US interest rate in EMU remains low

Date: 03/04/1997

By Tim Jones

WHEN he was collared recently by a gaggle of news wire journalists, US Treasury Secretary Robert Rubin was surprised to be quizzed on whether he thought the European single currency project would be delayed.

“Well, no,” he said, adding that the last time he had talked to European finance ministers about the issue at a meeting of the Group of Seven highly industrialised states, they seemed to be “serious”.

That was back in the summer of 1996.

American economic policy-makers are keeping an interested eye on proceedings but that is all.

The European editions of US newspapers find it most enthralling because of the efforts the German, French and Italian governments are having to make to meet the budget deficit targets of the Maastricht Treaty. Americans like to write about how “bloated” Europe's deficits are, along with its welfare systems, labour and services markets. Progress towards EMU and the squeals of pain it elicits from what they regard as 'coddled' sections of society fill acres of column space.

But such stories are missing from the domestic editions of the Wall Street Journal or USA Today.

Americans are not - whatever Economics Commissioner Yves-Thibault de Silguy and his fellow euro-missionaries may say - sitting up and taking notice of EMU.

For the moment, many US policy-makers are genuinely puzzled by the pain that EU member states are putting themselves through in order to qualify for the single currency.

When the US went into recession in 1991-92, the country's independent central bank, the Federal Reserve, did not think about the external value of the currency and cut real interest rates - once inflation had been taken into account - to zero.

When they came to the so-called G7 'jobs summit' in Lille last year, officials from the White House and the labour department were armed with figures showing how this policy, coupled with giving freedom to the nascent information technology markets, had created 8 million high-technology jobs since 1992.

At the G7 meeting in Lyon last summer, Rubin listened with great interest to the plans for the euro - after all, it is a fascinating subject for anyone with a modicum of interest in economics.

But the US economy, not the united states of Europe, is his bread and butter. Only when the euro really gets in the face of the US establishment will it wake up.

This is exactly what European politicians are praying for. Many of them - and in particular the French and the European Commission - feel that Europe has for too long been an innocent victim of the wild fluctuations of the US dollar.

Looking back over the Exchange Rate Mechanism's crises since it was invented in 1979, most are able to pinpoint a frantic dollar swing as the catalyst for intra-EU problems.

The difficulty for European monetary authorities is that the dollar, the deutschemark and the yen are by far the most traded currencies in the world.

When the dollar rises against the mark, the mark tends to fall against everything else. When the dollar falls, which it has had an unhappy tendency to do over the past three years, this pushes up the mark and puts other European currencies under intense pressure.

A surge in the dollar has been the one beacon of hope in the European economy this year. With German unemployment rising and continued slow growth throughout the continent, speculation has grown that EMU will be delayed beyond the expected start-date of January 1999.

Only the rise of the dollar and the boost it gives to exporters in France and Germany has offered encouragement to euro enthusiasts. If, for any reason, this trend turns around, then EMU really could be off.

Even while they welcome the fact that the dollar is up, French politicians resent their reliance on Washington's largesse. A commonly heard complaint among European politicians is that the Americans practise a policy of 'benign neglect' regarding the external value of the dollar. They simply do not care whether it goes up or down.

During the eight-year term of President Ronald Reagan, the dollar gyrated as never before. When Bill Clinton took office, the impression that he and his staff had no opinion on where the currency should be on the international markets was one of the reasons for the demise of the old-style ERM in August 1993.

At international meetings, journalists ran from room to room collecting different quotes on the dollar's value from the treasury secretary, his deputy, the secretary of state and even the president's national security adviser. The Clinton team, it seemed, could not care less about the impact of their remarks.

“Why is it that the United States is so insensitive in this respect?” European Monetary Institute President Alexandre Lamfalussy asked recently, adding: “I do not belong to those who believe that they deliberately want a weak dollar. What does exist is a lack of interest in the exchange rate.”

The US benefits uniquely from its status as the world's biggest and most self-contained single market. Industry is able to obtain much of its raw materials for manufacturing from within this market and is therefore insulated from exchange rate fluctuations.

Even outside the US, most of the world's commodities - ranging from oil to metals - are priced in dollars.

But this tells only part of the story. The Americans are blessed in having caught the capital-markets bug early. Nowhere else on earth can those dying to get rid of their cash choose from such a range of investment in capital - from shares in a wide variety of companies to the long and short-term debt of the federal, state and municipal governments.

Pricing of the securities is standardised, trading rules are carefully policed and different types of investment paper can be easily compared with one other.

This is what is known as a large, deep and transparent capital market. People like investing in it. And that applies to everyone. British and German firms have bought swathes of the US economy while Japanese banks, pension and insurance funds have long had a taste for federal government debt.

As a result, when the dollar weakens it does not have the same effect as a fall in the value of a European currency, prompting a rise in long-term interest rates and discouraging investment. For international investors, no other market offers the same scope for sinking their cash.

This is what the euro is meant to change. If it works, then Robert Rubin will be begging to discuss EMU at every international meeting he attends.

With the advent of the euro, the capital markets of Germany, France, Belgium and Netherlands should theoretically become one. With the later arrival of Italy and the UK, the bond and share market would be huge.

“From that moment onwards, American insensitivity to the level of the dollar will change,” said Lamfalussy.

Commission President Jacques Santer is convinced that the euro will make the EU a major player in the G7 and the International Monetary Fund. “With a single currency, our influence in these institutions will be equal to our economic strength,” he said.

Once in this position, the Union would be able to strong-arm the Americans into signing tough agreements to keep the fluctuations of the world's major currencies within manageable limits.

When that happens, Rubin or his successor will have to take note.