Countdown To The Euro: Europe takes huge leap into unknown

THIS IS the week when Europe starts its gigantic experiment, the launch of a single currency for 11 members of the European Union.

It will soon be possible, for the first time since the fall of the Roman Empire, to travel from the Channel to the tip of Italy without having to change money.

The patchwork quilt of currencies that Europeans have used in their daily lives for more than 1,500 years is being replaced with a single one. The euro becomes a legal entity on 1 January. It will swiftly replace the national currencies and, within three years francs, marks, pesetas, lire and so on will have become history.

It is an experiment in the sense that there is no precedent for such an event. There have been currency reforms, of course, where a country has decided to replace an old currency with a new one: Germany has done so three times this century.

Sometimes countries have chosen to link their money to that of a foreign power - many to the United States dollar. There have been attempts by countries to bind their currencies together: there was an attempt at a European currency in the last century, which failed. And there have been occasions when a country has had its own money replaced with a foreign one, usually as a result of conquest, colonisation or some other political shock.

This is, however, the first time that a group of countries which are not part of a political union and which have not been conquered or colonised have agreed to give up their own currencies for another.

So anything said or written about the launch of the euro, and in particular its political and economic consequences, has to be taken with a pinch of salt. We have to guess; we cannot know. This is a journey without maps.

What we can do is make a stab at gauging some of the effects of this decision. There is one clear political consequence, and a number of less clear economic ones.

Start with the political impact of the new European Central Bank, the body that will "run" the euro. Up to now, the European political institutions have been quite weak. The key decisions supposedly imposed by the Brussels bureaucracy have almost invariably been approved by national governments; power still lies with the ministers of the countries concerned. As for the importance of the European Parliament - well, a quick test: can you name your Euro MP?

Now there is a new institution for Europe. All national countries have some sort of central bank to run their currencies. The recent trend has been to make that central bank more independent of the government, to give it more power. But central banks operate within the framework of a national government: the Bank if England has its independence because that has been given to it by a powerful parliament. The new European Central Bank in Frankfurt has been given its independence too, but the counterweight of the European Parliament is much weaker. In one sense, having a new independent body running the euro compensates for the weakness of other European institutions. In another sense, Europe has created a new focus of power, sharply reducing the scope for national parliaments to exert their own authority. Remember that Europe is not just getting a single currency. It is getting a single interest rate, too.

That, at least is the theory. If you ask practical questions as to how the European Central Bank will exert its power, the answers are guesses. Will European interest rates be high or low? Will the currency be strong or weak? Will the bank pay more attention to the needs of the countries on the fringe or will the big battalions dominate?

If we do not know what sort of currency the euro is going to be, judging its economic effects is obviously hazardous. But some things can sensibly be said. For a start, giving Europe a single currency will give a spur to economic integration. The fact that prices are fixed in the same unit will mean that they will tend to converge. Buy a new car in Inverness and it will be pretty much the same price as one in Truro; buy a car in Copenhagen and the price will be very different from one in Seville. Expect those differences to narrow swiftly - and expect the prices to narrow down, not narrow up.

That will have an enormous impact on companies. Those with plants in different countries, with different wage rates and productivity levels, will immediately be able to compare those differences. They will be forced to improve efficiency and Europe's economy will become more competitive as a result.

There will be other effects. We are already seeing the impetus for cross- European mergers; expect that to proceed apace. We are already seeing the impetus for a cross-European tax policy; the single currency will inevitably encourage that process, not because some politicians and officials are determined to impose common taxes, but because the scale of the differentials will be exposed. The pressure for companies to pay similar taxes across Europe will grow, for if large differentials remain, they will relocate towards the lower tax zones.

So the European economy will become more integrated and more efficient. Some parts will benefit; others will find the new burst of competition very tough. The single interest rate will be a particularly powerful discipline. It is not just that some parts will have to operate on interest rates that are too high for their local needs, others that are too low. It is also that finance will tend to flow towards areas and projects that deliver the highest returns. Investors will think pan-European, rather than in little national boxes. The leaders will bound forward, the laggards will suffer still more.

The fact that investors have a new common zone in which to operate will have one further impact - one that will, if the euro is successful, change Europe's place in the world. Since the Second World War there has been a single global currency standard, the dollar. It has been challenged at times by the yen and the German mark, and in the early post-war years sterling was bracketed alongside. But the dollar has really dominated. No longer. The euro will be close in value to the US dollar, backed by an economy of similar size. The world's currencies will have two anchors, not one. Will that be a source of tension or will they co-exist happily? Will people trust the euro?

And therein lies the greatest question of all. Will the euro succeed? History is littered with attempts at currency unions that have failed. I suppose the failure of the sterling area, made up of many members of the former British Empire, is as good an example as any. In fact, there has been no lasting currency union without a political union. So what Europe is attempting is a great daring, romantic leap into the unknown. As for Britain's role or non-role in this experiment, that is another story.