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GOODBYE, Antoine de Saint-Exupéry, Vasco da Gama and René Magritte. Over the next few weeks the French, Portuguese and Belgian banknotes they adorn will disappear, along with nine other European currencies. Their replacements are figments of the imagination: stylised bridges and doorways, symbols of European unity on the continent's new currency, the euro. The money, though, is real enough, and it is also the biggest step yet towards European political and economic integration. On January 1st, the euro area's 300m citizens could at last withdraw euro notes and coins and start spending their new money.

The switch should be rapid. Bank machines across the euro area are supposed to dispense only euros; in theory, retailers are supposed from now on to give change only in the single currency. So only euros will be going into circulation, while national currencies will be taken out. Within two months, all the national currencies will cease to be legal tender (see table).

Naturally there will be glitches. Although most bank machines were dispensing euros on January 1st, it will take a few days before all have been converted. 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 money before the turn of the year, perhaps not wanting to hold a lot of cash, and so were unable to deal with euros straight away. On New Year's Day the Lisbon branch of Portugal's central bank was crammed with traders heaving in plastic bags full of escudo coins, and with old people who were under the mistaken belief that they had to change all of their money in one day.

Inevitably, some queues have been longer than usual. A nine-kilometre tailback formed at a motorway toll station near Rome on January 1st. In Athens, Grigoris Tsigaridas, who runs a kiosk, said: “We're trying to give everyone change in euros even if they pay in drachmas, but inevitably there are mistakes and arguments. The people in kiosks are bound to get blamed a lot. We're telling each other we're part of a learning experience.”

For some Europeans, the changeover has been a breeze. Jonas, an elephant at Lisbon zoo, used to ring a bell when escudo coins were dropped into a bucket, refusing to perform if they were too small. His trainer reports that he now turns up his trunk at anything less than a ten-cent coin. Some humans, though, may find the adjustment harder.

Italians, for example, who remain big users of cash, will have to use more coins and fewer notes now that the 1,000-lire note, worth a mere 52 cents in the new money, is going. Last weekend, they drew huge amounts of lire from bank machines, fearful that they would be left short of cash in the new year. And if the French want to convert new prices into francs, they must multiply by the awkward number of just over six and a half.

Many Europeans have their misgivings about the new money, despite (or perhaps because of) 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 they coveted so long after only a decade.

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There are also plenty of folk who suspect that retailers will take advantage of their unfamiliarity with the euro to sneak prices up. Some are indeed doing so; but other people are rounding prices down, including Spanish utilities and Germany's biggest supermarket chains, which took out full-page newspaper advertisements on January 2nd to let the public know. Some shops are even promising discounts to customers who save them time by paying with euros or plastic. Le Figaro, a French newspaper, has cut its price from FFr7 to euro1 (FFr6.56).

A little private enterprise has helped to ease the adjustment. ¡Hola!, a Spanish magazine, gave away peseta-to-euro reckoners, and Greek retailers bought hand-held converters from African and Albanian street traders for euro3.20 a throw.

All in all, in the first couple of days, the lack of friction over the issuance of new notes and coins looked remarkable, given the scale of the logistical operation behind it all. By December 31st euro132 billion of notes, and 37.5 billion coins, had been distributed to banks, with some handed on to retailers and, in the case of coins, to the public. National currencies have to be collected, and shredded or melted down. Despite all the extra cash being driven around Europe, armed robberies in the past few months have been less frequent than usual.

The fact is that, despite this week's fireworks, the euro is already three years old. In economic terms, the introduction of notes and coins is like the formal opening of a huge new building that has been in use for some time. A lot of the changes associated with the introduction of a new currency were carried out long ago.

At the start of 1999, the exchange rates of 11 national currencies were irrevocably fixed (Greece, the 12th member, joined the club only in January 2001). Since then, these currencies have technically been sub-units of the euro. For the past three years a new institution, the European Central Bank (ECB), has been setting a single interest rate for the whole euro area.

The euro has thus become a fact of economic life, even if most Europeans could ignore it until this week. Big companies have long been publishing their accounts and trading in euros, and this has pushed many smaller ones into using it too. Share prices have been quoted in euros for the past three years. Governments have issued a quarterly average of well over euro100 billion of euro-denominated debt. Corporate-bond issues in euros, less than euro5 billion in the final quarter of 1998, reached euro64 billion in the second quarter of last year, as European telecoms companies scrambled to pay for third-generation mobile-phone licences.

The new currency has not, however, turned Europe into a dynamic economic powerhouse. Nor can it, if governments continue to shy away from making the necessary microeconomic reforms. The European Union's single market is still incomplete. Protected industries are yet to be opened fully to competition, and Europe's product and labour markets are still too highly regulated. The hope that the euro would rival the dollar as a reserve currency is also a long way from being fulfilled. Although the euro has taken the D-mark's place as the second-commonest currency in foreign-exchange reserves, it has only one-fifth of the dollar's share.

Critics point out that it remains feeble in the foreign-exchange markets, now buying around 90 American cents, compared with $1.17 when it was launched. They also complain that the ECB was too slow to cut interest rates in 2001, thus helping to push the euro area near, and maybe into, recession. In addition, the bank's presentation of its policy has often made it into a laughing stock. More than once, the ECB's president, Wim Duisenberg, has made daft remarks to journalists that have sent the currency tumbling.

The euro's weakness is not in dispute: Mr Duisenberg has often lamented its undervaluation. Moreover, the ECB's explanations of its interest-rate decisions (in particular, a quarter-point cut last May) have occasionally beggared belief. But this scarcely amounts to catastrophe. The euro's fall against the dollar was no bad thing, since it supported exports and growth in the euro area. In any case, the ECB's job is to guard not the external value of the currency, but its internal value—ie, to keep inflation in check. That it has done successfully, if too fiercely for some. Mr Duisenberg, meanwhile, has looked surer-footed in the past few months. He seems to have no plans to comply with earlier French hopes that he would depart in mid-year, to be replaced by a Frenchman.

In the end, carping about the euro's exchange rate or about Mr Duisenberg's incompetence is irrelevant. Neither tells you whether it makes economic sense to fuse 12 disparate economies into a single-currency area. The euro's fall had nothing to do with the currency's creation, and everything to do with markets' faith in America's growth “miracle”. Misplaced faith, as it turned out: since the euro's launch, GDP in the single-currency area has grown as fast as in Britain, faster than in Japan and only slightly slower than in America (see chart).

Full marks for the euro, then? Hold on. 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 were clear in the run-up to the euro's creation. Irish interest rates were slashed in 1998, for instance, even though the economy was racing, to bring them into line with those of its euro-area partners. These stresses continue. Ireland is still growing healthily, even if not at the breakneck speed of most recent years, and it could surely bear higher rates than the current 3.25%. The shrinking German economy, on the other hand, could do with a rate cut.

This is awkward, but not unbearable. Irish inflation, which peaked at 7% in November 2000, has since subsided to 3.8%—on the high side, but hardly rampant. German interest rates might not have been all that much lower, or cut much sooner, even if the Bundesbank were still in sole charge, given that domestic German inflation touched 3.5% last spring.

Yet as a test of the single currency, the tensions of the past three years have been mild. Much more awkward times lie ahead, especially if Europe's incipient recession turns nastier and America's recovery is delayed. The European Commission's president, Romano Prodi, said recently that sooner or later “there will be a crisis”. Whatever could he mean?

The first probable source of trouble is Europe's “stability and growth pact”, a fiscal accompaniment to the single monetary policy. Under this pact, governments have to present plans to the European Commission to bring their budgets into balance, and then to keep them there. Much more draconian, the stability pact lays down that any country whose budget deficit exceeds 3% of GDP must take immediate action to bring it back below that ceiling or face a fine that could be as large as 0.5% of GDP. There is an escape clause in cases of severe recession, but it is far too tightly drawn to be of much practical use: GDP must, for example, shrink by as much as 2% in one year if a country is automatically to avoid any risk of fines.

The overseer of the stability-pact provisions, the European Commission, says that most euro member governments are on the straight-and-narrow, even after the effects of the economic slowdown on taxes and government spending have been taken into account. However, it has pinpointed four laggards—France, Germany, Italy and Portugal—that are all supposed to come back into line by 2004 (see chart). In these countries, the commission says, the so-called “automatic stabilisers”, which increase deficits during any economic slowdown, should be allowed to operate only partially.

Why has Europe imposed such a barmy straitjacket on itself? The idea behind the pact is 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, in a form of free-riding. But the economic logic of tying euro members' fiscal hands in this way is flawed. It is questionable whether borrowing by any one country can significantly push up the costs for all others. What is more certain is that obliging those that still have work to do on their fiscal positions to keep tightening their budgets, even when their economies are in recession, is the sort of hairshirt philosophy that has undone many countries' economies in the past, the most recent example being Argentina.

The biggest problem is Germany, whose budget deficit is already dangerously high. A balanced budget by 2004, as required by the European Commission, looks far out of reach. Worse, the commission in its autumn forecast thinks that Germany's budget deficit will be 2.7% of GDP in 2002, which is much too close to the 3% ceiling for comfort. Some forecasters think the margin for error is narrower still.

Unless the German economy shows signs of renewed life soon, the euro area is heading for an awkward choice. On the one hand, everyone from the commission to the ECB to the German finance minister has vowed to observe the letter and spirit of the stability pact. A change of mind, or even a mere softening of the pact's terms, could weaken markets' belief in governments' commitment to fiscal rectitude. The loss of face would be all the greater because the pact was essentially a German idea. On the other hand, sticking rigidly to the pact risks prolonging a recession in the euro area's biggest economy.

The political implications could be huge at the European level as well. To put it mildly, it would set off a political crisis if Germany breaches the 3% limit and proceedings are set in motion to fine it for its behaviour. And the potential fines, which fortunately need the approval of a majority of the Council of Ministers before they can be imposed, are gigantic: in the case of Germany, as much as euro10 billion.

The second possible source of trouble is one that dogs any currency union: the risk of an asymmetric shock that afflicts one part of the region much more than any other. Russia's economic collapse in the late 1980s, for example, hit Finland especially hard. German unification soon afterwards administered a shock to the West German economy. If such things happen to a currency union, the policy response is hard, because there is no scope for any independent monetary or exchange-rate management. Moreover, Europe lacks the labour mobility and large central budget that makes the United States, say, able to cope with asymmetric shocks.

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Nothing smaller?

It may be that the risk of such shocks inside today's euro zone is not great. But the eventual enlargement of the euro area, especially as the Union expands eastwards, adds an extra dimension. Unlike Britain and Denmark, which have a formal “opt-out” from the single currency, and Sweden, which also did not join, the new entrants to the EU will be obliged to join the single currency once they have satisfied the Maastricht criteria on exchange-rate stability, inflation, and government deficits and public debts. Clearly, the potential cost of a single interest rate rises with the number of countries, because of greater risk of asymmetric shocks.

Until now, the euro area has avoided any big asymmetric shocks. The main economic events of the past three years—changes in oil and food prices and a global economic slowdown—have had broadly similar effects on all 12 countries. Throw in Eastern Europe, however, and the probability of events with different regional effects is sure to increase. A new economic crisis in Russia, say, would have far greater effects on Latvia, say, than on Ireland.

On top of this, living standards in the aspirant countries are lower, sometimes much lower, than anywhere in the current EU. Giving up the freedom to adjust interest rates, and accepting a monetary policy that may be either too tight or too slack could hobble their progress towards western living standards. And that raises the risk of a backlash against European integration in these countries.

Neither of these sources of trouble, however, looks likely to break the currency union itself. Rather, they make it even more important that changes are made to introduce more flexibility into Europe's economies. Besides doing away with exchange-rate risk, the creation of a single currency ought in theory to increase competition, by making prices easier to compare. Big companies have already gained from this. Now that notes and coins have arrived and national currencies are about to die, ordinary citizens ought to see some benefits, too: a loaf of bread or litre of milk should cost much the same on both sides of a border.

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, there will not. The price of cars, for example, will continue to vary, thanks mainly to the block exemption for exclusive dealerships that has been permitted by the European Commission (but which may soon be scrapped). So will the prices of energy and postal services, thanks to national monopolies and the foot-dragging of politicians over opening up their domestic markets to competition.

The euro can only expose regulatory and other obstacles to competition. It cannot sweep them away. It would be comforting to think that the continent's politicians will do their damnedest to wring all the available economic benefits out of the clarity that the single currency will create. There is a danger, though, that they will not. The cosseting of monopolies, France's 35-hour week, and Germany's sinking of a pan-European takeover code last year scarcely smack of commitment to the thorough structural reforms that Europe needs.

There are risks ahead for Europe's single currency. But there are also benefits to be had. It is high time that Europe's governments acted to maximise those benefits—and to help the euro work more efficiently for the good of the Union.

Copyright © 2002 The Economist Newspaper and The Economist Group. All rights reserved.