International Institutions to Determine the Value of a Currency

This article throws light upon the two international institutions to determine the value of a currency.

1. The International Monetary Fund (IMF) or Adjustable Peg System:

It was the IMF system which dominated the pattern of international monetary payments from 1947-72.

The objectives of the fund were to achieve free convertibility and to promote stability in international monetary system. These objectives were satisfied until 1972. In 1988 the IMF had 146 members.

Quotas:

Each member country was required to contribute its quota depending upon the national income of the country and upon its share in world trade. The quota was made up of 75% in the country’s own currency and 25% in gold or foreign currencies. In this way it was hoped that there would be enough of any currency in the pool for any member to draw on should there be any balance of payments difficulties.

Voting power in the IMF is related to the size of the quota. Thus, the USA and the other industrialised countries have managed to dominate the fund for most of its life. It has been necessary to revise the quotas seven times, firstly to increase the overall size of quotas to take account of the growth of world trade and of inflation, and, secondly, to revise the relative size of members’ quotas.

Borrowing:

Originally each member of the fund could borrow in tranches (slices) equivalent to 25% of their quotas, taking up to five consecutive tranches, i.e., it was possible to borrow the equivalent of 125% of one’s quota. Today it is possible to borrow up to the equivalent of 450% of one’s quota over a three year period. This is not an unconditional right to borrow and the fund imposes conditions of increasing severity upon a member as it increases its borrowing.

The borrowing methods from the Fund has received modifications and some of the methods are given below:

(a) Stand-by Arrangements:

This method of borrowing has become the most normal form of assistance by the Fund. Resources are made available to a member, which they may draw if they wish. The stand-by facility is often enough to stabilise a member’s balance of payments without actually drawing it. It is necessary for a member to agree to IMF conditions.

(b) General Agreement to Borrow (GAB):

In 1962, the group of 10 industrialised nations agreed to make a pool of $6 billion available to each other through the IMF. Since 1984 the size of the pool has been increased to $17 billion and it has been agreed to help less developed countries.

(c) Compensatory Finance Scheme:

In 1963, it was decided to give loans with fewer conditions to members experiencing temporary difficulties because of delays in the receipt of their export credits. By the early 1980s this accounted for almost 1/3 of all the Fund’s lending.

(d) Buffer Stock Facilities:

In 1969, it was decided to give loans to members to allow them to pay for the buffer stock schemes.

(e) The Supplementary Financing Facilities:

In 1979, the scheme was started to give long-term assistance to less developed countries. It has a special fund of SDR $7.8 billion made available by 14 richer countries.

(f) The Extended Fund Facilities:

In 1974, this scheme was introduced to help those members with long-term assistance experiencing more protracted balance of payments difficulties.

Special Drawing Rights (SDR):

In 1969, it was decided to create international liquidity for the first time. This was developed by giving members an allocation of special drawing right at the IMF. This is not tied to the currency of any country but merely as booking entries. When it was first introduced they were linked to dollar and thus, to gold.

However, since 1974, the value of a unit of SDR has been calculated by combining the value of 5 leading currencies. SDRs could be used without prior consultation with the Fund, but only to cope with balance of payment difficulties.

The functions of SDRs can be summarised as follows:

(a) A means of exchange:

SDRs can be used to settle indebtedness between nations, but with the consent of the fund only.

(b) A Unit of Account:

All IMF transactions are now denominated in SDRs.

(c) A Store of Value:

In 1976 it was decided to reduce the role of gold and make the SDR the principal asset of the IMF. It can be seen that the SDR fulfills the store of value function of money to some extent. It can thus be described as quasi-money.

The Adjustable Peg System:

The object of the IMF system was to create a set of rules that would maintain fixed exchange rate against short-run fluctuations. It guaranteed that changes in exchange rates would occur only in the face of persistent quasi-equilibrium in the balance of payments. It was also ensured that when such changes did occur they would not spark a series of competitive devaluation.

The basic characteristics of the IMF system was that US dollar held by foreign monetary authorities were made directly convertible into gold as a fixed rate ($35 an Ounce) by the US Government, while foreign government fixed the rates at which their currencies were convertible into US dollar. It was this characteristics that made the system a Gold Exchange standard.

The rate at which each country’s currency was convertible into dollar was fixed or pegged. The pegged rate could be changed from time to time in the face of ‘fundamental disequilibrium’ in the balance of payments. A system with these two characteristics – a rate that is pegged against short-term fluctuations but that can be changed from time to time is referred to as an Adjustable Peg System.

In order to maintain convertibility of their currencies at fixed exchange rates, the monetary authorities of each country had to be ready to intervene in the foreign exchange market. In order to be able to do this, they had to have stocks of gold and foreign currencies — such as dollar or sterling. When a country’s currency is in excess supply, their authorities could sell foreign currency or gold in exchange of their own currency.

When a country’s currency was in excess demand, their authorities would buy foreign currency and sell their own currencies. If they wished to increase their gold reserves they would exchange dollar for gold from the Federal Reserve System, thus, depleting the US gold stock.

The problem for the US was to have enough gold to maintain fixed convertibility of the dollar into gold. The problem for the other countries was to maintain fixed convertibility between their currency and the US dollar. Thus, the IMF system was an adjustable peg, gold exchange standard where the ultimate international currency was gold.

Countries hold much of their foreign exchange reserves in the form of US dollars, which they could convert into gold. However, the 1970s saw a collapse of the adjustable peg system despite the Smithsonian agreement of 1971 to patch-up the system.

The Collapse of the IMF System:

It was not realised at the time of the 1967 U.K. devaluation that it was the beginning of the end for the adjustable peg system. The basis of world economic power had changed since 1947 when the Fund was set up. At that time the economies of the then West Germany and Japan were in ruins, but no changes came about in the IMF system to take account of their subsequent development.

The US dollar was not devalued in 1967. The lower prices of the devalued currencies and increasing Vietnam War expenditures by the US combined to produce growing deficit in the US balance of payments. This deficit convinced the speculators that the dollar was seriously overvalued. Speculators rushed to buy gold because a devaluation of the dollar would take the form of raising its gold price.

The first break in the IMF system came when the major trading countries were forced to stop pegging the market price of gold. Speculative pressure to buy gold could not be resisted and the market price was allowed to go free in 1968. From that time a two-tier rate of gold was established; one was the official price of gold — for monetary purposes — was maintained at $35 while the price of gold for commercial purposes was allowed to float upwards.

Once the free-market price of gold was allowed to be determined inde­pendently of the official price, speculation against the dollar shifted to those currencies, that were clearly undervalued relative to the dollar. The German Mark and Japanese Yen were particularly popular targets, and billions of dollars flowed into speculative holdings of these currencies. The ability of central banks to maintain pegged exchange rates were in doubt.

The US Leaves the Gold Standards (1971):

The announcement of the US government in 1971 was that it would not be possible to exchange dollars for gold at the official price ended the gold standard. This was caused by a massive balance of payments deficit in the US and realignment of the economic power in the world which had led to massive and continuing surpluses and the accumulation of vast reserves by Germany and Japan.

However, the situation was made worse for the USA by its high rate of inflation. This system worked reasonably well while the US price level was relatively stable. Countries that were inflating a bit too fast could occasionally devalue their exchange rates, and countries that were inflated even more slowly than the US could occasionally revalue their exchange rates.

Occasional upward and downward readjustments relative to the dollar served to keep the system near equilibrium. But if the US began to inflate rapidly, it became necessary to devalue the US dollar relative to most other currencies. The only way the required US devaluation could be brought about was for all other countries to reduce their currencies against dollar.

Prompted by continuous speculation against the dollar, the US government first suspended the gold convertibility of dollar in August 1971 and then made a de facto devaluation of the dollar by persuading those nations whose balance of payments were in surplus to allow their rates to float upward against the dollar.

The Smithsonian Agreement 1971:

The abandonment of the gold standard swept away the adjustable peg system. But the Smithsonian agreement of December 1971 was an attempt to reestablish the adjustable peg. This agreement put the value of gold at $38 per ounce, an effective devaluation of dollar of 8%. The new rate for the pound was therefore, £1 = $2.60. Since then Smithsonian agreement, the world has been on a de facto Dollar System. It allowed a 2¼% variation in the value of a currency.

The variation was unacceptable to the EEC countries and, therefore, on 24th April 1972, they established a variation between their own currencies of half that of the Smithsonian variation. The Smithsonian variation was said to provide the tunnel within which the smaller European snake moved. The U.K. joined the snake system on 1 June 1972 but left it later. When the government announced that the pound was to float.

The Smithsonian agreement did not last long, as most countries were obliged to float their currencies in 1972 and 1973. However, two legacies remain. Since it was the last time when currencies were fixed against each other if is a reference point. The other legacy is the European Currency snake which became the EMS in 1979.

The Oil Crisis:

The mobility started in 1971 was made much worse by the oil crisis of 1973. A fourfold rise in oil price resulted in a transfer of money from the developed countries to OPEC nations which brought about a most fundamental shift in economic power. This cost the oil importing countries an extra £ 100 billion per year.

Oil prices were doubled again in 1978 causing a liquidity problem even greater than that of 1973. This price rise was an important factor in the subsequent world depression. This hit the industrial countries hard but was disastrous to the oil-importing developing countries. The subsequent slump in oil prices left some less developed oil exporters with large debts which they found almost impossible to service.

The Plaza Agreement -1985 and Louvre Accord of 1987:

In the Plaza Agreement of 1985, there was a consensus of opinion among the G-5 — the USA, the U.K., the then West Germany, Japan, France — industrial nations that they would like to establish a more stable system of exchange rates and they decided to bring about an orderly decline in the value of dollar, which was considered to be overvalued.

The Louvre Accord (Paris) was an agreement among the G-7 nations to stabilize variations in their exchange rates within certain limits which were not published. However, they could be deduced from the subsequent actions of the central banks of these countries. For example, since March 1988 it became obvious that the Bank of England was committed to hold the pound at or below the level of £1 = DM3. These agreements illustrate the urge to return to a more orderly pattern of exchange rates. The fact that they were not arrived at through the IMF shows its decline.

The Problem of International Liquidity and IMF:

International liquidity problem refers to the lack of universally acceptable means of payment. Since the World War II, the dollar and, to a certain extent, the pound, have attempted to fulfill this role. The floating exchange rate regime has made the situation worse.

However, we can summarise the stock of official international liquidity as being gold and foreign currency reserves held by nations, plus their IMF quotas and also their SDR allocations. It could be argued that there has been an excess of unofficial liquidity.

The expansion of Eurocurrency in the 1970s left many developing countries hopelessly in debt and they found it impossible even to borrow on the commercial market today. However, the scale of the problem was so great that the resources of the IMF and other international agencies were inadequate to deal with it.

The annual conference of the IMF in 1976 officially recognised the end of fixed exchange rate system. This Jamaica Agreement also ‘demonetized’ gold and member countries were no longer required to use gold as part of their quota to the IMF. The TMF also agreed to get rid of its gold stocks.

The IMF role declined significantly during the 1980s. Many LDCs were considered un-credit worthy by the IMF and some countries decided not to borrow from the IMF, because of the austerity programme laid down by it when giving loans, such as the role of the IMF with industrialised nations was also reduced. The floating exchange rates regime reduced the need to borrow foreign currency for official purposes. In addition to this, fall in oil prices have reduced or eliminated the current deficit of many countries.

2. (IBRD) The World Bank:

The International Bank of Reconstruction and Development was set up in 1946 as the sister organisation to the IMF. Its original aim was to help develop the war-devastated economies of Europe. One of the important problems facing the World Bank was its lack of funds.

Funds came from three sources:

(a) Quotas:

The membership of the World Bank is the same as that of the IMF. Members make contributions in relation to their IMF quotas. Of the quotas, 10% is subscribed while the other 90% is promised as a guarantee for the Bank’s loans.

(b) Bonds:

It can sell bonds on the capital market.

(c) Income:

A very small proportion of the Bank’s funds come from its income. The World Bank gradually turned its attention from Europe to the less developed countries (LDCs) of the world. Today it is almost wholly concerned with helping LDCs. It gives advices and information, besides making loans.

The World Bank has increased its operations by forming the following new organisations:

(i) The International Financial Corporation (IFC). This was set up in 1956 to enable the Bank to give loans to Private Companies and Governments.

(ii) The International Development Association (IDA). This was established in 1960. Its objective was to make loans for longer periods and on preferential terms to the LDCs. The IDA has become known as the ‘soft loan window’.

(iii) The Multilateral Investment Guarantee Agency (MIGA). This was set up by the G7 nations in 1988 and is controlled by the World Bank. The object of the agency is to guarantee long-term private investment in LDCs.

The political instability in many countries make it difficult and expensive for them to borrow. The agency guarantees investors’ funds against political risks but not against normal business risks. The effect of this guarantee is to level the degree of risk in investments with that in other advanced or stable nations. Like IMF, its role is now limited. The limitation comes both from lack of funds and from political disagreement. The role of the World Bank is increasingly overshadowed by that of the commercial lending.

The General Agreement on Trade and Tariff (GATT):

GATT has been an important organisation for the promotion of free trade. It came into existence as a result of the Havana Charter in 1948.

The main aims of GATT are the following:

(a) Most favoured nation:

Every signatory of the GATT was to be treated as ‘a most favoured nation’. Existing systems of preference were allowed to continue but could not be increased.

(b) Tariffs and quotas:

Members agreed to work towards the reduction of tariffs and the abolition of quotas. In the first 20/30 years of its existence GATT was by and large successful but in recent years protectionism has once again become widespread (i.e. JAPAN/EEC/the USA)

(c) Trading blocs:

The establishment of common market-type agreement such as EEC and EFTA were allowed, but they were encouraged to be outward looking rather than insular. Progress in GATT was achieved through a series of rounds of talks, the most famous of which was the Kennedy round of the 1960s. In recent years there has been north-south dialogue. The forum for these discussions is the United Nations Conference on Trade and Development (UNCTAD). The object of the LDCs can be summed up in a phrase ‘trade not aid’.

The poor countries are mainly producers of primary products, but they are not allowed to trade freely with the rich countries because they are discriminated against by protectionist policies of the rich. The depression of the 1970s and early 1980s and increased protectionism of the rich had made the plight of the LDCs worse. The economic condition of the LDCs is really desperate but the high ideals of international cooperation of the immediate post-war period seems to be receding.

The Organisation for Economic Cooperation and Development (OECD):

The Organisation for European Economic Cooperation (OEEC) came into existence in 1947 to administer the European recovery programme (Marshall Aid). This was an important institution, which helped to establish the European Payments Union (EPU). The OEEC became the OECD in 1961.

Its objectives are:

(a) To encourage economic growth, high employment and financial stability amongst members;

(b) To aid the economic development of less developed non-member countries.

Now the OECD has 21 members including its non-European members such as, the USA, Canada, Australia and Japan, who joined in 1965. One of the most important functions of the OECD is to provide statistical information of the economies of its members.

The Bank of International Settlements (BIS):

The purpose of this Switzerland-based institution (formed in 1930) was to enable central banks to coordinate their international payments and receipts. It was originally established to regulate German reparations. It is one of the oldest and most successful of international institutions and also it is profit- making institution.

Since the World War II, the BIS have acted like a central bank for central banks. The board of the BIS was made up of representatives of the central banks of the U.K., France, Germany, Belgium, Italy, Sweden, Netherlands and Switzerland. Other countries, such as, the USA and Japan regularly attend its meetings.

The main functions of the BIS are:

(a) Promotion of cooperation between central banks

(b) Monitoring euro-currency market

(c) Provide export advice to other institutions and

(d) Organise finance for countries with payments difficulties.

The European Economic Community (EEC):

The origin of the EEC can be traced back to the European Coal and Steel Community (ECSC), which was established in 1948 by few members—France, Italy, Belgium, Holland and Luxembourg. West Germany later joined the ECSC but the U.K. declined to join. Its objective was to abolish trade restrictions on Coal and Steel between member countries and to coordinate pricing and production policies.

The EEC was finally established on 1st January 1958 by the Treaty of Rome. Once again the U.K. did not join the EEC. The U.K. finally joined the EEC in 1972/1973 together with Ireland and Denmark. Greece became member in 1981 and Spain and Portugal in 1986. The introduction of the single European Act in 1987 should complete the process by which these twelve members function as one (i.e. Single Market).

The Main Features of the EEC:

There are two main features of the EEC:

(a) Customs Union:

The establishment of Customs Union involves both the abolition of tariffs between members and the erection of a common external tariff to the rest of the world. Each country must have some external tariff; otherwise imports would flood into the community through the member state, with the lowest tariffs. In some cases—e.g. the imports of products from France’s ex-colonies’ — the lowest duty was adopted and several old colonial states have associate status with the EEC.

The original arrangements for these states was superseded by the Lome Convention in 1975. Under this arrangements, some 46 developing nations in Africa, the Caribbean and the Pacific are allowed to send all their exports to the EEC duty free. However, the U.K. was not allowed to join the EEC until she agreed to erect considerable tariff barriers against her Commonwealth Partners.

(b) Common Market:

The EEC is generally known as common market, which refers to the running of the economies of the members as if they were one, i.e. they have common price and production policy (of the ECSC) in all industries. A common market agreement implies the free movement of labour, capital and enterprise within the EEC. Apart from agriculture (CAP), there is no common policy yet in other areas. Despite its formation since 1958 it is only in 1992 that, a true common market was created.

The Structure of the EEC:

The Treaty of Rome envisaged that the EEC would eventually lead to economic and political unity.

So far it has become possible to have four essential components of state organisation:

(a) The Council of Ministers:

This is the executive or cabinet of the EEC. It consists of one minister from each state, which minister it is to be depends on what is being discussed. For instance, if the issue were agriculture then it would be the minister of agriculture who would attend. Voting in the council is weighted; for example, the U.K. has ten votes while Luxembourg has only two. The Council is assisted by a committee of permanent representatives.

(b) The European Parliament:

It is an embryonic legislature of the EEC and meets at Strasbourg. Since 1979, its members have been directly elected. There are 518 members of the parliament of which 81 are elected from the U.K. At the moment, it has very little power and authority. Its main function today is to monitor the activities of community institutes.

(c) The European Commission:

The commission is the secretariat of the EEC. It consists of 17 permanent members of which 2 come from each of the 5 largest countries and one from each of the other 7. There are 2,500 staffs working for the commission in Brussels. The Commission is responsible for the day-to-day running of the Community and for the development of EEC policy.

(d) The European Court of Justice:

The function of the court is to ‘ensure that the law is observed in the interpretation of the treaty of Rome.’ It is the final arbiter of the interpretation of the EEC treaties and it deals with disputes between member states and the Commission. It is, thus, the judiciary of the EEC.

The U.K. and the EEC:

By joining the EEC the U.K. has become a part of a community of 320 million people. It is claimed that the economic advantages which the U.K. gained were enormous and fundamental — those of increased specialisation and comparative advantage. The gains from the EEC may not be readily appreciated by the average citizen. Real advantages are likely to be increased rate of growth of GDP despite some minor changes, it is called trade creation.

However, the common tariff of the EEC prevents Britain from benefiting from comparative advantage worldwide. The most obvious example is foodstuffs, whereby the U.K. is required to consume expensive European food, when it could be imported more cheaply from outside Europe. This diminution of comparative advantage is called trade diversion. Despite the 1992 changes complete economic unity is still far away. Mean­while, the EEC aims at the harmonisation of the economies of the member countries.

Some of the implications of this for the U.K. are given below:

(a) Taxes:

It is the EEC policy that there should be no significant differences between rates and methods of taxation. One of the reasons why VAT was introduced in the U.K. was to bring it at par with the EEC. Differences in taxes would be discriminatory. For example, France claims that high excise duty on wine in the U.K. discriminates against French exports of wine.

(b) Metrication:

Most of the EEC countries have always used similar weights and measures, but for the U.K. this meant abandoning the old standards in favour of metric units, e.g. in 1981 petrol began to be sold in litres rather than gallons.

(c) Social Security:

It is EEC policy that social security benefits and payments be similar and transferable. This will enable people to work more easily in different EEC countries.

(d) Competition:

EEC Jaw is aimed at regulating competition throughout the EEC.

(e) Free Movement of Labour, Capital and Enterprise:

It is part of EEC policy that its citizens should be free to work anywhere in the EEC. There is supposed to be free movement of capital and enterprise as well anywhere in the EEC. But many barriers to the movement of capital are still there. Again it is believed that the 1992 changes will lead to a much free movement of capital and enterprise.

(f) Monetary Union:

It is an objective of the EEC that, there should be free convertibility of members currencies and a European Monetary Union be established as soon as possible. In joining the EEC the U.K. has simply followed the trend of her own trade, the European market have occupied a larger and larger share of her trade since the World War II. While the EEC may be beneficial to the U.K., many LDCs have described it as ‘a rich man’s club’. This is because the common external tariff seems to keep out primary products from the LDCs.

The European Monetary System (EMS):

In the later 1970s, dissatisfied with the validity of floating exchange rates led most of the member countries of the EEC (except the U.K.) to form the EMS. This system is viewed as a tentative step back towards fixed exchange rates.

Members of the EMS agree to fix their exchange rates relative to each other but to float as a bloc against the currencies of the rest of the world. Although harmonization was not a precondition to establish EMS, this remains the ultimate objective of those most committed to the European ideal. It has now been agreed that, they will establish a common currency and a single central bank and harmonize monetary and fiscal policy within the 1990s.

The EMS is based on a newly devised unit of account called the European Currency Unit (ECU). The value of one unit is determined by taking a weighted basket of all member currencies. The value of members’ currencies is allowed to fluctuate by + or – 2.25% of the central rate established by the value of the ECU (the U.K. joined the EMS on October 1990 and pound was allowed to fluctuate by ±6% initially.

The EMS was an attempt to deal with exchange rate volatility in a fairly pragmatic way. The agreement committed the central banks of member countries to intervene whenever any of the currencies threatened to deviate from its par value against other currencies by more than an agreed amount. Since harmonization of domestic macroeconomic policies was not achieved, member countries continued to have different inflation rates.

Since, there have been frequent devaluations and revaluations of the agreed parties between member countries; they have usually been of relatively small magnitudes. This may be one of the reasons why speculative pressures have not been intense.

Two other features tend to keep speculative pressure under control.

First, by intervening collectively, the central banks of the member countries have a larger clout against the speculators.

Second, since the group of currencies as a whole floats against the rest of the world, some of the advantages of the flexible exchange rate system have been retained.

The single European Act to abolish all barriers of movement between members of the community by 1992. It was intended that all major obstacles to trade between EEC countries should be removed. This meant that goods and services should be free to pass between EEC countries. In addition, obstacles to the movement of capital (such as exchange control) would be abolished. Maastricht agreement paved the way for harmonization of monetary, fiscal and other policies within the EEC countries.

The Gains:

The gains of a unified market should be those resulting from the benefit of competitive advantage across the whole of the community .The 1992 measures would bring bigger gains than the mere abolition of tariffs. It was estimated by the Cecchini Report (1988), that, the potential gains of the 1992 changes were about £150 billion. However, the practical difficulties of abolishing tariffs and harmonizing taxes and so on-may well reduce this.

European Union (EU): After Maastricht Treaty of 1992:

The flagging course of the EU showed signs of renewal in 1994 which dominated the year when member-states began setting out their views for the forthcoming review of the Maastricht Treaty, schedule for 1996. The promise of the talks was for a renewed advance towards monetary Union, closer cooperation on defense and foreign policy, and important reforms of the European institutions aimed at realigning their relationships and introducing greater levels of democratic control.

The increasing confidence behind the EU’s developing foreign and security policy began to be reflected on the economic front during the year when Europe began to move out of economic recession while inflation continued at a low levels. There was evidence of remarkable currency stability despite abandoning of the narrow band limits of the European exchange-rate mechanism in 1993.

Much hope for reinforcing economic recovery was pinned on the signing of the GATT in April in Morocco. The achievement of an agreement after 8 years of difficult negotiations came despite some reservations, especially in France. The only question remained was whether the agreement would be ratified by national parliaments.

Politically the year was dominated by the European parliament elections in June, 1994, the first since the institution was given wider powers under the Maastricht Treaty. Against a background of recession and political disagreement, opposition to integration appeared to be growing in Italy and France, and it continued unabated in the UK.

In Germany also increasing numbers of citizens questioned the desirability of abandoning their strong Deutsche Mark in favour of a single European Currency. Although the singing of the Maastricht Treaty on political, economic, and monetary union had introduced the principle of subsidiarity, allowing member states greater control over their own affairs, an underlying suspicion of centralized government remained. Elected members would have to deal with the questions of integrating new member states into the EU beginning January 1, 1995.

Jacques Delors, outgoing president of the European Commission, pointed out that governments would have to step up the fight against unemployment, promote economic growth, and prepare the EU for the next century. The European economy was at a crossroad between survival and decline. Government leaders would have to focus on 4 main areas: on growth, Competitiveness, employment, and economic guidelines for the second stage of European economic and monetary Union.

The talk on Europe’s economic future were overshadowed by the difficulty in agreeing on Delors’s successor as president of the European Commission. Ultimately, they chose the prime minister of Luxembourg, Jacques Santer, who would take office in 1995. After a long and bitter debate, the MEPs approved his nomination.

Then came the controversial debate about “a two-speed Europe”—a possible “hard core” of EU countries committed to comprehensive economic, political and defense integration and others outside. For the EU, 1995 was a year marked by introspection and internal debate about both its future constitutional development and its role in international affairs. However, the year began with the formal accession of three new members – Austria, Finland and Sweden — bringing the number to 15 states, but it ended on a note of uncertainty about the pace of further integration.

The declared objective of full monetary union and a single currency by 1999 provided the focus for much of the discussion about future European integration. Uncertainty about the single-currency was underscored with evidence of the economic difficulties facing a majority of EU members during 1995. These suggested that several EU countries might not satisfy the economic conditions laid down in the Maastricht Treaty for participation in the single-currency. However, at a special meeting of EU finance ministers; there was broad agreement for introducing a single currency in stages after January 1999.

At the EU summit in December, 1995, the single currency was given a name, the Euro, and the timetable for its introduction was extended to 2002, though a final decision to participate would be undertaken in 1998. There were disagreements between the EU countries about the speed with which the EU should open its doors to new members. There was also disagreement about the extent to which any enlargement should be preceded and balanced by steps toward closer political and monetary Union.

Many of these issues were due to be resolved in a special conference of the 15 EU governments in 1996 to review the Maastricht Treaty. By late summer it was clear that major differences still separated members about any radical changes in the EU decision-making institutions.

At one end of the spectrum, the German government pressed for qualified majority voting instead of unanimity for almost all areas of policy. Germany and other supporters of closer integration argued that the EU itself should take more responsibility for some policy areas still being decided by national governments alone.

These included foreign and security policy and some aspects of immigration, justice, and police cooperation. At the other end of the spectrum, the British government continued to resist any moves to closer political union. Prime Minister, John Major also refuse to commit himself to taking part in an eventual single currency even if the UK met the economic conditions.

Apart from the 1996 intergovernmental conference (IGC), the political agenda of the EU during 1995 was dominated by two important issues – the continuing war in Bosnia and Herzegovina and concern about unemployment and the competitiveness of the European economics. At the end of the year, there was guarded optimism that the war in Bosnia was over, but the future role of EU countries in the Balkans was far from clear.

EMU of European Union:

The drive to achieve economic and monetary Union by 1999 and to work for the enlargement of the EU dominated its political agenda in 1996. The debate about economic and monetary (EMU) and the introduction of single European currency were apparently overshadowed for sometime by the effects of recession and high unemployment in many EU countries raised doubts as to whether it would be in a position to meet such challenges.

There were fears even in most enthusiastic EU member states that they may find great difficulty in meeting some of the conditions for taking part in the planned move to a single currency in January, 1, 1999. The tough criteria — including limits on budget deficits and government debt levels — as well as the 1999 time table for monetary union has been set out in the Maastricht Treaty in 1992.

The attitude of the financial markets was also skeptical because of the serious problems being faced by some European economies at that time including the French economy and it appears that the French franc may have to be devalu ed against the Deutsche Mark and thus break an important criterion for monetary union.

However, the mood began to change after a meeting of the EU finance ministers in Verona, Italy, in April 1996 where it became clear that almost all members were determined to make the goal of EMU their overriding economic and political priority. They also agreed to maintain a strategy that would commit all the participants in the single currency to maintain long- term policies that would be oriented toward establishing stable economics.

At a meeting in June, same year, in Florence, the EU heads of government reinforced this approach which became clear that the political will existed to achieve a single currency despite domestic political difficulties for the governments concerned.

The extent of those difficulties became clear during the summer and after, when one government after another announced austerity measures designed to reduce their budget deficits and meet the Maastricht criteria for a single currency. During the summer, mass trade-union demonstrations took place in France against the social security reforms and discontentment with the government’s economic strategy continued to the end of the year as economic recovery brought little or no reduction in unemployment.

There were similar protests in other countries through the year, as anger about persistent high unemployment led to questions about the wisdom of the EU governments’ economic and social policies to prepare for monetary union. In Germany the unions organised strikes and demonstrations against planned cuts in welfare benefits, and similar protests continued in Belgium and Spain. In Italy, however, it was mainly the middle classes who opposed the government’s proposals to meet the budget deficits with new taxes and spending cuts.

In spite of these problems, the EU appeared to be significantly closer to its target of a single currency. During the winter .of 1997, an agreement has been reached by the EU member states on the details of the ways in which the new EMU system would operate.

A formal agreement on the stability pact, on the legal status of the proposed new single currency (the Euro), and on the operation of a reformed European exchange-rate system (to link the Euro with those EU currencies outside monetary union) was finalised at a summit in Dublin in December, 1996.

Reflecting this tremendous political determination to achieve the single currency, the European financial markets gradually become less skeptical about the prospects for accomplishing it. This was shown by a remarkable narrowing of interest rates between the main EU countries—namely, France and Germany. Despite this remarkable progress that had been made, the European Monetary Institute warned that governments needed to act further to achieve economic convergence, without which monetary union might fail.

Simultaneously the European Commission, the executive body of the EU, published forecasts of improvement in economic growth in 1997, which was to be the base year for judging the economic performance of countries to determine whether they could join the single currency.

The commission also predicted that 12 or 13 out of 15 EU countries might qualify for the EMU. Of these 15, two countries — Denmark and the United Kingdom while expected to qualify economically, had negotiated a political right to opt out of the single-currency. Most doubt was focused on the commissions belief that even relatively less-prosperous countries, such as, Portugal, Spain and Italy might qualified to join the single currency.

For all the growing optimism about monetary union, the German government and its central bank, the Bundesbank, expressed concern that the rigour of the EMU conditions might be in danger of being diluted. Thus, debate focused on issues such as the scale of penalties a government might face if it began to break the rules governing budget limits, debt, and inflation. Despite evidence that the worst of the European recession had passed, with the EU economics expecting a recovery, concern remained about unemployment.

The commission warned that the economic upturn risked becoming a jobless recovery. There was growing debate about whether the answer to unemployment depended on radical restructuring of the European labour markets and the abandonment of the European social security system. There is growing consciensious among the EU governments that the European welfare model had to be reformed but not scrapped.

The other major institutional issue dominated the EU politics was the inter­governmental conference (IGC) to review the Maastricht Treaty which involved measures to strengthen the supranational decision making authority of the EU institutions. It not only set out the goal of monetary union but also envisioned further steps to full political union, including a common European foreign, security and defence policy.

The commission president, Jacques Santer, told the European parliament that unless radical institutional reforms were agreed upon to improve the effectiveness and accountability of the EU, it would be difficult, if not im­possible, to open its doors to new members. The EU promised to begin negotiations with at least some of the would be new members six months after the completion of the IGC.

As the discussion in the IGC dragged on through the whole year, however, with little concrete agreement on the key issues, doubts were raised about the likely date of any new treaty. It may not be out of place to mention that significant progress had already been made in reducing areas of disagreement between most countries on such sensitive questions as voting in the council of ministers, a reduction in the national right of veto on decisions, extensions of the role of the European parliament, a stronger common foreign and security policy, and a bigger role for the EU in such issues as immigration and political asylum.

The major difficulty facing the IGC until 1997 election in Britain was the opposition of the British conservative government to any further strength­ening of the EU or any more to what London described as “a federal super­-state.” British conservative Prime Minister reiterated that he would veto any further extension of majority voting or any weakening of the national veto in EU matters.

Relations between the U.K. and the other European nations worsened when Mr. Major demanded withdrawal of ban on exports of British beef and beef products, which was thought to have a link with BSE or “mad-cow” disease and also wanted to reverse a decision of the European court obliging the U.K. to introduce 48-hour limit for the workweek.

After May 1 elections and victory of the Labour pasty has significantly changed the relationship between the other members of the EU and British Labour government under Tony Blair. British government’s present position on EMU is that it is in favour of joining, but not until after the next election, and then not until after a referendum.

The main point is that when, and if, Britain does join, it will have to go through a process of economic convergence. This means that British economic fundamentals must be brought into line with Europe’s. For borrowers, the key statistics are that the U.K. base rate is 7.25% and the likely euro interest rate is widely expected to be about 4%, that is a lot less than U.K. borrowers are paying at the moment.

For the 11 of the 15 countries likely to be in the first-wave of EMU, the euro rate will apply from January 1, 1999. British government policy suggests that sterling might not be replaced by the euro and its lower interest rate until well after May 6, 2002, the last possible date for the next general election. But convergence has to start happening long before that if the country and the currency are to be ready to act on a “yes” vote. Therefore, British interest rate will have to move downwards.

It is also government policy that sterling should enter EMU at an exchange rate to the euro weaker than prevails against European Currencies at present which will be a boost for the manufacturing sector and smaller companies.

For equity investors, the key statistics are that while the U.K. equity market has risen by 16% this year, first-wave EMU countries have done better. Germany have gone up by 28%, France by 30%, Spain by 45% and Italy by 47%.

It is likely that U.K. equities will benefit from convergence, as will be the bond market. Investors should continue to hold U.K. gilts rather than European bonds as they currently offer better value then European equities. Britain may not be going into EMU now, but its relative underperformance against Europe, combined with a widespread expectation that it will eventually join EMU, makes it attractive to investors who want to buy into Europe cheaply, and who are not in a hurry.

The stage is set for the long-awaited EMU drama. For the triumphal launch for the single currency, nothing has been left to chance. It has long been clear that 11 of the European Union’s 15 members will be declared eligible, despite the underlying divergence between their economics. And the British government is more determined than any other governments to ensure the success of this historic occasion on May 1, 1998. There is only one snag.

There is total deadlock on the question of who is to be appointed president of the European Central Bank, the independent institution created under the Maastricht treaty to run the new currency. Germany is adamant that Wim Duisenberg, Dutch head of the interim European Monetary Institute, must have the job, whereas France wants Jean-claude Trichet, head of the Banque de France, to be head of the ECB.

The decision must be unanimous and, since the bank opens for business on July 1, six months before EMU goes into operations, further delay may unsettled the markets. The pressure on the British Presidency to manufacture a compromise is thus considerable because delay will be undesirable, but much greater damage could be done if this battle is settle through the kind of horse- trading that is the trademark of EU politics.

May 2 send-off for the EU single currency will be considered by EU leaders in Brussels as the dawn of a new age, but their historic will not mask anxiety over this gambles attempted by a group of sovereign states. The euro will be seen by many of the continental political establishment as an historic leap towards political union. However, the territory is so uncharted that the experts and many of its supporters are at odds over the benefits and danger that lie ahead. Forecasts range from the birth of a glorious “European Century” to continental upheaval.

The “Europhobic” scenario, backed by the federalists and the European Commission runs like this:

The currency will galvanize the 11 economics of EU countries unleashing the economic power of 270 million people which will reap the benefits of years of fiscal sacrifice. It will be fuelled by low interest rates, set by ECB.

Economic frontiers will wither along with exchange risks and costs, consolidating a richer single market than the USA. Consumers and business will benefit from the transparency that will allow easy comparison of prices in a various new world that will create millions of jobs.

The optimists say the euro will swiftly rival the dollar as the world’s reserve currency, boosting exports from the biggest trading zone and equipping the EU with the global influence. The unity of EU will bring national taxes into line and help to save the “European social model”, the welfare system that is now under threat. The euro would not just create a European political space, but also “stop Europe’s slide towards a simple free trade zone”.

The gloomier forecasts run like this:

The continental recovery fetters because it has failed to tackle the underlying structural problems of high taxes and rigid labour laws that have held back growth and kept unemployment above 10%. European “one-size-fits-all” interest rates make life difficult for some countries as performance diverges. Intensifying the tension and the widely diverge tax policies among the European states, which is likely to retain fiscal sovereignty.

However, the famous “asymmetric” effect kicks in. Without a true political union with a central authority, economic trouble in one depressed region may not be relieved by the migration of labour or capital transfers, the safety value that operates in the USA. This will sharpen the pain of the suffering regions, fuelling further unemployment. Frankfurt and the EU will likely to be a popular scapegoats, feeding political tension that could blow the euro system apart.

The arguments in favour and against are not going to stop euro becoming the official of the first-wave 11 members, although national currencies may also be used at their euro values until January 1, 2002 when euro notes and coins enter circulation. By July 1, 2002, the national currencies cease to be legal tender. This is the likely timetable for the euro which will be started in January 1, 1999.

The euro is and always was political project, designed to propel the nations of western Europe towards union. Political will has ensured that the dream of Jean Monnet, the architect of post-war economic cooperation, have at last become a reality. But political will cannot solve the region’s chronic unem­ployment problem. It cannot raise its growth rate.

Euro-enthusiasts are in no doubt that there will be big economic benefit. Curbs on inflation and spending have brought lower interest rates to several countries, although there remains the question of their sustainability. The single currency means different things to different groups. To some it means a bulwark against foreign exchange speculators.

To bosses of multinational corporations it is a cost cutting exercise. They also argue that the euro will prompt the creation of genuinely pan-European business, with the loss of the devaluation option leading to elimination of the weak and inefficient. It will see the benefits of the economics of scale offered by the single market.

It would also “force the governments to introduce more flexible labour markets and reduce the cost of employing people”. They also believe that it can meet varying ex­pectations and that policies of low inflation and sound public finance will provide the background for growth and sustainable jobs. Opponents say any benefits may out-weighed by potential costs. They have a range of objections.

To some the main argument is that the politically unacceptable European Central Bank will be far too hawkish. To them it is a “disaster waiting to happen on the scale of 1914. Instead of using the weapon of mass destruction, we are using shouldering the arms of job destruction.”

To others, it is like a building without fire-exits: no escape if it goes wrong. It has also been pointed out that it is unlikely to lubricate structural reform. “People say the shocks will force these countries to make the supply-side reforms that will be needed. That must be a gamble and a politically naive one “.

Economists argue that conditions are not right for monetary union to work. In particular, the leak of a common language means labour-market mobility is limited, wages are not flexible and there is no fiscal mechanism for moving money from richer to poorer areas. On balance, it may be added that monetary union could either work badly or well, if the dangers could be guarded against, competition and integration would promote efficiency and growth.