Recent events make more likely a "soft" Emu incorporating Spain and Italy. But this will make it more vulnerable to currency speculation during the transitional period 1999-2001by Walter Eltis / July 20, 1997 / Leave a comment
The political turmoil surrounding European monetary union-following the victory of the French socialists and Chancellor Kohl’s rebuff from the Bundesbank-makes all prediction about the future of Emu dangerous. But whether the destination is a hard or a soft euro, the political will to start on time remains overwhelming. As has been pointed out before, Emu is primarily a political project. It has survived the covert undermining of the Maastricht criteria (through various forms of creative accounting) and it will now probably withstand the overt undermining of the criteria. Dominique Strauss-Kahn, the French finance minister, has already called Maastricht’s 3 per cent budget deficit limit “a bit ridiculous.” And it is hard to see how either France or Germany can now qualify for Emu under the original terms.
This laying bare of the political heart of Emu should not, however, preclude drawing attention to some of the practical difficulties for the three year transitional period (1st January 1999 to 31st December 2001) during which the Emu member currencies will be “irrevocably” fixed against one another but still remain legal tender. Indeed, the further politicisation of Emu may make it economically unsustainable during this transitional period.
A broad Emu, which is likely to include some of Europe’s most financially vulnerable economies, will generate some furious political rows at the European central bank. Some of the weaker economies are likely to find their definitively fixed exchange rates unsustainably high and will start to run large budget deficits, crowding-in resources from others with sounder finance.
The financial markets will be watching all this very closely. In theory, Emu cannot be broken by speculators between 1999 and 2002 because each national cur-rency will be an irrevocable part of the euro-a euro-DM, a euro-lira, a euro-peseta and so on. But those who hold lira denominated bonds (and Italy’s debt to GDP ratio is more than twice Maastricht’s permitted 60 per cent so there are plenty of them) may well prefer to switch to euro-DMs, just in case of a breakdown. Again, in theory this should cause no difficulty. If savers prefer to hold euro-DMs to euro-liras or euro-pesetas, the Bundesbank is obliged under the Maastricht treaty to simply print more Deutschmarks.
If the Bundesbank is willing to be an unlimited buyer of liras or pesetas and issuer of Deutschmarks, then the irrevocably fixed exchange rate will be sustained. All the liras and pesetas and Deutschmarks…