Bundesbank Profit May Be Hit By Emu

Germany could lose more than $10 billion (£6.1 billion) in central banking profits during five years as a direct result of European economic and monetary union (Emu), according to a report out yesterday. The Netherlands, Spain, Sweden and Austria would also lose out, while the UK and France would be the biggest net gainers.

The reason behind Germanys projected loss is the discrepancy between the large amount of D-Mark banknotes currently in circulation inside Germany and especially in eastern Europe and Germanys shareholding in the future European Central Bank (ECB).

The D-Mark accounts for an estimated 42 per cent of the EU monetary base - banknotes in circulation plus money held by central banks on behalf of commercial banks while Germanys share in the European Monetary Institute (Emi), the forerunner of the ECB, is 22 per cent.

 

The profits arise from what is known in central banking parlance as seignorage. Each banknote issued by a central bank is backed by an interest-bearing security. The more banknotes a central bank issues, the greater its profits, or seignorage, from those securities.

One of the main reasons for the glut of D-Mark notes, relative to Germanys population size and its gross domestic product, is the strong use of D-Mark notes as a hard currency in eastern Europe and especially in Russia.

Given Germanys history of low inflation, Germans also tend to use their currency as a store of value to a greater extent than is common elsewhere in the EU.

Under the Maastricht Treaty, the securities which give rise to seignorage will be pooled. As the balance sheets of the various national central banks are incompatible, the Emi has adopted a flat-rate method. Profits will be calculated on a monthly basis using a low interest rate and will then be shared out in proportion to each countrys shareholding in the ECB.

The precise shareholdings are not yet known and will depend on the number of participants in Emu. The smaller the number, the larger each nations shareholding. But Germanys shareholding will always be smaller than its respective share of the combined monetary base. According to projections by Central Banking, a quarterly journal, Germany could lose $10.44bn over five years.

This would reduce to a loss of $6.77 billion if the redistribution of assets was phased in during a five-year period, under a specific formula outlined in the Maastricht Treaty.

However, the ultimate decision about whether to allow phasing-in is subject to qualified majority voting in the ECB. The issue could give rise to conflict, as it gives France an advantage over Germany. The two countries already disagree on the extent to which the ECB can directly engage in foreign exchange and money market operations and the nomination of the ECBs future president.

The UK, if it joined Emu, would become the single largest beneficiary according to the calculations, with a projected five-year gain of $7.95 billion, or $5.15 billion if transitional arrangements were applied.

Mr Charles Goodhart, Norman Sosnow professor of banking and finance at the London School of Economics, said of course, Germany is going to be a big loser. The UK, if it joined would be a big gainer. But all this does not amount to much in economic terms. This is accounting not economics. He said that Germanys monetary base is bloated further by the black economy. High denominations, such as DM500 and DM1,000 notes, make the D-Mark the currency of choice in black-market transactions in Germany itself and especially in eastern Europe. Experts believe the transition to the euro could deal a lethal blow to the black economy, but this would depend on the mechanism by which national currencies are exchanged into euros. Mr Graham Bishop, European financial affairs adviser at Salomon Brothers, the US investment bank, said that if they dont hand their money in, as one might expect, then Emu could constitute a 100 per cent wealth tax on the black economy. Under the current arrangements, national currencies

lose their legal tender status in mid-2002. Mr Goodhart points out that this, far from being popular, could severely add to the public disaffection for the single currency, given the size of the black economy in some countries. *Dispute over ESCB profits, Central Banking, volume 7, no. 4. Central Banking Publications, 27 Chancery Lane, London WC2A 1PA, Fax: 0171-404 6436. The transition to the euro could deal a lethal blow to the black economy, as the D-Mark is the currency of choice in black-market transactions in Germany and especially in eastern Europe Copyright Financial Times