Wealth Creation Via Currency Unification

Wealth Creation via Currency Unification & Mama Mia! Here We Go Again!

By John E. Marthinsen and John C. Edmunds

Executive Summary

The benefits of joining a currency union and the costs of withdrawing from one can be enormous. One of the most important benefits is the dramatic increase in the market value of interest-sensitive assets (e.g., capital stock and other assets that yield annual income during future periods) in the countries that join. These benefits tip the scales heavily in favor of joining a currency union and staying in. Two recent events have highlighted the importance of computing the net benefits of currency unions. One of them has already happened. In 2004, ten countries (called the accession countries) joined the European Union (EU). These nations applied for EU membership years ago and worked to make their laws and institutions consistent with EU guidelines. The accession countries also set their sights on becoming members of the European Monetary Union (EMU), and are on track to adopt the euro. As a result, these nations have already captured many of the benefits that are normally associated with full-fledged currency union membership. The second event has been proposed but has not happened. Following the French and Dutch votes against the European Constitution, two Italian cabinet ministers a political party, suggested that Italy hold a referendum on withdrawing from the EMU and reissuing the lira. They obviously felt that having an independent central bank would be advantageous to the nation. It is unclear whether they considered the enormous potential losses in wealth that would occur if Italian interest rates rose as a result of this step. This paper asserts that the market values of a nation’s interest-sensitive assets depend on prevailing nominal interest rates. This paper estimates the effect of each of these events on the market values of interest-sensitive assets. Our calculations use a well-known valuation formula and published statistics to show that the accession countries have already earned strikingly large gains as a result of their successful efforts to become EU members and as a result of the changes they have made to join the EMU. Between 1993 and 2003, they increased their wealth by somewhere between €5 trillion and €11 trillion. Our calculations also show that, if Italy were to abandon the EMU, its losses could amount to between €4 trillion and €69 trillion. To put these magnitudes in perspective, US GDP for 2005 is about €10 trillion, so the gains and losses are in the range of half a year’s US output to seven year’s US output.