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Emerald Group Publishing Limited
Copyright © 1998, MCB UP Limited
Book reviews. EMU Getting the End-game Right
EMU Getting the End-game Right
David Begg, Francesco Giavazzi, Jürgen von Hagen and Charles WyploszCEPRLondon1997I75pp.SBN: 1 898128 26 X (paperback)£10.00
Decisions made at Maastricht, a sleepy town in Holland, whose only claim to fame prior to the treaty was that it was the site of the first prehistoric mammoth to be discovered, have already determined that the initial conversion to euro will be at the rates prevailing at the time of conversion. At Madrid, it was decided that one ECU will also equal one EMU, while the national currencies of the "ins" will convert at the rate prevailing at the end of December 1998.
The authors consider that failure to preannounce conversion rates will produce uncertainty that could invite "speculative attack", and warn of severe faults in the current arrangements for transformation to monetary union and that rectifying these is becoming increasingly urgent. The opportunity for manipulation of interest and exchange rates in the final stages of transition would be too tempting for politicians to avoid and any tampering will amplify this uncertainty.
This is reminiscent of the London Stock Exchange, which converted to electronic trading years after most of the rest of Europe (including Frankfurt and even France) explaining that it was waiting to make sure that all likely difficulties had been eliminated so that the transition would be seamless. They didn't and it wasn't.
In its wisdom, having lost several millions of pounds on an abortive computerisation attempt a few years previously, the London Stock Exchange arrogantly chose the tenth anniversary of "Black Monday", the October 1987 Stock Market crash, at a time when all the World's Stock Markets were already a little jittery, and every pundit had been wheeled out to give his views on the likelihood of Black Monday repeating itself. It did facilitated by the computerised trading system in London, which now allows "insiders" to manipulate the market at the press of a button, but continues to make it more difficult for individual traders, investing their life savings, to react to market movements. When an "insider" is able to manipulate the FTSE 100 by a significant amount with just a few thousand pounds, it is difficult to prevent the London Stock Exchange becoming the laughing stock of the trading world and it will be difficult for it to regain the confidence of the private traders.
Begg discusses the proposals that he considers would not produce the desired stability, including a return to the narrow bands of 1992-93, wider or no bands, establishing a currency board, and modifications that attempt to introduce certainty, such as the Lamfussy Rule and the Bartolini-Prati Bands. Begg suggests the strategy of using preannounced exchange rates for the Ins (but not rates against the euro) and allowing convergence to that goal, be it smooth convergence or a different-shaped "convergence cone". If intervention were needed to remain within the large cone, then it would not be necessary until the final stages as the cone narrows, when, Begg suggests, the intervention would be more "credible".
Begg explains the beautiful simplicity of how it is possible to finance Mr Prodi's gambit of promising to refund the extra 3 per cent interest rate necessary to meet the Italian entry criteria. The perceived certainty would raise the value of bonds, control the cost of government debt and improve national credit ratings, however the opportunities for increasing consumer prices will be vast.
This will be quite familiar to people who still have difficulty calculating the cost of a gallon of petrol, when all prices are displayed in pence per litre, or hear themselves involuntarily coming out with phrases like "I remember the time when the price of a gallon of petrol went up to 5 shillings and 9 pence". Many will also be able to recall the decimalization of the currency, when for the sake of simplicity the rate of conversion all too often became one new penny for one old one (representing an increase of 240 per cent).
Begg considers strategies for delayed entry and differentiates between nations that actively delayed entry and the ones that were delayed because they failed to meet entry requirements. The latter may have even greater difficulties in maintaining credibility and would be more liable to speculative testing of their currency and bond rates. At this stage it may be better to allow market forces to determine the new exchange levels and tackle devaluation if necessary, so that the nation could have the opportunity to bounce back from the clean slate, as occurred to Britain in 1993.
The book warns us, in a very thorough discussion of the economics of entry into EMU, of the potential difficulties of ensuring a smooth transition of the currency rates from the national currency-ECU rates existing before the conversion and a reasoned exposition of the methods of transition which would work and outlines those which may cause instabilities in interest rates, bond valuations and stock exchanges. The authors urge decision makers to rectify the fatal flaws in the current plans towards monetary union. In addition, the tendency of EU governance to be secretive reduces certainty and encourages speculative raids, which then force the politicians into ill-considered panic measures as occurred in 1993 when Britain was jettisoned from the ERM.
This is No. 7 of a series of publications entitled Monitoring European Integration. Complex exchange rate formulae are clearly presented, with graphs and charts being used to illustrate the text and sidebars and endnotes assist clarity, but an index and a glossary of the specialist terms would make the text even clearer. This book is an excellent academic assessment of the steps and pitfalls towards monetary union and adds another facet to the debate and the title's analogy to the final stages of a chess game is subtly apt.