April 26, 1998
11 Nations Take Key Step Toward Unified Currency
EU Selects 11 to Join Currency Bloc (March 25) German Economists Ask Delay on Euro Currency (Feb. 10) Much of Europe Seems Unready for Single Currency (Dec. 27, 1997)
Combined Economy of European Monetary Union
By EDMUND L. ANDREWS
RANKFURT -- Nearly 50 years after European leaders dreamed of uniting their nations to prevent another world war, 11 countries led by Germany and France are soon to surrender a central pillar of national sovereignty: control over their currencies.
Despite some remaining feuding and recrimination, leaders from all but 4 of the 15 nations in the European Union are expected to approve final plans next weekend for the introduction of a single European currency on Jan. 1.
Financial institutions and a few big companies will shift in 1999 to euro-based electronic transactions, although the actual bills and coins will not be in general use until 2002.
But in a real sense, the new order begins in Brussels next week, because European leaders are expected to spell out the exchange rates at which their individual currencies will be locked together. As a practical matter, their countries will immediately subordinate individual monetary policies in favor of a common European policy.
Most economists say the euro's long-term prospects are better than they dared imagine a few years ago. Inflation is low. Growth is accelerating across the Continent. And a world barometer for financial credibility, the currency markets, increasingly behave as if the euro were already a fact of life.
"The euro will be to the dollar what Airbus is to Boeing," said Norbert Walter, chief economist at Deutsche Bank Research. "We have better airplanes as a result of competition between Airbus and Boeing, and the euro will give us better reserve currencies."
Never before has a group of countries tried to introduce a common currency on such a scale without also forming a political union. Nor have political leaders worked together for so long to overcome historical divisions born of language barriers, cultural differences and war.
Yet with less than a week before European leaders reach their point of no return, the two most important nations are squabbling like jealous siblings. France and Germany are still fighting over who will run the new European central bank as well as about basic economic principles.
"There is still a difference in philosophy in France about the role of an independent central bank and about whether the central bank should look only at the question of price stability," said Otto Lambsdorff, a former German Economics Minister.
Huge gaps separate rich but sluggish economies like Germany's from poorer but booming countries like Spain and Ireland. Italy and Belgium continue to carry twice as much accumulated debt as most others and are obligated to make deep cuts in spending for years to come.
If the euro maintains credibility, it could transform Europe into one of the world's biggest and most efficient marketplaces. A failure would be an economic and political disaster.
For all the uncertainty about the new euro market, one thing seems clear: it will be huge. The cohesive Europe will have an economy almost as big as the United States' with combined annual output of $6.28 trillion, versus $8.1 trillion. It will be the world's biggest single exporter and importer. And it will be the center of a $2 trillion bond market, virtually equal to the market for United States Treasury securities.
And currency traders, who a year ago expressed their fears about the euro by fleeing from German marks to dollars, have remained calm as the final decisions have been made.
"We are convinced that the euro will seriously threaten the dollar as the world's reserve currency," said Avinash Persaud, a foreign exchange analyst at J. P. Morgan in London. "This process will be far quicker than many imagine, and it will be under way in a matter of months, not years."
Financial analysts predict that a unified European bond market will benefit from economies of scale and become a much stronger competitor to United States Treasury bonds, notes and bills.
"It will be a major market, and it will appear on the first day of business in January," said Graham Bishop, an adviser to Salomon Smith Barney in London. Indeed, governments and financial institutions are already preparing the structure for bond trading in euros.
Robert Portes, a professor at the London School of Economics, estimates that the rise of the euro could cost the American economy about $40 billion in benefits that derive from the dollar's role as world currency.
Most ordinary Americans are not likely to notice those effects, however. Compared with the normal and sometimes violent swings in exchange rates, which will still be a fact of life, the pressures created by the euro would be barely discernible. "The Deutsche mark is already a reserve currency, and every country in the world already uses it as a surrogate for Europe," said Stephen Bell, a senior economist with Deutsche Bank in London.
An unanswered question is whether the member nations can adhere to a one-size-fits-all monetary policy beyond the first few years. It is no accident that the euro is wildly popular in Spain and Italy, and grumpily opposed by more than 60 percent of all voters in Germany.
Thanks largely to the euro, long-term interest rates in Spain and Italy have plunged from more than 13 percent in 1991 to less than 6 percent Saturday. Though part of the credit belongs to the central banks of the two countries, which imposed years of strict monetary policy to wring out inflation, the forthcoming reality of the euro played a major role.
Under the European currency union, interest rates in different countries must converge because the risk of the underlying currency would be no different in Spain or France or Germany.
Low rates have helped ignite an economic boom in Spain and Portugal and are expected to do it for Italy as well. Spain's economy is expected to grow as much as 3.7 percent this year, compared with about 2.5 percent in Germany. Spain has added 65,000 jobs in the last year, while Germany has lost 400,000. Such disparities present difficult problems.
César Molinas, an economist in Madrid with Merrill Lynch, warned in a recent report that the euro could in fact create a boom-bust cycle in both Spain and Portugal. Under such a script, rising prices would make Spain's products uncompetitive and force an economic downturn.
At present, countries can protect their international competitiveness by devaluing their currencies to offset inflation. But that would be impossible under the single policy of a European central bank.
Italy faces hard problems, too. Like Spain and Portugal, it has received a windfall in the form of lower interest rates. But Italy also has one of the highest levels of Government debt in Europe, and under the Maastricht treaty of 1991 it must reduce that sharply. Prime Minister Romano Prodi will have to cut Government spending enough to start generating annual budget surpluses. But Prodi came close to losing control of his Parliament once last year, when he faced rebellion over proposed budget cuts.
The practical task of adapting to a single currency will be anything but cheap or simple. Daimler-Benz AG., the manufacturer of Mercedes-Benz cars and trucks, is spending $120 million to convert entirely to euro accounting by Jan. 1.
Company executives hope to save $60 million a year on currency transactions and on instruments to protect themselves from changes in exchange rates. Smaller companies, though, have barely begun to think about the conversion and are loath to face the added cost.
The euro is also expected to increase competitive pressure on companies in high-cost countries because they will no longer be able to conceal cross-border price differences easily. "I call it the Motel 6 effect," Bell of Deutsche Bank said. Just as it is hard to charge widely differing prices in the United States, it will be hard for companies to sell products across Europe with sharply different price tags.
"It's likely to cost many companies a lot of money," Bell added.
"The French!" snapped Klaus Engelen, international correspondent at Handelsblatt, Germany's leading business newspaper. "Their strategy is one of containment -- they want to contain Germany."
Few Germans speak out as angrily as Engelen, but many share his fears. Less than a week before the Brussels meeting, France and Germany are battling over rival candidates to run the central bank. The French insist that the job should go to Jean-Claude Trichet, president of the Bank of France. The Germans, and most other governments, have long supported Wim Duisenberg, former head of the Dutch central bank.
The fight has little to do with personalities, since both candidates have locked their own monetary policies with those of the German central bank. But it has everything to do with a deep reservoir of suspicion that has bedeviled the euro project since it was envisioned.
German leaders insist that the European central bank should be independent of political pressure and focus exclusively on fighting inflation. French political leaders have argued that the bank should have some accountability to political leaders and place at least some priority on job creation. And they want a Frenchman simply because he is French.
"If the first act of European construction is a co-opting by central bankers, that means the single currency will start with a kind of coup d'état," remarked Jacques Attali, a former adviser to the late French President, François Mitterrand.
Lambsdorff, who opposes concessions to the French, said: "I see a political threat from political intervention that would damage the independence of the central bank.
The risk is that the countries with strong economies will be expected to transfer resources to those with weak economies."
Despite the months-long feuding and several failed attempts at compromise, financial analysts say the credibility of the future euro remains surprisingly strong. That is because the basic laws governing the European central bank and its priorities represent overwhelmingly German views. Even if Trichet is chosen to run the new bank, he has a record as a dogged ally of Bundesbank policies.
"The idea that the euro will be a weak currency is rubbish," Professor Portes said. "The central bank governors of Spain, Portugal, France and Italy are the toughest hawks in Europe. To get the idea that that they will suddenly turn into monetary lax-ists when they move to Frankfurt is bizarre."