Economist.com

Ring in the euro

Jan 3rd 2002
From The Economist Global Agenda

On new year’s day euro notes and coins became legal tender, replacing national money in 12 European countries. The single currency, however, is already three years old—and an established fact of economic life. However, governments have much to do to ensure that its full benefits are felt

In Depth: Germany's earlier monetary union

Crossing the final bridge

GOODBYE, Clara Schumann, Vasco da Gama and René Magritte. Over the next few weeks the German, Portuguese and Belgian banknotes they adorn will disappear, along with nine other currencies. From January 1st, the euro area’s 300m citizens could at last get hold of euro notes, and start spending their new money.

The switch should be rapid. Bank machines will dispense only euros. Retailers are supposed to give change only in the single currency. So euros alone will be going into circulation, while national currencies will be taken out. Within four weeks, the Dutch guilder will no longer be an acceptable means of payment, followed a fortnight later by the Irish punt; all 12 currencies will be gone by the end of February.

To be sure, there have been minor glitches. Not all bank machines were dispensing euros on time. Some French bank and post-office workers went on strike on January 2nd, demanding more money and better job security. Many small shopkeepers had not stocked up with the new notes and coins before the turn of the year, perhaps out of an unwillingness to hold a lot of cash, and so were unable to deal with euros straight away. But, for the most part, the first couple of days of the changeover have gone remarkably well. So well, in fact, that foreign exchange traders marked the euro up by 1.34p against Britain's sterling, to 62.51p, its biggest one-day rise against the pound, in what traders described as a “relief rally”.

Many Europeans have their misgivings about the new money, despite the breathless enthusiasm of politicians, central bankers and big business for the project. Eastern Germans, in particular, have been disgruntled about giving up the D-mark after only a decade. Many people suspect that retailers will take advantage of the new currency to sneak prices up. That said, some shops are promising discounts to customers who pay with euros or plastic. Figaro, a French newspaper, has cut its price from FFr7 to euro1 (FFr6.56).

For all that, the changeover seems to be running fairly smoothly. By December 31st euro132 billion in notes and euro12.4 billion in coins had been distributed to banks, with some handed on to retailers and, in the case of coins, the public. Despite all the extra cash being driven around Europe, armed robberies in the past few months have, if anything, been less frequent than usual.

Yet, for all the fanfare, in reality the euro is not new, but already three years old. Since 1999 a new institution, the European Central Bank (ECB), has been setting a single interest rate for the whole euro area. Big companies have long been publishing their accounts and trading in euros, and encouraging smaller ones to use euros too. Share prices have been quoted in euros. Governments have issued a quarterly average of well over euro100 billion of euro-denominated debt. Corporate debt issues in euros reached euro65 billion in the second quarter of last year, as European telecoms companies scrambled to pay for third-generation mobile-phone licences.

Impressive as all this is, the grand claims made by some at the euro’s birth look overblown. It has not turned Europe into a dynamic economic powerhouse. Nor can it, if governments continue to shy away from microeconomic reforms. And, while the euro has taken the Deutschemark’s place as the second commonest currency in official foreign-exchange reserves, it still has only one-fifth of the dollar’s share.

Nevertheless, the euro has so far proved far from the disaster that some predicted. One common criticism is that the euro has been weak. It now buys around 89 American cents, compared with $1.17 when it was launched, and at one point was worth little more than 80 cents. A second criticism is that the ECB, in contrast to America’s energetic Federal Reserve, was too slow to cut interest rates in 2001, perhaps pushing the euro area into recession.

The euro is weak: but the euro’s fall against the dollar was no bad thing, in that it supported exports and growth. In any case, the ECB’s job is not to guard the external value of the currency, but its internal value—ie, to keep inflation in check. That it has done successfully, if too hawkishly for some.

Duisenberg isn't everyone's hero

More important, carping about the euro’s exchange rate or the competence of its president, Wim Duisenberg, is irrelevant. Neither says anything about whether it makes economic sense to fuse 12 economies into a single-currency area. The euro’s fall had little to do with the currency’s creation, and everything to do with markets’ faith in America’s growth “miracle”. For all his clumsiness, Mr Duisenberg has done nothing so bad that it has damaged the prospects for the single currency irrevocably.

Full marks for the euro, then? Not quite. The chief cost of the single currency comes from applying the same interest rate in every country, regardless of national conditions. The strains that this can impose are clear. Ireland is still growing healthily and should have higher interest rates than the current 3.25%. The shrinking German economy could do with a rate cut. This is awkward, but not unbearable. However, the tensions of the past three years have been mild. More testing times lie ahead.

There are two likely sources of trouble. The first is Europe’s “stability and growth pact”. Governments have to present plans to bring their budgets into balance and keep them there. The idea—to stop governments undoing the anti-inflationary work of the ECB by loosening fiscal policy, and to stop profligate governments from pushing up borrowing costs for all—is sensible. But it ties governments’ hands too tightly.

The second possible source of trouble is the eventual enlargement of the euro area, especially as the European Union expands eastwards. Unlike Britain, Denmark and Sweden, which have chosen to stay out of the euro area for now, new entrants to the EU will be obliged to peg their currencies to the euro and eventually to join it. However, the potential cost of a single interest rate rises with the number of countries, because the risk of “asymmetric shocks” increases. These are events that have different impacts on different countries and therefore require different policies in response.

EPA

Ready for change

Neither of these looks likely to break the currency union. Nonetheless, these risks make it all the more important that the benefits of the euro are realised. Besides doing away with exchange-rate risk, the creation of a single currency ought in theory to increase competition, by making prices more transparent. Where international price differences remain, the reasons for them should at least become clearer. Sometimes, there will be an economic justification, such as transport costs, or differences in the cost of land. Sometimes, it will become clear that price differentials are being shored up to serve special interests. The price of cars, for example, will continue to vary, thanks to the block exemption for exclusive dealerships permitted by the European Commission. Ditto the price of energy and postal services, thanks to the recalcitrance of national monopolies and the foot-dragging of politicians.

The euro can only expose regulatory obstacles to competition. It will take politicians to sweep them away. But the cosseting of monopolies, France’s 35-hour week, and Germany’s sinking of a pan-European takeover code do not offer hope. There are risks ahead. It is high time to maximise the rewards.