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Monday, January 5, 2009

Is the Euro the New Dollar?

A handful of euro notes
Leon Neal / AFP / Getty

Europe's single currency has come of age early. The euro turns 10 on Jan. 1, a milestone for one of the most powerful symbols of European identity. It has already endured a rite of passage over the past few months, as the global financial crisis battered European markets yet failed to fluster the euro. And, like any debutante, it has its suitors: a string of countries lining up to dump their national currencies and join the euro zone.

It's a remarkable achievement for a currency whose only global rival is the U.S. dollar. The greenback has more than two centuries of history behind it. But it wasn't until Jan. 1, 1999 that 11 E.U. countries locked their national currencies together into a fixed exchange rate. Three years later, physical coins and notes became available, replacing national cash in a massive changeover operation. (See the top 10 business deals of 2008.)

The euro zone is now 15 members large and has a combined population of about 320 million. However, many more people are directly affected by the currency, from would-be members whose money is already pegged to it, to countries like Montenegro and Kosovo, whose effective national currency is the euro. France's former African colonies also peg their common currency to Europe's. That means about 500 million people rely on the euro or euro-pegged currencies.

European Commission president José Manuel Barroso credits the euro for delivering lower inflation, lower interest rates and greater price stability, and helping to create 16 million jobs. More immediately, the euro is shielding member states in this time of economic turmoil, preventing a currency crisis in addition to the credit crunch. "The euro is sheltering businesses from the exchange rate volatility, which has battered them in previous downturns," Barroso said on Monday. "To put it simply, the euro works."

Before the euro, a financial crisis in Europe went hand in hand with currency woes: a run on weaker currencies, heavy intervention by central banks and finally a collapse of the parity system. "I've lived through currency devaluations, and they are fraught with anxieties," says Hans Martens, chief executive of the European Policy Centre. "But the way the euro coped with the financial crisis was absolutely great. You have a big island of stability, with small nations protected when the big waves became rough."

The euro's 10th anniversary will see the euro zone take on a 16th member, Slovakia. Eight other central and East European countries have set the goal of joining within the next six years, including Poland, whose political establishment dropped its longtime opposition after a recent run on the Polish zloty. The euro has found some other unexpected converts too, thanks to the financial crisis. The Danes voted against joining the euro zone in 2000, but they are set to hold another referendum in March. Iceland — not even an E.U. member — is pondering "unilateral euroization" after seeing its krona plunge nearly 80% against the euro in September and October.

And the biggest prize of all, Britain, is said to be warming to the euro. Barroso recently claimed that London is "closer than ever before" to euro-zone entry and that "the people who matter in Britain" think it should join. That may be overstating things a bit, but a report by research group Chatham House warns that as the euro zone grows, the U.K. risks being excluded from "deeper intra-E.U. economic consultation and coordination, including in areas of significant national interest, such as financial market regulation." (See pictures of the financial crisis in London.)

It doesn't help that the pound is wilting. Two years ago, one euro was worth just £0.65. Now, humbled by bank crashes, government bailouts and a collapsing housing market that has forced massive interest rate cuts, Europe's currency is within a pence or two of parity with the pound. "The debate has changed from a total fantasy in the U.K.," says Jean Pisani-Ferry, director of Brussels-based think tank Bruegel. "The political obstacles still remain strong, but it has changed the perception of the U.K. as the perfect system."

Pisani-Ferry says the financial crisis has been a defining moment for the euro, but he cautions against too much praise. The euro is still some way from dethroning the dollar as a global currency; just 27% of global foreign exchange reserves are held in euros compared with 62% in dollars.

And, he says, the euro's first decade has been characterized by budget rows and debates about the European Central Bank's monetary policy, when the focus should be on correcting big macroeconomic divergences, like Spain's and Ireland's recent (and ultimately doomed) property bubbles. "The euro zone needs more ability to act in times of real crises, or to prevent them," Pisani-Ferry says. "It is a slow process." But one that has come a long way in 10 years.


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