Euro – the first 100 days

The Euro had been traded for 100 days. Talk was of parity with the dollar after Europhoria disappated. Politicians bickered but the economists remained optimistic for the new currency’s global future. This appeared in Benchmark fund investment magazine in the second quarter of 1999.

The world is now several months into the dawning of the age of the Euro. Lately, however, the argument has been that it has not provided Europe with the new age of enlightenment that was widely expected. Here Feature Writer Gerry O’ Kane, talks to some of Europe’s leading economists to find out the consensus for the Euro’s direction and its power struggle with the mighty greenback.

The Euro was just there…

After warnings of an apocalyptic meltdown in Europe as the single currency was born, it all became something of an anticlimax. “It’s a terrible temptation to say that it was all a non-event because it went so well, but that was because of good planning,” says Dick Vesey, business planning director with Lloyds Bank Securities Services and responsible for the Euro transition.

Computer systems did not blow up. Banks did not find themselves billions of guilders short, despite a few delays. Target, the cross-border payment system run by the European Central Bank (ECB), moved record sums of currency from one nation to another. The world’s newest currency even managed a strong performance on its first day of trade.

Since then what had been termed europhoria has dissipated. Currently the Euro is down seven per cent and has been down by as much as 10% from its highs. Now there are worries it will soon be valued on a par with the US dollar. Has it all been a disaster?

Should one read most of the European media you would rapidly come to the conclusion that it has been and US economists are having a field day highlighting the problems. Some analysts think it is too early to give judgement and that the judgement which has been given is based on not taking account of all the evidence.

“I think the media is talking a lot of rubbish about it being a failure and there has been a lot of misrepresentation of the statistics,” argues Jim O’Neill, chief currency economist at Goldman Sachs.

Weak but no cause for concern

O’Neill is not one to pull punches and he admits that while it has not gone exactly the way everyone predicted, there is no need to worry. “As a new currency it has had a great start, the introduction was probably too smooth. For those expecting it to go up and up they have been wrong, and that includes myself. I suspect there is bad feeling about that – speculators lost money,” he laughs.

Others are more surprised at what has happened.

“Its introduction went smoothly and it is going quite well at the moment but there have been two major surprises,” says Gabriel Stein, chief international economist with Lombard Street Research.

“First there was the expectation that it would be a strong stable currency but it has been significantly devalued since launch and there’s talk of parity with the dollar [falling by another seven per cent].”

Certainly the strength of the US economy caught everyone on the hop. Stein argues it is only a matter of time, with the huge US current account deficit, before the dollar must weaken.

Political bickering

“Second, there was the speculation that it would challenge the US dollar as becoming a currency of world reserves. Again this didn’t happen,” he says. He says that investors do not see the Euro as the currency to move into at the moment. He puts this down to the strength of the US economy and the bickering between politicians and the powers at the European Central Bank (ECB), which led to the resignation of the German Finance Minister, Oskar Lafontaine, in mid-March.

Certainly the media has been making a great play of the political bickering. Lafontaine made no secret of his dissatisfaction with the ECB for not cutting interest rates in early March. The contrast in opinions was also evident at the G7 meeting in Bonn in February. Britain and the US argued for a balanced international recovery, with the US annoyed at a lack of policy from the Euro block for boosting global demand.

A public disagreement at a press conference between Hans Tietmeyer, president of the Bundesbank and Lafontaine on exchange rate levels for the Euro didn’t help either. Wim Duisenberg, head of the ECB, criticised Lafontaine’s penchant for spending his way out of trouble. So on the one hand the ECB is criticising national fiscal plans, while the politicians are going head-to-head with the ECB on monetary policy. It was not meant to happen that way.

Teething troubles

For both Stein and O’Neill the political pressure on the ECB is damaging. “Lafontaine apparently didn’t know when to shut up when it came to splitting with the ECB,” says O’Neill.

But both men do not feel the pressures are to be taken too seriously. For Stein they are teething troubles, while O’Neill says if you could put a figure on them they only make up 10% of the reason for the fall.

“They’re greatly exaggerated, after all, people in Congress constantly have a go at the Fed,” points out O’Neill.

More sceptical analysts argue that interested parties such as US financial houses and government are exploiting those issues. Where the two men differ is on where Europe is going economically. Both say the US economy is stronger than was expected which has led to a weakening of the Euro, but Stein views the European economy as weakening.

“Italy and Germany are in recession and so the politicians are trying to tell the bankers how to dictate monetary policy,” observes Stein.

O’Neill disagrees pointing out that figures just released show France and Spain with growth of 0.7 percent for the fourth quarter of 1998 and the Netherlands up by one per cent. He also points out that German consumption is up.

Dollar and Euro – the reserve currencies

Jim O’Niell also argues that the Euro is already becoming the second currency of reserve. His figures point to 50% of bond issuance this year as having been in Euros. He also makes an interesting observation, saying indicators show that the ECB has been buying US dollars, making the Euro weaker. It is a suspicion Stein has too. As for funds flow there are few figures showing how much new cash is coming into Euros.

“I do know that when I was in Japan recently Nippon Life told me they would change from having 90% US dollar investments to 50% Euros and that is a good indication of the future,” reveals O’Neill.

So what will be the future of the maligned Euro? For the first time opinion polls in Sweden (not currently part of Euroland) have moved above 50% in favour of joining. The UK government has made more positive noises about joining but remains fearful of popular press opposition.

Stein does make an interesting observation that O’Neill dismisses. “The Euro has been presented to Europe as a necessity; an historical imperative. Should an important economy like the UK, and I’m Swedish by the way, stay out of the Euro and remain an economic success, the recent pro-Euro lobby may lose impetus.”

As for the currency itself O’Neill still believes it will strengthen by the end of the year. Inflation is negligible in Europe and most economies are growing. As the global economy recovers, so the argument goes, then the zone will further strengthen. There is also a belief the US economy will not continue on its way upward. Should the Euro look like slipping to parity against the dollar the indications are the ECB will intervene and buy Euros, but alas, no longer to please Lafontaine’s fiscal policies to drive down his four million claiming unemployment benefit.

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