Introducing...the Euro Ready or not, Europe's new currency is coming--and it could change the world. Here's what you need to know.
(FORTUNE Magazine) – The moment is upon us. After years of preparation, decades of talk, and countless (so far incorrect) predictions of certain failure, 12 European countries are going to throw out their national currencies in a few weeks and replace them with something called the euro.
This is big. It's a major historical event, with political and economic consequences that may be felt for centuries. Three hundred million inhabitants of Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain--countries that spent a significant part of the last millennium waging war upon each other--will share the same currency, the same monetary policy, the same economy (the world's second-largest, after the U.S.).
To an extent they already do share all these things, of course. Trade barriers within the European Union were demolished back in 1993. The euro itself became a financial market reality in 1999, when the exchange rates of 11 currencies (the Greek drachma joined in 2001) were fixed irrevocably to one another and to the euro, and stocks and bonds started trading in euros.
Now, though, we're talking about actual cash you can put in your wallet. The bank vaults of Europe are bulging with more than 14 billion euro notes and 50 billion coins. On Jan. 1 they become legal tender. For the first few weeks--through the end of February in most countries--the old and new currencies will circulate side by side. That will be chaotic, and the changeover will be expensive. European Central Bank President Wim Duisenberg has said it will take between 0.3% and 0.8% out of the eurozone's GDP for the year, possibly enough to tip the region's faltering economy into recession.
But it's important to look beyond the craziness of the first few months and the grumbling from many inhabitants of the eurozone. The new common currency is a reality that Europeans, Americans, and everyone else with a stake in the global economy must deal with. And while its existence doesn't change everything about Europe's economy or business climate or politics, it could change a lot.
WHAT HAS THE EURO ACCOMPLISHED SO FAR? In order to meet the tough economic and fiscal policy prerequisites for euro admission put in place in 1997 (largely to mollify the Bundesbank, Germany's powerful central bank), governments in Italy, Spain, France, and elsewhere stopped spending vastly more than they took in. In the process they brought down inflation and interest rates. Along the way, they may have engaged in what euroskeptic Harvard economist Martin Feldstein calls "heroic acts of accounting manipulation." But they may also have laid the groundwork for economic growth and stability well into the future.
All that was before the euro became a financial market reality. Since then, Europe has seen the creation of a borderless, euro-denominated bond market that now rivals that of the U.S. in size. Equity markets are still struggling to cross national borders and achieve similar growth, but they are pushing in that direction. As a result, European companies and governments that were once dependent on banks and local investors for their financing can now look to global financial markets. That means they can raise money at lower cost--as long as they play by the rules set by global investors. Which in turn should lead to much-needed corporate and economic reform.
The new European bond markets enabled mergers that probably never would have happened before 1999, such as German mobile-phone operator Mannesmann's takeover of its British counterpart, Orange, then Vodafone's takeover of Mannesmann. Together with the worldwide boom in tech and telecom investments in 1999 and early 2000, easier financing also made possible a binge of ill-considered spending on third-generation wireless licenses that is now giving European telcos a huge hangover.
That's the way markets work, of course, but there's a problem with the timing. Most European countries, with their graying and often shrinking populations, are looking at looming shortfalls in their pay-as-you-go pension plans. As a result, they've been encouraging people to put retirement savings in the stock and bond markets, which, it turns out, hasn't been the best place to put them over the past couple of years.
HAS ANYTHING LIKE THE EURO EVER HAPPENED BEFORE? Although Europe has had common currencies before, most of them were imposed by conquest. There are less coercive currency unions elsewhere in the world today, like the African CFA franc and the Eastern Caribbean dollar, but they involve smaller or poorer countries deferring to the monetary policy of a bigger or stronger one (the CFA franc is pegged to the French franc, the Eastern Caribbean dollar to the U.S. dollar).
To a certain extent Europe's move toward monetary union has a similar dynamic: The 11 other countries involved had to adapt their fiscal and monetary policies to fit with the dominant European economy: Germany. It is no coincidence that the ECB is modeled after the Bundesbank and is located in Frankfurt.
Nevertheless, the ECB is a truly European institution. Its president and other members of its executive board are chosen by the heads of state of the euro countries. They serve staggered eight-year terms and can be removed only for "incapacity or serious misconduct." This is something new under the sun: an independent central bank that is truly independent of any political authority--free to make policy as it sees fit.
Some people question whether that is wise. Europe now has an integrated monetary policy but remains divided by language, custom, and national politics. If one region is suffering from high unemployment while others are booming, the ECB is unlikely to lower interest rates to help. But unlike in America, where jobless Michiganders can and do move to Georgia, Europe's unemployed are usually unwilling or unable (because of language barriers) to cross national borders to get a job. Some observers, including Martin Feldstein in a 1997 Foreign Affairs article, have predicted that the resulting tensions could lead to disintegration of the euro or even war. That doesn't appear to be on the horizon, but there's still something disconcertingly unfinished about the European project.
WHY HAS THE EURO BEEN SO WEAK? When the euro was launched in 1999, it traded on currency markets at $1.17. Lately it's been stuck around 90 cents. That's better than the 83-cent low it hit last year, but the currency's decline has still been a source of much head scratching, finger pointing, and possibly even hair pulling among European leaders. The euro has been weak because much more investment capital has been flowing from Europe to the U.S. than the other way around. Why? There are lots of explanations. An obvious one is that the U.S. economy has been growing faster than Europe's for the past decade--a trend that makes investments in the U.S. more attractive. Along the same lines, the big tech stock boom of the late 1990s and early 2000 was mostly a U.S. phenomenon, which meant that European investors who wanted in had to ship their money across the Atlantic. But the tech stock boom ended more than a year ago, and the U.S. outlook now is worse than Europe's.
Another possible explanation is that something about the switch to the euro, and its impact on how institutional investors like insurers divided their portfolios between domestic and international investments, has been giving the dollar a temporary boost. The simplest explanation of all is that the new currency simply hasn't built up the credibility of the dollar or the British pound. Much of the blame for that has been heaped on ECB President Duisenberg and his penchant for saying the wrong thing at the wrong time. That seems unduly harsh. The ECB has tried to be more open about its decision-making than the Federal Reserve. Duisenberg announces rate decisions in person, then fields questions from reporters, while the Fed sends out a brief written statement. Besides, there's not much the ECB can do about the euro's chief credibility problem: It's an untested currency, backed by an untested central bank, covering a region that's far from fully integrated.
WHY DIDN'T THE BRITS (AND THE DANES AND THE SWEDES) WANT TO JOIN THE EURO? One of the biggest stumbling blocks in the uniting of Europe is the pesky question of Britain. It's the region's second- or third-largest economy (after Germany and either just ahead of or just behind France, depending on the sterling-euro exchange rate). It is not, however, part of the single currency. Prime Minister Tony Blair seems to be promising a euro referendum in 2002 or 2003 as long as five mostly subjective tests are met. Sample question: "How would adopting the single currency affect our financial services?" Denmark put the euro to a referendum last year, and it was turned down by a 53% to 47% margin. Polls conducted in recent months in Britain generally put the no vote at about 60%.
Even if Blair can persuade his recalcitrant countrymen to approve euro membership, the idea of further political integration will run into all sorts of resistance north of the English Channel. Many Brits are, understandably, reluctant to give up their centuries of uninterrupted political liberty and representative rule to merge with nations that in some cases were dictatorships only decades ago. Many also identify more closely with the U.S. than with Europe. And there's a loopy element of British society that sees the whole European Union thing as a plot whose ultimate aim is to drive on the right side of the road.
As for Sweden and Denmark, they share a certain Scandinavian skepticism for European integration (Norway isn't even an EU member). Still, it is widely assumed that, if things go well with the euro, they will join eventually.
WHY ARE THE GERMANS SO GRUMPY ABOUT THE EURO? If they had put the euro to a referendum, the Germans would probably be on the outside looking in too (in which case there would have been no point in going ahead). In 1998, when the German Parliament gave its approval to the euro, most opinion polls showed two-thirds of the public opposed.
That wasn't because they were skeptical of European integration, in the manner of the Brits and the Scandinavians. It was because they loved their currency and didn't want to give it up. After World War II, traditional nationalism wasn't an option for the West Germans. Instead of rallying around their flag or their tarnished history, they opted for a less threatening symbol: the deutsche mark. It was the embodiment of Germany's remarkable economic rebirth. It was the strongest, most dependable currency in Europe. And until the canonization of Alan Greenspan in the late 1990s, the Bundesbank was the most respected central bank on the planet.
So the Germans, while generally pro-European, have always been suspicious of the euro. They're especially suspicious now, what with the new currency down 25% against the dollar since its inception. But other than griping, they're not going to do anything about it. Instead, they will almost certainly handle the transition next year with efficiency and dispatch. These are the Germans we're talking about, after all.
If the euro remains weak against the dollar, German grumbling could turn into something more serious. If, however, the ECB has anything like the Bundesbank's success in keeping inflation down and the currency strong, then the Germans will warm to the euro. So will other Europeans. And maybe, just maybe, the euro can provide the disparate, disjointed agglomeration that is the European Union a symbol of unity and togetherness to rally around.
WILL FRANKFURT OR PARIS DISPLACE LONDON AS THE FINANCIAL CAPITAL OF EUROPE? That was one of the big predictions before 1999--admittedly a prediction made mainly by Germans and the French. With Britain outside the eurozone, the reasoning went, London's status was sure to falter.
It has not. Sure, Frankfurt and Paris both have stock exchanges that are more innovative and dynamic than the stodgy London exchange. But the LSE has played only a minor role in the rebirth of London as a major financial capital. That rebirth, which began in the 1960s, was all about London becoming a center for making loans and issuing bonds denominated in U.S. dollars. So dealing in euros while not being in the eurozone has not been a big stretch.
Also, the mostly U.S.-based global investment banks that long ago picked London as their European base aren't going to move if they don't have to. In fact, most of the traffic has been in the other direction: As Europe's financial markets have become more European and less national, investment banks have transferred analysts and bankers from outposts around Europe to the home base in London. Deutsche Bank may be headquartered in Frankfurt, but its all-important capital markets operation is in London.
London has stayed attractive for a number of reasons. Income taxes are lower. Good tech-support people are easier to find. And it speaks English, Europe's language of finance and big business. Moving to London, or at least doing business in London, is not a problem for ambitious Europeans. Moving to Frankfurt or Paris often is.
SO IT'S MARCH 1 AND EVERYONE'S USING EUROS. THEN WHAT? Euro boosters are betting that, over time, the reality of a single currency and the pressures of a single financial market will smooth out some of the economic differences between countries. Already economic ups and downs are becoming more uniform across Europe. But is that really enough?
The only Europewide elected institution is the European Parliament, which is toothless. Then there's the European Commission, the executive branch, whose 20 members are chosen through horse trading between the 15 EU governments and must be approved--as a group, not one by one--by Parliament. Major decisions are made by the European Council of heads of state, and really big decisions (like the key ones involving monetary union) are usually arrived at ahead of time by the leaders of Germany and France, with the Italian and British Prime Ministers sometimes getting a word in too. Except for monetary policy decisions, of course, which the ECB makes for 12 of the 15 EU countries. Got that?
If this strikes you as a precarious way to run the world's second-largest economy, you're not alone. Some political leaders in Germany and France have called for an elected European president and a European Parliament with actual authority. At the moment, though, political unification isn't even on the agenda. Instead, topic A is how to bring former communist states like Poland and Hungary, which are nowhere near as wealthy or politically stable as the current membership, into the union. The project of defining what Europe is--much less uniting it--is going to take a while.
AFTER CONSUMERS START USING EUROS, WILL THAT MEAN STUFF COSTS THE SAME IN SPAIN AS IN FINLAND? In October a gallon of unleaded gas cost an average of $1.50 in Los Angeles and $1.91 in San Francisco. That's in the same currency, in the same country, in the same state. So no, prices won't be exactly the same all over Europe, even after the euro. The costs of labor, property, taxes, and so on will still differ from country to country, just as they do from state to state, or even town to town, in the U.S.
The move to a single currency will have an effect, however, on prices for big-ticket items like cars, and on financial services like insurance, that can easily be sold over the phone or over the Internet, says Michael Paul, a pricing consultant with the German firm Simon-Kucher & Partners. It will simply be much harder to hide cross-border differences in prices. That's good news for European consumers and bad news for corporate profits in some industries.
The biggest pricing change wrought by the euro, however, will be in the very short term. Take a candy bar that now sells for 99 German pfennig, says Paul. That converts to 51 euro cents, an ungainly price. Lower it to 49 cents, and you bite into profits. Raise it to 59 cents, and you'll be accused of price gouging. Worried about possible inflationary impacts of the changeover, Duisenberg has asked European consumers to raise hell whenever they see this happening.
There are other, more arcane pricing effects brought on by the fact that every one of the currencies being merged into the euro is worth less than a euro--that is, it's 1.96 German marks per euro, 6.57 French francs, 13.76 Austrian schillings, 1,936.27 Italian lire. What that means, says Paul, is that to the untrained eye, prices will appear to be squeezed closer together. The distance between 1.02 and 1.53 euros somehow seems smaller than that between 2 and 3 deutsche marks. And since charging different people different prices for what is essentially the same product is one of the great sources of corporate profitability in this world, that could be a problem.
Put it all together, and you get a year in which a lot of the easy certainties of the consumer products business in Europe will be thrown out the window. Companies that make the wrong decisions about how to price their candy bars or their deodorant sprays risk losing market share.
IS THE EURO GOOD FOR THE REST OF THE WORLD? If the single currency helps make Europe a stronger, more economically vibrant place, of course it's a good thing. There's been a lot of talk, mostly from the European side, about how the single market and currency union will give European companies a stronger base from which to do battle with American rivals. Great. The eurozone is, like the U.S., a genuinely capitalist consumer economy--not an export-obsessed juggernaut like pre-1990s Japan. If Europe becomes more competitive, its citizens will be able to buy more stuff, and the world will benefit.
There are also concerns, mostly from Americans, that the euro could displace the dollar as the safe currency of choice for investors and central banks around the world. Nothing close to this has happened yet, but as the euro matures, it may well take over some of the dollar's role as a global currency. In that case, U.S. monetary and fiscal policymakers will have a little less freedom to do what they want because global investors will have some- where else to put their money if they don't like where the U.S. is headed. But Americans have argued for years that the discipline of global financial markets is healthy for Europe and the rest of the world. Why shouldn't it be good for the U.S. as well?
If the euro helps bring on a more politically unified Europe, that's probably a good thing too. Yes, it means the U.S. won't be the only economic superpower anymore. That could lead to rivalry and tension, but it could also simplify Europe-U.S. relations immensely and give the U.S. a potent ally that shares most of its core beliefs and interests. If, on the other hand, the euro is a flop and its disintegration leads to tension or even war between European nations, that would be a very bad thing (just in case you were wondering).
Right now the euro is probably a net negative. That's because the European Central Bank and the 12 eurozone governments have been unable to do much of anything to counteract the slowdown in global economic activity exacerbated by the September terrorist attacks in the U.S. The ECB, still trying to prove itself, is afraid to take any action that could be perceived as soft on inflation, which means it can't cut interest rates with abandon. And most European governments can't offer much in the way of economic stimulus because they remain hamstrung by the very rules restricting deficit spending that made the euro possible.
Which says a lot about the euro as a currency and Europe as an economic force. There is potential, but the EU is not quite there yet.