Options for Europe – Part 13

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]

The Smithsonian Agreement – December 18, 1971 – Clutching at Straws

When President Nixon refused the demands by countries to convert dollars in gold (principally from the UK) on August 15, 1971, the dollar became a non-convertible fiat currency. If all nations had have followed suit and floated at that point the World would have been a better place. We will discuss why that would have been the case in a later chapter. The unilateral action by the US was seen as a major problem for the other nations in the Bretton Woods system. They had three options: (a) fully float their currencies against the US dollar and all other currencies; (b) jointly float against the US dollar – that is, maintain parities between themselves but allow for flexibility against the dollar; or (c) continue to peg to the, now non-covertible US dollar.

During the Deutsche Mark crisis in May 1971, the Germans had proposed that the Member States of the European Community arrange a joint float against the US dollar but this was rejected by the French, who steadfastly wanted to maintain the peg with capital controls to reduce the fluctuations. The French, irrationally, saw danger in anything resembling a float. Before the foreign exchange markets reoponed again following the shock announcement by the US to close the gold window and abandon convertibility, the Germans once again proposed a joint float and the French continued their resistance.

The widely-read German weekly newspaper Die Zeit wrote a few days before the collapse (August 13, 1971) that the German Economic and Finance Minister Karl Schiller was unhappy with the policy of the Bundesbank and wanted it to place the US dollar under more pressure in May (“Es ist kein Geheimnis, daß Karl Schiller zunächst mit der Politik der Bundesbank unzufrieden war. Der Wirtschafts- und Finanzminister hätte im Mai gerne einen stärkeren Druck auf den Dollarkurs gesehen” De Zeit, 1971a). It also said that the experience of the last three months made it clear that floating the Deutsche Mark eases the concerns of having to defend the parity (“Floating schützt vor Sorgen” De Zeit, 1971a).

Two weeks later (August 27, 1971), De Zeit covered the acrimonious and closed meeting of Finance Ministers (Ecofin) in Paris on August 19, 1971 where the Germans repeated their desire for a joint European float and the French again vetoed the idea. De Zeit said the “differences in Paris were to be regretted” and reflected, in part, a return of the “personal animosity between Karl Schiller and his French opponent Valery Giscard d’ Estaing” (“Im Wirtschaftsministerium werden die Differenzen mit Paris bedauert, aber nicht überbewertet, zum Teil auch nur „auf persönliche Animositäten” zwischen Karl Schiller und seinem französischen Gegenspieler Valery Giscard d’Estaing zurückgeführt” Die Zeit, 1971b). It also suggested it was difficult to understand the French fear of German “superiority” (“Auch für die französische Furcht vor der sogenannten deutscher „Übermacht” hat man wenig Verständnis”) and that other nations had seen the sense of floating with the Deutsche Mark.

The French Economic and Finance Minister, Valéry Giscard d’Estaing reaffirmed to the French National Assembly on May 13, 1971 (Assemblee Nationale, 1971: 1818) of the Government’s “determination not to change the current parity of the franc and thus leave, in this respect, no illusions and no hope for speculators. I confirm to the National Assembly that is obviously not a question of changing the current parity of the franc” (“Nous avons affirmé, dès l’origine, notre détermination de ne pas modifier la parité actuelle du franc et donc de ne laisser, à cet égard, aucune illusion ni aucun espoir aux spéculateurs. Je confirme devant l’Assemblée nationale qu’il n’est évidemment pas question de changer la parité actuelle du franc”). He also said that the French government would “remain faithful to the spirit and letter of the Bretton Woods agreement, which provides for fixed exchange parities” (Assemblee Nationale, 1971: 1819) (“nous restons fidèles à l’esprit et à la lettre des accords de Bretton-Woods, qui prévoient des parités de change fixes”). The French clearly were sticking to the hope that irrespective of the reality of international events that they could somehow make some progress to a monetary union, which would see stable exchange rates and a funding mechanism for the CAP. The head was firmly in the sand!

The foreign exchange markets reopened a week later on Monday, August 23, 1971 and only France held onto its fixed parity against the US dollar but that was only for official and commercial transactions (BIS, 1972: 27). All other European currencies were floating and appreciating against the US dollar. The Japanese initially tried to maintain the parity against the US dollar but this required massive intervention by the Bank of Japan (selling yen and buying dollars). The BIS (1972: 27) noted that the “Bank of Japan had to absorb dollars on a scale so massive … that on 28th August the yen too was allowed to float”. The reality was that all currencies were now finding their own value against the obviously overvalued US dollar in accord with their relative trading performance and domestic economic strength.

But leopards don’t easily change their spots or rather fools seldom differ! The major statements coming from the various governments indicated that “all the main countries wished to restore fixed exchange rates” (BIS, 1972: 27) but recognised the arrangements under the Bretton Woods system were unsustainable. There was the fear of the unknown. Many of the appreciating nations, especially Germany, were worried that their currencies would go to high and, as a consequence, resumed ‘official intervention’ (that is, buying US dollars and selling their own currencies) to limit the scope of the float. The export lobbies in these nations were powerful and feared they would be priced out of their markets as a result of the currency appreciating too far. Further, the various rates of appreciation altered the relative competitiveness of nations in terms of their own currencies, which introduced further political tensions. Speculators were not making matters easier by betting on differential movements, which exacerbated the political problems faced by governments.

Another problem was that the US government was reluctant to alter its value against gold, which the Europeans considered violated the “IMF rules by being unwilling to devalue” (BIS, 1972: 28). The argument was that the US balance of payments had reached a point of fundamental disequilibrium (which just meant that the outflow of capital into other nations would continue indefinitely and speculators would converge on the view that the US dollar was overvalued) and that such a state required a devaluation so that the system could recalibrate. Despite being the ‘big kid on the block’, the US had to bow to international pressure and the task was to work out what the new parities should be given the large US balance of payments deficits.

At the end of November 1971, the G10 Finance Ministers and central bank Governors met in Rome to try to work out a new set of currency parities. These discussions led to a meeting in December 1971 in Washington. During this period most of the major currencies had appreciated by considerable margins against the US dollar and it was obvious the latter would have to devalue if a system of fixed exchange rates was to be restored. On December 18, 1971 the G10 parties met at the Smithsonian Institute in Washington and signed the so-called Smithsonian Agreement.

The agreement established a new set of parities although unlike the Bretton Woods system, the US dollar would not be convertible into gold. It would remain a fiat currency that the other nations pegged against. The major components of the agreement were that the US agreed to devalue the US dollar to $38.00 per ounce of gold (from $35 per ounce which was the parity that prevailed under the Bretton Woods system). Most other nations agreed to revalue their currencies and the average upward revision was around 10 per cent, a significant realignment. France and Britain were passive and their parities altered in line with the US devaluation (about 1 per cent) (BIS: 1972: 29). The US also made not commitment to intervene in foreign exchange markets to maintain the value of the now, non-convertible dollar. The new international monetary system was no longer a gold standard but rather an unanchored US dollar standard. The technicalities of the differences between the two systems are beyond the scope of our discussion but essentially, the responsibilities among the parties (the US and the rest of the world) are reversed, with the US now required to uses its monetary policy settings to maintain price stability given there is no gold anchor but may choose not to. On the other hand, the pegging nations had to ensure their balance of payments were in equilibrium to avoid any pressures on their currencies against the US dollar. The nations also agreed to widen the band within which their currencies could fluctuation against the US dollar from plus or minus 1 per cent to 2.25 per cent, meaning there could now be a spread of 4.5 per cent against each other.

The initial response “to the Smithsonian agreement were generally very positive, reflecting relief that the period of floating exchange rates was over” (BIS, 1972: 30). But, by early 1972, the revaluations led to further speculative attacks on the US dollar which pushed several currencies (Deutsche Mark, Guilder, Belgian Franc and Yen) to their upper limits within the allowable ‘tunnel’.

It soon became obvious that the system was not viable. Facing an election, the US government was running a very expansionary monetary policy (interest rates low) which led to inflationary pressures in Europe and very strong balance of payments surpluses as a result of their higher interest rates attracting massive capital inflows from the US. Early 1973 became 1971 revisited.

THE CRISIS HAS OCCURRED AND TOMORROW WE WILL EXAMINE the FORMAL SNAKE IN THE TUNNEL – 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.

Assemblee Nationale (1971) Journal Officiel de la République Française, Debats Parlementaires, Jeudi 13 Mai 1971,
http://archives.assemblee-nationale.fr/4/cri/1970-1971-ordinaire2/025.pdf.

Die Zeit (1971a) ‘Die Dollar-Krise wird bedrohlich’, August 13, 1971, http://www.zeit.de/1971/33/die-dollar-krise-wird-bedrohlich

Die Zeit (1971b) ‘Report Aus Bonn’, August 27, 1971. http://www.zeit.de/1971/35/report-aus-bonn