Common Money Or Funny Money?Rudi Dornbusch
For some it is inconceivable, for others inevitable--a single European currency. Yet the dollar's rally and German rate cuts have relieved European Monetary System strains and revived a monetary flight of fancy--common money for Continentals.
To observers from across the Atlantic (or the Channel), Europe needs a single currency like it needs a hole in the head. If Europe cannot forge ahead with plans for political union, what's the point of a common currency? Regardless of this fact, prenuptial agreements to a communal marriage of the mark, franc, lira, etc., have already been signed, with the wedding date scheduled for 1999.
What is going on? The idea of Europe '92, the final stage in a single European market, was a shot in the arm for a region that needed one. Some Europeans hope that a common European money plays the same role, helping divert attention from high unemployment and poor economic performance. That is one of the reasons why common money will become a reality. It has various groups behind it: The banking community sees it as a business opportunity. Brussels bureaucrats are ready to claim credit for it. And a few countries need it badly to cover up their rotten fiscal situations. These are powerful but poor reasons for going ahead.
Clearly, the convergence criteria set earlier by the Bundesbank in terms of inflation or debt are not going to be met by most candidates. So the talk is of finding a more flexible approach. If the budget is off-target, well, just build in some commitments and deal with the problems later. The idea is to use the common-money community as a European therapy group.
DEBAUCHERY. That is the kind of agreement Italy would love. It would cover the fiscal mess with a veneer of eligibility to hard-money status. In exchange, Italy would help support France when it came to pleading the soft-money case. There is so much to be gained by France and Italy that irresistible pressure for one currency may already exist.
But why would the German bondholding public and inflation-wary German burghers accept the risk that their currency gets debauched? Well, they were never asked. Wisely for the officials, nobody ever thought of holding a referendum on that issue in Germany. Although there are elections on the way to '99, the German political parties all play the European card. The banks are gung ho to cash in on the venture. In sum, what on rational grounds is inconceivable may already be a fait accompli.
In the meantime, there are, of course, some hard questions around which the shadowboxing will continue. One is already resolved: The new European Monetary Institute will be installed in Frankfurt, giving that city a new edge in European finance, especially as Britain is sure to keep its pound out of any Eurocurrency. The next is what to call the new money. Be sure that Germany gets the last word on this, trading off that precarious privilege for accepting Italy's deficits. The compromise is to call it a gulden; that way, at least the name will not be French. And then there is the question of where to draw the line: Italy, yes--but Greece, Portugal, and Spain? First class is full; perhaps there will be some coach seats for the underachievers.
ALTERNATE SCENARIOS. Just to play devil's advocate, is there any way the drive to a common money might yet fail? At least two come to mind. Both recognize that from here to 1999, none of the participants can hold their breath. The first possibility is that Italy just cannot make it--one day there will be elections, and the present game of pretend will end. Italy's overindebtedness and budget problems will reemerge.
If that happens, a European money will be reduced to just what we have now: a de facto, stable, though not fixed, Franco-German currency relation with everybody else flocking around. The other possibility? The dollar weakens, as it does with great regularity. When that happens, the franc comes under pressure, and France finds the resulting high interest rates and high unemployment unacceptable. This makes for a replay of the 1992 currency mess.
Europeans distrust U.S. skepticism of the idea of a common money. They blame it on an unwillingness of the U.S. to give up world money leadership, hegemony, and all that. Ten years ago, that might even have been a good story. By now, a new European money already looks defective and will hardly challenge the dollar.
It certainly will not help Europe restructure and solve its labor-market problems. Anyone who doubts that can look at German interest rates. Ten-year bonds offer a big premium. For good reason.