies when circumstances suggest a role for such efforts.
III. Preparations for EMU in the UnitedStates
EMU is a massive and ambitious project in many ways. Just the magnitude ofthe change involved is cause for concern that something could go wrong, but notreason to believe something will go wrong. The Treasury Department, the Fed, and otheragencies are following developments closely, but have no reason to suspect that eventswill call for any unusual response on our part.
Almost all of the preparations for this project will fall to Europeangovernments and central banks and the private sector.
Officials from the Treasuryand the Federal Reserve meet routinely with European counterparts several times a year, atmany levels. Unsurprisingly, EMU has featured heavily in these discussions during the pastyear or so. That said -- the United States government has nodirect role in most of the preparations for EMU.For private sector companies who are actively involved in internationaltrade or finance or have European operations, it is another story. They have a lot of workto do in such domains as accounting, finance, and information management -- work which,given the close proximity of EMU probably needs to speed up in the months ahead.
There have been some concerns raised, for example, about the particulardifficulties in preparing computer systems for EMU -- problems which in many ways may becomparable to those raised by the year 2000. These and a range of legal issues raised bythe arrival of the single currency may require work by banking and securities regulatorsto draw attention to the problem and ensure that firms are prepared to meet theirobligations to customers and trading partners. Although I cannot guarantee Americanbusiness that EMU will occur as promised, I would advise them to be ready.
IV. Conclusion
Let me conclude where I began. The United States has a strong economic andsecurity interest in a stable and prosperous Europe -- which gives us a strong stake in aEuropean Economic and Monetary Union that gives the region the strength and confidence itneeds to move ahead with reform and to continue to integrate its economy more fully withthe rest of the world. As I like to say, if EMU works for Europe it will work for theUnited States. The more the single currency helps Europe develop a robust and healthyeconomy that is open to world markets, the more welcome the project will be. I would nowwelcome any questions.