The single currency: Everything you ever wanted to know
TUESDAY NOVEMBER 12 1996
Gillian Tett answers all your questions on European monetary
Will European monetary union happen?
The prudent assumption is that Emu will happen and that it will start
in 1999, or very soon after. But that remains probable, not certain.
Who decides whether it starts and who joins?
In the spring of 1998 European Union heads of governments will decide
at a summit whether Emu should proceed. This will occur after the European
Monetary Institute, the forerunner of a European Central Bank, and the
European Commission, have judged which countries meet the single currency
convergence criteria, which are that:
Government deficit and debts must be no more than 3 per cent and 60 per
cent of gross domestic product respectively;
Inflation rates and long-term interest rates be within 1.5 percentage points
and 2 percentage points of the average of the three countries with lowest
The currency has stayed within the Exchange Rate Mechanism bands for two
Countries must fulfil these criteria in 1997 to qualify as founder members
of Emu on January 1, 1999. Countries must also have an independent central
That sounds tough. Will any country actually manage that?
Many will have difficulties. But the criteria can be interpreted flexibly:
the Maastricht treaty indicates that debts that are falling towards
the target may be acceptable. Deficits close to the 3 per cent ratio may
also be accepted.
So who will join?
Emu is almost unimaginable without France and Germany. Countries already
closely tied to the D-Mark - Netherlands, Austria, Belgium and Luxembourg
- will almost certainly join. Ireland and Finland are strong contenders.
What about the rest?
Some might also join in 1999. Many may join later. The UK and Denmark,
for example, are reluctant on political grounds, but that could change.
Italy, Spain and Portugal may have problems qualifying in 1999, but could
be promised entry soon after. Sweden might also join at some point. The
only EU country which can be counted out for several years is Greece.
But if countries join at different stages, won't that complicate
Yes - but the Emu timetable is already staggered over several years.
So once the members have been chosen, what happens in 1999?
The single currency, the euro, is created as a unit of account. The
European Central Bank takes control of monetary policy in all Emu countries.
Will there be any euro
notes and coins around?
No. Existing notes and coins will circulate until euro cash is introduced.
So how can you have a "single" currency then?
The crucial point to keep in mind is the difference between cash
and a currency. After 1999 different forms of cash will exist
in Emu member states. But they will not be separate currencies - they will
be "non-decimal denominations" of the euro, locked in at permanent conversion
This concept is crucial. The easiest way to think about it is to visualise
a currency such as the US dollar. One US cent is a "denomination" of the
dollar. But imagine that there was another US coin - worth perhaps 7.2
cents. That coin would also be a denomination of the dollar: it would be
"locked" into the dollar at a fixed conversion rate, just like cents are
"locked" into the dollar at a conversion rate of 100 to one. And the US
cent and the new coin would be fully interchangeable.
After 1999, the notes and coins of the French franc and D-Mark will
be locked together and into the euro at permanent conversion rates. Just
as nobody would think of trying to convert cents into dollars at anything
other than 100 to one, so - in theory - the D-Mark and franc would be interchangeable
at fixed rates.
How will these conversion rates be decided?
The formal decisions will be taken by finance ministers on Day One
of monetary union, but it could come earlier to counteract market speculation.
Several ideas have been mooted. The Frankfurt-based European Monetary Institute,
the forerunner of European Central Bank, has suggested that average exchange
rates over three years (1996-1998) could be used.
This could be "weighted" to give more emphasis to earlier years to discourage
speculation in late 1998. Alternatively, the central parity rates in the
Exchange Rate Mechanism might be chosen. Or the actual market rates in
the basket currency, the Ecu, could be used (the Ecu is due to be replaced
by the euro at a rate of one to one in 1999 anyway.)
If the Ecu method is used, one euro would be roughly equivalent to DM1.9,
or £0.77 or FFr6.5 at current exchange rates. The ERM method yields
a similar (but not identical) level.
But what if I want to change
D-Mark notes into French francs at a different rate?
In theory, nobody should want to. There will also be legal measures
which would discourage this: debts in francs or D-Marks, for example, could
be freely converted into euros at any point, which reduces the motive for
But if the markets suspected Emu could collapse after 1999, some currency
dealers might try. They might, perhaps, buy more D-Mark denominated instruments,
which could create a separate market "price".
If there is one currency, will there be one monetary policy?
Yes. Interest rates will be set by the ECB.
Where does the ECB come from?
It will be the successor to the Frankfurt-based EMI, which is currently
making practical preparations for the ECB.
How will the ECB operate?
It will be structured rather like the Bundesbank. The Maastricht treaty
envisages that it will have a Governing Council, which will set monetary
policy. Central bank governors from each Emu country will sit on this.
There will be a full-time executive board in charge of day-to-day issues,
which will also participate in the governing council. Mr Wim Duisenberg,
Dutch central bank governor, is tipped for president.
What language will it use?
Most central bankers expect it to be English - even if the UK does
not join Emu.
Will the ECB have links with non-Emu members?
Another grouping, the General Council of the ECB, will be made up of
the central bank governors of all 15 member states. This will allow the
ECB to co-ordinate closely with non-Emu members: after all, most non-Emu
members could join Emu in the future, and most non-Emu members will be
tied to the euro through a new exchange rate mechanism.
Will all non-Emu members be part of the ERM?
It will not be compulsory. The UK and Sweden may be unwilling to join.
How will the ERM work?
The ERM will be anchored around only one currency - the euro (under
the current system the currencies are linked in bilateral bands.) Currencies
will normally move within 15 per cent bands, though some countries may
choose narrower bands.
The ECB is committed to supporting the system through intervention.
However, its obligations may be moderate, since it will have the right
to call for the realignment of currencies.
Will there be a parallel to the ECB at governmental level? A club
of finance ministers, say?
The issue is a political minefield. Any attempt to create an "exclusive"
club could divide the EU. Consequently, no new intergovernmental institutions
are officially planned. But the emergence of some form of Emu "club" is
certainly the next logical step. This is because it is difficult to separate
monetary policy from other areas of fiscal and economic policy. And some
decisions will be taken only by "ins" (such as sanctions in the stability
pact and external exchange rate policy).
How will the ECB make interest rate decisions?
The governing council will decide the direction of monetary policy.
Each Emu central bank governor will have an equal vote, together with each
member of the ECB's executive board.
Won't that cause arguments?
Almost certainly - particularly if some central banks want a rate rise,
and others want a cut.
How will the ECB judge whether a rate rise is needed?
Countries such as the UK and Sweden want to use inflation targets.
Germany has previously pressed for monetary targets. But Germany might
now be backing away from this - not least because monetary statistics could
be initially unreliable. A mixture of inflation and monetary targets is
Will the ECB be as tough as the Bundesbank in its fight against inflation?
The Maastricht treaty states the ECB's primary objective is maintenance
of price stability. It may be keen to demonstrate a tough stance in the
early months to establish its credibility. But decisions will be taken
collectively - and some central bankers might want a more relaxed monetary
Will the ECB want a strong or weak euro?
No one knows. Some economists think the ECB will want a strong euro,
to guard against inflation. Others think politicians will want to weaken
the euro against the US dollar, to help exporters. But the strength of
the new currency will also be affected by whether institutional investors
and central banks across the world buy euros as a reserve currency.
But what about other factors affecting the currency - debt levels,
The single currency convergence criteria are supposed to ensure the
Emu area starts on a healthy fiscal footing - and thus that the money is
sound. There will also be a fiscal stability pact to guarantee that countries
stick to healthy fiscal policies afterwards.
How will the fiscal stability pact work?
The details are still controversial. But current Commission proposals
envisage that countries will pledge to keep their budget deficit below
3 per cent of GDP. If they fail, they will be given 10 months to reduce
it. After this they would have to lodge a non-interest bearing deposit
with the Commission. If the country takes no action for two years, it could
face a fine of up to 0.5 per cent of GDP, if approved by two thirds of
But what if one country goes off the rails completely? Will it be
European governments have agreed a "no bail out" principle. Thus, in
theory, a country could go bankrupt after Emu - just like a US county can
go bankrupt. Consequently, credit agencies plan to give each country a
separate credit rating.
But it remains unclear how the ECB would respond if a country did ever
threaten to default, not least because this could threaten the credibility
of the system.
What will happen to the old national central banks in Emu countries?
Will they disappear?
No, though they are likely to shrink. They will join together in the
federally structured European System of Central Banks.
But what will they have left to do?
They will act as the operating arm of the ECB in each country: for
example, implementing ECB-set interest rates by operating in their own
local euro money markets. Other work not related to monetary policy (such
as banking supervision in many EU countries) will also remain their responsibility.
How will these money market operations be conducted?
The EMI will outline this early next year. The system will probably
look rather like current German practices: the ECB will set two rates which
will define an interest rate "corridor". Short-term money market rates
will move within these, mainly guided by tenders for repurchase agreements.
Will there be a single centralised money market?
It has been agreed that money market operations in euros will be spread
between the national banks. But there may be pressure for concentration
in the future.
What about other parts of the financial markets? Will they be in
The picture could be patchy. Government bonds issued after 1999 will
have to be denominated in euros. But treatment of outstanding bonds in
national currencies maturing after 1999 could vary. The French government
intends to convert all its financial markets to euros immediately - including
outstanding bonds. The Germans are expected to convert many outstanding
bonds. But some instruments may remain denominated in the old currencies
But if a packet of French bonds, say, is converted into euros, will
it still be a round number?
Probably not: investors could face some very ugly numbers.
Will the conversion to euros affect the way that Europe's financial
A single currency will create more transparency between markets - and
thus could create pressure for more concentration and harmonisation. However,
government bond markets may remain differentiated because investors will
treat countries' credit risks differently. Harmonisation of the markets
may also be undermined by current variations in market conventions.
Which financial centres will win or lose from this?
Europe's smallest financial centres, such as Brussels or Milan, could
suffer. But the potential business shift between London, Europe's largest
centre, and Paris and Frankfurt, is uncertain. If the UK joins Emu, London
would probably dominate the euro-related market. If it stays outside, the
picture will be complicated. The UK might lose some euro-related business
to Frankfurt and Paris because it may face curbs in its access to euro
liquidity in the future payments system, Target. But if the Emu area introduced
a tough regulatory framework, this might make the UK attractive as a quasi
Just as it has a euro-dollar market, for example, it might develop a
"euro-euro" market. The interesting tussle, if the UK stays out, will be
between Frankfurt and Paris: they will both be competing to be the main
international financial centre in Emu.
Will anybody be using euros outside the markets?
Several big European companies such as Siemens and Philips intend to
switch to accounting in euros in 1999. Any move by big businesses could
force smaller ones to follow suit.
Even if businesses do not use the euro for internal accounting, there
may be a tendency to quote prices in euros for trading from 1999 onwards.
Could companies actually stop using national currencies after 1999
Probably not, because consumers will still be using national currency
units. The public sector will probably be working in national currency
units as well. A further obstacle to any rapid switch is that companies
may not be able to pay taxes and file accounts in euros.
Can companies be forced to use euros?
European governments have agreed that there will be "no compulsion"
and "no prohibition" in the use of the euro between 1999 and 2002.
But what if one business partner wants to use euros - and the other
Commercial clout will probably dictate the outcome, unless banks bear
the conversion costs.
But won't coping with two currency units be complicated for companies?
Big companies which already deal in many currencies will probably not
have difficulties. Small companies used to dealing with one currency could
find it harder.
Why are notes and coins not being introduced until 2002 then?
Central banks say three years are needed to print the banknotes and
mint coins. Retailers and banks also want a long run-up. And the public
sector could need a long time to prepare: governments have barely begun
to consider logistics of changing their services over to euros.
But governments could change the date if they wanted: some Commission
officials, for example, have suggested introducing the cash in the autumn
How will the new cash be introduced?
The official scenario envisages a gradual introduction - in the first
six months of 2002. During this period the old currencies would circulate
as well. This could help consumers adapt. Retailers are vehemently opposed
to this. They want a "big bang" approach, with the old cash replaced by
the new very rapidly, instead of circulating in tandem for a period.
What will it look like?
A competition to design the banknotes is under way. There will be one
common design for the banknotes and coins, but space will be left for separate
national symbols on the coins, and probably the notes as well. The UK,
for example, could probably keep its monarch's head on the cash if it joined.
What happens to vending machines?
The industry says converting them will take six months: there are over
a million coin-operated machines in the UK alone.
What about non-Emu areas - the UK perhaps? Will its companies have
to worry about all this?
If the UK stays out of Emu, banks and financial institutions will need
to cope with a new "foreign" currency. Companies trading with Emu countries
may have to deal in euros. And if the Emu area is large enough, the euro
may even become a popular price reference for some business sectors in
But the UK will avoid the most costly part of the exercise - introducing
the new cash. Unless, of course, it decides to join later.
How much will all this cost?
Nobody knows. EU retailers have estimated a bill of between Ecu17bn
and Ecu27bn. Banks estimate their costs will be Ecu10bn - but that figure
is almost 18 months old and considered an underestimate. Nobody has tried
to calculate the cost for other companies yet.
Who gains from the switch?
Not Europe's foreign exchange booths. But computer companies will see
a surge in demand for their services, as systems are adapted to Emu. Accountants
and management consultants may see surging demand for Emu advice. And companies
which print banknotes have reason to celebrate. And, of course, if you
believe the Emu enthusiasts, all businesses should eventually benefit from
the economic integration and stability which a single currency could eventually
deliver. That, after all is supposed to be the whole point of this fiendishly
complex project. But that's another story...