Euro Inspires Little Confidence

By William Drozdiak
Washington Post Foreign Service
Monday, May 7, 2001; Page A01

BRUSSELS -- The first signs of the Great Money Mystery began to emerge last autumn. After a long period of stable growth, the amount of cash in circulation across Western Europe suddenly began to shrink – to the amazement of the European Central Bank.

By January, money was flowing out of the euro zone – comprising the 12 countries that have adopted Europe's single currency – at the alarming rate of $40 billion a month. Since then, the hemorrhage has accelerated, contributing to the strength of the U.S. dollar.

While the phenomenon baffles many economists, most agree that it may be related to the upcoming transition known as E-Day. On Jan. 1, more than 300 million Europeans who live in the euro zone will embark on what the central bank's chief economist, Otmar Issing, describes as "the greatest peacetime logistical effort in Europe's history."

Over two months, they will replace their francs, lire, drachmas and German marks with crisp notes and shiny coins denominated in euros. More than 50,000 trucks are being mobilized to haul in mountains of old money from banks, stores and automated teller machines and to distribute 16 billion euro notes and 56 billion euro coins – enough paper bills to circle the equator 50 times and enough metal to replicate 35 Eiffel Towers.

Since money is largely a game of confidence, economists believe that the prospect of something going terribly wrong during that mammoth enterprise has sent many investors scurrying for safe refuge in the dollar. Hans-Werner Sinn, head of one of Germany's most prestigious economic research institutes in Munich, said two groups in particular have moved huge amounts of European wealth into dollars: the criminal underworld, especially Balkan and Russian gangsters; and citizens of former communist regimes in Eastern Europe who have little faith in the untested euro.

According to senior German officials, Interpol agents and intelligence officials have reported that prostitution rings and drug smugglers who thrived during the disintegration of Yugoslavia have shifted vast amounts of their liquid assets out of German marks – which has long been their currency of choice – into dollars. The officials estimate that as much as $600 billion in criminal funds could pass through Europe's foreign exchanges this year.

"The reasoning of the gangsters is pretty simple," Sinn said. "If you are running black markets, you don't want to show up at banks with a large suitcase of marks and have to explain where they came from before you exchange them into euros. So in recent months, the Balkan and Russian mafias have discovered that dollars are safer and can provide greater cover for their activities."

This reduces the amount of cash in circulation in the euro zone because many of those people are nonresidents taking their German marks and other currencies out and trading them for dollars on their home turf.

Poles, Czechs, Eastern Germans and other residents of formerly communist nations are also getting nervous about the euro. Having gained access to Western currencies after decades of coping with nonconvertible currency in the Soviet bloc, they are worried about whether the euro can match the value standard set by the German mark, which will be obsolete. Rather than take chances, many are shifting for now into the dollar.

Such flight from the mark or the franc means a fall in the euro, compared with the dollar, because the values of the 12 euro-zone national currencies have been locked in relation to each other and the continental currency since the euro's birth in January 1999.

There are other reasons for the euro's weakness when compared with the dollar. Many investors may still believe the United States offers the safest long-term investments because of its unchallenged role as the dominant force in the global economy.

The euro's plight has been complicated by its unusual status as a phantom currency used mainly for banking transactions. Rather than compel everybody to shift overnight to the euro, European leaders decided that a three-year transition was necessary. Thus, since January 1999, bank assets and consumer goods have been marked in both the local national currency and the euro, though no euro cash will be accepted for everyday transactions until Jan. 1, 2002.

Both euros and the old currencies will be accepted for cash transactions in most euro-zone countries until Feb. 28, the day when the euro becomes the sole legal tender throughout the area. Banks will exchange old currencies for euros until Dec. 31, 2002, and the national central banks will perform such exchanges at least until 2004, and perhaps indefinitely.

The arrival of the euro as a tangible currency is already being called by many political leaders a psychological boost for the flagging crusade to build a United States of Europe. But in the less exalted view of financial markets, the euro's persistent weakness reflects investor skepticism about its credibility and the potential for chaos once the delivery trucks start to roll.

Now that the U.S. Federal Reserve has lowered a key interest rate below the level of a comparable rate set by the European Central Bank, the stage should be set for a surge in the euro's value. Yet the euro is still less than 90 cents – about 28 percent less than the value at its 1999 birth and near the point that prompted the world's major central banks last September to intervene on foreign exchange markets.

Wim Duisenberg, the European Central Bank president, has been criticized for refusing to lower interest rates to counter slowing economic growth. Duisenberg insists that the bank is determined to establish the euro's reputation as a rock-solid currency.

"Anchoring confidence in the euro, in particular for the general public, is a time-consuming task," Duisenberg said in the bank's annual report, which was released this week. "The best way to achieve it is to build a track record of low inflation."

The central bank has launched a $70 million publicity campaign featuring a jazzy Web site, television ads and a mass mailing of 200 million leaflets to inform Europeans about the changes to come in January. The bank, as well as many governments, are worried by signs that companies and citizens may be unprepared.

According to surveys, up to 70 percent of European firms are not ready to operate in euros. "This will be a much more complicated exercise than the Y2K adaptation of computers," said Detlev Sachse, a euro expert at Germany's Chamber of Commerce and Industry. "Companies have massively underestimated what needs to be done."

Similarly, as many as 90 percent of individual Europeans still keep their assets listed in national currencies rather than euros. Pedro Solbes, the European Union commissioner in charge of the euro project, fears that people may not realize how dramatically life will change Jan. 1.

"We don't want people to have the impression they are waking up in a foreign country when the new year arrives," Solbes said. "Only cash exchanges will benefit from a transition period. Bank accounts, tax returns, invoices and all accounting systems will have to be made in euros after January 1."

Despite the obstacles, Romano Prodi, president of the European Union's executive commission, said he believes the transition will be conducted smoothly. Prodi said his greatest fear is not that people will continue to flee from the euro, but rather that so many investors will jump back into the euro once E-Day passes with relative tranquillity.

"The markets do not like any kind of volatility, whether the direction is up or down," Prodi said in an interview. "The real concern may turn out to be a sudden rise in the value of the euro – along with an equally sudden decline in the dollar – that could be seen as a threat to monetary stability."

© 2001 The Washington Post Company

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