Lesson From Euro For East-Asian Common Currency

Presentation on

Seminar On East-Asian Economic Community

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Overview• Euro

– Historical Background– Several Exchange Rate system Development– Diversity as a Source of Competitiveness– EURO and Political Support

• East Asian Currency Prospects– East Asian Crisis as a Trigger for EAEC– Diversity of Backgrounds and Cultures– Suitability of EAEC institutions for EAEC currency– Prospects EAEC Common Currency

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Background & Precedent to Euro• WW II, devastating effects: materials losses &

human lives• ≈ 25 mlln Russian, 7 mlln German, French 0.8 mlln, British 0.4

mlln, total ≈ 61 mlln fatalities of WW II. A huge human losses

• Winston Churchill speech: University of Zurich, 1946 (German Problem)– German Problem: WW I left a reparatory burden for

Germany beyond the capacity of the German Economy [Keynes was against]

– Urging the unification of Europe continental, especially including German and France

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Subsequent vital Steps to Churchill

• Schuman Declaration 1950 (rapprochement) leading to ECSC (European Coal and Steel Community), 1952

• Initially intended to contain the war capacity of German becase these sectors are closely related to that

• Treaty of Rome, 1957 (Benelux, France, Italy, Germany) forming Customs Union : EEC

• There was an issue of convertibility, due to the lack of US dollars to buy American goods for restructuring

• It was also created: Intergovernmental Monetary Committee, in relatin to the problem of BOP deficits at that time

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Previous & Further Development• In 1944, the Bretton Woods was born, a fixed ER

system ( $ backed by gold ); But in 1971 it failed (Nixon)

• The assumption: fixed exchange rates – stabilize the prices of exports and imports for all participant countries – promote international trade and therefore economic growth.

• Werner Report for Europe, 1970: Wanted deeper integration, convertible currency, stable ER with free capital flow

• Inflation rate should be not far from one another• Gradual movement to monetary union• Barre proposed the European Monetary Co-operation Fund

(pooling). The Fund was created in 1973, as an instrument to coordinate the interest rate and to interfere in exchange rate

• Nonetheless, the Werner Plan was later aborted

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Continuing Effort • 1972: With the failure of stable alignment of ER

( Werner), the six with UK, Ireland, Denmark, Norway used “the snake fixed ER”

• It was a set of bilateral bands limiting currency fluctuations between the EEC member states, keeping the spirit of Werner.

• Unfortunately “the snake” failed before the year 1978, provoking the heads of government or state, Helmut Schmidt of West Germany and Valery Giscard d’Estaing envisioned to replace it.

• One has to note the quadrupling of the oil price in 1973/74 which could be a big problems for the monetary policy

• 1978, Helmut Schmidt and Giscard d’Estaing together, agreed to replace the “snake ER system” but anchored in DM

• West Germany is well known for its tenacity to hold the inflation low due to its bad experiences in skyrocketing inflation after the two WW

• The next slide shows how West Germany proves that reputation

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Inflation for the six plus Denmark, Ireland and the UK, 1970-79

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The EMS and ERM• 1979: The European Monetary System, EMS

is instituted with the objectives: • a zone of monetary stability via the EEC members, • low inflation rate, • stable Exchange Rate → ERM.

• ERM is a fixed ER but adjustable exchange rate, where the fluctuation must lie within the +2,25 percent and -2,25 percent band.

• For ten years, ERM could be considered a success • But several countries use other bands [Italy ± 6 %,

followed by Spain, UK, and Portugal]• This system will be re-adopted after the collapse of the

failure of the ERM in 1993

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The Crisis of ERM, 1992 →1993 its collapse

• Since 1979, the nature of the ERM (of EMS) has changed drastically:

• from a system of fixed but adjustable rates with limited international capital mobility – [ ± 2,25 % band of ER]

• to the "hard" mechanism in 1987: stable and narrow target zones and the removal of capital controls.

• Causes: fundamental# and speculative@• # Macroecnomic and political, as the German

Unification leading to monetary and fiscal policy mix• # The divergent costs & prices (due to monetary and

fiscal divergent, liberalization of international financial movement, …Danish referendum 1992, weak result)

• @ Speculative: sudden & arbitrary shift of expectations

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ERM between 1979-1990

ERM is a component of EMS (European Monetary System)

With an initial of more than 10% difference for Italy in 1979, the other countries were capable to almost converge the German inflation rate in 1990, except again for Italy

Such achievement was encouraging

But later development in 1992 was different

Mulhearn, C. et al, 2008: “The Euro. Its Origin, Development and Prospects”

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Amendment provoking Upgrade

• Before and after the collapse of the ERM, the original Treaty of Rome was further amended by many treaties. Some of them are:

• A first major amendment is the Single European Act (1986) completing the internal market. – The chief objective of the Single European Act was

to add new momentum to the process of European integration.

– An important innovation was that it moved away from the principle of unanimity for the harmonization of legislation.

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Amendment provoking Upgrade• One of the vital amendment is Treaty on European

Union or the Maastricht Treaty (1992), which created the European Union, consisting of three pillars:

• the European Communities (ECSC, EEC and the Euratom – the EEC became the European Community);

• a common foreign and security policy (CFSP); • and police and judicial cooperation in the fields of justice and home

affairs (JHA).

• The Maastricht Treaty specified the criteria to be acceptable for the member of the common currency (EMU):– Deficit must be less than 3 percent of GDP– Debt must be less than 60 percent of GDP– This is called the fiscal prudence criteria.

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Further Amendment provoking • Another vital treaty is Stability and Growth Pact

and Treaty of Amsterdam (1997). – This is a stress on the need for fiscal prudence for those

countries aspiring to adopt the one common currency– The Amsterdam Treaty is an amendment for the Treaty on

the European Community and Treaty on the European Union.

• A further amendment is contained in the Treaty of Nice (2001). – The Nice Treaty deals with reforming the institutions so that

the EU could continue to function effectively after its enlargement to 25 Member States in 2004 and subsequently to 27 Member States in 2007.

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Unemployment for EU, US, UK and three European States

Mulhearn, C. et al, 2008: “The Euro. Its Origin, Development and Prospects”

There was decline trend in Italy but a cyclical trend in Germany, France and EU but all ended lower in 2007 compared to 1999

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This is a further unemployment rate per period in the European areas for 2005, since 1960.

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Unemployment• In the two previous slides it is clear that the rate of

unemployment in 2007 were lower than those in 1979, with a cyclical form in between.

• Nonetheless the 2007 rates were mostly higher than those in the period of 1960-1980

• Those in Europe were higher than in the US and the UK

• By observing the periods before 1979, that general rise was happened in the period of 1980-1987.

• As in 1973, there was a significant rise in oil price in 1979 due to the Iran-Iraq war, leading to less investments outside oil sectors

• In the period of 1996-1999, the highest rates were happened in Spain (19.4%), Finland (12.2%) and then France (11.9%).

• Other big economy in the region: Italy (9.9%), West Germany (7.1%),

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RER, based on unit labor costs

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Real Effective ER after 1999

• The previous slide shows the development of REER, which is reflected by its unit labor cost

• Germany had a decline REER, increasing the competitiveness of the German Goods

• The decline of Germany’s REER to some extent disturb the role of euro as a common currency

• Portugal experienced the highest REER during the period after 1999, followed by Italy and then Spain

• This will deteriorate the competitivness of these countries, which will disturb the internal balance in economic development

• France was almost flat, with a small rise approaching 2006

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Greece, Ireland, … Euro Crisis • In 1992 the crisis is on the ERM, the system

of exchange rates.• In 2010, the crises in the Euro hit the states,

firstly Greece, then Ireland, and others … • The crises were provoked by the fiscal imprudence,

with budget average deficit of 5 % between 2001-2008 and the current account (CA) deficit 9 %.

• The average budget deficit of the euro-area was 2 % of GDP while that of CA 1 %.

• Greece’s deficit violated both the deficit and the debt limits as stated in the SGP

• The Greece’s membership in the euro has reduced the country’s risks, encouraging to get much credits Now it is seen as a negative factor

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Greece, Ireland, … Euro Crisis…

• The Ireland crisis is related to sovereign as well as the banks debts.

• The banks have been lending too much to the real estate, as also happened in Spain.

• The most urgent problem is to save the banks, due to its immense recapitalization needs

• The Irish government encourage the family housing construction, and the banks seized the opportunity

• The Irish banks are in deep trouble after the property price crash, could lead to whole banks bankruptcy

• At last the whole financial problems become at the burden of the government

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The consequences of the two cases• The previous two countries: Greece and Irish are

samples from euro-zone (+ Spain, Portugal, …)• The interest rates in the euro-zone is the same for the whole

region, including those countries where the interest rates were usually high; this is really a monetary shock for them.

• Low interest rates push the bank lending up, without considering the inherent risks suitably, especially to the country’s economy

• Countries with high inflation rate were followed by the wage level adjustment, but unable to raise the productivity level accordingly, weakening the respected country’s competitiveness.

• The social security systems are also raising the economic burden• The consequences are either too much loans, price hikes for

special sector like real estate, high CA deficits, and so on.

• The two case show differences in aspiration among countries, in spite of one common accepted idea.

• The differences in the fiscal-monetary mix for any country were neglected, the SGP is a “one fit all”.

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After the euro introduction, the divergent of PDB/cap within the euro-zone countries rises from 1999 to 2007. Most of the countries have a decline in growth rate within

the period 1999-2007 compared to 1992-1999

Euro-Zone GDP/CAP in constant prices 2000 USD

Country 1992 Growth % 1999 Growth % 2007

Austria: 20,529.90 0.019 23,436.61 0.016 26,664

Belgium: 19,339.20 0.018 21,836.90 0.017 25,030

Finland: 17,937.84 0.031 22,233.53 0.032 28,498

France: 19,592.96 0.015 21,776.43 0.010 23,636

Germany: 20,566.25 0.012 22,428.94 0.015 25,249

Greece: 9,102.41 0.015 10,079.00 0.051 14,962

Ireland: 14,342.66 0.073 23,449.11 0.042 32,568

Italy: 16,886.46 0.014 18,611.55 0.009 20,017

Luxembourg 34,951.47 0.031 43,267.25 0.034 56,358

Netherlands 19,870.90 0.025 23,635.60 0.016 26,845

Portugal: 8,973.39 0.025 10,654.17 0.009 11,454

Spain: 11,673.51 0.025 13,845.51 0.021 16,363

CV 0.50 0.51 0.64

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Important Traits of Euro Area• The Euro zone has a common currency, but

unfortunately the fiscal policies are still mostly under the control of the member states

• The formation of the common currency were initially a political move, triggered by the speech of Churchill

• The common currency seems to be expected paving the way to economic integration, in spite of other policies are mostly controlled by the member states

• The Stability and Growth Pact was expected to be the strongest instrument for streamlining fiscal policies.

• As a matter of fact, the “big countries” like Germany and France are still the dominant player in the region.

• They are shouldering most of the burden, the results of other countries imprudence based on SGP criteria.

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The Lessons• A group of countries aspiring establishing an

economic integration, namely through a common currency must consider the different needs in economic policies of each countries:

• Wage policies, related to inflation and to social safety nets, which could have been written in the constitution

• The public expenditure needs related to social needs and infrastructure building, related to development level

• Social aspiration derived from countries’ constitutions, how they value sovereignty in relation to cooperation

• The geographical dimension, population size and the existing distribution of income within each country

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Lesson from The Fed in USA• But what can we say, then, about the example of the United

States? … When the American Federation was constituted, its population was homogeneous and very small. Creating the United States, in 1776, was rather like creating a country the size of Switzerland today. At the beginning of the 19th century, the Union hardly counted more than eight million inhabitants and it reached thirty million only on the eve of the War of Secession. (Rosa, J.J. (1999): op-cit, p. 7)

• Another fundamental difference should give the eurocrats pause. For a long time the Americans did not need a single currency. And they transitioned toward a central bank at the federal level over more than a century, from 1790 until the creation of the Federal Reserve System in 1913.

Second Part: The Lesson From Euro-Zone For East-Asia

Presentation on

Seminar On East-Asian Economic Community

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History to the East-Asian Economic Cooperation

• East-Asian crisis in 1997-1998 has triggered a common effort to avoid its recurrence

• In November 1997, the ASEAN leaders invited the leaders from China, Japan and South-Korea to their meeting in Kuala-Lumpur

• The third meeting of the ASEAN+3 in Manila, 1999 specified the area of cooperation, one is in finance

• Pursuant to that, the ASEAN+3 finance ministers, convening in May 2000 on the margins of the annual meeting of the board of governors of the ADB, announced the Chiang Mai Initiative (CMI)

• In the financial matters, the objectives is among other to ensure financial stability in the East Asian region.

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A Precursor to the Regional Financial Cooperation

• The swap arrangements of the ASEAN (ASA) dated back to 1977

• It allowed members to exchange local currency for US dollars on a short term basis to alleviate “temporary international liquidity problems”

• Each of the 5 members originally contribute $ 20 million with a total amount of $ 100 million, but increased to $ 200 million in 1978. The duration of the swap could be 1, 2, 3 months, and were renewable once for up to 3 months

• The swap were only activated five occasions. The amount was small compared to the needs, and it was not activated in the 1997 crisis.

• In 2000, ASEAN leaders agreed to expand their swaps under the CMI, by increasing the amount of the ASA to $ 1 billion, but now including the 10 member of ASEAN.

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The Chiang Mai Initiatives (CMI)

• The CMI was launched on the sidelines of the annual ADB meeting in Chiang Mai, Thailand in 2000, by the ASEAN+3 finance ministers.

• It was designed to address the short term-liquidity problems and be supplemental to existing international financial arrangements in the event of an emergency

• The CMI involved: • An expansion of the ASEAN Swap Arrangement (ASA)

covering all ASEAN members • Together with a network of bilateral swap agreements

(BSAs) and • Repurchase facilities among ASEAN+3 countries.

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East Asia GDP/CAP in constant prices 2000 USD

Countries 1992 Grwth/yr 1999 Grwth/yr 2007

Japan: 34,535.46 0.005 35,664.16 0.017 40,707

Hong Kong: 21,041.39 0.014 23,179.32 0.049 34,041

Singapore 15,675.22 0.045 21,322.16 0.048 31,118

Brunei: 14,204.85 -0.014 12,890.47 0.044 18,150

Korea, South: 7,521.76 0.043 10,117.21 0.052 15,158

Malaysia: 2,881.58 0.036 3,689.87 0.039 5,018

Thailand: 1,657.62 0.022 1,925.38 0.038 2,592

Philippines: 870.706 0.014 957.719 0.029 1,202

China: 475.931 0.092 881.852 0.098 1,864

Indonesia: 691.613 0.016 772.626 0.038 1,038

Papua New Guinea: 630.325 0.012 684.203 -0.006 654

Vietnam: 250.603 0.060 376.588 0.064 617

East Timor: 368.654 -0.005 356.689 -0.021 300

Laos: 241.18 0.040 318.055 0.045 451

Cambodia: 211.824 0.035 270.158 0.080 499

CV 1.37 1.31 1.38

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East Asian Economic Performances since 1999

• The previous slide shows one indicator of the economic development in the region:

• Compared to 1999, the PDB/cap in 2007 are divergent, showing an unbalanced economic development within the region. The coefficient of variation in 1999 is 1.31 while in 2007 it is 1.38, a rise in inequality since 1999.

• The infrastructure availability compared to USA is as follows: Hong Kong 48.2 pct; Indonesia 9.6 pct; Japan 76.4 pct; Malaysia 60.5 pct; Philippines 29.3 pct; Singapore 76.4 pct; Thailand 34.3 pct (A note on Indonesia: Java, center of most industry activities, has higher figure than the national one)

• From these infrastructures data (not all countries), the trend for economic development will be diverging

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Financial needs for infrastructure provision is immense

• The very unequal needs for infrastructure provision will necessitate an appropriate mix of monetary and fiscal policies, different from one country to another

• Economic integration with a stress on the financial sector will have an unequal effects for all countries

• Those with excellent financial infrastructure will reap high gains, while those which are still struggling in the infrastructure provision will be disadvantaged.

• The following slide shows the level of public debt in several countries of the EA, which will necessitates a suitable regional financial management for their countries.

• There has been unequal requirement from one member country to another, a conflict of interest.

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• The case of euro-zone countries shows that after its introduction, there is a further divergence in the PDB/cap and unfortunately some are hit by the crises in 2010.

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Theoretical Arguments

• Countries in common currency must deal with– Asymmetrical shocks

• Asymmetrical shocks must be

– Flexibility • The incapacity to deal with asymmetrical shocks must

be balanced by the flexibility, for example in labor cost or labor policy flexibility

– Integration

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Local Currency• Now in Germany there are 16 regions using

local currency as an alternative to euro• This is a signal of the resistance to the euro at the local

level, which seems lose its importance in the process of globalization

• The local currency is named Schwundgeld because it loses value after a predetermined period of time

• The loss of value is intended to encourage the money owners to spend it quickly, which is hoped to produce a permanent stimulus to the regional economy

• So the use of euro is believed by this people not to help raising the regional economic development

• Is this not a threat to a large common currency area, namely the euro?

38ADB (2010): Emerging East Asia A Regional Economic Update

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IMF Classification of Exchange Rate Regime

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Infrastructure (in the civic sense) includes:

Transportation Roads

Highways Railroads

Public transport Airports

Health systems River freight Bike paths Sidewalks

Utilities Electricity

Natural gas Coal delivery Water supply

Sewers Telephone service

Radio and television bandwidth allocation Cable service

Municipal services Trash collection Police protection Fire protection

Flood protection Postal system

Minting and backing currency "Soft Infrastructure" is a term that denotes institutions that maintain the health and cultural standards of the population. Principally, this refers to

Public education Public health systems including public hospitals

Categories: Construction