Europe and the Euro: The View from Asia
Speeches
14 Mar 2000
Europe and the Euro: The View from Asia
Joseph Yam, Chief Executive, Hong Kong Monetary Authority
(Speech at the XII International Frankfurt Banking Evening, Imperial Chamber Frankfurt Romer)
Introduction
Mayor Roth, President Welteke, President Duisenberg, Governors,
Excellencies, Ladies and Gentlemen,
- There can be few things more irritating than foreigners coming
to your country and lecturing you on how much better things might
be for you if only they were in charge. In my particular experience
as a central banker there is no shortage of gratuitous advice on
how one's monetary and exchange rate policies might better be
conducted. Of course, I have encountered a number of visiting
bankers, businessmen and academics coming to Hong Kong who are
particularly well informed, who have thought carefully through the
issues, and whose advice is consequently much to be valued. But I
fear that they may be in the minority. So, I certainly feel a bit
awkward standing here. I don't consider myself to be an expert in
matters relating to the European economy or the euro, so I beg your
forgiveness right from the start. My only defence is that you did
actually invite me, so what I have to say is not entirely
unsolicited.
- This speech is going to be largely about perceptions, or rather
misperceptions, and how they may contrast with reality. Why? As I
said, I am not an expert on the euro. But I can certainly tell you
a lot about how it is perceived from my part of the world. And when
it comes to the behaviour of financial markets we all know that
perception is as important as reality.
Perception and reality - Hong Kong
- Allow me to illustrate this point by starting first with Hong
Kong, for I cannot resist the temptation to take advantage of this
opportunity to do a bit of advertising. I would like to describe
some of the negative perceptions which financial markets and
analysts have had about Hong Kong over the last few years, and how
these have compared with actual developments.
- First was the belief that Hong Kong's fixed
exchange rate with the US dollar would not survive the Asian
economic crisis. The reality is that it has survived, and the
Hong Kong economy has now rebounded strongly, with the year-on-year
growth rate of GDP for the fourth quarter of last year recording
8.7% and the forecast for the year 2000 now put at 5%. What the
doomsters refused to recognise, despite the compelling evidence of
the preceding one-and-a-half decades of the same fixed exchange
rate system, was that Hong Kong has a highly flexible internal
cost-price structure, which can quite quickly deliver the same
external relative price adjustment as a currency devaluation.
Although the time profile of the adjustment process is different,
as is the degree of short-term pain involved, internal adjustment
arguably leaves the economy leaner and fitter than it would if
everyone could simply depend on depreciation to see them
right.
- The second flawed perception was that the
intervention by the authorities in the stock market in August 1998
represented a fundamental reversal of traditional
non-interventionist policy. The mistake here was to fall into the
trap of characterising Hong Kong as a place where the authorities
never intervened. We have always made clear our preparedness to
intervene for such purposes as promoting efficiency in the market
economy, providing infrastructure, or providing necessary support
for the most needy in society. But our emphasis has always been to
keep intervention to the minimum. This may sound uncontroversial
today; indeed, it is probably an attitude shared by most
governments, including those here in Europe. But you should
remember that when Hong Kong was first vigorously espousing this
doctrine, perhaps 30 or 40 years ago, the vogue in most western
countries was for the state to assume an expanding role in the
economy. In keeping with Hong Kong's principles, the stock market
intervention in 1998 was specifically directed towards improving
the operation of the market economy rather than perverting it: it
was designed to frustrate market manipulation that would otherwise
have led to serious market dislocation.
- A third example of perceptions being at
variance with reality was the prediction that the Mainland Chinese
currency, the renminbi, would be devalued during 1999 and that the
Hong Kong dollar would inevitably be swept down with it. It is true
that the economic performance of the Mainland was for a time moving
in a manner such that devaluation could have been judged a not
unreasonable option. But those who predicted such an event tended
to give insufficient attention to the fact that the renminbi is not
a convertible currency, that the prevailing external position was
strong, and that the authorities had made it clear that they were
not contemplating devaluation.
- The read-across to the Hong Kong dollar required an even
greater leap of the imagination. Our exchange rate had never been
dislodged from its peg by previous depreciations of the Mainland's
currency, which have amounted cumulatively to some 75% over the
period since the establishment of our peg in 1983. Moreover, any
reasons for expecting a devaluation of the renminbi to have a
knock-on effect on the Hong Kong dollar because of competitiveness
considerations are weaker now than before, because Hong Kong has
evolved much more as a complementary economy to the Mainland of
China than as a competitor.
- As a final example I might mention the various
misperceptions which people have had more generally about the
relationship between Hong Kong and the Mainland of China, which
have perhaps caused some volatility in financial market sentiment
towards Hong Kong. I say "have" advisedly, rather than "do",
because, now that we are in our third year of "One Country, Two
Systems", I am pleased to find that the number of foreigners that I
encounter who still seriously misunderstand our system has dwindled
away. I would not anyway criticise those who did, or still do, have
mistaken understandings of Hong Kong's constitutional position.
After all, Hong Kong is a small territory, a third of the way round
the globe from here, and it would be conceited to assume that
everybody should know the intimate details of our situation.
- Anyway, for the avoidance of doubt, let me tell you that Hong
Kong enjoys complete constitutional autonomy in its monetary and
financial policies. And I can assure you that this autonomy has
been fully respected by the Mainland authorities. They are, indeed,
as anxious as I am to preserve a stable and prosperous financial
environment in Hong Kong.
- I hope you will forgive me for spending all this time talking
about Hong Kong and its currency rather than about the euro. I have
done so with a purpose, namely to illustrate the extent to which
observers may often be mistaken about the direction of policy or
the status of a currency. This is the source of much frustration to
those of us trying to preserve financial and monetary stability.
But we do have the consolation of knowing that there is a good
chance that those who have perpetrated or adopted those
misperceptions may have lost a lot of money as a result - if they
were brave enough to put their money where their mouth was.
Perceptions of the euro
- I shall turn now to the euro.
- I would be deceiving you if I said that the euro, as seen from
Hong Kong, enjoyed a particularly positive image at present.
Arguably one could expect no better for a currency which has lost
around 18% of its external value in little over a year, regardless
of whether this was judged to be the result of the strength of the
US dollar rather than any intrinsic weakness of the euro itself. It
is worth noting, however, that the euro was launched at a time when
the Euroland currencies were particularly firm against the dollar -
having climbed, in the case of the deutschemark, by almost 50%
since its low point in 1985. Against this background, and the
widening of interest differentials in favour of the dollar in
recent months, the direction of the euro's movement is, with
hindsight, hardly surprising.
- The depreciation of the euro is of course a fact, and it is
perhaps the only concrete basis for the scepticism that one hears
being expressed about the euro. But, from what I gather as an
observer from afar, there are a number of other factors, less
tangible, which also contribute to that scepticism. I shall go
through some of them with you, noting once again that perception
from many miles away may indeed be quite different from
reality.
- The first factor concerns structural
rigidities, which appear to observers from my side of the
world to be more serious in Euroland than in many other economies,
big and small. The severity of these structural rigidities is seen
to be undermining the ability and the efficiency with which
Euroland can respond to change. Of course, we recognise that some
loss of adaptability may be the price that has to be paid for a
relatively stable society and a comfortable social safety net, and
that the trade-off has effectively been arrived at through a
democratic process. But it is hard to believe, as an outsider, that
the trade-off is an optimal one. I cannot imagine, for example,
what goal of social stability could justify labour market and
social security arrangements that deliver an unemployment rate of
double digits; or contribute to delaying, if not preventing, the
arrival of the "new economy" in Euroland. I understand that some
still do not believe that there can be a new economy, in which the
technological revolution enables productivity gains that are
capable of sustaining a much higher rate of non-inflationary
growth. Of course, we should always question and critically examine
any unusual phenomena, rather than embrace them blindly. But,
meanwhile, investors are putting their money where this unusual
phenomenon is allowed, by structural flexibility, to be manifested
in full force, notably in the United States. This is seen to be a
factor contributing to the strengthening of the dollar and the
weakening of the euro, and reinforcing the scepticism about the
euro.
- One thing that we have learned from the Asian financial turmoil
is that global financial markets, made highly efficient by
financial liberalisation and the advance of information technology,
have become rather intolerant about policy mistakes. Strengths as
well as weaknesses are magnified in financial market behaviour to a
disproportionate degree as a result of the explosion of
international finance. What until recently were
considered to be small aberrations in policy can now be brutally
punished by the market. Even those who have been particularly
prudent can be tossed around rudely, as market sentiment sways and,
occasionally, succumbs to manipulative forces. So far, the emerging
markets have been the ones affected, overwhelmed by international
finance, perhaps to an unjustifiable degree relative to their
economic fundamentals. Although they found the situation difficult
to cope with at the time, most of them pulled through and are now
recovering strongly. The one common quality that they possess,
which is responsible for this rapid turn-around, is structural
flexibility. The explosion of international finance is poised to
continue, after the current lull, and will be made even more potent
by further advances in information technology. Euroland is, of
course, much bigger and more sophisticated than the emerging
markets in Asia, and so the risk of Euroland being similarly
overwhelmed by international finance is distinctly lower. But, seen
from Asia, even for the large and sophisticated markets, the risk
is not so low that it can be safely ignored. And if problems
materialise, structural rigidities that inhibit adjustment may
exacerbate and prolong the pain and disruption.
- I sense also that there are still doubts about whether Euroland
will cope well with the discipline of adjustment
imposed upon it by currency union and therefore be able to realise
fully the potential of such a union. Let me draw your attention to
an interesting and highly significant parallel between your system
of a unified currency across eleven countries and Hong Kong's
currency board system fixed to the US dollar. We both depend to a
very much greater degree than would otherwise be the case on
internal market flexibility as a mechanism of economic adjustment.
As you are aware, Hong Kong has always enjoyed a reputation as a
flexible economy. It is precisely that flexibility in the labour,
property and other markets that has ensured the sustainability of
Hong Kong's high rate of economic growth and currency stability
over the nearly seventeen-year history of our currency board
system. It is that flexibility, involving sizable and quite swift
price adjustments, accompanied by a considerable degree of labour
mobility within and between sectors, that has enabled Hong Kong to
cope with economic shocks. But, rightly or wrongly, the impression
from afar is that Euroland is some way from possessing these
necessary elements of structural flexibility. Consequently, there
is concern whether intra-Euroland adjustment between disparate
regions, when the exchange rate is no longer an instrument and
fiscal policy is supposedly constrained by Treaty criteria, will
prove to be too painful for some.
- There are other structural features of
Euroland, which also cause some concern to observers from my side
of the world. These include high taxation, stringent regulation and
cosy corporate governance characterised by the equity of major
businesses being closely held by friendly groups of long-term
investors, including one's bankers and associate companies - or
Euroland's version of the crony capitalism for which parts of Asia
have been so severely rebuked. From bitter experience, I know as
well as you do that the media tend to exaggerate the negative and
overlook the positive. The vision of Euroland which may
consequently predominate in the sub-conscious of Asian readers
might include such things as French truckdrivers blockading
autoroutes; German resistance to foreign takeovers; relatively high
taxes and a heavy burden of social security contributions; and
statutory ceilings on the number of hours employees may work.
- But let me refrain from venturing too far and turn to the
financial system of Euroland. The perception is
that it is dominated by the banking sector, which is in turn
dominated by a handful of huge traditional commercial banks. I
understand that, as at December 1999, commercial bank assets in
Euroland represented over half of total assets in the bank, debt
and equity markets. The corresponding figure in the United States
is only 15.8%. It is true that the relatively greater dependence on
banks in financial intermediation in the main Euroland countries
has served those countries remarkably well for many years. It
provided continuity of funding and support for long-term
strategies, and therefore insulated them from the scourge of
"short-termism". But the pendulum appears to have swung in the
opposite direction over the past 10-15 years. Competitive equity
and debt markets have been more efficient at delivering the
corporate restructuring and the funding for "new economy"
activities in a speedy manner in a world of particularly rapid
technological change and a world where international finance is
highly mobile. Such efficiency, with globalised markets, coupled
with a buoyant economy, is seen to be attracting substantial
capital to the US markets, and I understand that one major source
from where such capital comes is Euroland. Seen from Asia, this has
been another important factor contributing to the weakness of the
euro.
- These sort of images may explain why people talk of a
reluctance of foreigners to invest in Euroland, despite the very
clear signs that the overall prospects for non-inflationary
economic growth are now quite encouraging. You may argue that these
images are mistaken and flawed. You may well be right; I am not in
a position either to refute or to verify them. Euroland officials
should perhaps consider how much a problem there is of substance
and how much of perception, and address each as appropriate.
- Another factor that may contribute to scepticism over the euro
concerns monetary policy. But there is not a lot
that I would wish to say on the subject. You will appreciate that
central bankers are not anyway the sort of people to make public
assessments of one another! On the whole, I sense a feeling of some
sympathy for the European Central Bank. In the technical sense it
appears to have done most things right, in terms of keeping
inflation under wraps and so preserving the internal purchasing
power of the euro, but it has nevertheless had to preside over a
substantial decline in the euro's external value. Given that
Euroland as a whole is a relatively closed economy, the decline of
the euro may have caused more concern to outsiders than to
insiders. It has certainly influenced international investor
perceptions.
- My own observation, perhaps slightly cynical, of businessmen
and investors is that they are less concerned about the technical
content of monetary policy - provided that it is seen to be
reasonably disciplined - than they are about the conviction with
which it is delivered. Thus, the so-called "strong dollar" stance
of the United States is clearly stated. It is not contradicted from
anywhere within the administration. It inspires confidence, even
though it may lack precision - in fact what I think it means is
that the authorities will not stand in the way of a strengthening
of the dollar, rather than that they would necessarily resist a
weakening. By contrast, different Japanese officials have over the
past years made rather different pronouncements about where the yen
should be and what they might or might not do to secure that.
International sentiment towards the yen and investment in Japan
appear to have been damaged by such apparent vacillation.
- If these arguments are transposed to Euroland, they imply that
the ECB must continue to develop its own identity and assert its
own policies. Emerging uncertainties over whether an exchange rate
policy is lurking somewhere in the background should be firmly
resolved. Furthermore, national central bank governors and finance
ministers should exercise extreme self-discipline in commenting
publicly on monetary policy if their views in any way diverge from
the official ECB line, notwithstanding the withdrawal symptoms from
which they may suffer. The problem was nicely summed up by the
caption beneath a photograph of G7 finance ministers in a recent
edition of your German magazine, "Capital". It noted that there was
just one minister each to speak for the dollar, yen and pound, but
three who debated with one another about the euro. This may be a
scandalous misrepresentation of the true state of affairs, but
there are many readers who would, I am sure, have sensed a grain of
truth there.
- Another cause of possible scepticism over the euro relates to
what I would like to call popular acceptability.
Let me explain what it is. No one has yet seen the euro in the form
of cash. From Hong Kong we cannot witness as closely as you can
here in Euroland the extent to which the euro has already become
part of economic life. The separate national currencies are still
quoted in Hong Kong and any traveller knows that he can only take
those and not the euro in banknote form on his journey. There is a
feeling that, whatever the law says, the euro will not really have
arrived until it is there in your pocket. The sceptics will go on
to suggest that poor performance of the euro to date, coupled with
nationalistic resentment of the imminent loss of one's own
banknotes - to many an emotive symbol of national identity and
sovereignty - might yet cause a wave of popular opposition to the
euro at the eleventh hour.
- I should stress that this may not be a widely held viewpoint,
and most international businessmen and bankers have long since
discarded the national currencies from their minds and books in
favour of the euro. But it is possible for just a few vocal
doubters to have a disproportionate effect on the overall mood.
Plainly, the sooner that the euro is in physical circulation the
better, and I personally feel that the plan of a three-year wait
was a trifle generous.
- I should add an associated observation concerning pride in
one's currency. A currency is unlikely to win the widespread
confidence of international financiers if nationals of the currency
zone themselves lack pride or confidence in it. It is fully
understandable, though nevertheless unhelpful, that people whom I
meet here in Germany, for example, seem to have moved from pride in
the deutschemark to nostalgia for the deutschemark, rather than
from pride in the deutschemark to pride in the euro.
- So much for possible sources of negative perceptions. At the
same time there are positive aspects about the
emergence of the euro, although not all of them are necessarily
clearly visible from Asia.
- A notable achievement has been the establishment of the euro as
a major force in the international foreign exchange and bond
markets. High degrees of liquidity are being enjoyed, and in the
bond market issuance in euro quickly overtook the combined issuance
levels of the former component currencies. In this sense the euro
has already proved that it is greater than the sum of its parts,
and has succeeded in reaping those economies of scale which were
advertised as one of the several benefits of the single
currency.
- A related achievement has been the spread of usage of the euro
for invoicing and financing trade, not only within Euroland but
also by firms in other countries trading or competing with Euroland
or involved in supply chains leading there. This is a phenomenon
that is perhaps less evident in Asia than in countries nearer to
you here.
- Even less evident to us in Asia is the impact which the euro
may be having on competition and internal pricing within Euroland,
now that the single currency has stripped away exchange costs and
other impediments to price comparison. I must emphasise that I have
not had the opportunity to test this thesis for myself, so I can
only rely on what others tell me. Some claim that this will prove
to be one of the most emphatic benefits of the move to a single
currency. I could well believe that, but I am unsure what progress
may yet have been recorded.
- Thus, you will appreciate how in Asia we may not be aware of
the various benefits that the euro is delivering, whereas we are
relatively well served by the sceptics. There may be a marketing
job to be done here. And it is one which, to carry conviction, must
be performed as much by businessmen or bankers who actually use the
euro and experience the benefits, as by central bank, government or
European Commission officials, or by politicians and their
aides.
The HKMA view
- But let me say here that, insofar as the perception of the euro
within the Hong Kong Monetary Authority (HKMA) is concerned, it is
clearly a supportive one.
- As I implied earlier, we have a keen interest in the euro and a
quiet wish for its success. This should demonstrate to the world
that a fixed exchange rate (in your case more than a fixed rate - a
unified currency) vis-a-vis some or all of one's trading partners
is a viable option. There have been few other "fixers" since the
Bretton Woods system broke down in the early 1970s. But Hong Kong
since 1983 and other more recent currency board countries, such as
Argentina, Bulgaria and Estonia, have shown that fixing is a viable
strategy. It may indeed even be superior, given the discipline it
imposes and the salutary attention it focuses at the national level
on structural efficiency and flexibility. Of course it may not suit
all, and the IMF, for instance, continues mostly to espouse free
floating in its prescriptions for individual countries. But the IMF
does acknowledge that options at the other extreme of the spectrum
from free floating may be appropriate in some circumstances, and in
its pronouncements the IMF has given unflinching support to Hong
Kong's peg - as indeed it has to the euro.
- The success of the euro has further implications for the Asian
region. One lesson learned from the experience of the Asian
financial turmoil is that if we wish to reduce the vulnerability of
the small and open emerging markets in Asia to international
finance we need, among other things, to build bigger markets. One
way of achieving this, if not the only way, is to follow the
example of Euroland and go for some form of currency union.
Although the Euroland type of pre-conditions for currency union are
far from being satisfied in Asia at present, with so much diversity
and fragmentation in the geography, culture, stages of development
and policies, this is an option that Asia can ill afford to ignore
in the long run. The experience of Euroland operating with the euro
is therefore something that should be watched in Asia, and is being
watched in the HKMA, with keen, supportive interest.
- Meanwhile, one way of reducing the short-term vulnerability of
small and open markets in Asia to the destabilising influence of
international finance, while continuing to benefit from it, is
perhaps to promote the greater and prudent use of foreign
currencies in financial market activities. This is not an
advertisement for "dollarisation" - quite the opposite in fact. It
is a suggestion for consolidating the position of national
currencies by sparing them from certain extraneous influences. This
is particularly relevant to Hong Kong as an international financial
centre where non-domestic financial business and movements in
portfolio capital unrelated to economic developments intrinsic to
Hong Kong are abundant. In line with this thinking, we have come to
the conclusion that we need to develop our financial infrastructure
to facilitate the use of foreign currencies in international
financial transactions in the Asian time zone. We have just started
work on building a US dollar payment system and would have a keen
interest in doing the same, in due course, for the euro, if demand
for such facilities in the Asian time zone was evident. Hong Kong
looks forward to and is ready to facilitate the greater use of the
euro in Asia.
- For Hong Kong the emergence of the euro as a major currency
alongside the US dollar is also welcomed from a reserve management
standpoint, since the options for investment are broadened. There
is now a clearer alternative to the US dollar than before monetary
union. And it is a time when conservative, long-term investors are
looking for such an alternative. As you are aware, there is in the
US increasing concern about inflation being rekindled,
notwithstanding rapid, IT induced productivity growth. Of course,
prospects of tighter monetary policy tend to lend support to the
dollar. But there is the possibility that at some point the extent
of interest rate hike needed to preempt inflation and the
associated fears for its consequences for the real economy are such
as to scare investors away from US financial markets. Another
reason would be the possibility that productivity gains arising
from IT investments may experience diminishing returns.
- In the HKMA, we certainly are putting our money where our mouth
is. I have personally attracted some attention in the foreign
exchange markets for remarks I have made about the management of
Hong Kong's Exchange Fund, which holds, among other assets, our
foreign exchange reserves. Our target exposure to European
currencies (which may not necessarily mean the euro alone) is set
at 15% of the Fund and we have, over the past few months, moved
from an underweight position to the neutral position of 15%. This
target exposure may strike you as low. But we do hold some Hong
Kong dollar assets in the form of the Hong Kong dollar equities
that we have acquired in 1998 and we are obliged to hold US dollars
one-for-one as backing for the monetary base under our currency
board. If we exclude these, then among the remaining foreign
currency assets our targeted exposure to European currencies at
present is effectively a little over 20%. Superficially, this may
still seem on the low side. But with our peg to the dollar we feel
more comfortable having a substantial dollar reserve which covers
much more than just the monetary base, even though we do not
formally commit ourselves to convertibility at the fixed rate for
anything more than the monetary base.
- In managing our foreign reserves we also tend to be averse to
volatility. Thus, given our dollar focus, we have naturally been
worried by the volatility of the euro's exchange rate. Very
recently we informally polled ten leading financial institutions in
London. Their forecasts for the dollar/euro exchange rate by the
end of this year ranged from $1.22 down to 90c. This is a
considerably wider spread than the trading range already
experienced and suggests a huge measure of uncertainty, to a
horizon of only ten months.
- Of course, one might argue that this represents uncertainty
over the dollar as much as the euro. Yes indeed, and I apologise
for analysing things very much from a dollar base. Over time, all
currencies have experienced considerable volatility - the dollar,
the yen, the euro and its ancestors, sterling and so on. Yet in all
of these, investors have been able to enjoy significant positive
real rates of return over the long term. That may not be good
enough for everyone: some seek short-term gains; others may be
worried by mark-to-market volatility in the short term even if they
are there for the long haul. But long-term investors will give
considerable weight to the overall economic and monetary management
of the economy. As I mentioned earlier, there are a number of
aspects of the management of the Euroland economy about which
perceptions from Asia may be somewhat sceptical. As for monetary
policy, I would suggest that it is perhaps natural for outsiders to
be rather hesitant in their assessments, in view of the new
infrastructure for monetary policy, but as the ECB beds down one
would expect confidence to grow.
Conclusion
- My theme today has been that perceptions may be at variance
with reality, but it is often perceptions that drive financial
markets. Economic fundamentals can probably explain some of the
euro's weakness over the past 14 months, but not all of it. I have
tried to be frank in my assessment of the way in which the euro is
viewed from Asia. I hope I have not been so frank as to be
discourteous. Sentiment does appear currently to be somewhat frail
and the outlook uncertain. I derive no satisfaction at all from
that - we are all in more or less the same boat when it comes to
the vagaries of the markets. And as the manager of Hong Kong's
substantial foreign reserves, I am also held accountable for the
investment decisions taken. But I am confident that sentiment will
improve and our investment in the euro will come good.