The Euro, the new European currency
|German translation, Spanish translation|
By Josef Hund
of IWB Radolfzell e.V.,
Contribution to the EDUVINET "European Monetary Union" subject
(English translation of the German original by Hermann Seidel, GERMANY, Hilary McEwan, UNITED KINGDOM, Elaine Hampson, UNITED KINGDOM, 1999)
1.1 The notion of money
1.2 The functions of money
1.3 Kinds of money
2.1 Currency reform of 1923
2.2 Currency reform of 1948
3.1 An internal perspective of the Federal Bank of Germany (Deutsche Bundesbank) and a critical evaluation of its work
3.2 Complementation of agreed political-economic aims for a central bank
4.1 An attempt to explain the criteria from the experience of unsuccessful anti-cyclic policies to influence economic fluctuation
4.2 The criteria
4.3 Evaluation of the entry levels for inclusion
4.4 Evaluation of the agreements after founding the monetary union
4.5 How independent is the European Central Bank?
4.6 Cost benefits
4.7 Process of exchange
"Money is an individual's entitlement to a share of the national product, recorded in a general promise of value." (Schmoelders)
"The means of payment within a legal framework prescribed by the state." (Knapp)
The common person's understanding
The means of payment for which anyone can purchase goods within an economy.
With the foundation of the German Reich in 1871, legislation concerning
coins and notes became the responsibility of the Reich government. On 1st
January 1876, the Reichsbank established business as a successor to the
Prussian Bank. Until 1945 it was the German Central Bank.
The Minting Act of 9.7.1873 proclaimed the gold standard and ordered the withdrawal of all money that had not been issued in the Reich currency.
A government act of 30.4.1874 limited the circulation of paper money to 120 million Reichsmark (RM) in notes. The banking law of that time prescribed that one third of the circulating bank notes had to be guaranteed by a combination of gold and German exchangable money including bank notes. The remainder was guaranteed by good bills of exchange, valid for three months at the most. The remaining two thirds might only be exceeded to a very slight margin when the national economy was in need of money. This notion of a guarantee was based on the idea that bills of exchange had to be based on the real economic value of goods that had been created and must be financed during the turnover of the goods. Bills of exchange are promises of payment in the future for goods received, which are either going to be processed or offered directly to the consumer.
The exchange rate between the Reichsmark and gold was fixed at 1,392 RM for 500g of gold. At today's rates we would have a rate of about 10,000 DM for half a kilo of gold, which is seven times the price of 1874. At the beginning of the First World War the Reichsbank's duty to redeem bank notes with gold was abolished. Since the currency's guarantee through gold to one third turned out to be existing only formally, it also was abolished by an amendment in 1921 of the Banking Law.
The immediate burdens due to the war and the subsequent costs such as reparations resulted in an immense increase in the amount of paper money and necessarily led to a currency conversion.
One billion (or one million millions) RM were exchanged for one
1,000,000,000,000 RM for 1 Rentenmark.
Assets in money became worthless and thus the old age pension money saved by a great number of persons was gone.
4,20 Rentenmark had to be paid for 1 US dollar
20,76 dollars had to be paid for a troy ounce of gold (= 31.1035 g)
The price for 1.000 g of gold was fixed at 2.790 Rentenmark
(compare the gold price of 1874: 2.784 RM for 1.000 g)
The exchange rate between Mark and dollar was fixed via the gold price.
|1 troy ounce of gold=||31.1035 g of gold =||20,67 US $|
|1.50476 g of gold||1 US $ =||4,20 M|
|0.35828 g of gold =||1,00 Mark|
|999,594 g of gold =||2790 Mark|
Due to the crisis in the Great Depression the gold price increased, a fact leading to an adjustment in 1934. The rate was newly fixed at
|1 troy ounce of gold= 31.1035 g of gold =35.00 US $|
This meant a devaluation of the German currency by 40.943%.
Development of debts:
|1933||11,7 Billion Reichsmark|
|1939||41,0 Billion Reichsmark|
|1945||ca. 390 bis 440 Billion Reichsmark|
A freeze of prices, rigourously ordered and carried out by the German
government as from 1936 was maintained also by the allied military governments
in post-war Germany.This was leading to a hidden inflation or, simply put, one
did not get any goods anymore for one's money. A time of bartering began, a
flourishing "black market". There existed a surplus of money after the
war, contrasted by a low rate of production. A reason for this was that the
production plants had on the one hand been destroyed and on the other hand been
dismantled and taken away by the victorious powers. The currency reform was
basically carried out as follows:
Obligations were exchanged at a ratio of 10 RM : 1 Deutsche Mark (DM)
Wages, and salaries, pensions, income from renting or leasing at a ratio of 1 RM : 1 DM
A sum of 40 DM in June and again 20 DM in August was paid in cash per capita.
The hidden reserves of the past and a re-evaluation in DM produced an exchange rate of 100 RM : 98.1 DM in the conversion of RM into DM, of share capital of companies. This meant that for share-holders the going rate in the new currency remained almost identical. This meant also that company capital was assessed almost equally high so that share-holders could hardly complain about losses.
Thus the common person had lost nearly all their savings again and consequently the self-contributed security for old age twice within 25 years.
The Currency Conversion to EURO = A Currency Reform?
Will the new currency change towards the Euro be comparable to the currency reforms of the past?
The Federal Republic's currency has no gold guarantee but is a manipulated
currency instead. This does not mean manipulated arbitrarily, but oriented
towards certain objectives.
These objectives have been laid down in the government act concerning the Federal Bank.
The main task of the Federal Bank is to supply economy with sufficient money to avoid inflationary as well as deflationary developments in the value of money. For that the Federal Bank should be able to estimate economic dvelopment as precisely as possible so as to provide a sufficient quantity of money for the goods produced. A growth in the national product must be reflected by a growth in the same scale, of the amount of money provided.
These correlations are expressed in Fisher's circulation equation:
|Price level = amount of money x speed of circulation / volume of trade.|
When both the amount of money and the volume of trade are growing at the same percentage, the level of prices will remain cinstant unless the speed of circulation undergoes a change.
However, from this simple correlation various peoblems may arise:
Despite these problematic fields the Federal Bank is still pursuing a
concept of various defined quantities of money. This is to say that it wants to
ensure a stable value of money by controlling certain quantities of money. For
this purpose the Federal Bank establishes e.g. the quantity M3 (M = Menge =
quantity) under which name all cash, demand deposits, time deposits and ordinary
savings accounts are summed up. This clearly defined quantity of money is to
grow within a certain conceded range in accordance with the national product.
Exceeding this range, as a rule causes restrictive measures by the Federal Bank.
This way of acting may be criticized in so far as a shift in capital investment
at short notice will result in an increase of quantity M3 though the overall
available purchasing power in the economy has not changed at all.
Large industrial countries, such as the USA or France therefore turned away from this concept and have in recent years been pursuing a different one resting on interest rates. It has been realized that real interest rates of 2,5 - 3% have been the rule over the last decades. A higher interest rate will encourage saving and will slow down growth, one that is lower will boost consumption and consequently growth since the interest on savings as a premium for postponed consumption is too small.
An inflation rate of 1.5% and a real interest rate of 2.5% should result in a long-term capital interest rate of about 4%. Interest rates with a face value of 5.5 or 6% will stall growth.
The Federal Bank's way of measuring the inflation rate does not take into account that a considerable part of this rate is caused by increases in fees, taxes or tariffs on part of the state and not through actions of free participants of the markets. Moreover, quality improvement in products will not be considered as long as there is no corrective factor for, say, an increase in value by applying better or more economical technologies, which will not be recognized by statistics in the end. The non-existence of such factors might in various European countries already have led to a deflation in the manufacturing sector unnoticedly for some time, which may have resulted in job losses because consumers have been reluctant to buy goods.
Such questions are being discussed quite rightly by the future partners in the European Monetary Union.
What are arguments for defining the tasks of the European Central Bank narrowly as "safeguarding stability of currency value"?
What is an argument for the independence of the European Central Bank?
Currency experts must be able to pursue medium- and long-term strategies during their term unbiased and independent of day-to-day politics or election times so as to create and maintain confidence in a currency.
What are arguments for complementing political-economic responsibility of the European Central Bank?
Political-economic decisions in favour of employment in newly created branches of economy (caused e.g. by major structural changes) must not be counteracted by a policy exclusively oriented at stability of money. Misuse on part of the politicians can only be avoided by clear guidelines for interior policy. A negative example were the demonstrations in the streets, of German miners who in this way successfully fought for subsidies for coal mining for another eight years. Such a policy of racketing coud have devastating consequences in the different nations of Europe. A foretaste of such tensions was given by French and Spanish fishermen in the Bay of Biscay.
During the 1970s industrial nations have tried to overcome their structural
problems and those of economic fluctuation with devaluation or deficit spending.
Devaluations gave new impetus to employment but also resulted in an increase of
prices for imported goods, while anti-cyclic government financing through loans
put a strain on capital markets. While during a recession the negative effects
were negligible and the positive aspect of providing employment were dominating,
the repayment of the loans, as it is prescribed in the German stability laws for
times of a boom, was not duely respected. Thus government borrowing raised
interest rates rapidly and consequently new investment in such a country became
less profitable. Increasing unemployment with all ensuing costs and reduced
profit margins caused decreasing tax revenue. In order to balance this
development, contributions to the social security systems were raised and the
progressively rising rate of taxation washed an ever-growing real part of income
into public budgets after every pay rise due to inflation.On a local level the
rates of assessment for taxation were continuously raised in a similar way.
The loss of interior value as well as of currency value abroad along with a steep rise of unemployment were signalling the dead end street into which the industrial nations were moving because of wrongly applied policies to influence economic fluctuations. This is the background against which the clearly defined criteria for joining a European Monetary Union can be explained.
While the criteria for inflation and long-term interest rates represent a maximum deviation from an average of other EU members, the criteria concerning debt are oriented at the development of domestic economy and national product.
An aim is to make these framework rates of the invidual economies reach
desirable rates of stability. However, data about projects financed give no
answer to the question whether a particular object of financing makes sense or
not for an economy. A country which finances the building of motorways via tax
revenues and, partly, government borrowing, and a country which has private
enterprises finance such investment in the infrastructure, which eventually make
the users pay dearly over the next few decades, have to be assessed differently.
The debts arising from expanding a system of vocational training have got a
different quality than those coming from concert halls or museums. In my
opinion, employees correctly criticize that the criteria of stability are
one-sided, as long as the aim of stability of employment, i.e. a high rate of
employment, has not been included, since this endangers social stability in a
Furthermore, it was not clearly stated which tasks and which economic activities of a state are to be included in, or excluded from, the overall calculation. This having been neglected, the countries which want to be included try to shift debts into special funds with balancing tricks, or to outsource or privatize hitherto government responsibilities. It is not economic deliberations that lie behind such decisions but the arbitrarily fixed figures for joining or not.
In the two-year test phase with a narrow range of fluctuation in the EMU, the political-economic decisions must be increasingly harmonized among participating countries, which in turn will result in a convergence of their economic development.
There is no automatic mechanism of sanctions to discipline budget management of the participating countries, but sanctions that have been agreed on today may be cancelled by a majority vote.
The Central Bank will have the only responsibility for financial policy from the first day of monetary union onward. Its foremost task is to pursue the aim of price stability and it may support the general economic policy of the union only as long as this foremost task is not impaired. Its leading personalities will be experts who will be independent of political directives during their term of office. Representatives of the Federal Bank of Germany feel that the German strategy of money quantities ought to be considered to ensure a stable currency. However, to unite countries with diverging inflation rates will always create an average rate of inflation. The more stable currencies will become softer.
Tourists who no longer have to exchange money expensively will notice this as the most evident occasion of saving money. The savings of trade and industry, though, will be far more important, because transaction costs will disappear, faster payments can be enforced, and insecure calculations because of currency fluctuation will come to an end. Furthermore, the costs for business with the aim of safeguarding currency value will no longer be necessary. All this is of enormous importance, as Germany is trading 60% of her exports with European partners, a figure which may be similar for other European countries.
All money assets will be converted or exchanged at equal exchange rates within a determined period of time. This process can be compared to a long-term investment of money in a different currency, e.g. the U.S. dollar. As soon as the investing persons also live in the area for which the currency applies, they will realize that they have kept up their purchasing power and will monthly receive a comparable purchasing power as before along with their earnings.
Introducing the Euro means introducing a new kind of money alright, but it can in no way be compared to the German "currency reforms" of 1923 and 1948, which were in fact bankruptcies rather that reforms, in the course of which a certain bankruptcy quota was handed out. No economic thinking person would feel a conversion of a DM account into a Swiss Franc account to be a bankruptcy, but a change into another stable currency, something that many European citizens are dreaming of, be it for different reasons. Unfortunately, the positive expression "currency reform" was misused in the past as a cover-up of an oath of disclosure, so that the common person in Germany mistrusts our politicians' talk of "the Euro, the new European currency."