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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 – and is attracting serious attention here in the United States.
As you know, European heads of government decided to embark upon the creation 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 and Monetary Union by the end of this century. Putting these plans into practice has been a major preoccupation of European leaders ever since.
In a little more than six months’ time, the project is scheduled to be entering its final stages, with the selection of the initial members of the new currency union. A bare six months after that, on January 1, 1999, these countries would then cede control over their monetary policies and the implementation of their exchange rate policies to the new European Central Bank, and the new currency, the euro, would be a reality. By 2002, traveling across large parts of Western Europe could involve no more trips to a foreign exchange bureau than traveling coast to coast in the United States does today.
There is a growing and widespread belief in financial markets that EMU will happen, and it will happen on time. It is thus a very apposite time for this committee -- and for the United States generally -- to take stock.
Let me be clear: at bottom this is a European matter, for Europeans to decide. The Administration has never deemed it appropriate for the United States to enter debates over whether a single currency is right for Europe or over the details of how it should be structured -- still less which countries should join. I will not stray from this approach 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 US economy.
Let me focus my remarks on three topics: first, how the creation of a single currency could affect the European Union as a major economy and international partner of the United States; second, how it might affect the international financial system as a whole, and finally, how we are preparing for this change.
I. How EMU will affect Europe -- and its partners
As you know, America’s relationship with Europe has long been the cornerstone of our economic and foreign policy. We have supported European efforts toward closer integration since the very beginning. The creation of the European coal and steel community, 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 currency that we would have with respect to any major development in Europe. We are well served when the region is vibrant economically, and is working to open its markets andstrengthen its ties with the global economy. Europe will prosper from an economic and monetary union that supports these ends -- and if Europe prospers, 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 trade with 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 figure declining: 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 investment opportunities which have resulted from recent moves toward closer European integration. It is worth noting that the closer convergence in economic policies, and changing market expectations, that have been associated with preparations for EMU have themselves brought significant economic benefits to many countries. In Italy, for example, long term interest rates have fallen by five and a half percentage points since the beginning of 1993, as the gap between Italian and German bond rates has fallen in line with increased expectations of Italy joining EMU. This increased market confidence in Italian assets has cut government borrowing costs substantially and done much to spur the Italian recovery.
We are well served when the region is vibrant economically, and is working to open its markets and strengthen its ties with the global economy.
And yet, for all the positive effects that increased integration has conferred, no one doubts that Europe still faces serious economic challenges – challenges that will need to be overcome if EMU is to succeed.
First on the list is Europe’s high rate of unemployment, which has continued to rise -- with only brief respites -- since the early 1980s. The average unemployment rate in the EU last year was more than 11 percent, roughly twice what it was in 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 had serious fiscal imbalances to deal with in recent years. The 1992 Maastricht Treaty laid down criteria for entry into EMU which were intended to ensure all members had brought these problems under control before joining the union. These criteria have spurred many governments to make significant progress.
The Stability and Growth Pact agreed by European heads in Dublin last December is designed to ensure that countries continue to exercise tight control over public borrowing once they are part of EMU. But, as in the United States, every European country will continue to face an ongoing challenge in coping with the effects of an aging population -- both for pension systems and medical expenditures.
The governments of Europe have repeatedly indicated that they plan to carry out the structural reforms needed to address both high unemployment and these looming 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 reforms that are needed go right to the heart of the social democratic consensus in Europe which developed through the course of this century.
The advent of EMU will make it more, rather than less vital for governments 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 any freedom to respond by devaluing or revaluing their currency, or cutting or raising interest rates. Nor -- given the combined constraints of the fiscal stability pact and existing debt and deficit levels -- will they able to use fiscal stimuli to support growth.
If coping with the new currency were to distract policy makers from the need to pursue fundamental reforms, the reduced economic autonomy of the participants could thus come at the price of forgone growth. This makes it all the more encouraging to hear voices across the European political spectrum acknowledge that EMU requires structural reforms to succeed, and that EMU should push policies in that direction. As we have seen in the recent flood of cross-country mergers and acquisitions, the European private sector is already responding to the demands of the new situation. The challenge will be for governments to build on the growing consensus in favor of change – and channel it into genuine structural reform.
2. EMU and Europe’s role in the world economy
Just as it would be unfortunate if EMU distracted European policy makers from their domestic challenges, it must not distract them from the important international challenges Europe faces. Particularly critical in this context is the expansion of the EU to incorporate several countries of the former Soviet bloc.
This is an ambitious undertaking and one which the United States government hopes will succeed. While the difficulties and costs involved may be significant, so, too, are the potential rewards. Eastward expansion offers chances to transfer not only technology and capital, but democratic and market-oriented institutions and cultures. All of these would do much to cement these countries’ transition to a market democracy over the long-term.
More broadly, it will be important in the years after EMU for the European Union to dispel any remaining fears about the creation of a Fortress Europe by continuing to open up its markets and strengthen its ties with the global economy. EMU will raise issues for the future evolution of the G-7, and the nature of Europe’s participation in international organizations such as the International Monetary Fund. We look forward to engaging with the EU on these matters next year after the selection of the first members.
Efforts to resolve these issues must have one vital goal: that Europe emerges out of EMU with the capacity to play an active, constructive role on the world stage on political, monetary and other matters. The corollary is that European policymakers will have to avoid being overly preoccupied with building and refining the architecture 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 the biggest change in the international monetary system since the breakdown of the Bretton-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 have on the international financial landscape.
There have been two kinds of issues raised in this context: first, the impact of EMU on the international role of the dollar; and second, the potential effect on short term trade and exchange rate developments. Let me be clear: we generally do not speculate about the future values of existing currencies, be they our own or others. This humility certainly extends to future trends in the values of currencies that do not yet exist. With these general qualifications, however, I would like to make a few general observations about each of these issues.
1. The reserve role of the dollar
Point one to remember is that, ultimately, the dollar’s relative standing in the international financial system will always depend more on developments in the 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 will remain 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 foreign exchange 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 defining development in the global economy of our time, the growth of emerging markets. Most obviously, a very large fraction of international reserve holdings and cross-border transactions in Latin America and Asia are in dollars.
It is difficult to predict with any certainty what the role of the newly created euro will be. Those who foresee it growing very rapidly in importance point to the fact that it will be the common currency of countries representing a significant share of global output. Those who are more skeptical point to the fact that the new currency will be without a proven track record, and to investors’ desire to observe progress toward price stability before making a commitment. Even with the clear backing of its members, there are likely to be lingering doubts about the operation of monetary policy within the new system -- doubts which, ultimately will only be overcome by experience
Even with the clear backing of its members, there are likely to be lingering doubts about the operation of monetary policy within the new system -- doubts which, ultimately will only be overcome by experience
Where 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 true that EMU will almost instantaneously bring forth the creation of a very wide range of assets denominated in euros -- many times more than are presently denominated in the German mark. But it will take time before this variety comes close to matching the range available in the United States; or, given differing perceptions of the creditworthiness of individual government securities, the homogeneity of the American market for public debt.
In particular, European financial markets are unlikely to transform themselves over night. It is true that EMU will almost instantaneously bring forth the creation of a very wide range of assets denominated in euros -- many times more than are presently denominated in the German mark. But it will take time before this variety comes close to matching the range available in the United States; or, given differing perceptions of the creditworthiness of individual 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 is very unlikely that the appearance of the euro will have a significant impact on US borrowing costs in the foreseeable future.
2. Trade and exchange rate fluctuations
The exchange rates of the main Continental European economies have been fixed among themselves for some time now, with little tendency to fluctuate. In that sense, European monetary policies have been common for some years.
The general approach each country has taken has shown a recognition that strong monetary policies are essential for achieving a healthy environment for investment and growth -- investment and growth which Europe needs if it is to make a serious dent on unemployment. We welcome the widespread recognition on the part of European national governments that strong monetary policies need to be supported by a strong financial system and sound fiscal policies -- and require the existence of strongly independent central banks.
Going forward it will be very important that Europeans recognize – as many of them have -- that no nation or region can devalue its way to prosperity. Through this century we have learnt that competitive devaluations, in the face of depressed conditions at home, are a poor substitute for concerted efforts to tackle the domestic roots of the problem. The same will hold true in Europe after EMU. This is why it is especially vital that growth should be based on sound fundamentals -- including solid and broad-based domestic demand.
Finally, many have expressed concern that during the transition period to EMU financial markets could experience unusually high volatility. Given the magnitude of the change involved, this is not an unreasonable concern. However, we do not believe there is any intrinsic reason why the preparations for a single currency that have hitherto been announced should trigger any significant rise in volatility. At any rate, over time any such increase should subside as markets become accustomed to the new environment.
Others have suggested that EMU will lead to greater exchange rate volatility over the longer term, because governments may take a more relaxed attitude towards exchange rate fluctuations. The reasoning is that exchange rate disturbances are more disruptive for small, open economies. Europe is composed of individually smaller economies with higher trade-to GDP ratios than the United States 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 entity roughly the size of the American economy with similar levels of trade. Therefore, the argument runs, European governments will allow greater exchange rate fluctuations precisely because it is less of a problem.
One might speculate that this would take place, and yet, one could argue that EMU would actually dampen exchange rate instability by reducing the temptation to engage in counterproductive efforts to control exchange rates. The very range of these predictions suggests grounds for caution.
Once again, it is perfectly possible that EMU will be more a force for continuity. After all, the external exchange rate policy of the participants in EMU is likely to be quite close to Germany’s present policy, which is also quite similar, to that of Japan and the United States. There will still be a flexible exchange rate system among the major currencies, not targeted at particular levels of exchange rates. And we will still want to maintain an effective process for cooperation on monetary and exchange policies when circumstances suggest a role for such efforts.
III. Preparations for EMU in the United States
EMU is a massive and ambitious project in many ways. Just the magnitude of the change involved is cause for concern that something could go wrong, but not reason to believe something will go wrong. The Treasury Department, the Fed, and other agencies are following developments closely, but have no reason to suspect that events will call for any unusual response on our part.
Almost all of the preparations for this project will fall to European governments and central banks and the private sector. Officials from the Treasury and the Federal Reserve meet routinely with European counterparts several times a year, at many levels. Unsurprisingly, EMU has featured heavily in these discussions during the past year or so. That said -- the United States government has no direct role in most of the preparations for EMU.
For private sector companies who are actively involved in international trade or finance or have European operations, it is another story. They have a lot of work to 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.
Officials from the Treasury and the Federal Reserve meet routinely with European counterparts several times a year, at many levels. Unsurprisingly, EMU has featured heavily in these discussions during the past year or so.
There have been some concerns raised, for example, about the particular difficulties in preparing computer systems for EMU -- problems which in many ways may become parable to those raised by the year 2000. These and a range of legal issues raised by the arrival of the single currency may require work by banking and securities regulators to draw attention to the problem and ensure that firms are prepared to meet their obligations to customers and trading partners. Although I cannot guarantee American business 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 and security interest in a stable and prosperous Europe -- which gives us a strong stake in a European Economic and Monetary Union that gives the region the strength and confidence it needs to move ahead with reform and to continue to integrate its economy more fully with the rest of the world. As I like to say, if EMU works for Europe it will work for the United States. The more the single currency helps Europe develop a robust and healthy economy that is open to world markets, the more welcome the project will be. I would now welcome any questions.
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