Tue, Nov 27, 2001 page19

• Nobel laureate helped to father the euro system

  A univeristy professor played a big role in setting up tshe European currency, and he's optimistic about its chances

  • THE OBSERVER
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  Robert Mundell does not claim paternity of the single currency, although it is often ascribed to him. But the Nobel prizewinning economist is not guilty of neglect -- he merely sees himself as "one of several godfathers" to the euro, rather than its inventor.

  "I'm very gratified that it is coming to fruition. A single currency is close to being absolutely necessary for Europe," says the Columbia University professor.

  In 1972, Mundell worked as a leading member of the EEC's Study Group on Economic and Monetary Union in Europe. This followed his published works on "optimal currency areas," and a seminal 1973 article called "Uncommon arguments for common currencies."

  These were the theoretical bases for the process that will end with the launch of euro notes and coins on Jan. 1 next year.

  "I think Europeans have a mixture of anticipation, excitement and worry. It's a psychological challenge to shift their unit of account, especially for older people. "Think back to America, say, in 1792, when they shifted from pounds and shillings to Spanish dollars. They didn't sort that out for decades."

  So far, Mundell is fairly upbeat about the euro's 30-year journey from textbook to the high streets of Europe.

  "Every single economy in the Eurozone has a better monetary policy than it did before," he says. "Every country in Europe, and every citizen within, will have a world class currency and all, bar Germany, have lower interest rates than before. We are already starting to see the benefits of price transparency.

  "The euro has the chance to change the power configuration of the world economy."

  That's not how the currency markets have judged the fledgling currency to date. The virtual euro has lost a quarter of its value against the dollar since its launch in 1999.

  "That's turned out to be a blessing in disguise. The fall in the euro exchange rate has helped sustain European growth," Mundell says.

  He believes that the European Central Bank's monetary policy record to date has been impressive. The euro's depreciation has had nothing to do with alleged transparency and credibility deficiencies, he argues.

  "I'm not sure how much secrecy is optimal for a central bank. If it was completely open, individuals wouldn't give their real opinion and decisions would be difficult. The less transparency there is, the more discretion is left for policy."

  Further moves on transparency are not necessary, he says. "I don't think that publishing minutes really matters all that much, like I don't think it'll make much difference if you have [Bank of France governor Jean-Claude] Trichet as governor.'

  Mundell habitually picks out episodes from economic history to illustrate his views. On transparency, his example is Montagu Norman, Bank of England governor from 1920 to 1944, whose portrait imperiously stares down on today's British monetary policy decision-makers.

  "Montagu Norman was known as `the mystery man of high finance' and he excelled in his era of mystery, until his psychosis was discovered," he says.

  "You know, the Bank for International Settlements was set up in Basel only because it was close to his psychiatrist."

  As you might expect of a Nobel prizewinner, Mundell seems to know too much about his specialist area. But he has a refreshing desire to make his theoretical concepts relevant for the analysis of policy-making and of history.

  He describes the five tests that British Finance Minister Gordon Brown has devised as prerequisites to the UK joining the euro as "not bad".

  "They all make a certain amount of sense, but any one of them could be interpreted subjectively as being satisfied."

  Controversially, he believes that Britain could tolerate a joining rate far higher than is envisaged as feasible by unions and business leaders.

  "I think that if Britain could get a rate of about 1.5 euros to the pound, it would be about right. If it adopted a lower rate, there would be too much inflation in the service industries. Manufacturing would always want it lower, but this would mean inflation.

  "Quite apart from all the economic reasons, it would be no contest because the European countries would not accept too low a rate -- actually Britain may be lucky to get a rate of DM3 to the pound.

  His view is that volatility in the euro-dollar rate could prove the crucial test of British membership. "Britain should join but should insist on a system for a more stable dollar-euro exchange rate. Britain will face some trauma if the rate changes too much," he says.

  He also sees risks emanating from the regulatory, dirigiste tendencies within Europe.

  "Harmonization is generally a good thing. But Britain is rightly worried about harmonizing up rather than harmonizing down. I think that should be a condition that Britain will not have to change its tax system."

  Last year Mundell questioned the Britishness of the pound. The word originates from the Roman standard, and the pounds, shillings and pence denominations were first used by the Persians. It's the sort of stuff liable to make a euroskeptic's blood boil.

  But on other matters the average Conservative eurosceptic would find little to disagree with. He was one of the University of Chicago economic revolutionaries of the 1960s who espoused the all-conquering mantra of tight money and tax cuts.

  As his colleague Arthur Laffer wrote after Mundell won the 1999 Nobel prize, "To Mundell, the only closed economy was the world itself. The only meaningful monetary policy was global monetarism."

  The intellectual basis for the euro is entrenching monetary and fiscal discipline and shrinking the size and scope of the state. The euro is embodiment of this, more than a symbol of European togetherness.

  But Mundell's sights are set beyond Europe. He believes in a global currency -- the Intor -- formed as a G3 monetary union between the dollar, euro and yen areas. "What happens if this recession becomes far worse than anyone imagines? The slowdown turning to recession and even depression, with eight quarters of contraction rather than three?

  "This would be devastating for the world economy, but the US could not do much on its own. Neither could Europe or Japan. So you could create some measure, a unit of global purchasing power, and some sort of world central bank."

  His idea is that the three biggest currency blocs form a virtual union with locked exchange rates and common monetary policy, but retaining the paper currency.

  Mundell is well aware of the political exigencies of this. He has a political roadmap that starts with the formation of an Asia-Pacific dollar-zone, dollarization of Hong Kong, and then a link between the euro and the dollar. A possible global recession makes such arrangements all the more prescient, he says.

  "I'm not attaching a high probability to the chance of a monstrous recession, but we simply don't have the instruments to deal with it. This is why we need a unit of global purchasing power, and this could be used as the embryo for an international monetary system."

  It all sounds rather fanciful -- but then they probably said that in 1972.
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