WHERE WILL THE EURO GO NOW?

By: Arnold J. Haake, Royal Palm Bank
   

Since the early 1950’s and the landmark Treaty of Rome, European visionaries have had a dream to unite their continent with a single currency. On January 1, 2002 that dream became a reality for 12 nations and 280 million people in Europe as Euro notes and coins came into circulation. Of the 15 EU nations, only Britain, Sweden and Denmark retain their own currencies. 

Actually Europe is in phase two of the introduction of the Euro. Business has been using the currency for three years in phase one. Now 280 million or so European consumers have to make the switch. Largely in an atmosphere of celebration, mixed with some trepidation throughout Europe, the project that has been more than 30 years in the making came directly and tangibly into the lives of European consumers. More than six billion notes and 37 billion coins worth 144 billion Euros have been distributed to shops, banks, and cash machines. Another 526 billion Euros have been produced and will go into circulation or be held in reserve

The entry of the Euro marks the exit of 12 national currencies, ancient and modern, which will all cease to be legal tender in their own countries within the first three months of 2002. It will be the first time since the Roman Empire that bread, wine and salt can be bought with the same coin throughout Western Europe. For many of Europe's leaders, it has to be one of the most emotive moments in the post-war history of European integration.

In the short run European businesses should not be seriously affected by the switch in notes and coin as additional business costs related to the change over have already mostly been incurred, and in the long run, the change should bring substantial benefits. The Irish exporter no longer has to contend with the vagaries of the foreign exchange market when he invoices his Austrian customer or takes a business trip to Spain.

Also in the short term, the Euro is also not likely to rise or fall substantially against the US Dollar as a result of the change of coins and currencies. But in the medium to long term, the markets will expect to see Europe's leaders fulfilling their pledges to carry out root-and-branch reform of their economies before investment capital will flow back to Europe and the Euro. The Euro has fallen almost 25 per cent against the US Dollar in its short three year existence which indicates that the foreign exchange markets still question the political resolve of those same European leaders.

The basic financial question regarding the Euro will remain whether the introduction of the new trans-European state bureaucracy to manage the new currency is more efficient over the long haul than the smaller national bureaucracies and the fickle foreign exchange traders. Until this new bureaucracy shows the political fortitude to manage the currency and to match the supply of Euros with the growth of their economies, the Euro runs major risks especially against currencies and countries who manage their finances better. Most Europeans, especially those from fiscally conservative countries, are well aware of this risk. Due to the inherent natures of new and growing bureaucracies, no one can ever be sure now of their resolve. 

For many of the readers of this magazine it boils down to a very basic question: In Euro terms, will that dream house on the water in Florida be more or less expensive in the coming years? That is a bet that European consumers with hopes to enjoy the Florida lifestyle must ultimately make for themselves. It can be a bet with large financial consequences. 

And finally when confronted with such financial uncertainties, many currency risk managers start to cost average their estimated foreign exchange exposure. With this hedging strategy, one would convert a small amount of Euros to US dollars on a monthly or quarterly basis with a goal of capturing the largely unpredictable highs and lows of the market until one’s exposure is full covered. This common sense strategy does require discipline but it works in nearly every liquid market. Good Luck!