The Real Payoff Will Come Only From Big Reforms

The euro, the new European currency that debuted this New Year’s Day, could unlock great surges of productivity in Europe’s economies, with dramatic effects worldwide, particularly in the United States.

But success is no slam-dunk.

Think of the new currency as an enabling mechanism, a disciplining rod that can help governments reform their wasteful budgetary practices, as the Gramm-Rudman bill and other balanced-budget resolutions helped the U.S. Congress and White House reduce the federal deficit in this country.

Many of the 11 European countries adopting the euro have slow-moving economies with high unemployment, mainly because they impose high taxes on individuals and business in order to finance high levels of social benefits in tightly regulated economies.

All countries, from Germany at 10.6% unemployment to France at 11.6% and Italy at 12.3%, seek reforms to get their economies moving and create jobs. In most countries, that means cutting taxes, altering regulations and making workers shoulder more responsibility for retirement savings and health care expenses.

However, to introduce such cutbacks would be political suicide without the protective coloration of the euro.

The euro pact decrees that government deficits can’t be more than 3% of a country’s annual gross domestic product. Thus it is a convenient discipline that allows politicians to say to their constituents:

“Don’t blame us for cutting your benefits, blame the European Central Bank in Frankfurt.”

But the single currency by itself won’t deregulate economies and bring success to Europe. Tough political decisions on taxes and employment will still have to be made by Europe’s leaders. Otherwise, the euro will be a weak currency. It won’t be a rival to the U.S. dollar, as many European analysts are predicting this New Year’s, but a grave threat to Europe itself.

If countries cannot align their economic policies and make needed reforms, the strains of remaining in a single currency will prove unbearable. With interest rates set by a central bank in Frankfurt, but tax and economic policies set locally by sovereign nations, the potential for trouble is clear. Any country facing rising unemployment might well rebel against the budget-deficit limits and interest rate policies of the European Central Bank.

Foreseeing such troubles, former British Prime Minister Margaret Thatcher predicts the euro’s collapse in three years. Money managers the world over are similarly skeptical. “It’s a Titanic without lifeboats,” says Jamie Rosenwald of Rosenwald Capital Management, an institutional investment firm based in Redondo Beach.

But just because euro success will take work doesn’t mean it won’t happen. Americans should reflect that their country did not have a central bank and unified currency system until 1913, when the Federal Reserve System was established. Indeed, when Andrew Jackson attempted to set up the Bank of the United States in the 1830s, Congress tried to impeach him.

The introduction of a single currency is not a short-term or unconsidered matter. Rather it is a milestone in the continuing unification of Europe, and a binding agent to strengthen it for the global economy.

The single currency will eliminate the costs of currency translation. Productivity will rise as consumers and companies will be able instantly to compare costs of goods and services from Helsinki to Palermo and Nurnberg to Galway.

The euro will replace small, inefficient markets with a unified capital market that will give Europe’s people and businesses the kind of financial capabilities U.S. companies and individuals take for granted.

Mortgages will be more abundant to finance increased home ownership. The mortgage innovations that during the last 30 years have expanded U.S. mortgage markets to a $5-trillion total, have yet to occur in Europe. Now they well might.

European companies will get the financing they need to operate globally. If holdout Britain signs on to the euro, the total market of Europe’s stocks and bonds will be larger than that of the U.S., notes Bronwyn Curtis, London-based economist of Nomura Securities.

A more abundant capital market could give rise to more venture capital in Europe, spawning entrepreneurial companies and advances in technology. Europe has fewer technology-leading companies than the U.S. or Japan.

Much is being made this weekend of the size of the new single-currency economy: The 11 countries will have a combined annual output of goods and services of $6.5 trillion, compared with $8 trillion for the U.S,, estimates economist David Malpass of Bear, Stearns & Co.

And undoubtedly size will have an effect. The euro will cause central banks and companies the world over to switch some of their reserve investments out of U.S. dollars. And Europeans will become more assertive in international economic counsels--and in the management of multinational corporations. “The Americans will have to get used to making room for the voices and decisions of others,” says economist Albert M. Wojnilower of Clipper Group, an investment subsidiary of Credit Suisse First Boston.

But size alone, without speed and flexibility, won’t cut it in today’s global economy. U.S. success in recent years in developing technology, creating jobs and adroitly using investment capital, stems from an ability to adapt to change.

And that is just the opportunity the euro brings to European countries: It can enable them to open up and modernize their economies. But whether European leaders will seize that opportunity won’t be answered this New Year’s weekend.