Love affair with EMU falters

Date: 05/09/1996

By Tim Jones

THE run-up to European economic and monetary union is proving to be like one of those maddening on-again off-again romances.

One day - such as the day the Maastricht Treaty was signed in 1991 - the newspapers are proclaiming that this really is it; the single currency will be up and running within ten years. The next day, a slide in the value of the French franc or a Danish referendum means it is all over.

Late last year, monetary union was dead. France faced a swathe of public-sector strikes and Germany's budget deficit was overshooting. By June this year, EMU was born again. The currency had a new name and tougher budgetary measures were being set in motion to cap the effects of recession in Germany and France. The Euro was back.

Now, bored with a summer of no news, the headline-writers have decided once again that EMU is finished. The franc, they say, is under massive speculative attack and the German and French budgets cannot be brought under control in time.

After all, the decision about whether to proceed with EMU will be made on the basis of each country's 1997 fiscal data. If they want to make their budget deficits worth less than 3&percent; of gross domestic product by the end of next year, governments must cut spending and raise taxes now.

But new budget estimates from German Finance Minister Theo Waigel last week suggested that he would fail to meet this year's deficit target of 30 billion ecu and could overshoot by as much as 8 billion. The Bundesbank had already hinted that Waigel's original forecasts were unrealistic.

At the same time, across the Rhine, French Prime Minister Alain Juppé is piecing together yet another austerity package to be unveiled next week (10 September). This is expected to include real cuts - once the effects of inflation are taken into account - of as much as 2&percent; in public spending.

But pro-EMU sentiment in France has not been helped by an interview published last week with the new head of France's Caisse Nationale d'Assurance Maladie (CNAM), Jean-Marie Spaeth.

The former labour union leader spilled a few budgetary beans by announcing that the 1996 social security deficit would exceed the forecast made by his own organisation only two months ago. Now it will be much closer to

8 billion ecu than the 7.5 billion ecu predicted in June. “Our system of social protection cannot go on like this,” he warned. “It will explode in our faces.”

The labour unions in both countries have been mobilising against the endless budget cutting.

The effects of all this were predictable. A poor French budgetary outlook tends to weaken the franc, while the same figures in Germany often prompt investors to sink their money in deutschemarks and mark securities as a safe-haven against the collapse of the EMU project.

The franc, which was already below its spring levels, dipped close to its old floor in the Exchange Rate Mechanism of 3.4305 per deutschemark.

Something had to be done so - like Richard Gere and Cindy Crawford before them - German Chancellor Helmut Kohl and French President Jacques Chirac chose to make public their continued commitment to each other.

Following their regular summit meeting last weekend, they stressed their “perfect identity of views” that the franc and mark would form a monetary union in January 1999.

By early this week, the franc was back to 3.42 per mark.

In fact, the whole 'franc crisis' saga had been exaggerated out of all resemblance to reality. The currency did fall to a four-month low, but this was in a skeletal summer market where a small buy or sell order has a disproportionate effect. Greater volumes have been traded between the dollar and the mark, and these have fed through to the franc.

Moreover, while the franc did weaken to within a whisker of 3.43 per mark, this compares with its average of 3.45 throughout last year and the 3.58 it hit during the December 1995 strike-wave.

Investors did not head off to their Cayman Islands and Asian hideaways leaving behind large and risky positions in French government bonds assuming a January 1999 start-date for EMU. They were already highly sceptical and well-protected against surprises.

Even a surprise from Swedish Finance Minister Erik Aasbrink last week failed to astonish holders of kronor. The Swedish government, which has often allied itself with the UK in its scepticism towards aspects of EMU, finally made its position almost clear.

“We could perhaps reformulate the choice before us,” Aasbrink told a newspaper. “It is not a question of 'yes' or 'no' to monetary union but rather one of 'yes now' or 'no now'.” With the government still committed to budgetary balance by 1998, investors refused to be spooked.

The markets will be much more intent on scrutinising the details of the 1997 budgets in France and Germany, as well as those coming soon from the UK, Spain and Belgium.

They also want to see the EU's detailed blueprint for monetary union.

The European Monetary Institute is beavering away at the technical work, deciding how exactly to conduct monetary policy. But the big questions - how to discipline public spending in a monetary union and keep control of EU currencies outside the Euro-bloc - will not be answered until EU finance ministers and central bank governors meet informally in Dublin on 21 September.

Economics Commissioner Yves-Thibault de Silguy will come forward next week with his plans for an ERM II to bind 'out' currencies to the Euro-core and a fiscal 'stability pact' for monetary unionists.

The outlines of both are clear. Bonn is set to win its battle for a much tighter timetable for enforcing sanctions against governments which lose budgetary control, while ERM II will be a non-compulsory system binding 'out' currencies to the Euro but not to each other. There will be none of the tough sanctions demanded by the French against countries which devalue their currencies for competitive advantage.

With a draft agreement expected in Dublin, the major building blocks for EMU will be in place.

The Euro is then Kohl's and Chirac's to lose.