Forget Monetary Union Let Europe's Currencies Compete

On a recent trip to Spain, I was frequently asked by journalists and the business community about the plans to introduce in January, 1999, a common European currency, probably to be called the Euro. Although not an expert on monetary matters, I took a strong stand against this plan. I believe that a much better approach would be to increase, not eliminate, competition among European currencies.

Monetary union would be supported by a majority of the populations of all 15 member nations if they were confident that the future European central bank will behave like the German central bank. However, they fear that monetary policies of the European Monetary Union (EMU) will emerge from compromises and political infighting among members with different monetary and fiscal needs. A recent poll found that 73% of Germans "don't think" that a common currency could be as stable as the German mark, which probably explains why German Chancellor Helmut Kohl did not risk a referendum on the EMU among the German people. Under pressure from Euroskeptics within the Tory party, Britain appears to have decided to delay its entry in the EMU until after 2002.

SHARING POWER. Some Germans have already voted against the monetary union with their assets: The Swiss franc has been rising in value relative to the mark because Germans have shifted assets into Swiss franc-denominated assets, even though these pay lower returns than German assets. The franc will remain an independent currency because the Swiss have chosen to stay out of the European Union. German government bonds that mature after 1999 now command an interest premium as a result of the uncertainty about monetary union.

Plans for the EMU are most popular in Greece, Italy, Spain, and other countries that have had greater inflation and more erratic monetary and fiscal policies. Fortunately, there is a way to help the populations of these nations without punishing Germans and others with strong monetary policies. Rather than centralize power in the hands of a single central bank, a much better approach is to decentralize monetary power further by encouraging competition among monies.

An important step in this direction would be for each member nation of the EMU to permit the taxes it collects to be paid either in its own currency or in the mark, British pound, French franc, and possibly several others. Shopkeepers, employees, and suppliers would also be allowed to accept payment for their goods and labor in any of these monies. Market forces of supply and demand would determine the exchange rates between the currencies, so that the unpopular ones would lose value.

DEFICIT CHECK. Competition among currencies helps discipline irresponsible governments by reducing their incentive to increase their money supplies and to finance budget deficits arising from dubious expenditures, such as inefficient state enterprises. Currencies will fall in value if governments try to inflate their way out of fiscal difficulties, since individuals and businesses will shift transactions into stabler monies.

Presumably the population of each nation will continue to prefer its own money. But as they gain familiarity with the new system, consumers, workers, and businesspeople will make greater use of the monies with more stable purchasing power. This approach allows Germans and others to rely mainly on their own currencies as long as they continue to perform well.

After an adjustment period, the transaction costs of dealing in several currencies is likely to amount to only a minor inconvenience. After all, many shops at international airports now accept over a dozen monies, and they find that only slightly more inconvenient than taking American Express, Eurocard, and other credit cards. Moreover, businesses can economize on these costs if they wish by choosing to deal only in one or two monies. A dominant currency could emerge from the free choices of the different populations as they concentrate their transactions in the stablest currency, be it the mark, pound, or even the lira, if it is well-managed.

Nations from all over the globe have discovered the enormous advantages of competition over monopoly in the production of steel, telecommunications, air travel, and other goods and services. The European Union has completely ignored this lesson in its plan for a common money. But it may not be too late to reverse direction and thereby encourage greater competition between European currencies in order to penalize and discourage irresponsible government-based monetary and fiscal policies.

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