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The euro celebrates its first birthday this month, but the young currency has not had an easy time so far in the grownup world of foreign exchange
By Richard Lewis
One year older, but is the euro any wiser?
Any traveler that has visited the 11 countries of Euroland in past year will be just as aware as the local residents that something has happened to the money. Not a lot, but something. Restaurant and hotel bills, supermarket and filling station receipts show two prices - the local one and the euro version. Although not much of a change in itself, it is often enough to cause visitors to look twice at their receipt, similar to the momentary indecision sometimes felt when faced with bilingual road signs in an unfamiliar country.
Today, the screens of automatic cash dispensers glow with figures in euros and the local currency, causing that extra second of hesitation before pressing the button and hoping you get what you asked for. But surely there must be more to show for Europe's big idea - the long-awaited single currency.
For business and accounting purposes, the euro came into existence on 1 January 1999, and in 2002, notes and coins will come into circulation in participating countries. There is no doubt that the birth of the euro involved enormous effort and a huge act of faith on the part of its founder members. But despite the massive step involved in creating a common currency in the European community, member countries felt there were equally large rewards to be gained.
Among the prizes on offer from a single currency shared by 11 major interconnected economies are increased trading efficiency, greater price transparency and a reduction in the cost of trading among the countries involved. Hedging against currency fluctuations will be a thing of the past for intra-zone trade, which should also deliver considerable cost savings.
Before 1999, the import sector of euro-zone countries typically represented 20-30% of their gross domestic product (GDP), or even larger in the case of some of the smaller countries. The creation of Euroland effectively reduced the zone's import sector to about 11-13% of GDP overall, ensuring that exchange rate shifts will have a smaller impact on each country's economy in the future.
At the launch of the euro, there were also strong expectations that the new currency would become an important reserve currency, providing a "strong and stable" unit of account for foreign trade. But a questionmark hangs over whether the new currency has lived up to these expectations.
If asked whether the euro has really made a significant impact on business in Europe and around the world, the quick answer must be, "Not yet." This is hardly surprising though, as the improvement in Europe's economic performance only started to make itself felt on business sentiment toward the second half of 1999 and the weakness of the euro to date has not helped matters.
New start
The euro started life worth just under $1.20. From there, the currency sank to just over $1.02 before making something of a recovery in July and August. Toward the end of 1999, the euro stood at near parity with the dollar. The early hopes that the euro would be "strong and stable" have proved to be ill-founded, but it is still early days in the currency's life span. As the European Central Bank president, Wim Duisenberg, put it at the end of November, "Ultimately, there is only one way (the euro) can go and that is up." However, he had no "100% watertight explanation" for the euro's slide, putting it down to "a complex interplay of factors on world markets".
On a more positive note, the euro has made its presence felt as a reserve currency. This was largely inevitable though, given the large balances held in deutschmarks that automatically became euro balances at the launch of the single currency. The same kind of hereditary effects, however, have reduced the apparent importance of the euro as a large number of businesses are still mainly operating in the legacy currencies. A recent KMPG survey predicts that it will be after the completion of the transition period in 2002 before even 75% of Europe's top 300 companies will be paying employees, pricing and purchasing totally in euros.
Over the past year, some interesting features have emerged concerning the infant currency. For example, Intra-EU11 dispatches grew by 8% between August 1998 and August 1999, while Extra-EU11 exports grew by just 3% in the same period. Nevertheless, although the euro-zone trade surplus was down on 1998, it was still a healthy Euro 37.6 billion for the first seven months.
The USA has a large, and widening, external trade gap. This situation, along with accelerating growth in Europe, means that the euro is likely to gain strength. The convergence criteria for EMU (European Monetary Union) membership, which were so controversial at the outset with the massaging of already contrived economic data, have not been reinforced by experience. Far from converging, Euroland economies have been moving farther apart. November 1999 figures showed annual growth rate forecasts among the Euroland countries that varied from just over 1% in Italy to nearly 8% for Ireland. These growth figures are part of the reason for the continuing high degree of optimism for the euro. But any strong upward trend in the euro exchange rate is likely to be slowed by investor profit-taking when the currency hits $1.10.
Perhaps the main success of the euro to date can be couched in the negative - there have been no problems that business and the banking sector have been unable to cope with. And perhaps most importantly, the whole thing has not unraveled as some cynics suggested. Rome was not built in a day and the euro will not be built in a single year. But like the ancient city, it is here to stay.
Figure 1 - Dollar/Euro Exchange Rate Trend 1999
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Finance Do you have a written FX policy?
Do you have sufficient suitable staff to execute that policy?
Are FX risk positions made explicit?
Do you have a separate risk overview of FX operations?
Do you have standardized group FX accounting practices?
Do you avoid the fragmentation of FX operations?
Do you buy FX derivatives competitively?
Are FX forecast errors being explicitly managed?
Do you have tracking systems on all FX related exposures?
Do you have separate back-office operations?
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Paper money
The impact of the euro on the pulp and paper industries will be significant, but needs to be kept in proportion. According to PPI's Top 150 listing, 34 companies have their headquarters in the euro-zone (PPI, September 1999, pp 27-39). On top of that, there are a further nine Swedish companies in the Top 150 and it is widely expected that Sweden will join Euroland in the near future. The euro is now an important issue for all Swedish companies, especially as only about 10% of their business is invoiced in Swedish krona, while some 80% of their exports go to the euro-zone.
Inevitably there has been much gearing up for euro dealing. But it appears that the Swedish krona, traditionally important in the sawmilling business for pricing and invoicing, is already considered of reduced importance since the new currency was launched. For example, the bulk of pulp sales are still priced in US dollars. But in other products that have traditionally been priced in the currency of the purchasing country, the euro will soon be the only currency used in Euroland as domestic currencies will have ceased to exist by 2002.
In Finland, a home market representing just 5% of turnover has become a home market in the EU11 worth 80% of turnover. Companies within Euroland, whatever their nationalities, will now be assessing a number of money management issues related to the new financial architecture of Europe. Issues such as the most effective cash management structures within the single currency area and the remittance of profits to the most tax-efficient home will become increasingly important as the foreign exchange risk is removed.
Further consolidation in the European paper industry will also lead companies to think twice about where to send their profits. In talking to corporate treasurers, however, it appears that one matter has dominated their thinking in recent months - the so-called millennium bug or Y2K problem. Many are waiting to see out the millennium and its related bug before devoting themselves fully to euro-related matters.
Clearly, the geographical location of a company's headquarter is only one indicator of its corporate identity and that is becoming less and less relevant with the increasing globalization of the pulp and paper industry. This is likely to reinforce the idea that there is no getting away from the dominance of the mighty dollar. As a unit of account for foreign trade, dollar designated deals amount to about four times the value of the international trade account of the USA. At best estimates, the euro will never account for more than the total value of European Union trade.
Ultimately, this means that the dollar is always likely to be more than four times as important as the euro in world trade, even when the euro is fully established. Due to this fact, North Americans and even their bankers (apart from some specialists), tend to ignore foreign exchange (FX) matters. But Europeans should not be lulled into a sense of false security by the cozier situation provided by their fixed exchange rates in the euro-zone. If companies do decide they still need to hedge their exchange rates, several foreign exchange strategists are recommending portfolio positions featuring the Polish zloty as the best buy, with Mexican pesos providing good yields and the Korean won as a winner.
No major company in pulp and paper operates within the confines of a single national boundary. As a result, currency considerations can affect the bottom line by large percentage points. Box 2 shows a currency management health check, which points to the areas of risk that face pulp and paper companies regarding FX questions. A high scoring company should have nothing to worry about as the euro heads into its second year of existence. In contrast, the currency itself may have more to worry about in terms of boosting its popularity, which took a serious nose-dive at the end of the last millennium.
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