Euro's power about to be tested

By David McHugh
Associated Press

The euro sign is illuminated in front of the European Central Bank in Frankfurt, Germany. The newly erected sign will be officially unveiled during celebrations for the euro launch in Frankfurt on New Year's Day. Associated Press

On the eve of the Jan. 1 introduction of euro notes and coins, supporters hope the euro has only begun to show what it can do, predicting historic dividends in growth and trade — and even in peace and security, on a continent where two world wars were fought.

Economists say the shared currency already has had clear benefits since it was launched three years ago, not in the form of paper bills and coins but as a peg to which national currencies were fixed.

Since then, it's been the euro zone's real currency, although for many people the psychologically important moment is the addition of bills and coins next week.

It has eliminated the problems of exchanging money for businesses trading across borders. But the more expansive hopes — such as a measurable, long-lasting boost to growth and a political push to loosen stifling labor regulations — have yet to appear.

The idea behind the euro is simple: End fluctuations between national currencies, and cross-border trade grows. Competition is increased, pushing countries to further liberalize their economies and become more cost-efficient.

The euro has eliminated currency risk — the chance that a sudden shift in the exchange rate will sap businesses' profits or balloon their costs. And they no longer pay the commissions and costs of exchanging money.

For instance, before the euro, if an Italian bank wanted German bonds, it had to bundle the purchase with a currency swap — a time-consuming foreign exchange deal guaranteeing they could repatriate gains without losing their shirts.

New cross-border bond markets have blossomed, providing sources of credit that businesses across the zone can tap into, to expand factories and production.

When the notes and coins arrive, tourists will reap some of those same benefits, speeding from aircraft gate direct to the taxi without paying a 3 percent commission at the foreign exchange booth. And prices will be instantly comparable across borders.

These pluses are thought to offset the costs of countries' giving up independent monetary policies to the European Central Bank. Members can no longer cut interest rates to spur their economies out of recession, or put a lid on inflation during boom times.

That loss of control was one reason three EU members — Britain, Sweden and Denmark — stayed out of the euro.

Robert Mundell, the Columbia University economist whose writings provided much of the theory for the euro, says labor and capital should be able to flow across borders to help countries adjust to economic ups and downs, in the absence of a national monetary policy.

"My own view is that the euro area as it is at present will be successful — but that it would be an even greater success if it were joined by the remaining three 'outs,' " said Mundell, a euro supporter who won the 1999 Nobel prize in economics for work including his analysis of currency zones.

What pushed the region toward monetary union, in many ways, was what some economists have dubbed "eurosclerosis" — the persistent lag in European growth and productivity, through the 1970s, 1980s and 1990s, behind the United States. Although the U.S. population is smaller, at 278 million, it has carved out a bigger share of the world economy, at 26 percent to the euro zone's 16 percent.

The European Commission has estimated that the euro should add an additional 5.5 percent to growth over the first 10 years.

While currency hassles have diminished, the deeper effects remain elusive. It's still expensive to lay off someone in Germany, for instance, where workers get fat severance packages and high unemployment benefits. That saps productivity and makes employers reluctant to hire new staff.

Chancellor Gerhard Schroeder, in fact, says Germany must reduce its unemployment rate of 9.2 percent without resorting to U.S.-style rules that make it easier to fire people.

The notion that the euro will push governments to overcome political resistance to labor-market reform "is one of the conventional wisdoms repeated by European officials," said Swedish economist Lars Calmfors, who headed the government commission that recommended Sweden stay out of the euro.

That part remains an experiment, he said.

"It might be the case. But I could dig up as many arguments in the opposite direction," said Calmfors. "There is no solid theory to support the case, and no empirical evidence."