Today the euro, tomorrow the “intor”

Date: 29/11/01

By Dick Leonard

As the final preparations are made for the issue of notes and coins, the euro has received a thundering endorsement from the world's leading authority on currency unions.

Canadian Professor Robert Mundell, of Columbia University, received the 1999 Nobel Economics Prize for his work on "optimal currency areas". In a lecture in Brussels earlier this month, he claimed that all the member states of the eurozone had greatly benefited from their adoption of the single currency.

He summed up the advantages already gained as "a better monetary policy than before for every country in Europe, a continent-wide capital market, lower interest rates in nearly all eurozone countries and the complete disappearance of speculative capital movements".

The most obvious gainers, Mundell argued, were the southern European states - Italy, Spain, Portugal and Greece. They had a long history of high inflation rates and were forced to impose tight and strict monetary policy rules to bring inflation down.

Sometimes, he reflected, constraints originating from outside the country can act as a stimulus for unstable national governments. This seemed to be the case in Italy, where frequent changes of government had hindered progress towards monetary and fiscal stabilisation. Only after joining the exchange rate mechanism was Italy able to achieve this.

At the other extreme, Germany, whose population had been reluctant to give up the Deutschmark, had gained economically from the changeover. Its currency had suffered from a long-lasting tendency to over-appreciate, which was a continual drag on its export trade.

Nor had the eurozone economies suffered from the weakness of the euro in international currency markets.

In retrospect, this should be seen as a "blessing in disguise", because it was helping to sustain the EU economy during a pronounced US slowdown.

Mundell believes the weakness may continue for some time, as the probability is that most of the large amounts of European currencies held abroad (particularly in Russia and Eastern Europe) will soon be changed into dollars.

In the longer run, however, he foresees a large and sustained demand for the euro. It is now the number two currency in the world, with potential for expansion, not only to the UK, Sweden and Denmark, but to the candidate countries of eastern and central Europe.

The CFA (Communauté Financière Africaine) franc states of Africa are also tied to the euro. The euro area is likely to have a gross domestic product at least 30 greater than that of the US.

Mundell expects that in future central banks would want to hold as many euros as dollars in their currency reserves. These now amount to $1.6 trillion (€1.8 trillion), and would likely double to $3.2 trillion (€3.6 trillion) over the next dozen years. To match the $1.2 trillion (€1.4 trillion) currently held in dollars, demand for the euro would average $100 billion (€114 billion) a year.

Asked what were the disadvantages of the euro, Mundell said there were none - except for the nostalgic desire to cling to individual currencies as a sign of national identity.

The advent of the euro, he said, was the most momentous development in the international monetary system since the dollar supplanted the pound sterling as the most important trading currency after World War I. Its significance was even greater than the collapse in the 1970s of the Bretton Woods system of semi-fixed exchange rates, which had continued since 1946.

Not content with praising the euro, Mundell went on to make a proposal for the creation of a world currency. The first and crucial step, he said, should be the linking of the three main trading currencies - the dollar, the euro and the yen. In his opinion something similar to the current market rates, of approximately 120 yen to the dollar and the euro at 90 cents, would be an appropriate starting point.

Given the political will, Mundell did not think this would be an unduly difficult operation. Five conditions would need to be met, he said:

• l fixed exchange rates
• l a common inflation target
• l a common measurement of inflation
• l a common monetary policy enforced by common monetary institutions
• l agreement on distribution of seigniorage (the profits accruing to governments from issuing their own currencies).

Once a fixed link has been established, Mundell believes that other leading currencies, such as the Chinese renminbi, the pound sterling and the Canadian dollar, would come under pressure to be pegged to the new currency union. With their adhesion, a virtual world currency would be created, which he suggests should be called the "intor" (an amalgam of international and or, the French word for gold).

Not all currency experts, however, would agree with Mundell that linking the three major currencies would be such a simple operation. German economist Daniel Gros, a leading authority on the euro, told me he totally disagreed with Mundells view that current market rates would be a practicable basis for an indissoluble link.

Both the US and Japan would need a large devaluation, in his view, if their economies were to thrive. This would amount to a major upward valuation of the euro, which would not be acceptable to Europeans at present.

So there would be considerable problems to address before Mundell's plan could become a realistic possibility. The proper forum to resolve them is the Group of Seven meeting of finance ministers, who (perhaps in conjunction with the IMF) would set up the necessary institutional framework.

They should not delay a serious examination of the plan. As Mundell says, a global economy needs a global currency.

The launch of euro notes and coins may signal the emergence of a true world economy. Author argues a global currency is the next step.