Options for Europe – Part 12

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[PRIOR MATERIAL HERE FOR CHAPTER 1]

[THE NEXT SECTION FOLLOWS ON THE DISCUSSION ABOUT THE BASIC DIFFERENCES OF OPINION BY THE FRENCH AND GERMAN ABOUT HOW THE ECONOMIC AND MONETARY UNION MIGHT BE INTRODUCED. IT COMES UNDER THE HEADING – “The Monetarist-Economist (Franco-German) struggle on the road to union”]

The failed Snake in the Tunnel – an early warning ignored

[PREVIOUS MATERIAL HERE]

[NEW MATERIAL TODAY FOLLOWS]

On March 6, 1971, the Committee of Governors of the Central Banks of the Member States met as these currency pressures continued to mount in the face of huge capital inflows into Europe and out of the US, which forced the central banks, particularly the Bundesbank to sell large volumes of their currency to defend the fixed parity. The meeting sought to devise a way to reduce the fluctuations between the European currencies. Under the Bretton Woods system, the IMF allowed currencies to fluctuate by plus or minus 1 per cent with respect to the US dollar. This meant that European currencies could, in principle fluctuate by as much as 4 per cent against each other because a plus or minus 1 per cent against the US dollar translated into a range of plus or minus 2 per cent against each other. The Community Member States considered that degree of variation to be too large and in the European Monetary Agreement, signed in 1958, they agreed to limit fluctuations against the US dollar to plus or minus 0.75 per cent and plus or minus 1.5 per cent against each other. At the March 1971 meeting, the Governors agreed they would experiment with a narrowing of allowable margins in value between the Member State currencies from 1.5 per cent (plus or minus 0.75 per cent) to 1.2 per cent (plus or minus 0.6 per cent) and thus defining a new ‘snake’ for the currencies to follow.

Another main concern of the meeting was to establish a “Community-wide level of the US dollar” (“‘niveau communautaire’ du dollar”) (Committee of Governors, 1971: 8). That is, the ‘tunnel’ that the ‘snake’ might move within. After considerable discussion nothing was agreed, except to defer the question and seek more technical input to later meetings.

Events, however, overtook them. The system of fixed exchange rates relied on nations having gold resources to meet temporary balance of payments deficits and the US guaranteeing US convertibility into gold. The IMF also played an important role in extending loans to nations who were short of foreign currency, that was needed to defend their exchange rates at times of considerable pressure. The reality of world trading relations was that these requirements could not be sustained.

There had been heavy capital inflow to Germany in 1970 after Germany had increased its interest rates to stop its economy overheating and this continued into 1971 (BIS, 1971). The BIS (1972: 23) wrote at the time that the “outflow of funds produced a US external deficit of a size never before seen, though soon to be dwarfed by that of 1971”. To reduce the overwhelming upward pressure on their currency, the Bundesbank was selling the Deutsche Mark “on a substantial scale” (BIS, 1971: 13). In early May 1971, the scale of the Bundesbank US dollar purchases became huge as various German commentators (leading research institutes) started to talk of a Deutsche Mark float (BIS, 1972) and other European discussions about the need to create more flexibility between the European currencies and the US dollar were on-going.

The crisis came to a head on May 5, 1971, when the Bundesbank suspended further foreign exchange market intervention (that is, they stopped selling the Mark to buy the US dollar) and closed the foreign exchange market. The central banks in Austria, Belgium, the Netherlands and Switzerland “followed suit” (BIS, 1971: 13). The Germans had a tainted choice: either alter domestic policy settings (cut interest rates) and risk a worsening inflation, impose capital controls and revalue their currency or free themselves from the external constraint imposed by the Bretton Woods system by floating. The German Government, in defiance of the Bundesbank, actually proposed a joint float of all the Member State currencies against the dollar, a proposition that only the Dutch supported (Hoffmeyer, 2000: 30).

The Council of Ministers of the European Communities were determined to maintain the fixed parities claiming that “‘under normal circumstances’ a system of flexible exchange rates within the Community was not compatible with the efficient operation of the Community” (Bundesbank, 1971: 9). Of-course, these were anything but normal circumstances and so the Germans were begrudgingly allowed “for a limited period” to “extend the margins of fluctuation of the exchange rate of their currency” (Bundesbank, 1971: 9). Four days later, Germany and the Netherlands floated their currencies and both immediately appreciated. In addition, Austria revalued by 5.05 per cent and Switzerland by 7.07 per cent (BIS, 1972). The French steadfastly refused to abandon the parity and discontinued “further negotiations on monetary questions” with the other Member States (Hoffmeyer, 2000: 30), thus putting paid to the agreement of the Committee of Governors of the Central Banks to experiment with a more restricted snake.

The fact that two currencies had appreciated and two others had revalued within the fixed-exchange rate system and the fact the the US trade balance went into deficit as its economy improved tolled the death knell for the Bretton Woods system. The bell rang on Sunday, August 15, 1971 when the US President effectively brought an end to the Bretton Woods system of fixed exchange rates by closing of the gold window and the suspending the US dollar gold convertibility.

What all this showed was that nations with very different economies and export strength would always find it difficult tying their exchange rates together unless they were prepared to accept politically unpalatable choices regarding ….

THE CRISIS HAS OCCURRED AND TOMORROW WE WILL EXAMINE THE IMMEDIATE AFTERMATH LEADING TO THE SMITHSONIAN AGREEMENT DECEMBER 1971, THE BASEL AGREEMENT 1972 AND THE SHENANIGANS THAT FOLLOWED.

THIS IS LEADING TO THE CREATION OF THE EMCF, THE FAILURE OF THE SNAKE, AND STAND-OFFS GALORE!

[TO BE CONTINUED]

[THEN MORE TO FOLLOW – ON THE INITIATIVES LATER IN 1970s DEBATES, DELORS REPORT etc COMING]

Additional references

This list will be progressively compiled.

Bundesbank (1971) Monthly Report of the Deutsche Bundesbank, May 1971, Frankfurt-am-Main.

Hoffmeyer, E. (2000) ‘Decisionmaking for European Economic and Monetary Union’, Occasional Papers No. 62, Group of Thirty, Washington DC.