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Understanding The Euro

Europe's new monetary unit will impact any company doing business on the continent.

By Irving Vigdor

europe_624T he euro is the new currency that fuels economic growth by making it as easy to do business across Europe’s national borders as it is across the United States. Thus, it provides a sales and marketing tool the likes of which has never been seen before, whether selling, buying or investing.

To understand the euro you must know some basics about its history, how it works and why. Armed with this knowledge it will be easy for your company to take advantage of it in Europe. Dealing in euros as the medium of exchange makes doing business easier and convenient because the euro places you in a fair, if not favorable competitive position against your U.S. and foreign competitors.

What Is The Euro?

The euro arrived January 1, 1999. To date, 11 of the 15 European Union (EU) countries have joined the European Monetary Union (EMU).

Switzerland, who is not an EU member, is adopting the euro as its second currency. Cuba has switched from a dollar-denominated economy to a euro-denominated economy. These acts provide optimism for the euro’s future.

In Cuba’s case, however, the reason is unusual. Since the U.S. embargo, much of the business Cuba did with the United States shifted to Europe, so it makes sense for Cuba to be euro denominated.

EMU members may use their national currencies as well as the euro, but all bank transactions are exchanged to or from euros. But on December 31, 2002, national currencies will be consigned to history and the euro will be the only medium of exchange for all EMU members.

Bank’s foreign currency operating expenses will be cut about 90 percent in 2002, and for companies who deal in EMU currencies, they can reap all the benefits now.

How The Euro Works

Until 1999, hidden in the exchange rate and fees were premiums of 3 to 8 percent. However, by 2003 there will be one conversion fee in the EMU.

The euro works because each of its members’ currency exchange rates are fixed permanently to the currencies of all the other members. Even though the EMU comprises 11 of the 15 EU nations fixed currency values are the mechanism that allows the euro to be traded across EMU borders with no change in value. Therefore, there is a zero exchange rate risk when dealing across EMU borders.

EMU Membership

In 1998 the EU took certain steps so that the Czech Republic, Hungary and Poland might be accepted into the Union within a few years.

In 1999, the EMU enacted a capped annual budget of $92 billian through 2006. Therefore, if any or all of these states are admitted to the EU knowing their EMU membership costs in advance helps them prepare to meet the EMU criteria.

In early 1998, both Denmark’s and Sweden’s publics, by small margins, voted against joining the EMU. But a 9.5-mile tunnel, overland rail and vehicle bridge which connects the two markets was almost finished. Sweden, whose economy is much larger than Denmark’s, would, for the first time, have easy access to Europe’s mainland and its markets. Today the majority of voters in both countries appear to have swung in favor of the EMU, and the consensus is that they will join the EMU by 2003 latest.

In spring 1999, England announced it would probably join the EMUby 2002 (after their national elections).

By September 1999, British Foreign Secretary Robin Cook, addressing a group of executives in Tokyo, said that the euro is already bringing new strength to EMU’s economies and lauded the euro as a positive economic force. Normally, nobody would pay much attention to Cook’s remarks but the euro has become a political issue between the Labor and Conservative Parties. Part of the problem is that interest rates in England are about double those in the EMU.

A few English towns are experimenting with the use of the euro, and it is now believed that the consuming public has come around to believing that the euro will be a good thing for England. Most internationalists believe that England has little choice and must join the EMU to remain competitive.

On September 5, 1999, Greece, which has been working hard to meet the criteria, announced it would apply for EMU membership in March 2000, for EMU approval in June. Greece’s inflation rate for July was 2.1 percent and its annualized inflation rate might be low enough by this March. There are internal political issues that might come into play which could cause Greece to withdraw its application for EMU membership.


The Long Road

To appreciate how difficult and long the road to Euroland was we must go back to 1946. Winston Churchill, England’s famous Prime Minister, envisioned a United States of Europe as it began recovering from the devastation of World War II.

Together with a few of Europe’s leaders, he realized that each country’s economy could not sustain itself independently against each other’s, nor could they stand up to the economic might of the United States. Churchill’s dream crawled and clawed its way to become the 15-nation EU which conceived, implemented and established the euro.

In the late 1940s, Belgium, the Netherlands and Luxemburg formed the first European Common Market. As a result of the Treaty of Rome (1957), France and Italy joined and the "Benelux" became the "Common Market." As its membership grew, the name changed to the European Economic Community (EEC).
The euro, even though four EU countries have yet to join the EMU, is backed by the 15 EU currencies. (Many continue to refer to the euro as the euro dollar. The euro is the euro and the euro dollar is something different.)

In 1986, the EU took a gigantic step and agreed that all member nations would be internally duty free by 1993. This act gave the European textile industry a boost by broadening its markets on the continent.

In 1991, the Maastricht (Holland) Treaty formed the European Monetary Union and the European Central Bank (ECB) over which political leaders have no say.

Further, it provides that one currency must be implemented by January 1, 1999 for EU members who meet EMU membership criteria.

In 1995, the first try failed, but the Treaty of Cannes put a new plan together. Every detail of the EMU had to be approved by all not later than May 1998.

Modern Miracle

Imagine the more than 2,000 matters the myriad of sub-committees had to deal with and have ratified so the euro could arrive on time. It boggles the mind to think of 15 independent national legislatures, with their internal politics and national pride, could achieve unanimity and that 11 nations would opt to join the EMU.

The Maastricht Treaty, which put teeth into the EMU, was worked out by Europe’s industrial powerhouses — Germany, France, Italy and England — without consulting any of their other EU partners. Yet eight more nations joined while England did not.

The ECB operates with complete independence and every EMU member’s central bank relinquished its powers to control ECB policies even though ECB decisions might directly affect their nation’s economies. In effect, national central banks, which act like the Federal Reserve Bank, made themselves subservient to the ECB, which establishes interest rates, protects currency, etc.

Every rule and act relating to the EMU had to be unanimously ratified by all 15 EU members by May 1998.

The euro arrived on January 1, 1999 and though the permanent exchange rates equaled a value of 1.00 = $1.05 it opened at $1.17 and fluctuated between $1.14 and $1.18 for a few weeks. Afterwards, it fluctuated between $1.04 and $1.09 through October 1999. There were a few days when it dipped to about $1.02.

Though the euro’s performance has been less than what had been expected, optimism about the future of the euro as the powerhouse that drives business has not waned.

There is little room for doubt that the euro is a sales and profit driver, something U.S. textile companies sorely need.

EMU Requirements

1) A nation’s budget deficit may not exceed 3 percent* of Gross Domestic Product (GDP).

2) As of January 1, 1999, inflation cannot exceed 2.7 percent*. The formula that determines the rate follows: the inflation rate for any member may not be more than 1.5-percent higher than the average inflation rate of the three member countries with the lowest rates of inflation.

3) Long-term interest rates may not exceed 7.8 percent*. Formula: Long-term interest rates may not exceed 2 percent of the average inflation rate of the three member nations with the lowest inflation rates.

4) Total outstanding government debt must not exceed 60 percent* of GDP or working towards this target.

5) A member nation’s currency should have remained within normal fluctuation margins for at least two years before the decision is made to join the EMU. This is an over simplification of a highly complex matter.

*based on 1997 performance — Rates may change annually.

January 2000