Consumer Finance International Retail Banking Wealth Management LoBue Technology				Moving to the Euro... ARE WE REALLY READY OR ARE WE A STEP AHEAD OF TIME? The euro has arrived on the international scene with much fanfare... but is the world really ready? Looking at history as a lesson for the future. "Business men of all sorts are showing their willingness to come into this arrangement, which I venture to characterize as the constitution of peace." Winston Churchill? Francois Mitterand? Helmut Kohl? It certainly sounds like a European statesman who believes a single currency will succeed both as a strong economic unit and as a means to eliminate war. That was the reason for the ratification of the Treaty of Rome in 1958 and the establishment of the European Commission. But in fact, these words were actually spoken by United States President, Woodrow Wilson, at the signing of the Federal Reserve Act in 1913. A HISTORY LESSON  While the strength of the United States economy now depends largely on the careful fiscal policies laid out by the Federal Reserve Board, it took the United States three attempts and more than 100 years to create a working central bank. Can the European Community succeed on its first try? Has it made the necessary political adjustments to ensure economic stability? To better understand what the future may hold for the euro and the steps that must be taken to ensure its success, a quick review of the history of the American banking system might present some interesting clues. When the US decided in 1781 to call its monetary unit the dollar, it was comprised of 13 member states and was very similar to today's European Union of 15 sovereign nations. States' rights advocates believed the federal government had no constitutional right to meddle in their affairs and this included the banking system. Each state chartered its own banks, which issued their own demand deposit notes. Banks would only accept notes from other banks at a discount. As a result, interstate commerce was difficult, monetary stability was almost impossible, and counterfeiting was rampant. It was estimated that a third of paper money in circulation was bogus. In 1791 Congress created a national bank, named The First Bank of the United States, to help pay off debts from the Revolutionary War. During its 20-year charter, it competed with state banks for customers from its home in Philadelphia. Political pressure from states' rights activists who questioned Congress' right to open a bank, pushed for its closure and won. The war of 1812 severely hurt international trade and notes issued to finance the war needed to be retired. This economic turmoil forced Congress to once again grant a 20-year charter to establish the Second Bank of the United States in 1819. During this time an important battle over a state's right to tax a federal institution reached the Supreme Court and decided the constitutionality of the federal government's right to charter a national bank. In 1819, Justice John Marshall decided, in McCulloch vs. Maryland, that Congress did have the right to establish a bank and that states can not tax a federally chartered bank. This effectively meant that monetary policy for the country belonged in the hands of the federal government. Despite strong evidence in its favor, the Second Bank of the United States also became a victim of politics, lost its national charter, and monetary control again returned to individual states. It was Abraham Lincoln who in 1863 finally brought the country together under a single currency. The National Banking Act was enacted to encourage the sale of government bonds to help finance the North's involvement in the Civil War. In order to expedite the development of the national banking system, a 10% tax was placed on state bank notes, effectively eliminating them from circulation. The government's new notes, commonly referred to as "greenbacks," were last issued in 1971. For a short time this system helped to stabilize the economy, but because there was no allowance for seasonal currency needs, or any flexibility in national or local lending practices, it failed to stave off two financial panics. Congress realized that a better system needed to be developed and in 1907 established a national banking commission. Its members traveled overseas to determine which aspects of various European central banking systems could be molded into an acceptable American monetary institution. Their findings helped to create the Federal Reserve system, which took effect in 1913. Its original purposes were to give the country an elastic currency, provide facilities for discounting commercial credits, and improve the supervision of the banking system. After WWI, the federal government expanded its role to manage currency and credit in order to solve worldwide economic imbalance as well. These three national banks chartered by Congress were established to pay off debts from war, whereas the European Commission was created as a way to ensure peace throughout the continent. Some have called it a "top-down" revolution spearheaded by elite politicians. This elite sees the introduction of a single currency as only one step, not the end result, of the process towards lasting peace. While the success of the euro is critical, there are still a number of important hurdles to overcome before the euro can truly take its place as the second strongest economic unit in the world. CAN HISTORY BE REPEATED?: SOME ESSENTIAL DIFFERENCES?   The design of the European Central Bank, which was recently empowered to monitor Europe's single currency, roughly resembles the Federal Reserve system in the United States. Both systems are charged with the responsibility of maintaining a healthy economy. However, Housen points out some troubling differences. WHO IS ACCOUNTABLE?   When the Federal Reserve chairman determines that the economy is growing too quickly, he or she can take steps to curb growth and hold off inflation. Before making its decisions, the Fed is required by law to take production and employment figures into account. In theory, it also works with the Treasury department to guide the economy. The White House can also try to influence the outcome since the Fed can be held accountable for its actions by Congress. In Europe, the aim of the Maastricht Treaty was to ensure that no single government could control monetary policy. The role of the European Central Bank is to oversee the euro with price stability as its goal. It is expressly forbidden to "seek or take instruction from community institutions or bodies, from any government of a member state or from any other body." "As a result," states Housen, " the bank is accountable to no one. Even the proceedings of the council's meeting can remain confidential." THE EFFECTS OF ASYMMETRICAL SHOCKS   Allowing the central bank to freely decide monetary policy can lead to political trouble. For example, if asymmetrical shocks are incorrectly handled by the central bank or individual governments, they could lead to a loss of confidence in the government and strong resistance to remaining tied to a single currency. Asymmetrical shocks occur when a group of economies experience growth or contraction at different rates. When the United States faces an asymmetrical shock, there are several steps the government can take to avoid long term problems. First and most importantly, the work force in America is very mobile. Moving from state to state is relatively simple. There are no language or strong cultural barriers. If emigration fails to balance the employment market, the federal government can step in to help alleviate economic stress. For example, if auto sales plummet and unemployment in Michigan threatens the local economy, the government can take surplus funds from California and send them to Michigan in the form of education grants to retrain people, tax incentive programs to stimulate new business, or other growth-oriented policies. In Europe, the adoption of a single currency has eliminated each member country's option to handle its own economy. Now, if France suffers from a drop in tourism while Germany is experiencing strong growth due to an increase in demand for automobiles, the European Central Bank must decide which country needs more help. If short-term interest rates for the euro are dropped, France might recover, but the move would increase the rate of inflation in Germany. "Take into account all 11 countries," suggests Housen "and the magnitude of the problem the European Central Bank must deal with becomes very apparent." ECONOMIC CONTROL AND ITS IMPACT ON POLITICAL POLICY   When each country had its own currency, it had three options at its disposal to help put its economy back on track. These options include: interest rate adjustment, exchange rate intervention, and fiscal adjustment. For France the correct monetary policy might be to use interest rate adjustments to encourage growth in other sectors of the economy. Or the government might believe that exchange rate intervention is the best way out and could devalue the franc and reduce the cost of a trip to Paris. The last option would be to pump money directly into the tourism industry through direct subsidies to encourage job growth. The single currency is encouraging businesses to consolidate, and while these corporations become stronger, the jobless rate will increase. People in Europe are first either Italians, Dutch or French, and Europeans second. They face cultural differences, language barriers, and social institutions that keep them from crossing borders to look for work. The right policies must be established to help people relocate for jobs. It is a steep uphill battle and politicians who are guiding the transition must decide whose job it is. Currently, there is no help available to individual countries. The European Commission in Brussels, which oversees the member governments, does not have the power. It has a budget of only 2.5% of all taxes received in the member countries, with more than half of the funds going directly to agriculture. The result is that the EC has no significant resources to offer and if they do attempt to choose one country over another, the political implications could result in conflict, calls of favoritism, and eventually a collapse of this fledgling economic unit. When the president of the European Central Bank, Wim Duisenburg, recently lowered rates for the euro to 2.5%, he mentioned that he had done his job, but the ball is now in who's court? Is it the responsibility of the heads of government in each of the 11 member countries to initiate radical political changes, or will the European Commission need to be granted more power to see that strict political policies can be established and enforced? The media continues to watch the economic effects of Europe's new single currency. The hope is that the politicians spearheading this transition remember the original goal of European unity and focus on policies that encourage long-term change and political harmony. "The reality of a successful, united Europe with a strong single currency," concludes Housen, "will arrive when its people see themselves as Europeans first." return
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