COLUMN

Singing the euro blues

The European Union's currency continues its slide against the dollar, even as Europeans wonder whether the euro was worth all the effort.

JAYATI GHOSH

ITS short life has already been a very eventful one. When it was introduced on January 1, 1999 by 11 European nations as the currency of finance (even if not yet of daily use), the euro was celebrated as the crowning achievement of European economic and financial integration. Because it represented an economic bloc even larger than the United States, it was also seen to present a major threat to the U.S. dollar in international financial markets.

But the fledgling currency seems to have confounded its supporters by shrinking, rather than growing, over the past year. In the 11 months of its existence, it has declined about 15 per cent against the dollar and more than 30 per cent against the Japane se yen. And on the closing day of trading in the first week of December, it actually fell below what many had seen as the important psychological barrier of 1:1 parity with the dollar.

As in so many movements in international currency markets, it is very hard to explain the euro's fall in the recent weeks with reference to the so-called "fundamentals". There is now clear evidence of accelerating growth in the hitherto sluggish European economies, and there has even been a recent increase in the benchmark interest rate set by the European Central Bank (ECB).

If despite this the euro has continued to fall, it has largely reflected what can broadly be called "unfriendly market sentiment". Hardly anyone really knows what forces determine this vague and frightening term, but at least this much is clear: private financial markets always react adversely to any talk of new taxation, or even the mildest of official statements regarding public intervention to save jobs or to meet other social criteria within any country.

The governments of developing country "emerging markets" have long come to accept this unpalatable fact, and those governments that remain keen to keep foreign investors happy at all costs (such as in India) have come to be obsessively careful to avoid a ny remote possibility of new taxation or even increases in socially relevant government intervention. But now, even OECD (Organisation for Economic Cooperation and Development) governments have been forced to deal with the consequences of this pressure f rom international finance.

Thus, apparently the latest run on the euro has come about because private markets are unhappy with the "leftist" sentiments that have recently been expressed by several European leaders. The current anger of the market is directed against the German Cha ncellor, Gerhard Schroeder, who had earlier tried to present himself as the darling of international capital, in the process demolishing the domestic political support base of his own party.

Germany has been the sick economy of the European Union for some time now. It accounts for one-third of all euro-zone output, but in growth terms it has been lagging behind almost all its euro-zone neighbours, especially France. Even the German Governmen t's council of economic advisers has predicted that Gross Domestic Product (GDP) growth next year will be only 2.7 per cent, after remaining at 1.4 per cent this year. Meanwhile, the eastern region continues to stagnate, and unemployment continues to inc rease.

In this uneasy context, even the slight recovery of the past few months has done little to dispel social disaffection within Germany which is now putting more pressure on the German Government. Two recent moves by Schroeder have therefore been such as to be classified as "market-unfriendly".

FIRST, the German Chancellor decided to use state funds to bail out Philipp Holzmann, a troubled construction company which accounted for a large number of workers. This has been interpreted by international financiers, who have typically viewed continue d unemployment more favourably than employment generation, as a sign that the German Government does not want to carry out major "reforms" of the labour market that would put many more people out of jobs.

Second, the European Union has been trying to agree on a cross-border withholding tax on savings which is obviously unpopular with private capital markets even though it is widely seen as necessary both to raise resources for important items of governmen t social expenditure and to put some limits on volatile capital flows. Recently, Schroeder indicated that if the E.U. failed to reach an agreement on this, his government would consider imposing such a tax unilaterally anyway. This has created much angst among financiers (especially those in the City of London) who had been lobbying to stall the process at the E.U. level, and this is cited as the proximate cause of the euro's latest slide.

It is indeed ironical that Germany, which had been the chief champion of the euro from the early stages of the process, may find that it stands to lose the most from the loss of autonomy in national decision-making that monetary integration has involved. Germany has among the lowest rates of growth of GDP and the lowest rates of inflation in the euro-zone. This means that it also faces the highest real interest rates as a consequence of the uniform monetary policy. This in turn hampers growth further. M eanwhile, the U.S. dollar continues to soar, rising on a wave of confidence in the apparently endless U.S. boom. This creates a complex problem for Europeans.

WHATEVER may have been the public pronouncements to the contrary, there is no doubt that a large part of the earlier enthusiasm for the euro was based on the expectation that it would emerge as a major rival to the dollar and allow Europe some of the ben efits of becoming finance's favourite destination. That expectation has so far been belied.

Meanwhile, any positive impetus to trade and import substitution that could come from the depreciation of the currency has been more than outweighed by the constraining role played by the E.U.'s stability and growth pact, which effectively prevents the u se of fiscal stimulus to activate economic growth. As a result, the economic policymakers of the E.U., and especially of the largest country in it, Germany, now appear caught in a cleft stick of their own making.

They had subjugated their domestic interests at the altar of the common currency in the hope of being able to exploit the patterns of international capital flows, but it is now clear that they are still subject to the pressures of whimsical and demanding international financiers. And this means that they are even less able to meet the legitimate demands of their own citizenry. In the circumstances, it is not surprising that more and more Europeans are questioning the way in which the entire of monetary integration has unfolded so far.