The introduction of euro-denominated notes and coins in January 2002 is a major milestone in Europe's financial history. Since its inception early in 1999, the euro has been seen as a great disappointment, perhaps even a failure. Nevertheless, the changeover to notes and coins, with more than 300m people using them, enhances the prospect that the single currency will survive and eventually flourish.
The euro's negative image is largely due to its persistent weakness. At the end of 2001, although above its all-time lows, the euro was trading some 20%-25% below its early-1999 level against the US dollar, and some 10%-15% lower against sterling. Although economic fundamentals have often pointed to a stronger euro, all previous recoveries have proved to be false dawns, often followed by renewed declines. The main factors accounting for the euro's inability to sustain a recovery are low growth, the failure of the European Central Bank (ECB) to establish credibility, and concerns over political tensions.
The successful introduction of notes and coins will have some positive consequences. First, it will strengthen the euro's global role in trade, reserves and capital markets. Second, it will consolidate its status as the world's second currency after the dollar. Third, and perhaps most controversially, it should eventually strengthen the euro. However, even if the ECB's performance improves, the inadequate pace of reform and liberalisation will continue to hamper Euroland's growth and dynamism. Moreover, while the risks of political disintegration have diminished, the fact that Euroland comprises independent states, with divergent national interests, is bound to hold the euro back. My conclusion, therefore, is that a euro recovery is likely, but it will occur later and be more modest (totalling only some 5%-10% against the dollar and sterling) than most commentators expect.
The introduction of notes and coins also creates a new reality for the UK, with one foreign currency circulating throughout the largest single market for our exports and imports. Many UK businesses trading with Euroland cannot enjoy the exchange rate stability and low transaction costs available to their competitors across the Channel. Indeed, the size and importance of Euroland unleashes pressures for greater euro usage in the UK, particularly in retailing, hotels and travel. More significantly, remaining outside permanently may damage inward investment and the UK financial sector. Nevertheless, there are powerful arguments against joining. Transferring authority for setting interest rates to the ECB, and giving up the devaluation weapon, are decisions that could significantly increase the risk of recession and instability.
Britain's bitter experience with previous attempts to fix the exchange rate, coupled with the loss of sovereignty that joining entails and the UK's relative success outside the euro, explain the public's hostility to it. The UK is better able than most existing participants to meet the Maastricht criteria for joining, but it will be more difficult to determine whether Gordon Brown's five tests, of the benefits to the UK of joining, can be satisfied. A referendum on entry around mid-2003 is possible. However, given the complex Blair/Brown relationship, and the need to show that the benefits are 'clear and unambiguous', UK entry will probably be delayed until after the next general election.