EMU: postponed by common agreement?

EMU was always a political rather than a purely economic project. Although it carries clear economic advantages for companies trading across frontiers, EMU’s main aim was to prevent a greater Germany from transforming its economic might into political influence throughout Europe, by removing the Deutschmark as an instrument of Bonn’s national policy. Chancellor Kohl has gone along with the project because he belongs to that generation of Germans who instinctively believe that, without a united Europe, their own country will become aggressive again. In turn, the French accepted the strict criteria for EMU in the full expectation that, ultimately, the Germans would not insist on them being applied.

Both sides are now deeply disappointed. For the Germans, the abolition of the Deutschmark was to be just a step on the way towards a United States of Europe, complete with a federal parliament and government in Brussels. The French are now determined to avoid this .At the same time, the French have discovered to their horror that the Germans are deadly serious about the convergence criteria for EMU, something that no country, apart from tiny Luxembourg – which has no real currency of its own – currently meets. But the biggest problem has ultimately proved to be the economy, something nobody expected when Maastricht was concluded at the end of 1991.

After a period of hesitation, the French government of president Jacques Chirac implemented an austerity programme designed to meet the convergence criteria for EMU. Chirac and his prime minister, Alain Juppé, withstood a confrontation with the trade unions at the end of last year, thereby renewing their commitment to monetary union. Nevertheless, it is now obvious that, in order to qualify for the introduction of a single currency, the French will not only have to abide by the budget stringency measures already put in place last November, but will have to toughen them even further.

The reduction of the budget deficit is only possible under current French government spending plans if the French economy grows near the planned 2.8% this year. And that’s something no analyst expects, even in the rosiest of forecasts. So either France ultimately misses the Maastricht deadline at the end of 1997 or it has to face another showdown with trade unions towards the end of 1996, something for which no French politician has any stomach.

More important, Germany, the country assumed to qualify for EMU almost automatically, could turn out to miss the convergence criteria after all. Last year, the German budget deficit was 3.6% of GDP, still above the 3% target. This year, it may not be much closer. The latest bout of uncertainty is directly related to indications that growth in the German economy has slowed down. Although the country’s research institutes still believe that this does not amount to a recession, with German unemployment having registered a surprising rise to over 11% last month, it has given everyone food for thought.

Theoretically, monetary union can take place with only two out of the union’s 15 member states. In practice, everyone in Brussels accepts that the key players are France and Germany. But France cannot make it without another political crisis, and Germany’s ultimate success is also now under question. The Commission and national governments continue to claim that all is well. The EU has decided on the name of the currency and on the transition period required before the new banknotes and coins come into general circulation. In short, they have made all the decisions which everyone knows are the least important. But it helps to maintain the credibility of the EMU timetable, and the French and German governments will show new vigour in defending that over the coming months.

So watch this space for the launch of new “revitalization” plans from both the French and the Germans. These plans will aim to boost employment or limit the growth in the number of unemployed by talking about a new “association” between employers and workers unions, aiming at some tinkering with labour markets such as introducing flexible working hours, etc.

These plans will fail to produce the necessary results. The conclusion is inescapable. At some point in the near future, governments will have to admit that monetary union will not take place by 1999. But the way this admission will come is of supreme importance to the future of monetary union. If Europe manages to postpone EMU in a relatively orderly manner, then there is some chance that monetary union will ultimately be accomplished. However, if governments continue to pretend that nothing has happened and only admit defeat in the face of a currency crisis, the chances of a monetary union will be jeopardized, perhaps for decades.

Here are the current scenarios for what will happen when the pretence that EMU can still be achieved fades away:

1 A French admission of defeat, coupled with a formal request from Paris that monetary union should be postponed. The French lose their nerve for another belt-tightening budgetary exercise this year or next. Instead they make a dash for growth, relaxing financial stringencies in order to get unemployment down. Probability: highly unlikely. For the French such a policy U-turn would be a complete strategic defeat which no government, including president Chirac’s, could countenance.

2 Faced with France’s difficulties and the increasing strain on relations with Paris, the Germans themselves ask for a postponement of EMU. Probability: slightly more plausible, but not very likely.Despite the failure in 1995 and the likely shortfall again this year, the Germans will meet all the convergence criteria in 1997. That’s because the German economy will see a growth surprise. If the Germans ask for a postponement, that will let the French off the hook and preserve everyone’s national pride. But, at the same time, a postponement of EMU as a result of a German request will never be very credible. Financial markets will assume that the Germans have lost interest in monetary union altogether and no amount of promises from Bonn will make a difference. Besides, such a postponement explicitly demanded by the Germans will mark the end of chancellor Kohl’s credibility, since the German leader has staked his reputation on this project which is increasingly under attack from the Social Democratic opposition in Bonn.

3 A crisis in the financial markets, with the French franc under considerable attack and with the Banque de France unable to defend the national currency. Probability: plausible but not likely. The reality is that, despite all the gloom and doom, the French have succeeded in defending their currency until now. Indeed, with everything at stake in a future financial crisis, the Germans will have every interest in defending the French even further.

4 A combination of French internal troubles, repeated market runs on national currencies and increasing political difficulties for the Germans culminates in a decision of all EU member states to get together and agree on a postponement of EMU. Probability: the most likely scenario. Although the French would dearly like to postpone EMU, they do not want to be seen to ask for this on their own. And, although the Germans may wish to accommodate them, they do not want to appear to be responsible for postponing EMU either. Britain, perhaps ruled by the Labour Party by then, might also welcome some breathing space and so would the southern states such as Spain and Italy, which at present have no hope of joining a monetary union. It is usually forgotten that any postponement of EMU will require a formal revision of the Maastricht Treaty which, in turn, needs the agreement of all 15 member states. Dispersing responsibility for postponement among the states would also be politically convenient.

There are some problems in reaching a consensus on postponement:

* Should a postponement be for a specified period? Yes, Germany and France will argue, as will Belgium, Luxembourg, the Netherlands, Ireland and almost everyone else – apart perhaps from the British, Swedes and Greeks.

* Should it take place before, after or during negotiations for the union’s enlargement further east? The Germans will push for the two processes to run together and will win on this point.

* Should the postponement be short or long? The consensus will be that the postponement should be of a short duration, perhaps a couple of years.

* What will happen in the meantime? The French and Germans will insist on the immediate imposition of rigid pegging between currencies, coupled with continued supervision, so that countries meet the convergence criteria. The emphasis will be less on relaxing the criteria for a couple of years and more on reducing the pain by prolonging the process.

Will markets interpret the missing of the deadline as the end of monetary union? The real answer to this will not be found in what governments do, but more by what happens in Germany. If chancellor Kohl maintains his grip on power and wins the 1998 elections in Germany, pressure for monetary union will intensify again. If, however, the chancellor disappears, or his party loses the elections, all bets are off. Then, instead of a formally unified currency, Europe will have a Deutschmark-controlled zone at its centre. Either way, the current plans for monetary union have no chance of working and the admission of this will probably come ( de facto, if not in strict legal terms) by the end of this year.

Finally, does it matter if EMU is turfed off the agenda for Europe? That’s an even bigger question than how EMU will be called off. I intend to tackle that one next time.

What makes EMU impossible – low growth, unemployment and rising debt

David Roche is president of Independent Strategy, a London-based research firm.