NYTimes.com Article: Euro Beginning to Flex Its Economic Muscles

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Euro Beginning to Flex Its Economic Muscles

May 18, 2003
By MARK LANDLER 




 

FRANKFURT, May 17 - Its leaders are divided and its
economies are distressed, but Europe stands tall in one
respect. The euro, its toddler currency, is growing into a
cheeky rival to the dollar, one of the most visible symbols
of America's power in the world. 

After a hapless debut in January 1999, marked by a long,
stomach-churning slide in its value, the euro has made up
virtually all the ground it lost against the dollar. It now
trades at an exchange rate of about $1.15 per euro, only
three cents shy of its value on the first day of trading. 

More important, the euro has gained stature as a safe haven
for investors and governments. 

The dollar remains the world's default currency - the
lingua franca of oil traders and bond dealers, and the
bedrock of foreign reserves held by central banks from
Brussels to Baghdad. But the euro is gaining ground, both
as an attractive currency in which to issue bonds and as an
alternative to the dollar for national foreign exchange
reserves, notably in southeast Asian countries with
predominantly Muslim populations. 

With the United States piling up vast deficits, economists
say the euro has a chance to consolidate its gains. "U.S.
federal finances are coming under increased strain," said
Niall C. Ferguson, a senior research fellow at Oxford.
"Money that had been invested in dollar-denominated assets
is shifting to euro assets. For the euro to become a little
brother to the dollar seems perfectly plausible." 

Such a role would vindicate the guardians of the euro, who
watch over it from the European Central Bank's
glass-and-steel tower in Frankfurt. They have always had
grand ambitions for the currency, viewing it as an
alternative to the dollar and an instrument to drive
Europe's integration. 

Yet an almighty euro carries risks for champions of a
united Europe. It could supply fresh ammunition to
opponents of the monetary union in Britain, Sweden and
prospective members. 

It could also open fissures between existing members that
depend on exports and stand to suffer from a currency that
rises too far, too fast. Last week, three euro countries -
Germany, Italy and the Netherlands - reported that they
were on the brink of recession. 

"If it goes much beyond $1.25, we've got a problem," said
Daniel Gros, director of the Center for European Policy
Studies, a research group in Brussels. 

The introduction of euro notes and coins here last year was
striking for how smooth the process seemed. After a noisy
buildup, the German mark, the French franc and the Italian
lira faded into history like quaint relics. In the
financial markets, where the euro had traded as a virtual
currency since 1999, the transition was equally seamless,
with investors showing prompt acceptance of the new
currency. 

The shift toward euros is most pronounced in the global
bond market. From 1995 to 1999, according to Professor
Ferguson's research, 53 percent of all corporate bonds were
issued in dollars, and only 20 percent in the currencies of
the 12 European countries that now use the euro. 

In the four years since the common currency began trading,
however, 44 percent of new global bonds have been issued in
euros, nearly equaling the 48 percent issued in dollars.
There is also anecdotal evidence that central banks,
especially in some Asian countries, are beginning to
diversify their reserves, to reduce dependence on the
dollar. Bank Indonesia, the nation's central bank, has
increased its holdings of euros, currency traders said. 

"We are strongly tied to the dollar," Rizal Ramli, the
former finance minister of Indonesia, said in an interview.
"But with the dollar's decline, it is wise for Indonesia to
diversify its reserves into euros." 

In Muslim countries like his, Mr. Ramli said, there is a
political dimension to the shift. The American-led war on
Iraq was fiercely opposed by Indonesia. Vice President
Hamzah Haz, an Islamic leader, has encouraged local
investors to switch from dollars to euros. A similar switch
has occurred in Saudi Arabia and other Middle Eastern
countries, currency traders say, though accurate numbers
are elusive. 

"Some people, especially in the Muslim world, think that
this is not a secure asset from a political point of view,"
Mr. Ramli said. 

In Malaysia, Prime Minister Mahathir Mohamad recently
suggested that the state oil company, Petronas, switch to
euros from dollars for its oil trading. His rationale, he
said, was purely economic. "The U.S. dollar has depreciated
by 25 percent," he said in opening a new Petronas natural
gas plant. "In other words, we are earning 25 percent
less." 

Mr. Ramli played down the politics, noting that the yield
on euro-denominated assets is better than that on dollars.
If that were to change, he said, even Muslim countries
would quickly switch back. 

Some analysts caution that one should not jump to
conclusions from anecdotal reports about central banks.
According to the International Monetary Fund, 68 percent of
the world's foreign exchange reserves were held in dollars
in 2001, the latest year for which it has figures. 

That number has remained roughly constant since 1999, and
rose from 55 percent in 1992. The 13 percent of reserves
held in euros in 2001 also stayed constant from 1999. 

"Incumbency has enormous advantages," said Barry
Eichengreen, a professor of economics at the University of
California, Berkeley. "Sterling hung on as the world's No.
2 currency for the better part of the 20th century, even
though Britain stopped having the No. 1 economy in the 19th
century." 

Still, Professor Eichengreen said there was no reason the
euro's influence would not eventually match the dollar's.
The euro zone already has 300 million people; it would have
more than 450 million if Britain, Sweden, and the countries
of Central Europe adopted the currency. 

Most are eager to do so, believing it will help their
populations. But the price of belonging to a monetary union
- obeying strict fiscal rules and one-size-fits-all
interest rates - has made some Central Europeans relieved
that they will not be allowed to adopt the euro until at
least 2007. 

"It would be so easy to sell the concept of the euro if
there weren't these tough requirements," the prime minister
of Hungary, Peter Medgyessy, said recently in an interview
at a conference in Munich. "That is why we should be very
cautious about setting a date for joining the euro zone." 

Among Western Europeans, feelings are even more ambivalent.
Sweden, which is scheduled to hold a referendum on joining
the monetary union in September, has historically been
pro-Europe. But in recent polls, public sentiment has swung
narrowly against the euro. 

Part of the problem is that Swedes fear a strong euro would
cripple their exports. They also point to neighboring
Germany, which has limped through four years with the euro,
in part because the tight monetary policy of the European
bank is arguably ill suited to its faltering economy. 

The same arguments are heard in Britain, where the
chancellor of the exchequer, Gordon Brown, is to deliver a
judgment next month on whether the country has met five
economic conditions for entry to the union. His verdict is
widely expected to be "not yet." 

Mr. Brown's obdurate resistance has revived rumors of a
rift between him and Prime Minister Tony Blair, who favors
the euro. The two men issued a statement on Friday denying
that they were are at loggerheads. 

In one respect, the rise of the euro should remove a
barrier for Britain. Because the pound, like the dollar,
has lost value against the euro, the danger of converting
it into euros at an inflated rate has been mitigated. 

"If you lock in the pound at too strong a rate, you run
into some of the same problems Germany did," said David
Walton, the chief European economist at Goldman Sachs in
London. Still, Mr. Walton said Britain's reluctance to join
the union was driven less by economics than by politics -
springing from inchoate but deeply held notions of
sovereignty and national identity. 

Ultimately, the success of the euro will also depend on
politics. That is why the currency's creators seem quite
satisfied with its rebound. While they recognize it is
mostly a reflection of the dollar's weakness, they relish
the chance to erase the memory of its stumbling start. 

"The European bank once had to come out and tell the
market, `Your money is safe,' " said Mr. Gros, recalling
one of the currency's low points in 2000. "This takes away
that embarrassment." 

http://www.nytimes.com/2003/05/18/international/europe/18EURO.html?ex=1054276890&ei=1&en=2d60c11e917adfc5


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