Donna Block
SHARE WORLD
First birthdays are usually a watershed, a milestone, and reason to celebrate. On January 1 2000 the euro, Europe’s single currency, will have its first birthday, but it appears no one’s going to be coming to the party.
The 11 European participants in the euro will not be breaking open the champagne and toasting their decision to take part in the currency they brought to life in January 1999.
Introduced as the European currency of finance, although it is not yet in daily use, the euro was celebrated as a crowning achievement of European economic integration. It was supposed to be the first real rival to the United States dollar. But in 11 months, the fledgling currency has defied widespread expectation that it would replace the dollar as the premier reserve currency. Instead it has become a thorn in the side of some participants and has tumbled 15% against the dollar and 22% against the yen.
Economists feel there are many reasons for the euro’s decline: the US’s unyielding economic growth, Japan’s recovery, sluggish growth in the euro-zone economies, and a niggling feeling that European policymakers cannot come to terms with each other and are unable to guide the new currency. This attitude came to the fore last week when Gerhard Shroeder, the German chancellor, said his country might unilaterally introduce a withholding tax on all cross- border savings. This action by Germany added credence to the assumption that participating governments were in disarray and unable to undertake a radical reform of the region’s economies.
Economists are concerned that such a stance by Germany would send capital fleeing from the euro-zone, depressing the euro even further.
Nonetheless, it is unlikely that European Central Bank members will act immediately to shore up the currency. Although the decline in the euro looks bad, the weaker currency has a competitive advantage when it comes to exports, and although it may lead to higher inflation, the euro-zone inflation rate is at 1,4%, a low, comfortable level. Financial markets are still confident in European shares, and interest rates on European bonds are becoming more attractive than they were earlier in the year.
But the euro’s decline does pose some problems. By slipping below a one to one ratio against the dollar, the euro crossed a psychological threshold and investors started shifting assets from Europe to the US in order to frustrate the risk from any Y2K computer problems.
According to traders and analysts, investors have long complained about Europe’s patchy economic recovery, political leaders’ reluctance to tackle tough corporate reforms, and lack of signs these issues are being addressed. Throw in a war between Yugoslavia and the NATO forces, the resignation of German finance minister Oscar LaFontaine and then the entire European Commission and it becomes clear why sentiment has waned and investors are fleeing to a safe haven of choice – the US.
To add insult to injury, if the euro declines much further, the weakness could start to fuel concerns that real inflation is once again a possibility. That may force the European Central Bank to protect price stability by raising interest rates – a move that could jeopardise the economic recovery under way in countries like Germany and Italy. Rates would increase on mortgages, auto loans and consumer credit lines.
Politically, the euro’s weakness is likely to harden the resistance of countries that have thus far refused to adopt the euro, including Britain, Denmark and Sweden. British executives had been fairly strong supporters of adopting the euro in the next few years, but they have become increasingly cool. Many now see little real advantage in giving up the pound sterling.
Looking ahead, however, analysts agreed with European officials’ forecasts that the euro has room to appreciate. The upshot is that the potential for growth in the euro- zone is good and although the euro has been flirting with parity and fallen below the dollar a few times, there are plenty of investors out there willing to pick up the currency at bargain basement prices in anticipation of European growth and a bounce back.
The euro has not had a great first year but the single currency project has given a definite boost to the transformation process in Europe’s economy. And if the politicians can get it together and cooperate, the future for Europe and the euro looks bright.