Memorandum by Dr William Porter
Evidence presented to the Treasury Committee of
the House of Commons on the subject of Economic and Monetary Union
by William Porter,
writing in a private capacity. June 2000.
The evidence takes the form of a two-page discussion
which makes two main arguments in a total of four points. Four
Annexes (not congruent with the four points) expand the summarised
arguments somewhat. A fifth Annex describes the author. Paragraphs
are numbered as requested in the Guide for Witnesses. The arguments
are simple, but it is submitted that they are powerful and reasonably
self-supporting. They are therefore presented briefly. Points
that are poorly-presented or controversial can be expanded upon,
by supply of supporting documentation, references, further written
evidence or oral evidence, which the witness is available to give.
The euro is unique. A currency is a legal construct.
The boundaries of the euro uniquely do not coincide with those
of a legal jurisdiction and of a political entity.
The euro therefore pools monetary sovereignty.
As a direct result of the unique nature of the
euro, a decision to join EMU is irreversible, regardless of nominally-retained
monetary sovereignty. In certain circumstances a new currency
could be introduced and circulate in parallel, but the status
quo ante can never be recovered.
There is widespread misunderstanding on this
issue, even in expert circles. The possibility of voters misunderstanding
The EMU debate must be conducted with no misunderstanding
on this central point. Entering EMU under a misapprehension that
it can be left should not be an option. Parliament has a key role
to play in ensuring that any guidance that Parliament receives
from a referendum is in the context of that understanding, perhaps
achieved via the wording of the question.
Secondly, the unique nature of EMU leads to
the current debate being coloured by assumed conclusions that
EMU either must end or must lead to political union.
Thinking through to those conclusions instead
of assuming them creates corollaries.
Consideration of adopting the dollar instead,
if only as a "control thought experiment" as part of
that process would put the issues into clearer relief.
2. Joining EMU is irreversible, in the sense
that despite retaining monetary sovereignty a country cannot leave
EMU by introducing a new currency and redenominating euro obligations
into it. The proof is simple: see Annex A for an expansion of
the following summary. Currencies are a legal construct. A sovereign
state retains monetary sovereignty. It can legislate the nature
of all currency transactions within its borders and under lex
monetae this precedent is respected by all other jurisdictions.
Globally, the currency of the United Kingdom is what Parliament
says it is, at whatever rate to the old currency Parliament decides.(1p
= 2.4d, for a weak example). For all major currencies other than
the euro, that is an end to the matter. This includes adoption
of the euro.
3. But the precedent will be subordinate
to another jurisdiction's own lex monetae if the two are
in conflict. This issue is unique to the euro and makes it indissoluble.
French-law contracts, for example, with private-sector counterparts
in the leaving country, assumed not France, will be enforceable
in euro in the French courts irrespective of the legislation of
the leaving country. (The EU's being agreed to have taken monetary
sovereignty would clearly put the issue beyond doubt.)
4. If the leaving country would have a weak
currency (and this works in reverse), entities would have ample
notice to ensure that their claims on the leaving country were,
to the extent possible, in a surviving-country jurisdiction and
the leaving country's claims were in the leaving country's jurisdiction.
This would impose very large costs, which are likely to be prohibitive
in light of the large cross-border flows and claims. The balance
sheets of banks, for example, are inextricably mixed across jurisdictions.
These costs will grow as all new trade is denominated to the detriment
of the leaving country (for example, as simply as moving deposits
from one branch to another of the same bank). If the currency
leaving were weak, these costs would weaken it further, creating
a negative spiral and economic meltdown.
5. The decision to enter EMU is therefore
permanent and irrevocable. The exception is the total, multilateral
breakup of EMU, which alone reclaims de facto monetary sovereignty.
A country can introduce a new currency to circulate in parallel
but this will fail unless needed as escape from a total collapse
of the system. The status quo ante is irrecoverable in
all circumstances (See Annex B).
6. Although EMU countries retain monetary
sovereignty, this is illusory and, for all practical purposes,
EMU entry is irreversible. The status quo ante can never be regained.
7. The point is clearly central to any consideration
of the merits of the EMU case.
8. There is widespread misunderstanding
on this central point, even in the most surprising circles. (See
Annex C for documentation. Further quotations can be provided,
but for now the witness submits the assertion.) It is therefore
likely that the vast majority of the voting public is capable
of becoming confused on this point.
9. There is widespread, erroneous belief
even in expert circles that EMU is reversible. This suggests the
possibility of confusion on the subject among the electorate.
10. All elements of the debate should
be conducted in the context that, as a matter of Parliamentary
record, UK entry into EMU would be permanent and irrevocable.
11. The issue causes other forms of confusion.
Those who, consciously or unconsciously, cannot accept the precedent
of a currency whose boundaries do not coincide with a legal jurisdiction,
tend to resolve the novelty either by considering EMU as being
unilaterally revokable (monetary sovereignty thereby remains uncompromised,
thus retaining boundaries coincident with those of the existing
jurisdiction) or an inevitable step on the road to a European
sovereign entity (for good or ill). Just as the first resolution
is wrong, the second is an assumed conclusion.
12. Maybe the disconnection between currency
and jurisdiction is indeed ultimately unsustainable, in which
case the euro must be ended multilaterally, or Europe must become
a sovereign State. But the possibility should at least be considered
that an apolitical monetary union is possible. The debate should
not be conducted with this important conclusion assumed, one way
or the other.
13. There are important corollaries even
to considering the question. If the possibility of the current
arrangement being stable is rejected, then the EMU debate can
be conducted on the basis of Economic, Monetary and Political
Union. If not, the political evolution of Europe can be considered
separately from EMU. And if monetary unions can exist independently
of political union, then the UK's decision on whether to forgo
monetary sovereignty need not be confined to the euro. Adoption
of another currency can be considered. This improvement to the
logic of the current debate is explored in Annex D.
14. Those who feel or claim that EMU
is apolitical and those who feel that it leads to an inevitable
erosion of all sovereignty should both therefore consider the
alternatives to both EMU and sterling. Essentially, dollarisation.
See Annex D.
15. More generally, the nature of the
uniqueness of the euro must be understood in the debate.
THE IRREVERSIBILITY OF A DECISION TO JOIN
A1. When Greece adopts the euro on 1st January
2001, all Greek drachma contracts globally will become euro contracts
as a result of lex monetae being applied in all major jurisdictions.
For the Greek drachma, that is an end to the matter, as it is
for any other currency being redenominated by its sovereign government.
The exception is the euro.
A2. No law passed in Greece can affect the
legal status of, for example, the German currency under German
law. And no law passed in Germany can affect the legal status
of the currency of any other sovereign nation, including Greece.
Under treaties incorporated into the law of all participant nations,
the currencies of Greece and Germany are "non-decimal denominations"
of a euro. Under the laws of all major jurisdictions (all participants
and major non-participant jurisdictions, who have passed laws
to the effect: see footnote), they are as interchangeable as silver
and brass coins or five- and ten-pound notes. This interchangeability
of currencies issued under different jurisdictions is unique to
and complicates irretrievably the normal application of lex
monetae, which is an essential component of monetary sovereignty.
A3. Let us say Germany "leaves EMU"
today. The German Parliament passes a law reintroducing the Deutschemark
at the existing parity of DEM1.95583 to
1. The physical euro is never to be introduced, existing
Deutschemark notes and coins are to be used for convenience, and
existing euro debts are to be redenominated into Deutschemarks.
Domestically, this causes minimum fuss: is imperceptible as, at
one level, the introduction of the euro has been. But internationally,
things are not that simple.
A4. French-law contracts, for example, between
French parties and private-sector counterparts in Germany, will
be enforceable in euro in the French courts. French courts will
see even surviving references to the "old" Deutschemark
as a reference to 1/1.95583 of a euro, since this is enshrined
in French law. Laws passed by the German Parliament which deem
references to "old" Deutschemarks as being references
to "new" Deutschemarks can therefore have no impact
at French law. As nor can any attempt to deem references to one
euro to be references to 1.95583 "new" Deutschemarks.
The normal precedent of lex monetae is subordinate to the
fact that French courts will not recognise the attempt of any
foreign power to legislate over the domestic currency of France,
still, for these purposes, most definitely a State with monetary
sovereignty. (The EU's being agreed to have taken monetary sovereignty
would clearly put the issue beyond doubt.) Entering the euro does
not destroy monetary sovereignty but effectively pools it with
other members' monetary sovereignty, at which point it is irretrievable
unless by mutual agreement.
A5. The position at other jurisdictions
is more complex, and much confusion is likely, there being no
precedent (Scott, 1998).
A6. If the leaving country has a weak currency
(and this works in reverse), people would have ample notice to
ensure that their claims on the leaving country were in a surviving-country
jurisdiction and the leaving country's claims were in the leaving
country's jurisdiction. This would impose very large costs, which
are likely to be prohibitive in light of the large cross-border
flows and claims. These costs will grow as all new transactions
are denominated to the detriment of the leaving country (as easily
as moving money between branches of the same bank). If the currency
leaving were weak, these costs would weaken it further, creating
a negative spiral and economic meltdown. An estimate of initial
costs would be given by
(GROSS annual cross-border flows of all types)
x (currency move) x (lead period in years) x (some fraction) +
A7. This can clearly reach many percent
of GDP within a few months. As the costs mount and the currency
falls, the cost mount until complete destruction of credit occurs.
A8. The decision to enter the euro is therefore
permanent and irrevocable. The status quo ante can never
A9. This argument is referred to elsewhere
in this evidence as "the main critique".
A10. Appendix B explores the possibility
of introducing a new currency to circulate alongside the euro,
but that this is possible only in theory and will be ineffective.
Appendix B also explores the fact that only the total, multilateral
break-up of EMU reclaims de-facto monetary sovereignty.
A11. Although EMU countries retain monetary
sovereignty, this is illusory and, for all practical purposes,
EMU entry is irreversible. The status quo ante can never be regained.
THE THEORETICAL "OPTIONS" OF INTRODUCING
OF A NEW CURRENCY IN PARALLEL, DISSOLVING EMU ENTIRELY OR JOINING
B1a. This is the preferred vehicle for arguing
that EMU is reversible. The fact that monetary sovereignty, while
pooled, is retained does indeed mean that a new, officially-legislated
currency can be introduced to circulate in parallel. This cannot
recover the status quo ante, but provides an opportunity
to recreate monetary sovereignty effectively from scratch. This
is likely to be very difficult, to the point of being unfeasible
in most circumstances. Its importance in thinking that EMU is
reversible should certainly not be exaggerated.
B1b. Establishing a new currency, so that
effective monetary sovereignty is recovered, requires its widespread
adoption by the banking system and the government, including the
redenomination of government debt. The main critique prevents
the government legislating equivalence between the euro and the
new currency. It can however redenominate its debt and demand
use of the new currency for taxes. There is no way to extinguish
domestic private-sector euro obligations. This establishes a situation
where a foreign currency (the euro) is circulated very widely
in competition with the domestic currency. In most countries,
this has already occurred to some extent. In Deutschemark note
form, the euro circulates widely in Eastern Europe. In Argentina,
the peso is interchangeable with the US dollar. To regain actual
monetary sovereignty, the new currency has to establish itself
throughout the economy. Gresham's law does not apply: history
suggests that foreign currencies circulate in response to a valueless
local currency. (Scott 1998). There are three cases.
(a) A new, weak currency. Were the euro still
a strong currency, with a new weak currency to be introduced,
the situation would resemble some of the history of Eastern Europe
and the economy would remain effectively "euro-ised".
Redenomination of government debt would provide some short-term
windfall gains to the public sector, in common with any such default,
but would not gain monetary independence and would incur large
costs. The country would be in breach of EU Treaties and would
lose whatever say it has in euro monetary policy. Those owing
overseas debts (and see main body: this is likely to include everyone
transacting overseas) would still be on the hook. Would a sovereign
(for rhetorical purposes) East Germany expect to gain from reintroducing
the Ostmark? Failure.
(b) A new currency and a chronically weak
euro. Were the euro chronically weak, the new currency could establish
itself. The original EMU would remain intact, but become irrelevant.
This method has been used by former Soviet Republics in connection
with the rouble. This indeed provides relief from the problem
of a euro devaluing to worthlessness (taking the legacy currencies
with it) but this scarcely constitutes reversibility of the decision
(c) A new, relatively stable currency and
stable euro. The economy might have diverged from the remainder
of the EU, leading the government to wish to regain monetary sovereignty.
New claims and government debt could be accrued in the new currency,
but old claims remain. Establishing the new currency requires
widespread redenomination to take place voluntarily on the part
of the private sector. Either debtors or creditors will push for
this, through the markets, depending on the reasons for introducing
the new currency and the monetary policy being pursued within
it. Debtors will seek to "redenominate" through the
markets into a weak, lower-interest-rate currency, creditors the
opposite. With a very small natural base and with the whole private
economy denominated in euro, this implies either a monetary policy
exactly matched to that of the euro, or a quick degeneration to
case (a), driven by the interests of debtors gaining the upper
hand or a slower degeneration in the direction of case (b), driven
by creditors. The latter is probably the most stable outcome.
It implies the new currency being very strong. The economy will
be faced with a choice of two monetary policies and an internally-floating
exchange rate. A form of internal divergence is conceivable, with
very sharp and sudden internal price moves between those parts
of the economy that remain euro-ised and those that are not.
But, in addition to these problems, the situation
is unstable in that any tendency to weakness on the part of the
new currency degenerates into case a unless the currency has become
very firmly established. Monetary sovereignty can therefore only
be regained for as long as the new currency is needed to be strong.
As soon as the need changes, case a occurs, leading to failure
of the new currency. The only case in which it never does so is
Thinking to a conclusion, therefore, it is highly
unlikely that introducing a new, parallel currency can regain
monetary sovereignty. However, it does provide a way to mange
the euro becoming worthless
(a) Post the EU assuming monetary sovereign
status (if ever). The issues are much simpler and are those
of any single sovereign State reforming its currency. The issue
in the euro is the current disjoint between the currency area
and sovereignty. Monetary sovereignty of the component States
is of course lost and this is not a true exception.
(b) Pre the EU assuming monetary sovereign
status. The main critique concerns the creation and management
of international claims in a way that harms the leaving country.
Surviving countries' jurisdictions continue to recognise euro
claims on the leaving country. But if all countries left, some
mechanism could be agreed to destroy all euro claims in
favour of, for example, a basket of new currencies the
reverse of EMU. Lex monetae would redenominate all euro
claims globally to the basket, given that the laws of all ex-EMU
countries would legislate that change. This would be an enormous
project, but no more so than the creation of EMU itself. In extremis,
it is just conceivable as a possibility.
Note that this mechanism is most unlikely to allow
a country to leave EMU even by mutual agreement with all survivors.
How could it be arranged? Could all claims on and by entities
of the leaving country be agreed across all EMU member jurisdictions
to be denominated in the new currency? This creates arbitrary
transfers of wealth within the EU. Remaining countries are most
unlikely to agree to this. Could a basket be agreed which made
a "new euro" and some fraction of a new (eg) Deutschemark
out of a euro? Why should French companies endure this complication?
And what of a euro claim by an EMU-country entity on a leaving-country
entity under English or New York law? Creditors would immediately
seek to establish these claims, which could be argued to survive:
this would be new legal ground. And non-EMU claims under non-EU
lawclaims of UK banks, for examplewould remain in
This idea is controversial and, to the author's
best knowledge, original. The witness has published it nowhere
B3a. In a clumsy analogy, consider a frog
on a lorry in a traffic jam at Spaghetti Junction. The frog suspects
its lorry is going to London: the frog wants to go to Manchester.
The frog has retained the right to hop. Hopping off in the general
direction of Manchester, it is crushed. But it can hop onto another
lorry that it believes is more likely to be going in the right
B3b. The leaving country's authorities could
announce that on some certain date in the future, their currency
was (to name the clear obvious example) the dollar with existing
claims redenominated at then-prevailing market rates. Lex monetae
is clear: claims in the law of the leaving country are in dollars,
other claims in euro. The mechanism is broken whereby the market
can accrue claims in the currency they know will be stronger.
Even if a judgement is made as to the course of the dollar vs
the euro and asymmetric claims build up against the leaving country,
the eventual exchange is at market rates and involves no gain
or loss (compare the ECU at the end of 1998). The main critique
B3c. A key underlying assumption is that
the destination currency is sufficiently robust to be able to
absorb the impact of the incoming entity. The complicity of the
destination-currency authorities is clearly highly desirable but
is not indispensable in all circumstances.
Argentina and Hong Kong are actively considering adopting the
dollar independently of the US authorities.
B3d. One potential example is Ireland. Were
the UK to stay permanently out of step with the euro economies
and out of EMU but economically in step with Ireland, as is currently
the case, it is argued by the witness to be theoretically feasible
that Ireland could adopt sterling. Probably politically impossible,
of course, but this evidence attempts to ignore politics to the
B3e. Interest-rate contracts of course create
transfers of wealth in this process, to the extent the interest-rate
structures are different in both currencies. This problem is manageable
and was managed in the transition to EMU. New interest-rate transactions
can be stopped or the law of new transactions can be chosen freely
once the government's plans are known. This is a small problem
compared to that imposed by the main critique. Therefore there
are likely to be costs, but these are strictly determinate in
contract to the indeterminate costs of creating a new currency.
Domestically, wealth transfers will arise but the government has
tools to offset these, eg through the tax system. These issues
existed in the creation of euro. EMU "convergence" occurred
over a period of years but created very large wealth transfers,
mainly away from the governments of high-interest-rate countries
and in favour of bond-holders. The issues were manageable and
B4. Note that true monetary "sovereignty"
can only be regained under option 2, for which the consent of
others is required.
B5. Exceptions are academic. Joining
EMU involves effective loss of monetary sovereignty unless either
the sovereignty pool is mutually dissolved, the euro becomes worthless
or monetary sovereignty is transferred to the authorities of another
WIDESPREAD MISUNDERSTANDING OF THE IRREVERSIBILITY
C1. Romano Prodi, the President of The European
Union, was interviewed in the Spectator of 27 May 2000.
Q: did Mr Prodi believe that, if the Danes
voted "yes", they might later be allowed to change their
A: The President hesitated, hefting his words
carefully. "What I have said is that there is no provision
in the treaty for withdrawal. This is stating the obvious. But,
of course, in an extreme case, one could always foresee, for example,
that Texas might leave the dollar. But this is not strictly in
the US constitution".
Q: . . .I pressed him for clarification: are
you really saying that existing members of the euro might choose
to opt out again?
A: "If there were exceptional circumstances,
and provided it was not done in a way which was hostile to the
European Union. It is impossible to foresee for certain."
Q: But, in theory, a country could go back
to its old money while remaining a full member of the EU?
A: "Certainly, it's possible. There are
countries today which are full members of the EU but are outside
There has been no provision for Greenland to leave the EU, he
added helpfully, but it had still happened.
C2. In private correspondence and discussions
with UK opinion-makers and officials, the witness has also noted
widespread misunderstanding of the issues involved. A typical
example is "You forget sovereignty. Just as a country can
redenominate in Euro, so it can re-redenominate in DM and if it
is a fait-accompli markets will react maturely". Precisely:
sovereignty is inviolate, as argued. But the "mature"
market reaction, readily achieved, is to attack the bare throat
of the leaving country, imposing prohibitive costs. The market
is central to the main critque.
C3. There is a strong appetite for analysis
on the subject among investors.
C4. The theoretical possibilities explored
in Annex B do not provide a method for reversing EMU, and are
capable of being misunderstoodeven, misrepresented.
C5. Further quotations can be provided,
but the witness submits as proven the assertion that:
C6. There is widespread belief even
in expert circles that EMU is reversible. Therefore the possibility
exists of the electorate misunderstanding this central issue
MISUNDERSTANDINGS OF THE NATURE OF EMU CONFUSE
D1. It is an intensely political act
. . . However, just as the euro cannot be conceived of except
politically, it cannot be made to work except economically. It
is, after all, an economic union. Statement by Prime Minister
Blair to the House of Commons 23 February 1999.
D2. Considering EMU as a political act is
disputable. "It is, after all, an economic union" is
closer to the mark. The confusion of the euro decision with a
political agenda, simply because all other major currency areas
coincide with a political area, colours the debate irrecoverably.
The euro is unique in being a currency that does not coincide
with a political area. Maybe this is ultimately unsustainable,
in which case the euro must be dissolved or Europe must become
a sovereign State. But an open mind should at least consider the
possibility that an apolitical monetary union is possible. If
this possibility is rejected, then the EMU debate can be conducted
on the basis of Economic, Monetary and Political Union. If not,
the political evolution can be considered separately from EMU.
In which case the UK's decision on whether to forgo monetary sovereignty
need not be confined to the euro. Adoption of another currency
can be considered.
D3. Those who feel that EMU is apolitical
AND those who feel that it leads to an inevitable erosion of all
sovereignty should therefore consider alternatives to both sterling
and the euro. The obvious possible choice is the US dollar.
D4. Transforming the UK's monetary choice
from the binary, sterling or euro, to the ternary, sterling euro
or dollar, provides a "control experiment" on whether
the EMU debate and the European political debate can be separated.
This would appear to be so: there is no serious suggestion on
any part that Argentina or Hong Kong, if they adopt the dollar,
would face inevitable political absorption into the US. Introducing
the dollar as a third alternative actually clarifies the issues.
The decision trees in D19 illustrate how the concept can enrich
D5. It also provides a "control experiment"
on the "Five Economic Tests". Quoting from the above-referenced
statement by Prime Minister Blair:
. . . sustainable convergence between the
UK and countries within the euro zone; flexibility to adapt to
change in the UK and in continental Europe; the impact on investment
and the UK financial services industry; and whether joining the
single currency would be good for employment . . .
D6. Without arguing the issues to conclusion
here, a case can be made that the dollar fills the conditions
more fully than currently does the euro.
D7. Over the past 15 years, the correlation
between monthly closes of sterling Base/Repo Rate and the US dollar
Fed Funds target has been 73 per cent. The below chart shows,
in part, how this can be the case.
Chart: Quarterly year-on-year US real GDP
growth, plotted against UK real GDP growth 1985 to present. Line
of best fit shown. Ten most recent observations circled. Source:
D8. The correlation with the Bundesbank/ECB
Discount rate is minus 26 per cent over the period. See the below
chart for a possible explanation.
Chart: Quarterly year-on-year euro-11 real
GDP growth, plotted against UK real GDP growth 1985 to present.
Line of best fit shown. Ten most recent observations circled.
D9. It could be arguedperhaps rather
bravelythat, based on the latest ten (circled) datapoints,
recent data reflect better UK/euro-11 convergence. And that the
longer data are unrepresentative due to eg German reunification.
But the contrast with the US is striking. And note in particular
how periods of greatest UK economic weakness coincided with greatest
euro-11 strength but greatest US weakness.
D10. Modern economies are increasingly focussed
on services, less on heavy industry. India is a major exporter
of computer software development services. China has attracted
significant criticism for failing to curtail software and music
piracy. Quoting again from PM Blair's statement to the House:
In the modern world, one has only to look
around to see that technology, global finance, mass communicationto
say nothing of travel and cultureare coming together. The
world is moving together.
D11. Physical distance is becoming less
important to trade than are distances of language, culture, training
and legal system.
Information Technology and its impact on modern society:
Manufacturing employment has declined to
about 20 per cent, and soon less than 10 per cent of all workers
should operate the industrial system. Industrial capacity will
always remain essential, of course, just as agriculture continues
to be important even now. However, today more and more of the
US workforce is in the production, transformation or storage of
information (clerical workers, services agents, data-entry jobs,
software programmers, investment brokers, etc).
D12. Again, a conclusion is not sought here
but there is a case to answer that these considerations work in
favour of dollarisation rather than joining EMU.
D13. Currencies being legal constructs,
the common-law legal approach common to the UK and US is a further
factor to be considered in these circumstances. It can at least
be argued that the Internet is shrinking trade-routes in the emerging
information industries faster than global cultural barriers are
falling. Economic convergence is not just a matter of trade but
is also strongly dependent on how similar economies respond to
global stimuli compared to different economies. The UK economy
can be argued to resemble the US economy more than eg the French.
This similarity has, for many years, dominated trade links reinforced
by proximity, as shown by the above correlations. This dominance
is arguably likely to increase.
D14. It could further be argued that the
political effects of such a move would be desirable, although
the move would obviously be controversial.
D15. PM Blair to the House 23 February 1999
I want us in a Europe that at best is moving
firmly in the same direction, rather than trying to hold us back.
That is a vision that lets us adapt the European social model
to the new realities of global commerce; a vision that binds the
EU and America closer together and lets us learn from one another.
D16. A risk to that process would be that
Britain in EMU might become part of the perceived problem: dollarisation
would reduce that risk. And (Annex C) the euro could conceivably
be adopted later. But, once surrendered in any direction, monetary
sovereignty could not be regained.
D17. A poor understanding of the unique
nature of EMU leads to the current assumptions in many circles
that EMU either must end or must lead to political union. Clearer
understanding would improve the debate.
D18. The debate would be enriched by consideration
of adopting the dollar, if only as a "control thought experiment".
D19. Exhibit to Appendix DDecision
Accepting that, if EMU is apolitical, there
is at least a case to answer that dollarisation should be considered,
if only as a control experiment, clarifies and enriches the debate.
The current decision tree may be stylised as below, while the
second decision tree shows the much richer debate that should
Full decision tree follows
E1. William Porter is a bond-market analyst
at an investment bank. He has wide experience in currency and
interest-rate markets. This evidence is submitted in a purely
individual capacity and these views are in no way connected with
those of his employer. Some of the views are controversial within
that firm. The witness is grateful, however, for the interesting
discussions that he has on the subjects with colleagues and others:
the issues raised are central to financial markets.
E2. His areas of study centre on central
bank policy, where he has worked closely with officials of the
Bank of England and the ECB, and on the effect of regulation such
as the UK Minimum Funding Requirement on financial markets.
E3. The witness was actively involved in
making EMU happen, through his work on creating the reference
rates necessary for the functioning of financial markets in any
currency. He is a member of the Euribor Steering Committee (Euribor
is the euro equivalent of LIBOR) and, working with that committee
and the ECB, created EONIA, the reference overnight rate used
to settle financial transactions and, due to its success, now
used by the ECB in formulating policy.
E4. The witness is British and has lived
in the UK, USA and Japan. His "EMU politics" are that
currencies are economic tools. Similarly to Flag Carrier airlines
a generation ago, they attract national pride that is unrelated
relative to the job they have going forward and which is a major
drawback to their management. But they are tools that can be turned
to political ends. He is therefore an EMU agnostic but thinks
that any decision to retire irrevocably a currency that has served
for 1082 years has to be got right, cannot be "political"
and must be made in an environment of general agreement on the
underlying nature of the decision.
E5. The fact that the irrevocable decision
is being made at a time of intense change increases the burden
of proof yet further.
E6. The experience of the recreation of
the only other currency zone of comparable size and diversity
is relevant. Ingo Walter, at New York University, teaches that
reconstruction of the South following the American Civil War was
massively delayed by "Economic and Monetary Reunion"
(not his words). Through a monetary policy unsuited to its needs,
the South largely missed out on the entire Industrial Revolution
and only caught up as the "rust belt" faded from the
American economy. Only now, a century on, has the South "converged".
It is therefore worrying that many people active in the debate
miss some of the lessons to be learnt from the dollar and that
US experience is not more widely quoted; indeed, is sometimes
35 See Annex E for information on the witness. Back
See footnote to Annex A. Back
At the outset of EMU, for the avoidance of doubt and given the
complex nature of the project, many foreign jurisdictions passed
special Acts covering continuity of contract etc. This is, however
the exception and is not normally done. eg the Argentinian currency
reforms of the late 20th century. Back
This footnote is that referred to from the first conclusion. The
pound sterling/Scottish pound parity is a partial counter-example
and a useful illustration. The Treaty and Act of Union unified
the government but not, completely, the legal systems. The familiar
Scottish note issue, governed by the Bank Charter Act of 1844,
is backed by holdings of Bank of England notes (held, for convenience,
at the Bank of England in the form of specially-created £1
million notes). The status of the Scottish pound is not dissimilar
to that of a euro-constituent currency. But the Scottish pound
is not dissimilar to that of a euro-constituent currency. But
the Scottish pound is irrecoverably lost, even to a future sovereign
Scotland. Scottish banks would hold a large part of their assets
in Scottish law and a large part of their deposits in the law
of England and Wales. An attempt to unscramble the two pounds
would be doomed. What of the Englishman whose salary is paid into
a London branch of a Scottish bank? A Glaswegian with a mortgage
at Barclays London? Would the two, now sovereign, Parliaments
cooperate in unscrambling the mess? Who would pay? Back
"When the euro falls apart" Hal S. Scott, Harvard Law
School. International Finance 1:2 1998. The witness does not agree
with many of the conclusions, as the paper's title might suggest,
but this is an excellent survey of the legal issues. Back
A full study of the mechanics of adopting a foreign currency is
beyond the scope here. Briefly, for the process to be sustainable,
the adopting country has to accumulate enough of the target currency
to retire the liabilities of the central bank in the retiring
currency. A monetarily-sovereign State can achieve this unilaterally,
given the right policies. While not essential, the assistance
of the target currency's authorities is useful: this is how countries
join EMU - the "Eurosystem" assumes joint responsibility
for the new member's central-bank liabilities. But these remain
distinct. The process is more difficult for an existing EMU member
adopting a foreign currency, but theoretically possible while
still monetarily sovereign. In contrast to the indeterminate sums
mentioned in the main critique, the liabilities of the central
bank are strictly determinate. Transfer of EMU central banks'
FX reserves to the ECB makes the process more expensive but the
mechanism is intact. Back
Texas seceded from the United States on 23 February 1861. The
American Civil War started on 12 April 1861. Mr Prodi is correct
in: the US Constitution was silent on the point of secession,
in contrast to the Treaty on European Union, Article 6.2 "The
Union shall respect the national identities of its Member States".
But the Civil War clearly established the precedent that the American
Union is indissoluble. The dollar resides in Federal law: Texas
is a State with no monetary sovereignty. An illustration, perhaps,
of the differences between Common-Law and non-Common-Law jurisdictions-See
Appendix D. Back
But no ex-EMU members: this is a non-sequitur. Back
Of nil relevance. A sovereign State can attempt to negotiate its
way out of the Treaties, as Denmark did for Greenland. The inevitable,
large costs of attempting to leave EMU explored herein are not
incurred on leaving the EU. But any country leaving the EU would
have to retain the euro. Back
See footnote to Annex B. There is one essential difference
between the adoption of the euro and the dollar. In the former
case, UK views would be represented by a seat at the ECB Governing
Council that sets euro monetary policy. This would be unlikely
to be the case at the Fed. But better non-voting in a converged
economy than being outvoted in an unconverged economy - see discussion
in balance of this Appendix. cf Ireland, although the UK would
be perhaps be more influential. Central Bank of Ireland Spring
2000 Bulletin ". . . Ireland's inflation rate, at 4.6 per
cent in February 2000, is now by far the highest among EU countries
. . . With higher inflation, real interest rates are lower here
than elsewhere . . . The Irish economy is just one percent of
the total euro area economy. It follows that Irish experience
will not greatly influence nor dictate policy. . . As monetary
policy is no longer determined to suit Irish conditions, our economy
is more vulnerable than before to overheating and the consequences
of this - inflation and a loss of competitiveness."
There is also a clear legal difference:
adopting a third currency would be against the spirit of the Treaties,
although not the letter. Even the latter would of course not prevent
at least considering the concept. Back