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By Newsweek Editors
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In nervous times like these, Europe might consider what 20th-century Chinese revolutionary Zhou Enlai reportedly said about the historical impact of the French Revolution: "Too soon to tell." Now, just six years after the introduction of the euro, the upcoming May 29 French referendum on the European Union constitution has provoked widespread debate on the future of Europe's most far-reaching achievement: monetary union. Many love it, many hate it, but for the silent majority the currency itself has become a remarkably normal fact of life. Without living up to the hopes of its biggest promoters, or the nightmares of its greatest detractors, it has more or less succeeded in doing what it was supposed to do.
"The Euro. Our Money." That was the perhaps presciently bland slogan that the European Central Bank settled on to promote the debut of the single currency's notes and coins on Jan. 1, 2002. Despite predictions of disaster, Europe managed to swap 12 different national currencies for a new one, literally overnight, with surprisingly few logistical problems. The ECB and the euro itself were created three years earlier, when 11 central banks (Greece joined later) handed their authority over interest rates and other monetary decisions to Frankfurt, and banks, credit-card and many other companies began using the new currency for their accounts, billing and electronic transfers.
For day-to-day business, Europe is now clearly better off with the euro. The system was designed to avoid the currency crises of the early 1990s, when volatile swings in the franc, mark and other major currencies threatened to bring down the whole European project in trade wars, and it has done so. The euro has also, as planned, created a single giant capital market where companies can raise large amounts for expansion or acquisitions. It has smoothed the way for unprecedented deals like Europe's first 50-year corporate bond, sold in March by Telecom Italia for 850 million euro. Banks save millions of euros a year by not having to deal with currencies and interest rates on simple transaction costs. Academic studies have found that the euro has boosted trade among member states by 4 to 16 percent, in goods from turbines to tea.
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The ECB has already established itself as a financial heavyweight in what may be record time. Though politicians have blamed the bank for not boosting growth, that was never part of its formal mandate, which (unlike the U.S. Federal Reserve) focuses on inflation fighting. If it is true that a good central bank upsets everybody a little bit, whether they are bulls screaming for low rates or bears demanding high rates, then the ECB has made the grade. "The ECB has established itself as an institution capable of fulfilling its mandate, and its reputation is quite strong now,' says economics professor and central-banking expert Paul de Grauwe.
The most vocal advocates of the euro expected many good things to follow, such as an acceleration in economic growth and the creation of a more vibrant labor market. That hasn't panned out, but the new currency can't be blamed for problems with roots decades old. The euro zone growth rate languishes at below 2 percent largely because national politicians are afraid to force through the deregulation needed to promote a flexible, competitive economy. The most vocal advocates of reform now occupy posts in Brussels. There is certainly movement in the labor market, with Poles slaughtering German pigs and Greek chefs delighting Dubliners. But there is no dodging the disappointment of those who expected more revolutionary reform. ''We had all hoped the euro would spur a lot more investment and growth," says Michael Hume, senior economist with Lehman Brothers in London.
Perhaps the most legitimately worrisome sign of fracture in the euro zone is the fact that some national economies are speeding up, while others are slowing down. The euro was supposed to encourage, even enforce, greater coordination of taxing, spending and growth policies among member nations, but it has not. The recent gutting of the Stability and Growth Pact, which tried but failed to cap national deficits at 3 percent of GDP, will make that more difficult. Spain and Ireland, which are growing fast, could use higher interest rates to ease the threat of a housing bubble, while sluggish Germany and the Netherlands need a jump-start from lower rates.
Still, even the excitable financial markets are coming to see the upcoming French vote with greater equanimity. Just about every investment bank in Europe has published a report in recent weeks called something like "What If the French Vote No?" Much has been made of the fact that the spread between the interest rates paid on 10-year bonds in Germany and Italy jumped in March, when polls first started forecasting a no vote in France. That suggested that investors expect a no vote to undermine European cooperation, and leave laggards like Italy even farther behind. But the spread has stabilized since then. "We all got excited there for a while," says one bond analyst. Moody's, the credit-rating agency, says a no vote will have no impact on its sovereign ratings.
Indeed, if France or the Netherlands or anyone else slaps down the constitution, the rejection itself will not trigger a euro crisis. But political frictions could emerge from anywhere: a fight over deficits or the size of the EU budget. What if, analysts ask, Italy's struggles with swelling debt provoke the market to dump its bonds? In the rosy view, the ECB cuts rates and opens its discount window to angry creditors, defusing the crisis, before quickly reversing itself to prevent any threat of inflation.
There is one scenario, however, that might ruffle the long-view calm of even Zhou Enlai. The ECB has not moved interest rates in two years, and so far has received generally high marks for steadfastness--but what if this is a cover for paralysis? UC Berkeley economist Barry Eichengreen notes that after the 1929 stock-market crash, the 15-year-old Fed, divided between rival factions, dithered as the economy fell into depression. What if the ECB's governing council hesitated in the face of a national crisis, like the hypothetical Italian case above? Markets, doubting European solidarity, could force Italy into default. Contagion could drive up rates across the euro zone. A crisis like this, says Eichengreen, will present "the ultimate test of the euro." Fortunately, a failed vote for the constitution is not going to be that test.
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