THE ECU

The ECU

5/1987
EUROPEAN DOCUMENTATION


1. The origin of ECU

"The ECU started life as a unit of account used only for budgetary purposes. It now serves increasingly as money within the Community, not only for official purposes by the European Community institutions that created it, but also, on an even greater and increasing scale by companies , banks and private individuals.

Such growth in the private use of the ECU (European currency unit) in so short a period of time has been possible only because national currencies alone cannot meet all the needs of increasing cross- frontier trade and capital movements within the Community and worldwide. A generally accepted form of money is also required to reduce and spread more evenly the risks associated with the use of national currencies in cross- frontier transactions.

The growing use in international trade and on the financial markets of a unit of account initially needed by the Community institutions for their own internal accounting purposes required the background of a strong European Community and of the European Monetary System (EMS), established in 1979. Only the unit of account of a Community determined to ensure cohesion and a stable economy could have transcended the narrow framework of its official use and have been taken up by the private sector , which was looking for a currency unit for cross-frontier transactions. The ECU is being used today in two separate circuits: there is the official ECU used by the monetary authorities and the private ECU used by business and the population at large, both being identical in definition.

The European Community originally comprised six Member States, and since 1986 has 12 all with equal rights but separate currencies. Since its foundation , it required a common measure of value. This was essential for drawing up the Community budget, for settling claims and obligations, and, following the introduction of the common agricultural policy in the early 1960s , for expressing common prices for agricultural products. This uniform measure of value was not a common currency, merely a common yardstick or unit of account.

The Community s first unit of account (u. ) was that used by the European Payments Union (EPU), set up in 1950. Its value was equivalent to the weight in gold of one United States dollar - 0..88867088 gram of fine gold. Conversion of the unit of account into national currencies was based on the official central rates for Member States' currencies fixed at international level under the Bretton Woods agreement. With the disintegration of the system of fixed exchange rates , it was not long before the Community s unit of account began to split as well. As a result, several units of account came into being in the Community, some of which were based on the old and less and less applicable parities , while others were geared to the fluctuating daily rates of the currencies concerned.

On 21 April 1975 , the Community decided to follow the example of the International Monetary Fund and to create a European unit of account made up of specific quantities of the then nine Member States' currencies. At the time, the IMF unit of account, the special drawing right (SDR), consisted of agreed quantities of 16 currencies in a common basket.

The Community s new basket-type unit of account was christened the European unit of account , or EUA. With its introduction in 1975 , the foundation was laid for the ECU. When the European Monetary System (EMS) was launched on 13 March 1979 , the EUA formula was retained unchanged , but a review clause was incorporated and the EUA renamed the ECU..."

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2. Nature of the ECU

"The architects of the EMS drew on differing sources in arriving at the name 'ECU' For the then French President, Valery Giscard d'Estaing, it was supposed to be reminiscent of the gold coin introduced by Louis IX (also known as Saint Louis) in the thirteenth century and subsequently circulated throughout Europe. The British and German representatives took the name from the initials of ' E uropean currency unit..."

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B. The function of the ECU in the European Monetary System (EMS)
 
1. Centre of the EMS

"The ECU is a pillar of the European Monetary System (EMS) and the symbol of a zone of monetary stability in Europe. This was made clear in the resolution adopted by the Member States' Heads of State or Government at their meeting in Brussels on 5 December 1978 at which the EMS was launched: 'A European currency unit (ECU) will be at the centre of the EMS. ' The EMS was designed to bring about greater measure of monetary stability in the Community. The Heads of State or Government wanted it to be seen 'as a fundamental component of a morecomprehensive strategy aimed at lasting growth with stability, a progressive return to full employment, the harmonization of living standards and the lessening of regional disparities in the Community . It was ' to have a stabilizing effect on international economic and monetary relations

Given these objectives , the ECU has a role to play not only within the EMS but also, in the longer run, within the international monetary system, whose stability it seeks to help reinforce. Only if the Community works for greater stability internally can it usefully contribute toa return to increased monetary stability externally, that is to say in the world at large.

The Heads of State or Government expressly assigned four functions to the ECU; it is to serve as:
(a) the denominator (numeraire) for the exchange-rate mechanism;
(b) the basis for a divergence indicator;
(c) the denominator for operations in both the intervention and credit mechanisms;
(d) a reserve instrument and a means of settlement betWeen monetary authorities in the Community..."

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(d) A reserve currency in the making and a payment instrument 

"The European Council made it clear when it launched its initiative in December 1978 that in introducing the ECU it wanted not only to create a unit of account but also to lay the foundations for a currency and reserve unit. Since the inception of the EMS, EMS participants have deposited 20% of their gold reserves and 20% of their dollar reserves with the European Monetary Cooperation Fund (EMCF). In exchange, the EMCF has credited them with ECUs.

By requiring the deposit of gold and dollar reserves as the counterpart to the creation of the ECU , the Community has shown that the ECU is not a source of liquidity additional to existing reserve instruments and created out of nothing, but that the ECUs issued are entirely matched by other, immobilized currency reserves. The deposit arrangements applicable during the first phase must not, however, be confused with definitive transfer of part of Member States' gold and dollar reserves to the EMCF. So far, Member States' deposits with the EMCF of 20% of their gold and dollar reserves have merely been in the form of three-month revolving swaps. The deposit arrangements themselves are renewed every two years. Physically, the gold and dollars remain the possession of Member States' central banks, which also bear, the investment risk and recei~e interest payable on the dollar portion. The ECUs credited against the original depC?sit do not therefore yield any interest. Interest becomes receivable only when Member States use their ECU credits for payment purposes..."

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The private use of the ECU

1. Origin
"The development of the private ECU markets began in 1979 when a number of Belgian banks opened ECU-denominated sight and time deposit accounts for the Community institutions at the latter s request. This enabled the Commission to simplify its cash management and to transfer ECU-denominated financial contributions and interest subsidies to the European Investment Bank (EIB) directly in ECUs..."

[Mrt: How different is ECU from early stage of SDR?]

Source: http://aei.pitt.edu/1019/1/monetary_ECU_2nd_edition.pdf