The ECU on its way to stage III of the EMU


Christa Randzio Plath


I would like to concentrate on two milestones on the ECU's way to stage III. The first lies in the past: On 1 November 1993, the Maastricht Treaty entered into force. Its article 109 G states that the currency composition of the ECU basket shall not be changed. This provision is meant to and will harden the ECU over time, albeit very slowly. It was also meant to facilitate planning for the users of private ECUs, virtually all of them financial institutions that create and use the private ECU as a financial innovation. Until then, the composition of the ECU basket had been revised every 5 years. On the last revision, in 1989, the Spanish Peseta and the Portuguese Escudo had been included in the basket.

A different milestone will be set somewhen next year, hopefully on 1 January, with the accession of, again hopefully, four new member countries. It has been decided in the negotiations that the ECU basket will remain unchanged, as foreseen by the Maastricht-Treaty, and for the same reasons. Therefore, only twelve out of sixteen currencies of the member states, or only 75 per cent of all currencies, will be represented in the basket. As a consequence, it can be argued that the ECU will no longer be a Community unit. It will therefore have lost a part of its character that made it the symbol of European monetary unification. It will, in a sense, already create a Europe of 'variable geometry', but one in which the variations occur in an arbitrary fashion, being based on timing instead of economic criteria. This decision certainly raises further questions of a similar nature. Can the European Union, for instance, demand in good faith that the new member countries, whose currencies are not included in the ECU, accept payments out of the Union budget in that unit? And once those countries enter the exchange rate mechanism of the European Monetary System, can they be demanded to accept official ECUs to settle claims based on possible obligatory intervention at the fluctuation margins?

The arguments in favour of the decision not to change the ECU basket with adhesion are sound at first glance. At a second glance, however, one can doubt whether it was a wise decision. The arguments advanced aim at promoting the ECU as a financial innovation; indeed, the present ECU can justly be called a derivative financial instrument based on the underlying national currencies. The aim of promoting it as a derivative product is comprehensible since it has not had any commercial success in the real sector worth speaking of. But it unavoidably raises the question whether the standardization of the ECU as a financial product can take precedence over its role as the symbol of monetary integration in the EU, as limited as it may be. In 1994, a routine revision of the ECU basket would have taken place in any case, had it not been for the Maastricht Treaty entering into force. In my opinion, it would have been as possible to include the four new currencies in the basket as it was possible to include the two currencies in 1989 during the routine revision. It would not have set any precedent for further adhesions, because those are not likely to occur before the start of stage III of the European Economic and Monetary Union, which will create a totally different scenario.

In the minds of many people and the general public, it is the present ECU that will be the common currency in the third stage of Economic and Monetary Union, replacing the national currencies. While this is, of course, false, one can easily arrive at that conclusion by reading Art. 109 L, paragraph 4, last sentence, last half sentence of the Treaty Establishing the European Community. This provision states that the ECU be rapidly introduced as the single currency of the member states participating in stage 3. One has, of course, to read first Art. 109 L, fourth paragraph, first sentence, last half sentence, which says that the ECU will become a currency in its own right at the starting date of the third stage. While it is unclear what this will mean exactly, it necessarily presupposes a certain breach between the basket-ECU and the single currency-ECU that will have an irrevocably fixed exchange rate against the other participating currencies in the third stage. These exchange rates will eventually become conversion rates. The external value between the currency basket and the real ECU currency on its first day will be preserved. Therefore, a link between quite different ECUs exists.

It is unclear and left open in the Maastricht Treaty if the present basket ECU will continue in the third stage in the case that not all Member States participate in it from the outset. There may be a political need for that, as there seems to be a political need now. Behind this is not economic but political reasoning. The reasoning goes, that in the remaining at most 4 1/2 years until the introduction of a single currency, people should start using the currency basket ECU as a transaction currency, if not as a parallel currency. The reason advanced is that people should familiarize themselves with a transnational currency.

The present ECU, by its very nature, is superior to those currencies prone to devaluations, but inferior to those liable to revaluate. Since 1979, it has devalued by 22 % against the DM and 20 % against the Guilder. Imagine, all obstacles for the use of the present ECU had already been removed at the beginning of 1992. The Commission lists in its White Paper "removing the legal obstacles to the use of the ECU" under those obstacles the agreement between the social partners in Germany that wages be paid only in DM. In the absence of those agreements, had a company paid its employees in ECUs, while another company had continued paying in D-Marks, what would have been the result after the crisis in the European Monetary System in 1992 for those paid in ECU? What would have been the consequences in devaluing countries? Only by auxiliary constructions, for instance indexing payments in ECUs against national currencies, could unwelcome and arbitrary distributional effects have been avoided. An employee in Germany would be paid more indexed ECUs after the revaluation of the ECU, a worker in, say, Italy less indexed ECUs after the devaluation of the lira. Such a system has no discernable advantages, it entails considerable cost. On the other hand, the promotion of the ECU as a financial instrument for banks and enterprises could make sense. The unit is, for instance, used to hedge currency positions. But such a promotion must be left to the private sector. Any artificial privilege would not only discriminate the national currencies; it would also create the danger the decision on entering the third stage could be negatively influenced because the ECU would lose artificial privileges when becoming the single European currency, creating resistence against such a move.

There seem to be no major obstacles to its use, anyway; any person or company willing to use it can do so freely. The status as a foreign currency, missing in Germany and possibly in the UK (the situation there is still unclear) would only mean the removal of some constraints in the financial field. Compared to the present situation both in Germany and the UK, the difference would be negligible - which is not to say that the unit should not be granted foreign currency status, which the European Parliament has demanded. But one should not think that such a move would entail any major consequences. The fact that it has not gained any importance as a transaction currency except between state-owned corporations - like the national railway companies - shows implicitly that it is not attractive by non-political, commercial standards. As a financial innovation, the ECU has had some success in the past. The ECU-bond market reached its peak in the period before the first EMS-crisis in the autumn of 1992 due to the long period of exchange rate stability since 1989. Since then, issuing activity in ECU has slowed drastically, although the market was sustained by borrowing programmes of sovereign borrowers (the Commission and some Member States). Activity has, however, picked up again after the Maastricht-Treaty entered into force on 1 November 1993, removing uncertainty.

In the third stage, there will unavoidably be a stage 3a where the ECU and the participating national currencies will circulate in parallel with irrevocably fixed exchange rates without fluctuation margins. This will probably be a prolonged period of time, because it would be impossible to exchange billions of banknotes and billions of coins in a "big bang". Before the third stage, the ECU in its present form can continue playing its role as a financial innovation on monetary and capital markets. According to the Commission, the impact of the temporary widening of the Exchange Rate Mechanism's bilateral fluctuation margins to 15% on August 2, was quite limited, and after ratification of the Maastrict Treaty by all member states, the prospect for the ECU has improved markedly.

The single European currency in the third stage will certainly replace the D-Mark as one of the three leading currencies worldwide. The hope is that the ECU may even replace the US-dollar as the foremost international currency. The dollar now holds a share of around 45% of the invoicing of the six major industrialized countries, while the US share in trade is only around 27%. The yen accounts for 5% and D-Mark, French franc, UK pound and Italian lira together for around 50% (data from 1987). Foreign exchange transactions are dominated by the dollar with shares of 56,8% (trading home currency against a foreign currency) and 89,4 % (trading among third currencies) (data from 1989). Official foreign exchange reserves are denominated in US dollars at 63%, in yen at 7 % and in European currencies at 22% (16% in D-Mark) (data from 1988).

What would be the economic gains the Union could achieve by at least partially replacing the US-dollar by the ECU? The European Commission attempted to answer that question in its famous study "One Market, One Money", from which the above data are taken. It arrives at the conclusion that those gains are quite minor at not even 0,01% of Union GNP due to lower transaction costs by increased use of the ECU in trade of goods and services and by seignorage from foreign holdings of ECU cash. Foreign exchange reserves in the EU could be lowered by perhaps 200 billion US dollars. Some advantages cannot be quantified. They consist of a strengthened European position in international gremiums, and an enhanced weight in international policy co-ordination. The lower number of participants would make it easier to arrive at meaningful co-operation and co-ordination in international monetary policy and may be a building block of a more stable international monetary system.

The Union will reap those benefits only if it achieves a liberal exchange rate regime in the third stage. The Treaty on Monetary Union prescribes such a system already for the second stage and allows only for emergency measures. Even limited emergency prohibitions of capital transfers and payments would damage the reputation of the ECU seriously. If the European currency crisis of 1992 and 1993 shows one thing clearly, it is that currencies and currency managers live by their credibility and reputation. If the ECU were prone to become a mouse-trap currency, even for a limited period, even the relatively low gains from its enhanced international use would not materialize. The European Union can vest the ECU with a legal tender function and could perhaps prohibit its use for certain transactions, but it cannot force others to use it against their will. The first and second international currencies, the US dollar and the D-Mark, have either always been freely convertible or, in the case of the D-Mark, became internationally important currencies only after liberalization.

Finally, I would like to remind that the final goal of Monetary Union is what the Union should aim for, not a prolonged second stage. Instead of trying to establish a parallel currency system through the back door and under another name, all forces should be directed towards reaching that final goal, under the conditions of the Treaty in the light of nominal, real and structural convergence so that the single currency will be a strong currency, finalizing the internal market.