Feathers fly as EMU approaches

Date: 20/11/1997

The Italian question holds the key to understanding recent French manoeuvrings over the euro, reports Tim Jones, who warns of more to come in the run-up to decision day next May

THE last few months before the arrival of the euro were always going to be the most fun but, until we got here, we really had no idea just how much fun it was going to be.

The run-up to the crucial Brussels summit which will be held next May Day weekend, where the countries ready and willing to form a single currency area will be chosen and the European Central Bank established, promises to be positively thrilling.

Of course, much of the excitement in watching Formula One motor racing, steeplechases or boxing bouts is derived from the less than charitable desire to see a car crash, a horse topple on to its rider or a 100-kilo bruiser get knocked out. The diplomatic shenanigans over EMU will be no exception.

Underlying everything is the Italian question. Will it be enough that the Olive Tree coalition of Prime Minister Romano Prodi has achieved the previously unthinkable task of shrinking the public sector deficit to 3% of gross domestic product this year?

The Italian establishment desperately wants to get the country into EMU. It is not just that this would be an extraordinary foreign policy victory, but also that swapping the lira for the euro would in itself perform wonders for Italian government finances.

For years, the financial markets' lack of trust in Italian governments has meant that they demanded a much higher rate of return for holding their debt than they did for buying equivalent bonds from Germany or France or the Netherlands.

Even now, the markets demand a half per cent more for holding Italian debt which is due for repayment ten years from now than they do for its German counterpart while, for short-dated debt, the difference is a massive 2%.

Given that outstanding Italian public debt totals more than 1 trillion ecu, simply paying interest to creditors accounts for more than the whole deficit. Joining the euro-zone should theoretically narrow these interest rate differences to close to zero and, at a stroke, wipe billions of ecu off the government's debt-servicing bill.

For Prodi and his friends, letting Italy into euro-land is a matter of simple equity. They have done everything that was asked of them: clamped down on inflation, brought the budget deficit below the key 3%-of-GDP mark and created a highly independent and Rambo-like central bank.

They have the support of French President Jacques Chirac and his co-habitée Socialist administration, although Paris has its own unique reasons for this.

Italy is traditionally an ally in protectionist trade and industrial liberalisation battles and, most importantly, is seen to be a potentially crippling currency devaluer. As Lyndon Johnson said of J Edgar Hoover, it was better to have him "inside the tent pissing out than outside the tent pissing in".

The problem is that the Germans do not see it that way. While heavy industry might be happy with the disappearance of the lira, the Bundesbank and 'stability'-minded politicians in Bonn want to see a bit more form from the Italians. Keeping them out for just two years would satisfy German public opinion that those reckless Italians had really changed their ways.

The recent French diplomatic manoeuvrings over who should be the first president of the ECB are, in fact, all about the Italian question.

Expect more. Paris will want as many trade-offs as possible thrown into the pot for next May in the hope that they can get the Italians into the single currency bloc and water down what they perceive to be the northern European bias of the whole project.

The strange story of French single currency policy over the past two years has had one underlying theme: the attempt to negotiate away the very EMU chapters of the Maastricht Treaty which they agreed, signed and ratified by popular vote between 1991 and 1992.

A Socialist president, prime minister, foreign minister and their officials all knew what they were negotiating and signing up to: President François Mitterrand took the unusual step of defending the treaty in a two-hour-long national television debate during the referendum campaign in 1992.

Yet everything, from the fuss over creating a 'stability council' of finance ministers to act as a counterweight to the Frankfurt-based ECB to replacing Dutch banker Wim Duisenberg with a French presidential candidate at the new central bank, is all about squeezing the toothpaste back into the tube. And it will be just as difficult.

Nevertheless, the candidacy of Bank of France president Jean-Claude Trichet has thrown a wild card into the single currency debate.

He has no chance of being adopted since Duisenberg remains the Germans' favoured candidate. For this reason, the latter's chances of holding on to the job he wants were looking pretty good until the Dutch government made an unbelievable mistake. Faced with a rival candidate, Foreign Minister Hans van Mierlo implied there was room for compromise when he should have stuck to his man. Duisenberg should probably start clearing his desk.

Since most governments do not have a prospective candidate for the ECB presidency, they are now turning their attention to the executive board of the bank.

Until a few weeks ago, most of the prime ministers now squabbling over this issue had no idea what the executive board would be or how many members it should have.

But, in the same way that the 'stability pact' to enforce budgetary discipline under EMU was a terrible bore until two weeks before last December's Dublin summit, the question of the executive board has now become seriously trendy. As with most of these issues, its novelty is open to question.

The drafters of the Maastricht Treaty always envisaged that a seat or two should be left open for 'member states with a derogation', otherwise known as those not chosen to enter the first wave of EMU members. But only now, following the promise of an open seat on the board from German Chancellor Helmut Kohl to UK Prime Minister Tony Blair, has this debate seen the light of day.

Although Blair has won the support of the formerly reluctant French government for this idea, he has failed to ask himself a fundamentally important question: what difference will it make to him, or anyone else, whether there is a British national on the executive board of the ECB or not?

Is Bank of England governor Eddie George or his successor going to represent the interests of the UK, its people and industry in Frankfurt?

For that matter, would the Bank of Italy's Antonio Fazio speak for the Italians?

Of course they would not. Wim Duisenberg has not spoken for the Dutch since he was a finance minister two decades ago. When did he last take a decision on monetary policy because it would be good for Royal Dutch/Shell or Philips? Answer: never.

A sensible prime minister would ride this one out, gain a valuable piece of political capital and look for another job for one of his own where nationality might actually make a difference.

The end of Jacques Santer's term as president of the European Commission in December 1999 offers an ideal opportunity.

Major feature. The Italian question holds the key to understanding recent French manoeuvrings over the EURO. Author warns of more to come in the run-up to decision day next May.