Hamish McRae: Happy birthday to the euro – but the real test for the currency lies ahead

Here in Brussels, farmers are demonstrating in the streets about the high prices of diesel and fertiliser, and the capital of European bureaucracy is still pondering the long-term consequences of the Irish rejection of the Lisbon reform treaty. But Europe does have something to celebrate – the euro has just had its tenth birthday.

Given some of the reservations, including my own, about the long-term prospects for the currency, just being around might be considered an achievement, but of course it has done more than survive. There have been bumps on the way but it is currently the strongest major currency in the world, and the eurozone has had a reasonable growth and employment performance for the past decade. Not bad at all.

But its success raises questions. If the past few years have been the "nice" decade for Britain – Mervyn King's non-inflationary,continuous expansion – maybe these have been easy years for the euro. Maybe tougher times for the currency, and indeed the continental economy, lie ahead.

But first the scorecard. If you compare the performance of the world's three largest currencies since 2000, there is no question which has become most favoured. As the first graph shows, the euro initially lost ground against the dollar, leading to some pretty critical comments on the markets. Since 2002, however, it has been stable, with the dollar gradually deteriorating. The yen has been the weakest currency, something that has not received as much attention as it deserves.

Another measure of the euro's general status is the extent to which the global central banks choose to hold it in their reserves. It accounted for 26.5 per cent of the total last year and the proportion is rising. If countries that at the moment peg their currencies to the dollar shift to a basket of different currencies, that will rise further. Private investors naturally hold a large proportion of euro-denominated securities in their portfolios. So the euro has become "sound money for the world".

That phrase is taken from a new Goldman Sachs paper, The Euro At Ten: Performance And Challenges For The Next Decade, which calibrates the progress of the currency and makes some judgements about its future – one of which is that Britain is unlikely to join it for the foreseeable future. Part of the reason why that should be so has to do with British political attitudes towards the EU, but the lack of support is also partly a function of the relative success of the UK economy over the past ten years.

The next graph compares the growth rates of the eurozone, the US, the UK and Japan during the lifetime of the currency. Overall growth has been highest in the US and UK and, if you adjust for changes in the population, growth per head has been fastest in Britain. But growth per head of population has been as fast in the eurozone as in the US, something that not many people realise. The eurozone has actually created more new jobs over the past decade than the US.

In any case, relative growth performance is not simply a function of the currency. Other policies, including regulation and tax, are just as important. Whether a single currency has really boosted internal European trade is not clear. You would have expected it to have done so but as the next graph suggests, while intra-European trade has risen, overall European exports have risen just as fast. So while the euro may have had some impact on increasing trade within Europe, it does not seem to have had the radical impact many expected.

When comparing European performance against other countries, you also have to note that Europeans have chosen to work fewer hours than Americans – a long-term trend that was happening long before the euro was conceived (see next graph), and one that many Americans would rather like to follow, were they given the chance.

The central point here surely is that the euro has achieved the main objectives needed to secure its place as a reliable global currency. It is perceived as being well-managed, with the reputation of the European Central Bank, after a wobbly start, now at least as solid as that of the US Federal Reserve or the Bank of England. In fact, many would argue that it has been more effective than the Fed in restraining inflation, particularly given the diverse needs of the different eurozone members. Its record on inflation is not as good as that of the Bank of England, though better than the Fed, but it has sufficient credibility to sustain long bond yields lower than either the US or the UK.

But arguably these were easy times. What happens next? Well, Goldman does look into the future, notes the possible new members and acknowledges the possibility that some countries might leave the eurozone, even though there is no specific provision for that. The paper makes a point I have not seen before: that it would be easier for a country to leave the zone if its economy were strong than if it were weak. In other words, it would be easier to revalue out of it rather than devalue out of it. So the idea that the potential leavers might be Italy or Greece may be wrong: the costs would be very high in terms of higher interest rates and so on. But would Germany really dump the euro? It is hard to envisage the circumstances where that might happen. Or Ireland? Surely not. Currency unions of the past have broken up and investors buying long bonds are making assumptions, not just that the currency will be around in 30 years but also that the institutions behind it will not allow a rapid depreciation of the currency during that time. This currency union does not have a national government behind it but it looks solid because it is backed by the discipline of an independent central bank and the fiscal structure of European Monetary Union.

So Goldman's conclusion is that the euro is secure for the foreseeable future and it notes that the markets seem to agree. Besides, which other currency offers something better?

Nevertheless, we are undoubtedly heading into a period of higher inflation. But is it likely that eurozone inflation will be significantly worse than the rest of the world? I would have thought not. That said, the next few years are going to be bumpy. The European economy, like that of other developed regions, is slowing and will slow further. Yet European interest rates seem likely to rise next month. That will cause a stir, particularly in Spain and Ireland, where housing markets are facing huge pressures. The Italian economy is projected to grow at less than 1 per cent this year, and higher rates will not be welcome there either.

The issue is how well countries can cope with interest rates that are set for a large region but will inevitably be wrong for particular parts of that region. During the upswing, it did not seem to matter too much that Spain and Ireland had inappropriately low interest rates. But during the downswing, it will hurt a lot to have inappropriately high ones. It is then that politics intrude – as they have been doing in Brussels and Ireland, and doubtless will in other parts of Europe in the months to come. I still think the real test of the durability of the euro will come in the next cycle, perhaps ten years away, rather than this one. But, meanwhile, expect more tension than we have seen to date.

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