The Euro, Round 2

Will the advent of notes and coins help or hurt growth?

Hoisting the odd box of fax paper is about the hardest labor most of the 200 employees at Volksbank Ostholstein Nord, a bank in the north German town of Neustadt, normally do. Yet managers these days are actually paying staff to tone up at a local gym. That's because they'll have to help move 42 metric tons of bags and cartons when euro notes and coins start arriving at the bank's 15 branches. "We're talking dozens of trips a day carrying heavy bags of money up and down stairs to the safes," says Johannes Hadermann, who heads the bank's euro-conversion project. Other banks are more concerned about the health of their buildings. The weight of the money they'll handle in the weeks after euros go into circulation could buckle weak floor and ceiling beams.

Meanwhile, merchants and retailers are bracing themselves for an onslaught of angry, confused consumers as Europe takes on the biggest and most complex peacetime logistical operation in history: the conversion of 12 European currencies--worth $315 billion--to real euro notes and coins, starting on Jan. 1, 2002. The conversion is the second part of a two-stage process. The first stage, the introduction of the electronic euro in January, 1999, let markets start trading in the single currency. Now comes the real thing: European consumers will trade in their francs, marks, and lire and start paying their butchers, grocers, and dry cleaners with the freshly minted, crisply printed currency of monetary union.

The euro conversion is not just gargantuan in logistical terms. The potential consequences, good and bad, are enormous. On the plus side, the conversion to notes and coins should give new legitimacy and power to the single currency. Trade between euro-zone nations could grow dramatically--as could the region's economy. Mergers and acquisitions might accelerate, and the value of the euro itself could climb back toward parity with the dollar. "The arrival of the notes and coins will knit the single market together and give the economy a huge boost," says Anton van Rossum, chief executive of Fortis, a Belgian-Dutch financial-services group. "I'm very bullish about its impact."

On the minus side, analysts fear the conversion could spark consumer and labor outrage as shoppers and workers see clearly for the first time the wide gaps in prices and wages among euro-zone countries. Others are concerned that the costly conversion process will curtail Europe's already anemic growth, while the mechanics of repricing will push up inflation. Some alarmists claim that if everything goes wrong, the European economy could grind, at least temporarily, to a halt.

For officials of the European Union and European Central Bank, the changeover must go smoothly. The cost of chaos would be incalculable. Unprepared small businesses may have cash-flow and payment problems. And the political impact in Sweden and Britain, which are still weighing whether to join the euro zone, would be profound. In addition, Europe's margin for error is slashed by the broad slowdown in the European economy. The great fear is that the euro conversion will aggravate it.

QUICK CHANGE. Still another worry is the decline in the euro's value. The currency has lost nearly a quarter of its worth against the dollar in the 30 months since its virtual launch. The relentless fall, coupled with a new economic downturn--just as the region seemed to have emerged from a near 10-year slump--has turned many Europeans against the single currency, especially in Germany, where opinion polls show that fewer than half of all voters support the idea. That means a rough introduction could trigger a Continentwide political crisis. Plummeting public confidence in the euro could spark a catastrophic "popular uprising," warns Nicole Fontaine, president of the European Parliament.

During the changeover, which starts on Jan. 1 and lasts just two months in most countries, 14.5 billion new notes and 50 billion coins will be exchanged. National currencies, which cease to be legal tender on Feb. 28, will be recycled. The vast majority of notes have already been printed and coins minted. The ECB has just contracted with three additional printing plants to make sure there are no delays. Almost every day, a convoy of armored vans packed with 600-kilogram containers of new notes, trailed by a fleet of police cars, leaves the Bundesdruckerei--a printing shop in Berlin--for storage sites around the country. Similar scenes occur daily across the euro zone.

The euro was born on Jan. 1, 1999, but has remained an abstraction, used in corporate accounts, stock and bond markets, European Union budgets, and other arenas that don't require exchange of actual cash. When it becomes tangible, expect long lines in banks and shops as 302 million euro-zone citizens fumble like foreign tourists with the strange money. Millions of products and services will have to be repriced. All manner of contraptions that take and dispense money--including parking meters, ATMs, jukeboxes, and 3.2 million vending machines--will have to be reprogrammed.

The operation will affect countries and companies far beyond the euro zone. Up to $35 billion worth of Deutschemark notes circulate outside the EU, mainly in Eastern Europe. Montenegro, for example, is one of several regions that use the mark as its currency--and must switch, too. Authorities report that criminals in Eastern Europe are busy converting marks into dollars. No point alerting the police by lugging in suitcases of cash at changeover time.

GRASS IS GREENER? The switch is likely to unify euro-zone commerce in ways that were never possible before. Price, wage, and tax disparities between countries will be glaringly obvious. Cars typically cost as much as 10% more in Austria than they do in Italy, for example. Already, some Austrian auto buyers cross the border to shop, but the number of border-hoppers will rise dramatically once the vehicles are all priced in the same currency. It will be the same with gasoline, which is now about 15% cheaper in Luxembourg than it is in Germany.

Businesses in low-wage zones already worry that workers will agitate for raises. "We think the unions could cause trouble when their members start comparing wages across borders," says Joao Carlos Tavares, CEO of Gastronomica da Alcoava, a food-processing company in Vila Real, Portugal, whose employees earn one-third less than their counterparts across the river in Spain.

Economists expect the costs and bottlenecks of the conversion and consumer hesitancy to spend to knock at least 0.25% off 2002 growth for the euro zone. Given this year's unexpectedly harsh slowdown, that would be bad news indeed. The hope is that once the bumbling ends, the new currency will spark a growth spurt, especially if it coincides with a broader global recovery. Businesspeople hope that the euro will make it harder for national authorities to justify blocking cross-border mergers and acquisitions, especially in financial services, where regulators still defend their financial systems against interlopers. "The new notes and coins will change that," says Angel Corcostegui, chief executive of Spain's Banco Santander Central Hispano, whose cross-border plans national authorities have quashed.

The new money's arrival could also affect inflation, monetary policy, and the euro's value against the dollar and yen. How that will all play out stumps the pundits, though. In Britain, prices shot up 3% after decimalization in 1971 because retailers used it as an excuse to raise prices. Yet when France launched the nouveau franc, eliminating two zeroes, in 1958, prices fell. No one knows why.

This time, Europeans fear the worst. Germany's top consumer association is already complaining that retailers--who promised not to raise prices during conversion--are covertly doing so now. Some suspect that's behind the German inflation surge. Consumer advocates worry about price increases that are pure marketing devices. For instance, 990 escudos becomes 4.94 euro, which shops will probably round up to 4.99 euro, a 1% increase. Multiplied millions of times, such changes could really boost inflation. "There's a lot of nervousness floating around," says Franco Bruni, an economics professor at Bocconi University in Milan. "Some people see the euro as a sophisticated trick of the ruling class."

One reason it's so hard to predict the economic impact is that the new currency will distort consumer behavior in contradictory ways. Some people will spend heavily to get rid of the old currency. Others will sock the new cash away in the bank until they feel comfortable spending it. Credit-card use may rise.

The weight of conversion will fall most heavily on businesses, and one of the big questions is whether they'll be ready in time, echoing the Y2K readiness debate. Small retail outfits that handle a lot of cash will find the transition most painful, while big, publicly traded companies whose accounts are already in euros will feel little pain.

Cash registers in most big stores can already cope with both euro and the national currencies. They were converted at the same time they were readied to deal with Y2K. But many small shops haven't thought about the changeover. "We have no time for that now," says Babak Raisi, who manages Copy-Shop Garbe, a photocopying shop in Stuttgart. "We've just got time for business."

Adopting the euro will cost a fortune. The Association of German Banks estimates the conversion will cost its members around $63,000 per branch in transportation, insurance, customer information campaigns, and staff costs. Landesbank Baden-Wurttemberg will have to put an extra 600 people in its 240 branches, some for up to two months, and ask them to work 10- or 12-hour days, including New Year's Day and Saturday, Jan. 5. Eric Bouche, who heads up the euro project at France's Credit Lyonnais, says that introducing the coins and notes will cost French banks about $1.5 billion--on top of the $3 billion they shelled out in 1998 to convert accounts to the euro.

WINDFALL FOR SOME. Retailers will be just as badly hit. The preparations will be at their most frenetic during Christmas. "The timing couldn't be worse for shopkeepers," says Jaak Gabriels, Belgium's minister for small businesses. Stores will need extra security, since retail experts calculate they will handle up to 10 times more cash than usual--even though they'll probably have fewer transactions. That's partly because they'll be receiving payment in the old currencies and giving change in the new. Eurocommerce, a Brussels-based retailers' association, estimates conversion will cost retailers some $29 billion, or 2% of annual sales.

Of course, the euro's arrival will be a windfall for some. Security-transport companies, such as Securicor, are already fully booked between September and next March and expect bumper earnings this year and next. Temporary staff agencies also expect a bonanza. Some companies even have new products tied to the launch. For Italy's Gucci Group, it's the perfect occasion to outfit Italians with new wallets that accommodate the bigger euro notes. The "euro watch" from Switzerland's Swatch Group includes a calculator for transactions in the old euro-zone currencies.

Logistics experts at the central banks, which are ultimately responsible for the new currency's introduction, insist everything will go according to plan. There have been snafus, though. Several million 100-euro notes printed at Munich's Druckerei Giesecke & Devrient had to be found and destroyed last summer after quality-control officials found they contained small errors. Then there was a scare last year, when a senior central banker left details of the secret security features for the euro note on a plane. The papers---a criminal's treasure--turned up intact.

How prepared is the public? Most big shops have been pricing goods in both currencies for some time. The ECB and national central banks have just launched big publicity campaigns, which will intensify over the year. Polls show that more than 95% of Europeans realize that the tangible euro is on the way. Still, only half know how to convert their national currencies or are aware of the timetable. For many, reality will strike this month, when companies start issuing paychecks in euros. That's the point at which Europeans begin to realize that the tools they have used to measure value are about to become quaint relics of the monetary past, like ducats or florins. For Europe, Jan. 1, 2002, will be a point of no return.

By David Fairlamb in Frankfurt, with bureau reports

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