Lecture given by Philippe Maystadt: The governance of the eurosystem (Luxembourg, 15 November 2006) Source: MAYSTADT, Philippe. La gouvernance de l'eurosystème, (Discours pour l'Université du Luxembourg). Luxembourg: 15 novembre 2006. 16 p. Copyright: (c) Translation CVCE.EU by UNI.LU All rights of reproduction, of public communication, of adaptation, of distribution or of dissemination via Internet, internal network or any other means are strictly reserved in all countries. Consult the legal notice and the terms and conditions of use regarding this site. URL: http://www.cvce.eu/obj/lecture_given_by_philippe_maystadt_the_governance_of_th e_eurosystem_luxembourg_15_november_2006-en-080d54ff-b644-4f64-9a5a- 8db1592b5e0e.html Last updated: 05/07/2016 1/12 Lecture given by Philippe Maystadt, President of the EIB: The governance of the eurosystem (Luxembourg, 15 November 2006) I. From the Werner Report to Economic and Monetary Union 1. A brief history of monetary unification Very soon after the entry into force of the Treaty of Rome, Europeans began to seek further economic integration through monetary unification. This ambition to establish European Monetary Union was expressed openly as the international monetary system began to experience a period of crisis in the 1960s. From 1960 onwards, the decline of US competitiveness meant that the value of the Federal Reserve’s gold stock gradually became lower than that of the dollar balances, given the official parity of $35 per ounce of fine gold. The establishment of the Gold Pool in 1961 and its dismantling in 1968, along with the establishment of GABs 1 from 1961 onwards, are illustrative of the beginning and worsening of the crisis of confidence in the dollar, which continued until the currency collapsed in the 1970s. It was against this background, in particular after the devaluation of the French franc and the revaluation of the German mark, that, at the Hague Conference held on 1–2 December 1969, the Six decided to commit to the gradual establishment of European Monetary Union. The Werner Report, published on 15 October 1970 following the Copenhagen Summit, provided for the establishment of this union in 1980 in stages: • The establishment of a Community currency or, failing that, the total and irreversible convertibility of the European currencies. • The centralisation of monetary policy and, therefore, the creation of liquidity, in order to guide the European economies. • The establishment of the EMCF (European Monetary Cooperation Fund), which would become the EMF (European Monetary Fund), based on the model of the IMF. Unfortunately, the worsening of the international monetary crisis meant that this plan could not be implemented (except for the establishment of the EMCF on 3 April 1973). In 1972, a European exchange-rate system was established, known as the ‘European currency snake’. Against a backdrop of increasing exchange-rate instability, the European economies, which mostly traded between themselves, were particularly handicapped by the variations in the exchange rates between their currencies. The ‘snake’ aimed to avoid this by limiting to a maximum of 2.25 % the disparity between any two European currencies: the European currencies 2 could fluctuate by ± 2.25 % in relation to the dollar 3, but together, with no more than 2.25 % between the strongest and the weakest 4. However, the snake was not able to stabilise the European currencies in the long term, and the countries participating in the system left it and rejoined it on several occasions. In 1979, the mechanism was therefore strengthened with the establishment of the European Monetary System (EMS), based on the ECU. The ECU, or European Currency Unit, was a theoretical construct. It did not exist as a method of payment. It was a basket of currencies, an average of the European currencies weighted according to the ‘weight’ of the economies taking part in the system. Each currency was defined in relation to the ECU, which was a central rate. At the same time, a grid of 2/12 bilateral rates was established between the currencies participating in the system. Around these bilateral rates, fluctuation margins of ± 2.25 % were authorised: an upper rate of + 2.25 % and a lower rate of - 2.25 %. If one European currency neared this upper or lower rate in relation to another, action was taken by the two countries involved (purchase and sale of currencies, etc.) in an attempt to maintain stability. A system with obvious limits This system improved monetary stability in Europe. However, the pound sterling did not participate in it for long, the Greek drachma not at all until March 1998, and other currencies were granted widened fluctuation margins (Spain, Portugal, Italy). In 1993, the EMS did not prove to be sufficiently solid to resist the speculative attacks which are liable to occur in today’s financial markets; the fluctuation margins of 2.25 % had to be abandoned and replaced by wider margins of 15 %. The 1993 crisis actually served to highlight the weakness of the EMS in an increasingly globalised market, while the reserves available for the central banks to intervene were largely inferior to the amounts that could be raised by international speculators (like a policeman who drives a 2CV while the thieves drive Porsches!). In such conditions, maintaining fluctuations within narrow margins increased the instability of the system: speculation was encouraged, since it was clear that, without the means to match its ambitions, the system would not be able to resist it for long! Towards the single currency From 1989 onwards, people in Europe were aware of these difficulties. They knew that the only long-term solution was to replace the various European currencies with a single currency. The conditions required for this transition and the stages involved in the establishment of a European Central Bank still had to be devised. The Treaty of Maastricht, signed on 7 February 1992 following lengthy negotiations, set out the stages required to achieve Economic and Monetary Union, EMU and set the EU irreversibly on track towards a single currency, due to be adopted, at the latest, on 1 January 1999. 2. Arguments in favour of the single currency The need for Europeans to adopt a single currency was based on three main arguments. 2.1. To increase the efficiency of the single market — The abolition of the costs associated with foreign exchange transactions leads to an estimated saving of around 0.5 % of the Community’s GNP. Take the famous example of the traveller who set off with 1 000 Luxembourg francs in his pocket and travelled to all of the other countries in the European Union in one day, exchanging his money each time. He returned home in the evening with less than 500 francs, without having spent anything. — More significant savings are made as a result of the elimination of uncertainty over exchange rates, leading to the disappearance of foreign exchange risk premiums. 3/12 — Only the single currency can ensure complete transparency of price competition. In the financial sector, in particular, genuine competition between credit institutions or insurance companies can be guaranteed only when the financial products that they offer to the public are expressed in the same currency. — By enabling economies of scale and scope to be made across borders, European Monetary Union strengthens European businesses faced with competition from the US or Japan. To sum up, the single currency makes the operation of the single market easier, less costly and more transparent. 2.2. To obtain genuine monetary stability The second argument in support of the single currency is linked to the need for monetary stability. In 1986, the Single Act authorised the free movement of capital in Europe. What was the situation before this liberalisation of the movement of capital? We have seen that the EMS aimed to maintain European exchange rates within fluctuation margins of roughly 2.25 %. Countries still had the freedom to pursue different monetary policies: greater or lesser control over money supply, tighter or more flexible measures against inflation, higher or lower interest rates, etc. For example, before 1980, people in France and Belgium were not worried about living with relatively strong inflation, while Germans, who had been particularly affected by pre-war hyperinflation, waged a relentless fight against it by imposing strict controls on their money supply and, hence, maintaining high interest rates. Capital does not like inflation, as this causes it to lose value; it does, however, appreciate high interest rates. Capital thus tended to move from France or Belgium towards Germany. This led to risks of devaluation in the countries losing capital. But exchange-rate controls, which complicate and limit movements of capital, slowed down its movement. In spite of differing monetary policies, these exchange-rate controls meant that exchange rates were able to remain relatively stable. Of course, from time to time (rather often …), this inevitably led to changes in parity when, despite ‘filtering’ of exchange rate controls, the mark appreciated too much, while Belgian and French francs continued to depreciate. What happened with the Single Act? As part of the process for the establishment of the single market, Europe opted for the free movement of capital. From that point on, if the countries of Europe wished to maintain a certain monetary stability, despite capital being instantly able to leave countries pursuing a monetary policy which did not suit it, there was only one possible solution: European monetary policies had to converge; they had to lose their independence. This led to the alignment of the monetary policy of several central banks (Netherlands, Belgium, Austria and France) on that of the German Bundesbank. This has become known as the pegging of the Belgian franc (or of the Dutch guilder) to the Deutschmark. There was, nevertheless, no guarantee — and this was proven on several occasions — that these arrangements between central banks were sufficient to tackle the destabilising forces which can develop in a fully integrated market.