Will Russia rock the euro?
Four months before the launch of Europe's unified currency,
an unexpected challenge from abroad
By Jonathan Miller
MSNBC CONTRIBUTOR
LONDON, Aug. 30 -The euro - Europe's new single currency - is "the event of the century," according to German Chancellor Helmut Kohl. Now the euro faces a launch in the midst of economic turmoil in Russia. If the crisis spreads from the collapsing stock markets to the general economy, it could stop western Europe's economic recovery in its tracks. Will the euro still work, and become a major competitor to the dollar, or could it be undermined by the Russian crash?
EUROPE'S POWERFUL new central bankers have barely finished moving into their offices in the Eurotower in downtown Frankfurt. Russia was not even on the agenda of the bank's policy council for its meeting Sept. 1, the first after Europe's long summer holiday.
It was never part of the plan to launch the euro, Europe's new currency, just as a great deflationary blast of cold air blew in from the east. Now, with just four months to go before the launch, the managers of the currency, the centerpiece of Europe's long-planned Economic and Monetary Union, face a new layer of complication.
At the very least, the crisis in Moscow puts pressure on the new European Central Bank (ECB) to reduce interest rates to keep western Europe's long-delayed economic recovery on track. But this would make the euro a weaker currency than anticipated, and runs the risk of sparking inflation.
At the worst, matters in Russia could continue to deteriorate, pushing the Poles, Czechs and Hungarians into recession or worse and ultimately, in a form of economic domino theory, tipping western Europe into a recession of its own, just as the new currency was starting to circulate among its citizens.
The merger of 11 currencies into one, supervised by the new ECB, is the most ambitious step yet towards the unification of Europe. On Jan. 1, the 11 members of the single currency will formally launch a new currency that will instantly be second in size only to the dollar. In the days following its formal launch, it is expected that up to $1 trillion of international investment will shift from dollars into euros, instantly turning the new currency into a major force.
Now the fears that a worsening Russian crisis could spill over into western Europe is threatening to turn the currency launch from a largely ceremonial occasion into a far more delicate operation. There is little risk that the euro launch will be derailed entirely. There is, however, a risk that the new currency will be less robust than planned as the eleven nations of Euroland weather the storm.
The swiftness with which the climate for the euro has changed appears to have caught many senior European policymakers by surprise. In an Aug. 24 speech to a Munich business group, Wim Duisenberg, the president of the European Central Bank, said his key objective for the new currency was to provide stability by defeating inflation. As his audience filed from the room, few could have imagined that by the end of the week, the worry on most lips would be of a Europe-wide deflation, caused by the collapse of the Russian economy and spreading economic turmoil in Asia and Latin America.
Officially, the institutions directly concerned with the introduction of the single currency deny that the events in Russia are likely to materially affect the euro launch at all. As markets sagged across Europe, the bank's spokesman in Frankfurt admitted that Russia was not even on the agenda - at least, not officially. "You can imagine that they will discuss the current issues," he said. In Brussels, the European Commission spokeswoman, Martine Reicherts would not even admit the possibility that the Russian crisis was a threat to monetary union. "We should not exaggerate the stock market reaction," she said.
Others were even more bullish. Dominique Strauss Kahn, the French economics minister, boasted that the 11 members of the single currency were "the chief area of stability" in the current crisis.
Those who have watched their portfolios being decimated may not concur, but Strauss-Kahn is right that on the fundamentals, Europe's direct exposure to Russia remains limited. The Russian economy in fact is only the size of Holland's. "Trade flows between Europe and Russia are small. Germany is the most exposed economy in terms of trade and its exposure is less than 0.5 percent of GDP," says Jeffrey Weingarten at Goldman Sachs in London. Economist Brian Reading, director of Lombard Street Research in London, agrees: "The ruble crisis is short-term bad news but in a couple of months its effect will be minimal."
Lorenzo Codogno, managing director of Euro economics and interest rate research at Bank of America, agrees there is short-term risk. "Russian debt default has set off a contagion which has attacked Canada, Scandinavia even Greece and is now looking at the countries of monetary union, particularly Italy and Spain. The interest rates which were supposed to be converging have in fact widened. Spreads will get even wider, as money goes into the German mark. But this is short-term; There is still a strong economic rational behind the euro and a strong political commitment. ECB has the right tools to defend the currency."
The head of European economic and fixed-income research at Merrill Lynch investment bank, Cesar Molinas, said: "There are many rumors about the current financial turmoil bringing serious difficulties for the launch of EMU. I cannot see why. It's too late for any speculative attack to have any impact on EMU."
There are some in Europe who say that defending the euro is too limited an ambition and that the continent should be helping the Russians. They say Europe has in part contributed to Russia's problems, by focusing on the launch of the euro and doing little to encourage the Russian economy's transition from communism to a market economy.
"The big defector in the Russian crisis was the European Union," complains Sergio Romano, the former Italian ambassador to Russia who is now a professor at Bocconi University in Milan. "It is pitiful that just a few months before the launch of the euro, Europe isn't capable of coming up with a common position."
That's a view that attracts little sympathy in Paris, Bonn or London, where the feeling is that the Russian problems are of their own making, the result of political corruption and a refusal to implement the basic economic reforms demanded by the International Monetary Fund and the best way for Europe to protect itself from the fall-out is to keep its distance. The euro may be weakened by the troubles of the ruble, but unless the crisis gets much worse, few in Europe doubt that it will launch on time.
Jonathan Miller is a London-based writer.
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