Birth pangs of the euro

Will the euro be able to survive the vicissitudes of a currency change and also challenge the hegemony of the U.S. dollar?

SEPTEMBER 1, 2001 was a historic day for Europe. Thousands of tonnes of banknotes and coins of the new European common currency, the euro, were delivered to the central banks of 12 European countries for circulation as legal tender.

The euro, which will shortly replace the existing national currencies of 300 million Europeans, was unveiled in Frankfurt by Wim Duisenberg, President of the European Central Bank (ECB), who described the occasion as "a moment when the flow of history is present". He said: "It required much insight, understanding and determination to convince the different countries of Europe that their place in an increasingly interdependent world could only be assured by a single currency which promoted greater commerce both among themselves and with the the rest of the world."

A change of currency is something of a radical break with the past, and in history there have been only a few instances of such a complete changeover. One instance is the failed attempt by Muhammad bin Tughlak, the 14th century Sultan of Delhi, to introduce token currency. One reason for its failure, it is said, was that people were confused by the change and refused to accept it.

Given the logistics involved in launching the euro, there are fears of large-scale confusion when it begins to circulate on January 1, 2002. For one thing, existing national currencies will still be legal tender for two extra months, although the change would be returned only in euro. There could be delays in working out the precise exchange, leading to long queues in places such as ticket counters and shops. At the same time shops could round up prices to the higher figure to facilitate payments, in the process hurting consumers and contributing to inflation.

From mid-December, "starter-kits" of euro money will be sold to familiarise shopkeepers and other consumers before the launch. Coinciding with the presentation of the euro in late August, the ECB also launched a campaign to inform the public - through leaflets, television advertisements and special events - about the euro and the unique security features of the seven denominations of banknotes. The security devices range from complicated metallic threads to holograms and micro-printing.

Counterfeiting of the euro is another major worry ahead of its launch. Police experts feel that the criminal mafias - notably the Russian, Italian and Albanian ones - are preparing to flood the market with false euros, taking advantage of people's unfamiliarity with the new money. Since the euro's inception in 1999, bankers, businessmen, stockbrokers and money market traders have used it as a paper or virtual currency and in electronic commerce. Meanwhile, in order to minimise the risk of counterfeiting, the ECB refuses to release even currency notes of small denominations that could otherwise have helped prepare the public for the euro ahead of its New Year launch.

The manufacture of new automatic teller machines, vending machines and cash registers, and the conversion of old ones to make them compatible with euros and cents, is under way. The costs of this transition are estimated to be substantial. Firms and banks also require to change their accounting and software systems.

Once the euro becomes the only official currency, those holding the old national currencies can exchange them for euros in the banks. These savings, held in cash and generally stashed away in the traditional way in homes and safe boxes, would then have to 'emerge', thereby adding to inflationary pressures. Although there are no precise estimates of such cash holdings for the European Union (E.U.) as a whole, gigantic sums are estimated to be involved. France and Germany together would account for two-thirds of this kind of cash.

In France alone, the quantum of money thus stashed away in "woollen stockings" was estimated last year to be 150 billion francs, of which less than 35 billion francs circulated back to the Bank of France at the rate of around three billion francs a month. Besides, a large portion of European currency is held outside the E.U. The German currency is preferred by people in East Europe and the Balkans. Between 30 to 40 per cent of Deutschmarks circulate abroad.

There is also a vast amount of money acquired from criminal activity waiting to be converted into euros, though banks are generally required by their national laws to watch out for possible money laundering. The scale of the problem may be gauged from the fact that money from criminal activity constitutes only 10 per cent of all unaccounted money generated through tax evasion and by the black economy. The parallel economy as a whole in Europe is estimated to be generating around $300 billion.

Of the total black money generated in the E.U., Spain's share is estimated to be around $40 billion. The real estate sector has been specially attractive as an outlet for black money in Spain. There has been a boom in construction activity in recent times, while the prices of houses in the major cities have generally increased by nearly 15 per cent during the current year. The Spanish government considers the introduction of the euro as an opportunity to control black money. According to officials there, large amounts of unaccounted money will get dissolved with the coming of the euro.

DESPITE the numerous and difficult short-term measures required to ease the transition, governments, chambers of commerce and banks throughout what is called the 'euro zone' are being spurred on by the long-term prospects of the euro. It was conceived as a way to integrate the European economies further by facilitating cross-border trade and investments. The conclusion of the monetary union, with the euro circulating from Ireland to Greece, is expected to lead to lower prices for goods and services by making price differences within the E.U. transparent. This would also help boost growth. Manufacturers are expected to benefit because the costs of changing money can be avoided and they will be protected from currency fluctuations. The ECB has, in fact, announced that the introduction of the euro has ended currency fluctuations, making transactions easier throughout Europe.

The 12 countries of the euro zone are Germany, France, Spain, Italy, Greece, Portugal, Finland, Austria, Holland, Luxembourg, Belgium and Ireland. Britain, Denmark and Sweden, which are also members of the European Monetary Union, would be watching the progress of the new currency after its introduction.

Since January 1999, when the euro has existed as an electronic currency, it has lost 30 per cent of its value against the U.S. dollar. It is hoped that its use as legal tender would help regain confidence in it and boost its standing in the currency markets. Europe had hoped that the euro would challenge the U.S. dollar and that businesses in other countries would hold their assets in euros. But a strong U.S. economy, at least prior to the recent slowdown, and the relative weakness of the European economies, with problems for the German economy in particular over the last few years, caused the euro to fall.

On the very day that the euro was unveiled to the public, the ECB cut interest rates by 0.25 per cent in an attempt to boost growth in the stagnant economies in Europe. The rate is now down to 4.25 per cent. The ECB has been slow with rate cuts, being more concerned with controlling inflation. Price rises have, however, slowed down in recent months in France, Germany and Spain, while the inflation rate overall for the euro zone is down to 2.8 per cent from the annual rate of 3 per cent in June 2001.

Over the same period the United States Federal Reserve cut interest rates seven times, bringing it down to 3.5 per cent. But the ECB is proving too conservative and preoccupied with controlling inflation to be able to deal effectively with the problems of stagnant growth and high unemployment rates in the euro zone. In fact, the European stock market indexes went down after the announcement of the interest rate cut.

The euro is becoming a real currency at a time when the economic slowdown threatens to turn into a worldwide recession. Consumer goods sales in the U.S. recorded a 0.1 per cent growth in July this year and the Dow Jones stock index lost 2 per cent in end-August, going below the 10,000 points level. Gross Domestic Product (GDP) in the U.S. recorded a 0.2 per cent growth for the second quarter of 2001. The Japanese stock index, Nikkei, also touched a new low at the end of August.

According to analysts, in the context of the current economic crisis the euro has not lived up to its promise of being an effective rival to the U.S. dollar. Neither has Europe been able to take advantage of the U.S. crisis to challenge the latter's political and military hegemony. The U.S. accounts for less than 20 per cent of world trade and around a quarter of world production. Yet the dollar is used in about half of all trade transactions and in three-fourths of the world's financial transactions. A successful euro could fundamentally change the balance of the world financial system affecting American financial markets and interest rates.