STORY OF THE WEEK: It is too early to say whether the boost the euro received upon release of the notes and coins will be the start of a sustained rally against the dollar and sterling
The lychee is an unusual symbol, but the small knobbly fruit may yet make its appearance on the back of the euro coins that began circulating this week. At three seconds past midnight local time on January 1st, the mayor of St Denis, capital of the French Indian Ocean island of Réunion, bought a kilo of lychees from a market stall in the first cash transaction carried out in the euro zone.
Mr Rene-Paul Victoria paid 76 cents for his fruit in an act that signalled the completion of a 10-year project aimed at creating a currency to rival the dollar. It was a hugely symbolic act on many levels - not least the career of the otherwise eminently forgettable Mr Victoria.
For the 300 million citizens of the euro zone, it demonstrated the price transparency that will be one of the few immediate benefits of the introduction of the currency; the price of lychees in Réunion can now be easily compared with the price of lychees in Renvyle.
To the world financial markets it underscored the irreversible nature of economic and monetary union, as well as the determination of the 12 euro-zone states to make it work.
Sentiment is a powerful factor in the international currency market, and the successful introduction in its physical form of the three-year-old currency has produced a significant dividend.
The surge in the value of the euro since January 1st goes far beyond what can be explained by factors such as its replacement of the deutschmark as the folding money of choice for the Russian mafia.
It is far too early to say whether the boost the currency received will be the start of a sustained rally against the dollar and sterling. If it is, it will be the source of considerable satisfaction among the architects of the euro.
They modelled the new currency on the deutschmark - and the European Central Bank (ECB) on the Bundesbank - in the belief that a currency managed by a politically independent institution committed to low inflation was the key to creating a rival to the dollar.
To date, this part of the project has been a conspicuous failure, with the International Monetary Fund estimating that the euro is 25 per cent undervalued vis-à-vis the dollar.
The past three years have exposed some serious fault lines in the single currency project, not least the lack of a common purpose between the ECB and the finance ministers of the 12 participating states.
Euro enthusiasts will now hope that once citizens of Italy, Spain and the other 10 states begin to feel some affinity for the euro they will be supportive of government policies conducive to maintaining its strength.
The Irish, however, may yet come to rue the ascent of the single currency to its rightful place in the firmament. The weakness of the euro over the first three years of its existence may have been a disappointment to some but it was a godsend to the Republic.
The decline in the euro's value against the dollar from $1.17 to $0.90 helped the Republic remain competitive at a time when its structural competitive advantages, such as low labour costs, were being eroded. A similar 11 per cent fall against sterling has delivered a fillip also.
The consequences of a strong euro for the Republic's competitiveness could be very negative. In its recently published Winter Bulletin, the Central Bank examined two possible scenarios.
The first was what would happen if the euro reached parity with the dollar this year, as some organisations such as the Economic and Social Research Institute (ESRI) predict. The result would be a reversal of all the gains in competitiveness made since 1998, without even taking into account the further erosion of competitiveness by inflation this year, according to the bank's economists.
They also looked at the more likely scenario of a sharp 7 per cent appreciation in the euro against the dollar in 2002, followed by a 5 per cent appreciation in 2003, taking the euro to parity.
The bank also assumed that the euro would appreciate against sterling during the period. This scenario "would result in a competitiveness level that is markedly more adverse than at any time since 1995, with the exception of a short period in late 1996 and early 1997," according to the bank.
It adds the caveat that these hypothetical situations ignore a number of important factors such as economic growth, but "they nevertheless highlight the ease with which Ireland's competitiveness gains of recent years could be reversed". In simple terms, it means that Irish exporters will have a very hard time.
The Central Bank is using the forecasts of the Economist Intelligence Unit (EIU), which predicts year-end rates of $0.96 for 2002 and $1.02 for 2003. Against sterling, the EIU is predicting end of year rates of 64p and 66p respectively.
The ESRI is forecasting parity this year on the basis of the large deficit on the current account of the US balance of payments, the positive differential between US and euro-zone interest rates and narrowing of the growth prospects between the US and the euro zone.
The financial markets are much less optimistic about the euro's fortunes. Goodbody Stockbrokers predicts the lag between the US recovery and the European recovery will put further pressure on the euro and force it down towards $0.84. For the full year they are predicting a recovery to $0.87 this year and $0.92 in 2003.
IIB Bank also believes that parity is unlikely but Mr Austin Hughes, IIB chief economist, does not rule out the prospect of a rally towards $0.95 in the second half of the year. He points out that Mr Alan Greenspan, the widely respected chairman of the US Federal Reserve, turns 76 this year and the issue of who will succeed him is expected to come to the fore in the latter part of the year. A similar debate will also be taking place in Europe, with ECB governor Mr Wim Duisenberg drawing close to the middle of his term and the deadline for his promise to step aside at that point.
Mr Greenspan will be a hard act to follow and his successor, however able, will not inspire the sort of international confidence in the way the US economy is managed that underpins the strength of the dollar.
In contrast, Mr Duisenberg has failed to win the market's trust and, combined with the lack of economic cohesion shown by the 12 participating states, this has been a significant drag on the euro.
A new dynamic may emerge in the context of Mr Greenspan and Mr Duisenberg's stepping down which could be euro positive, argues Mr Hughes. In the meantime, he expects the euro to test levels as low as $0.85 as the US economy starts to pull ahead.
The current rally is due mostly to technical factors and the true trend will not emerge for a couple of weeks, when currency traders are back at their desks and have taken stock of the situation. Many would have sold the euro in the run-up to Christmas as insurance against any glitches in the changeover. The relative smoothness of the introduction of notes and coins has already spurred them to unwind these positions, contributing to the recent bounce.
For the time being the focus will be on the euro-dollar exchange rate, but Irish exporters will also be keeping a weather eye on the euro-sterling rate. British euro entry is still far from certain, but for those who take the view that it is inevitable, the introduction of euro notes and coins brings the day a step closer.
The British currency experienced its biggest one-day slide against the euro on Wednesday when it hit 62.8p, but most commentators believe that the euro would have to rise to 67p before Britain could join the single currency without negative economic consequences.
The sharing of a common currency with its largest trading partner would have many obvious benefits for the Republic and would eliminate the possibility of sterling-based economic shocks. The downside is the loss of competitiveness for Irish business vis-à-vis their British competitors both in Britain and internationally. But at least they will be able to compare the price of lychees in Renvyle with the price of lychees in Reading.
