Contents At A Glance

[Introduction to the Euro] [Businesses which will most probably be affected by the euro in 1999] [Strategic issues that businesses need to think about] [Businesses who operate across borders] [Transition to the Euro] [Background on the Economic and Monetary Union (EMU)] [The Maastricht Treaty] [Chronology of EMU Through 1996] [European Financial Centres]

Ever since the European Economic Community (EEC) started in 1957, people have suggested more economic cooperation between countries – including a single currency.

Introduction to the Euro [Return to Top]

On January 1, 1999 eleven European countries will form an economic and monetary union (EMU) and introduce a single currency - the euro. The 11 countries of the euro zone are: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain, although this number is certain to expand later.These countries will lock their national currencies together and share the new currency. They will also share a single interest rate, set by the European Central Bank (ECB), and a single foreign exchange rate policy. However, euro notes and coins will not be available until January 1, 2002. Until then the old national currency notes and coins (French francs, Deutschmarks etc) will continue to circulate. But in law they will be part of the euro.

The euro will mean certain changes for business both within these countries and throughout Europe. It should influence the markets in three important ways:

1. Cheaper transaction costs: The single currency will allow countries in the euro zone to trade with each other without changing currencies. This will reduce (but not remove) the transaction costs. It will cost less for companies to make payments between countries within the euro zone. Firms in the euro zone will notice the greatest difference. However, businesses from outside the euro zone which trade with companies inside it will also notice the effects.

2. Stable exchange rates: The single currency will remove exchange rates between countries in the euro zone. This may lead to better decision making for its companies. If UK companies purchase products priced in euro the exchange rate risk may be transferred to them. It is possible that some domestic UK businesses which do not currently experience exchange rate risk will do so in future.

3. Transparent price differences: The single currency will make price differences in different countries in the euro zone more obvious. This may affect companies who charge different prices for their products in countries within the euro zone. On the other hand, companies buying from the euro zone will be able to compare prices more easily. Either way, this will sharpen competition.

Businesses which will most probably be affected by the euro in 1999 include:

Exporters and importers: Exporters and importers will need to be ready to deal in euro.

Multinationals: Some multinationals that operate in Europe plan to use the euro after January 1, 1999, to simplify their accounts and finances.

Firms in supply chains: Many firms may find themselves being asked to deal in euro if they are in supply chains headed by multinational companies.

Retail banking: Banking systems will be ready to make payments in euro. Most banks are likely to offer euro accounts for businesses.

Retailers: Most retailers do not expect to use the euro in the UK from 1999. However, some shops (for example in tourist areas) may have customers who customers until euro cash is available in 2002.

Wholesale financial markets: Financial markets will start to use the euro instead of the currencies it replaces on January 1, 1999.

Subsidiaries: Subsidiaries owned by a parent company based in the euro zone may find that its Group's accounts will change to the euro.

Strategic Issues that Businesses Need to Think Now About Include:

Increased cross-border competition: Businesses who want to export into the euro zone may be at a disadvantage against competitors within the zone who share the same currency as the importer.

Cross-border mergers and other joint ventures: Increased competition might make business mergers within the euro zone more likely. Sharing the single currency may also make them easier.

Distribution and purchasing: Distribution and purchasing arrangements may become simpler and cheaper inside the euro zone because businesses there will not have to worry about exchange rate risk when trading with each other. However, UK companies purchasing goods and services may also benefit.

Raising finance: Firms may have more choice since bond and equity (share) markets may be more attractive in euro.

Market opportunities and risks: The euro will bring new opportunities and threats for many businesses – not only those trading in the euro zone. Companies will need to reconsider their marketing strategies – especially where products are priced in euro.

Pricing: Companies who export goods into the euro zone may have to decide whether to set new pricing points since the same price is unlikely to be as 'attractive' in euro as in the old national currencies.

Businesses who operate across borders in continental Europe, or have firms based in the euro zone might need to make practical changes as to:

Financial systems and accounts: If your company accounts include any transactions in major European currencies, you will need to include (or change to) the euro. This may mean adapting your accounting system.

Business finance: Your firm, especially if it has cross-border operations, should think about what financial services it may need. Larger businesses may need to think about the effects of EMU on the financial markets, as well as on their own internal treasury

Pricing policy: If you decide to change your company's pricing strategy on goods for export into the euro zone you should consider the manufacturing and packaging implications of making those changes.

Information technology (IT): There is no single solution to setting up your IT systems to handle the euro. The most important thing is to look into it now because the changeover may not be simple – and many businesses are already trying to deal with another IT challenge – the Year 2000 (Millennium Bug).

The euro in the UK: While the UK stays outside EMU, the euro will be a foreign currency and will not be legal tender in the UK. UK businesses will not have to accept it unless they agree to do so. The Government will facilitate businesses who do wish to use the euro in the UK.

Transition to the Euro [Return to Top]

There will be a three-year transition period before euro banknotes and coins are introduced on January 1, 2002. During this period, national currencies will continue to exist but as units of the euro. Rates to convert them to the euro will be fixed.

The Maastricht Treaty, which was signed in 1992, determined three stages for achieving monetary union. The first had already started in 1990 with the removal of any restriction on capital movement. Stage two began on January 1, 1994: the European Monetary Institute (EMI) was established and governments could no longer have overdraft facilities or any other type of credit facility with the central banks.

The third stage of EMU will start on January 1, 1999. According to the Treaty, the exchange rates of the participating currencies will be irrevocably fixed, monetary policy will be conducted by the European Central Bank and the Council shall take the measures necessary for the rapid introduction of the single currency. The Treaty does not determine how and when the single currency will be introduced. This was decided by the European Council at its meeting in Madrid on December 15 and 16 in 1995. It was at this time that the Madrid Council decided that the name of the single currency will be the euro.

The Introduction Consists of Three Phases

Phase A

Phase A was to reach consensus on which member states fulfill the necessary conditions to enter the monetary union in 1999 as outlined by the Treaty on the European Union. These conditions include the independence of each member state's national Central Bank and the achievement of a high degree of sustainable convergence of the economies. For the latter, the Treaty specifies four so-called convergence criteria: price stability, sustainability of public finance, the observation of normal fluctuation margins with the Exchange Rate Mechanism (ERM) and the level of long-term interest rates.

Member states that do not fulfill the necessary conditions for the adoption of a single currency at the beginning of 1998, will join monetary union in a later stage. The Treaty provides that at least every two years, or at the request of a member state concerned, the Council shall decide which member states with delayed entrance to monetary union fulfill the necessary conditions to join monetary union.

Phase B

Phase B starts on January 1, 1999, as provided in the Treaty and is the beginning of stage three of EMU. It will entail the fixing of the exchange rates of the participating member states and the euro becoming a currency in its own right. The European Central Bank will start conducting a single monetary policy and national central banks will no longer conduct their own monetary policy, but begin to act as agents for the ECB. In an economic sense, the monetary union will begin to exist, even without euro notes and coins which will begin to circulate three years later. Any remaining interest rate differential will be caused by technical factors, such as market liquidity and differences in credit risk.

In this phase, the euro will only exist as book money in the bank accounts. Notes and coins will all be denominated in national currencies. Payments in euros will only be able to be made by bank transfers, cheque, credit card, electronic fund transfers, etc. Any legal obstacle for using the euro will have been removed on a non-compulsory basis. National notes and coins will continue to remain legal tender within the country of issuance until the completion of the changeover process.

To assist exchange rate fixing and monetary union, monetary policy operations between the national central banks and the commercial banks will be carried out in euros. A new interbank payment system called the TARGET system will be put in place to ensure that payment operations between the European System of Central Banks (ESCB) and the banking system can be processed effectively.

Phase C

Phase C begins on January 1, 2002, when euro banknotes and coins will start to circulate alongside national notes and coins -- giving both legal statuses, or accepted as a means of payment. It ends when notes and coins denominated in national currencies cease to be legal tender. At the end of phase C, national notes and coins will lose their legal tender status. Member states can decide to shorten the length of Phase C arising from the additional costs of a long dual legal tender situation which would require dual cash handling, dual accounting, dual pricing, etc. Although phase C ushers in a changeover to euro banknotes and coins, it does not imply that national notes and coins will have become valueless. They may still be exchanged free of charge at the national central banks for a certain period.

Background on the Economic and Monetary Union (EMU) [Return to Top]

Up to a quarter century before the signing of the Treaty of Maastricht in 1992, Economic and Monetary Union (EMU) has been a recurrent aim of the European Community. When the Community was set up, the international monetary system was that of Bretton Woods, which provided currency stability with the U.S. dollar as the dominant monetary standard. This system began to show signs of weakness in the late 1950s. By 1968-69, re-evaluation of the Deutschmark and devaluation of the French franc threatened the stability of other European currencies. EMU became a goal of the Community at the Hague summit in December 1969. A high-level group, chaired by the Luxembourg prime minister, Pierre Werner, was asked to report on how EMU could be achieved by 1980.

The Werner report of October 1970 proposed a three stage process for achieving a complete EMU within a ten period. The final objective would be the free movement of capital, the permanent locking of exchange rates or the replacement of the currencies of the six member states by a single currency. In addition, Werner recommended a strengthening of economic policy coordination and the settling of frameworks for national budgetary policies.

In March 1971, the Six agreed in principle on a three stage approach to EMU, even though they were divided over some of the report's main recommendations. The first stage, narrowing of exchange-rate fluctuations, was to be tried on an experimental basis, without a commitment to the other stages.

The break-up of the Bretton Woods system and the floating of the U.S. dollar in August 1971, affected exchange rate stability in Europe. As a response, the Six created the 'snake in the tunnel', a mechanism for managing the fluctuations of European currencies (the snake) inside narrow limits against the dollar (the tunnel). The oil crisis, dollar weakness, and policy divergence hampered exchange rate stability and within two years the snake was reduced to the German, Benelux and Danish currencies.

Interest in EMU had not disappeared. EMU was one of the proposals that Leo Tindemans, prime minister of Belgium, made in his 1975 report on the European Union, though he acknowledged that it could only be a long run goal. In 1979, the European Monetary System (EMS) was launched, which was built on the concept of stable, but adjustable exchange rates. All the member states' currencies, with the exception of the British pound, joined its Exchange Rate Mechanism (ERM). It provided for a grid of bilateral rates and fluctuations that were not to exceed a margin of 2.25%. The EMS introduced a new currency, the ECU ('European currency unit') as a weighted average of all EMS currencies. The EMS succeeded in reducing exchange rate volatility, which between 1986-89, was a quarter of what it had been in 1975-79.

The 1985 program for the completion of the single market aimed at removing all non-tariff barriers to the free movement of goods, persons, services, and capital. It became clear, however, that the benefits of the internal market would be difficult to achieve with the uncertainties created by exchange rate fluctuations and the high transaction costs for converting one currency into the other. The single currency was seen as the vital missing piece in the single market project. Moreover, many economists pointed to the so-called impossible triangle: one may not have at the same time free capital movements, stable exchange rates, and an independent monetary policy.

The European Council meeting at Hanover in June 1988 established a committee, chaired by the then President of the Commission, Jacques Delors, to study EMU. The Delors Committee included all EC Central Bank Governors and independent experts. Its report, submitted in April 1988, proposed to achieve EMU in three stages. The Madrid European Council of June 1989 decided to proceed to the first stage of EMU, the liberalization of capital movements, in July 1990. In December 1989, the European Council decided in Strasbourg to convene an Intergovernmental Conference at the end of 1990 in order to negotiate a Treaty on Economic and Monetary Union. This Intergovernmental Conference, held in 1991, resulted in the Treaty on the European Union, concluded in Maastricht in December 1991 and signed on February 7, 1992.

The Maastricht Treaty [Return to Top]

The Maastricht Treaty provides for monetary union to be achieved by the end of the present century. A European System of Central Banks (ESCB) will be established, which will be in charge of conducting a single monetary policy. Its primary objective will be to maintain price stability. The ESCB will consist of the European Central Bank (ECB) and the national central banks of the member states. They will all be independent of Community (or now 'Union') institutions and the governments of the member states, so as to make sure that no other policy considerations interfere with the price stability objective.

Monetary union will be achieved in three stages as described in earlier sections, and economic policies of the member states will be regarded as a matter of common concern. They shall be based on the principle of an open market economy with free competition, favoring an efficient allocation of resources. One of the guiding principles of economic policy will be sound public finance. The Treaty introduced an 'excessive deficit procedure' to ensure that member states achieve, and maintain that soundness.

After the signing of the Maastricht Treaty in 1992, it was generally expected that stability in the ERM would continue until monetary union had been achieved. In September 1992, however, speculation triggered by an initial 'no' in the Danish referendum of June on the Treaty and an uncertain outcome of a similar referendum in France, forced the Italian lira and then the British pound out of the ERM. Another currency crisis in July/August 1993 put the French franc under pressure and on August 2, 1993 it was decided to widen the fluctuation bands of the ERM to 15%.

On January 1, 1994, Stage Two of EMU began formally and the European Monetary Institute (EMI) was established, a body charged with strengthening cooperation between the national central banks in preparation for the third stage of EMU.

The Commission set up an expert group on the changeover to the single currency in May 1994, with the remit of advising it on the technical preparations for introducing the single currency. This expert group was chaired by Cees Maas, a former chairman of the EU's Monetary Committee. On May 31, 1995, the Commission adopted the 'Green Paper on the practical arrangements for the introduction of the single currency'. This proposed to introduce the single currency in three phases and, together with an EMI report of November 14 on the 'Changeover to the single currency', formed the basis for what was decided at the Madrid meeting of the European Council on December 15 and 16, 1995.


The Chronology of EMU Through 1996 [Return to Top]
 March 25, 1957  Signing of the Treaty of Rome
 January 1, 1958  Establishment of the European Economic Community
 December 1969  The Hague Summit requests a report
 October 1970  Werner Report
 March 1972  Creation of the snake in the tunnel
 March 13, 1979  Start of the European Monetary System
 June 1988  European Council, Hanover requests a study
 April 1989  Delors Committee Report
 February 7, 1992  Signing of the Maastricht Treaty
 June 2, 1992  Referendum in Denmark
 April 1989  Delors Committee Report
 February 7, 1992  Signing of the Maastricht Treaty
 June 2, 1992  Referendum in Denmark
 September 20, 1992  Referendum in France
 August 2, 1993  Widening of ERM fluctuation bands to 15%
 November 1, 1993  Coming into force of the Maastricht Treaty
 January 1, 1994  Beginning of Stage Two of EMU: establishment of EMI, prohibition of central bank credit to governments
 May 31, 1995  European Commission Green Paper on the practical arrangements
 November 14, 1995  EMI report on the changeover
 December 15-16, 1995  European Council in Madrid
 December 13-14, 1996  European Council in Dublin
 Source: User Guide to The Euro, Editors, Graham Bishop, José Pérez, Sammy van Tuyll van Serooskerken, Federal Trust, 1996, London

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-- Posted the week of November 17, 1998