Technology set to show its strength in currency debate

Our leaders aren't making contingency plans. The private sector is doing it for them
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The Independent Online
Sterling officially back at DM3.00? The dollar at a six-year high? The first has happened despite the widespread view that this is not sustainable; the second despite a widening current account deficit. Why are these seemingly perverse things taking place? Have the markets gone mad?

Not really. What has taken place in the past few weeks has been that the perceived status of the euro has shifted in a quite extraordinary way. Sterling and the dollar are attractive partly because of interest rate expectations, but that is only a surface reason, for we all knew weeks ago that rates on both sides of the Atlantic would move higher this year. The underlying reason for the change in sentiment is because investors do not want to hold any currencies which might be converted into the euro. Sterling and the dollar are safe havens.

The markets still seem to believe the euro will happen. They reckon it may even happen on time, though this looks less likely by the day. But it has become radically more likely that, if it does happen on time, it will be a weak currency. The tensions that this might create, in particular in Germany which would have exchanged the mark for the euro, hardly bear thinking about. I happen to think that the probability of the euro happening during the next 10 years are less than evens. That is still a minority view, but the balance is swinging that way.

Given the increasing likelihood of failure, or at least delay, you would imagine that our European leaders were doing some contingency planning. How might European economic integration be pushed forward in the absence of a single currency? They aren't. Or at least if they are not a squeak has emerged.

Fortunately, however, the private sector is doing it for them. There are a number of practical reasons why currencies will become less of a barrier to international movements of trade and finance thanks to technological advance. If the politicians make a mess, technology will rescue them.

Some examples. The most obvious is the way in which, for retail payments, credit cards are gradually bringing the benefits of an international currency. At the moment there are still barriers in transaction cost, currency conversion, speed and security. But the shift to debit cards is cutting transaction costs dramatically: in the US this is typically about one-third of a credit card.

As the experience of the telephone companies in handling micro-payments is applied to retailing more generally the transaction cost of electronic sales could fall to fractions of a penny - just like the transaction cost of a phone call.

Currency? Technically it would be possible to have instant currency conversion, so that the purchaser would see the price in his or her local currency, and pay that precise price. We are not there yet, though an interesting intermediate stage has been reached at Heathrow, where some of the shops offer their own (more favourable) exchange rate for non-sterling purchases, in effect making up their own exchange rates rather than taking those handed down by the market.

Speed? As telecommunications links, tills and card verification all continue to improve, soon card transactions will become significantly quicker than cash ones.

And finally security: here there are two camps. One reckons it will be possible to make credit (or debit) card transactions totally secure by adding voice recognition, or a palm-print reader. The other camp believes the way forward for small transactions is the smart card.

The prototype here is Mondex, the card developed by a consortium led by NatWest, where the value is embedded in the card and deducted each time it is used. The card could be recharged at points in banks and retailers, rather like cash dispensers. Interestingly, Mondex has been bought by Mastercard. From the point of view of the supplier, the smart card has enormous attractions. The "money" is carried around by the user, just like cash, so there is no serious security problem. All that can be lost is the cash embedded in the card.

The cash could also be withdrawn in any currency, just like a credit card, so in theory it could be a new international currency, usable anywhere in the world. Whether people want to use it is less clear. We simply do not know. But if Mondex and its successors do not fly it will be for social reasons, not technical ones.

Fixing retail transactions within Europe so that everyone can use their own currency is the most obvious potential benefit from technology, but in terms of total economic impact it is relatively unimportant. For commerce potential benefits of a common currency include common pricing and the elimination of exchange risk in long-term contracts.

Common pricing is one of the most important single commercial benefits of a common currency. At the moment companies can price differently in different markets because the exchange rate conceals these differences. If they had to price the same, it would encourage them to concentrate production in the lowest-cost areas, rather than source locally and charge higher prices in high-cost locations.

Technology cannot force common pricing to the same extent that a common currency would do, but it is going to make pricing more transparent and the more it does so, the more pressure there will be on producers not to over-price. The mechanism here is the Internet, or rather some refinement of what is still a crude prototype of what linked computers will become. One of the effects of the Internet in the US has been to give buyers infinite information about pricing. The price of any commodity, or commoditised service, is infinitely available. Electronic search engines are being developed to hunt out the cheapest deal. The effect is to make the market much more efficient. Add in automatic currency conversion and any business will be able to cross-check the price of any commoditised product or service. Technology will create transparency of pricing.

What it will not do is eliminate exchange risk. What it may do, however, is to cut the cost and extend the capability of hedging. At the moment companies hedge their short-term exchange rate exposure. They do not cover their long-term exposure because the costs become prohibitive. But the use of technology ought to enable financial institutions to make a step- change in the cost of operation, which in turn will tend to be passed on to customers. So at one remove technological advance will even help here.

It would be absurd to try to claim that technological advance will make the euro irrelevant. It is not a substitute, because conceptually economic integration that results from technical change is different from economic integration that results from political change. But what it can do is to cut many of the costs of having multiple currencies. And if the project fails, Europe will need all the help it can get to maintain the momentum of economic advance.