EMU uber alles: the German syndrome

As the Europhile brigade is so often fond of pointing out, the man on the Hamburg omnibus may be in favour of greater European unity in principle, but is much more wary when it comes to monetary union.

The reason usually given is that the average German does not want to give up his "precious deutschmark". This is undoubtedly true - for many Germans the mark is a symbol of which they can be unequivocally proud. As well as being a symbol of the German economic miracle, the stability of the currency stands in stark contrast to past experiences with other "marks" this century. In addition, of course, it is also a symbol of the post-war period of German history and a tangible token of Germany's break with its troubled past.

Even when the currency is obviously too strong, to the degree that it may be costing Germans jobs, it is psychologically difficult even for economists in Germany to call explicitly for that dreaded word: devaluation.

But when it comes to EMU there is another dimension to German fears. It is that they are afraid they would be replacing their strong mark with a weak euro. And they point to the behaviour of the ecu for justification.

But this is to compare apples with oranges. The ecu has indeed been weak against the mark; since it was last reconstituted (for the last time) in 1990, it has lost as much as 11 per cent of its value against the German currency (in March 1995), and currently stands 6.3 per cent below its level in l990. But the ecu is not a normal currency: you cannot spend it anywhere and its value depends on the value of other currencies. The ecu is a "basket" currency, made up of fixed amounts of 12 "real" currencies.

The dirty dozen in question are those of Germany, France, Italy, the UK, the Benelux countries, Spain, Denmark, Portugal, Ireland and Greece. The ecu does not include any amounts of Austrian schillings, Swedish krona or Finnish markka because those countries were not in the EU when the basket was "frozen" by the Treaty of Maastricht.

But among the 12 that are included are a number not renowned for their strength. These include our own sterling, the lira, the peseta, the escudo and the drachma. (Although sterling and the lira have both done well of late, neither has scaled the heights at which they stood against the mark in September 1992.) These currencies add up to only some 25 per cent of current weighting but, as the chart shows, they are responsible for 100 per cent of the depreciation of the ecu against the mark since 1990.

The other notable point about the infamous five is that they are precisely those currencies which do not seem likely to join the first wave of monetary union in 1999. No one can be certain yet which countries will be invited to take part, but the general consensus at the moment does not include any of the five weaker components of the current ecu.

When EMU takes place, the currency that would replace the mark will not even be called the ecu and it will differ from it in a number of crucial and fundamental ways. The new euro will no longer be a basket currency, but the legal tender of a number of countries and the Maastricht criteria are there in effect to ensure that only the strongest countries in Europe are included in that group. As a result, the euro into which the mark will metamorphose would have little, if any, of the weakness associated with the current ecu.

A better picture of how the euro might have behaved against the mark is created if one splits the ecu basket in two: one containing the five "weaker" currencies, and the other seven, six of which will probably be in the first wave of EMU. (Denmark, included in the "strong" basket, will probably opt out, but this has no material effect on the results.) And those results are impressive.

The chart shows what has actually happened to the mark/ecu rate, as well as to the "weak" basket and the "strong" basket. The actual mark/ecu rate is the line in the middle and it clearly shows the depreciation of the ecu against the mark up till 1 March 1995, and its subsequent recovery since then. The lower line shows how the "weak" five- currency component of the ecu has behaved against the mark. And the top, almost straight line depicts the remainder of the basket, also against the mark. It is clear the portion of the basket containing only the seven relatively strong currencies has remained remarkably stable.

In the seven years since January 1990 we have witnessed episodes of huge strain in the ERM, particularly on Black Wednesday in September 1992 and again in August 1993, yet the mark value of the "strong basket" never deviated by even as much as 2 per cent from the value of the mark. Even more surprising to those who have blindly accepted the arguments of EMU opponents, the "strong basket" has spent over 80 per cent of the time since January 1990 being stronger than the mark - only episodes of extreme speculation against the ERM have prevented this "strong basket" from tracking the value of the mark even more accurately. The conclusion is clear: German fears about the future weakness of the euro are not well founded historically: indeed if EMU had taken place in l990, the euro could have been expected to have had about as much stability as the mark has displayed since then. This argument does not address the more symbolic values that are enshrined for many Germans in their currency, but it should illustrate that the new European currency need not be the weakling many assume it will be.

q Chris Golden is head of research at the Japanese broking house Nomura in London.