Euro and it's impact on U.S. corporations, The

Introduction

The international monetary system will undergo a major change beginning in 1999. The changes brought about by the introduction of the Euro, a new currency to be adopted by eleven European countries will rock the world of international finance and commerce. The continuing development of global business will take a big step forward, as the impact of the change will be felt outside the European Community as well The purpose of this article is to explain the development of the Euro, its application in the field of international cash management and finance, and the potential changes to everyday business, especially in the United States. Even though the United States is not directly impacted by the new currency, the secondary repercussions for all United States businesses, not just those doing business in Europe, will surely be felt sooner rather than later. It is incumbent upon managers in all areas of business to contemplate the impact of these changes on business activities and plan accordingly.

The Development of the Common Currency

The replacement of local currencies with a "common currency" across all of Europe was an objective of many Europeans since the development of the Common Market after World War II. Seen by politicians as a way to more fully integrate Germany into a postwar Europe, thereby greatly lessening the chances of another European war, economic integration began with the formation in 1957 of the six-nation European Common Market. As the ECM has grown to become the EU (European Union) with fifteen member states, separate currencies have still been seen as an impediment to more fully integrated markets within Europe.

After World War II, the Bretton Woods international monetary system was implemented. This was a fixed exchange rate system with the U.S. dollar being backed by gold and international reserves being made up of gold, foreign currencies, and borrowing lines from a newly established institution, the International Monetary Fund (IMF). This system eventually broke-down in 1973, when the dollar would no longer be backed by gold. President Nixon's decision to "float" the U.S. dollar resulted in a revaluation of European currencies versus the U.S. dollar. The Europeans, however, remained most concerned about exchange rates among themselves. Not wanting to give one country an advantage over another via a more competitive exchange rate (beggar thy neighbor policy), the Europeans came up with many modified exchange rate systems over the next twenty years. Names for these systems included the "Snake", the snake within the tunnel, the ERM (exchange rate mechanism), etc. All this energy was expended by the common market countries to make trade terms more predictable without giving any one country a prolonged advantage over another. After bouncing from one exchange crisis to another in the post-war period, the leaders of Europe met in Maastricht, Netherlands in 1991 and wrote a treaty outlining the terms and conditions for monetary union within the European Community. It now appears that on January 1, 1999, the next step on the way to full European union will take place with the creation of the Euro.

What is the Euro?

Currently, currencies within Europe are tied to one another through the Exchange Rate Mechanism. The ERM limits changes to each currency's bilateral exchange rate to each ERM participant to 2.5%. Over the last few years, these exchange rates have remained very constant to one another. The last crisis in the ERM occurred in 1992 when Britain and Italy needed to adjust their exchange rates and took themselves out of the ERM. Since then, Italy has rejoined the ERM and intends to convert to Euros by year-end.

With the establishment of the Euro, all participating countries will fix their exchange rates to each other. No further fluctuations among national currencies will occur. The most likely exchange rates for one member country to the other will be their current central ERM rates. The combination of all these rates will become the equivalent to one European Currency Unit (ECU)'s value on December 31, 1998. The current basket currency, known as the ECU, will cease to exist at that time. The value of the Euro to non-Euro currencies, such as the U. S. dollar, the British pound, and the Japanese yen will start off on January 4, 1999 (the first business day of the new year) equivalent to the closing value of the ECU of December 31, 1998. After that, the EURO will fluctuate to the other major currencies of the world, as the German mark or French franc do currently to the dollar. Asking the question regarding the future value of the Euro vis-a-vis any other currency is similar to inquiring as to the future value of the pound or Swiss franc. It is a legitimate question with no sure answer. It will depend on many factors, such as the economic health of Europe, the monetary policy followed by the European Central Bank, a new institution charged with the responsibility of managing the Euro money supply, and external factors that exist today influencing all freely-floating exchange rates.

The Economic Rationale for the Euro

Imagine what the United States would be like if each region of the country had its own currency and followed its own economic policy. Interstate commerce would certainly be more difficult as currency exchanges would need to be added to all payments and receipts transactions. Accounting records might need to be kept in a different currency for sales tax reporting purposes on sales made by a New York company on sales to Californian customers. Advertising prices on national TV would also be a nightmare, as consumer confusion as to what price to pay for the same article would occur. Individual regions could try and improve their economy by devaluing their money, thereby cheapening their local goods vis-a-vis their out-of-region competition. This is the reality of Europe today, and the introduction of the Euro is designed to create a much more efficient and dynamic European business environment. Some analysts predict the Euro to be the catalyst to energize the economies of Europe into the 21 st century. Lower inflation should occur, as national politicians will no longer be in the position to unduly influence monetary policy, i.e., inflate the economy artificially in order to gain political advantage. Along with lower inflation, interest rates should decline as well. Most of the predicted benefits to businesses and consumers alike will result from greater business efficiency, monetary stability, and a more positive psychology toward Europe's role and stature in the international marketplace.

The Euro Timetable

When the participants in the Euro are formalized and the bilateral conversion rates are set in early May, 1998, the next important date will be January 4, 1999, the date of the Euro's introduction. After the currency is introduced, one must keep in mind that the Euro does not become legal tender until January 2002. Until then, the national currencies will remain legal tender in their own countries, with a period of dual currencies when the Euro is introduced in January 2002 until the national currencies are phased out by July 2002. However, the Euro can be used to transact and settle deals in the wholesale market between 1999 and 2002. The Maastricht Treaty states that there is "no prohibition or compulsion" to using the Euro during this period. Settlement arrangements provide for settlement of foreign exchange trades in national currencies either in Euros or in national currencies.

The Euro Future

Assuming the Euro works well and the benefits accrue to the people of Europe, what future steps will the European Community take? This is a political question, but one that businesses need to keep in mind when making investment decisions regarding Europe. Most talked about is the harmonization of tax policy. Europe does not want capital allocated based on tax differentials among its states. Therefore, much effort will likely be expended toward the goal of encouraging Euro partners to equalize taxes across all jurisdictions. Will political unity be far behind? While many in Europe ultimately hope for a "United States of Europe", the likelihood of this occurring in the next decade is not great. It is difficult envisioning the unification of the Northern countries of Germany, Belgium, the Netherlands, France, and Austria with the Mediterranean nations of Spain, Portugal, and Italy. That is a task for future generations to contemplate.

The Euro, U.S. Business, and International Cash Management

What does all this change in Europe mean for a U. S. company? How should we plan or react to these historic changes that are taking place? What does this mean for me? Regarding the finance area, one must review one's current setup and analyze the potential changes. What are the programs and management tools in place that will be impacted by the switch to the Euro? To gain a better understanding of what will and will not change, let's review how companies manage their money in Europe today.

The Cash Management Example

The basic principles of international cash management are minimization of bank balances, efficient allocation of resources (cash), minimized foreign exchange transactions, and enhanced knowledge of payments and receipts. Many U.S. companies accomplished these goals via a European Co-ordination Center. This is a treasury management center located in a tax-advantaged locale such as Brussels, used by the U.S. company to coordinate intra-European cash flows. Local cash balances are swept into a central locale and managed from that point. Often these centralized accounts are used to effect all international flows, both third party and inter-company. In this manner, all payment requests are coordinated for the various affiliates, currency exchanges are minimized, and better control over funds occurs. These "netting centers" are managed by the company itself or with the assistance of a local bank familiar with the concept and possessing the appropriate software to help manage this activity.

Concepts familiar to U.S. companies such as bank balance reporting, sweep accounts, and centralized treasury management are being mimicked, more or less successfully currently in Europe. What will the introduction of the Euro mean for these European treasury centers? More broadly, how will it impact U.S. importers and exporters now doing business in Europe?

Cash management in Europe will become much simpler. Treasury centers will have ten fewer currencies to deal with. Therefore, centralized management of Euro bank accounts will be much easier. In fact, companies will likely pare down the number of accounts they hold. Depending on the business involved, one centralized Euro account could be used to replace individual bank accounts maintained in each country. This fact alone will likely lead to the continued integration of European Banks. More cross-border mergers and acquisitions will occur. Banks will need to offer the latest in technology as companies will demand more pan-European services than currently exist.

Demand for foreign exchange services will be reduced for European businesses while commerce conducted abroad will likely grow. Many banks that specialized in intraEuropean commerce between, say, France and Germany will see these niches replaced by foreign exchange deals with Eastern Europe or Asia. As the global economy expands outside the European Union, foreign exchange transactions will still be needed to conduct business with these newer markets. Until such time as a new Bretton Woods agreement occurs or the gold standard is re-established, currencies will continue to float and cause headaches for the individuals managing those exposures. The "headache" will only go away for the business conducted by the eleven nations within these same eleven nations.

As of 1992, 47.6% of world exports were denominated in U.S. dollars. U.S. companies have become accustomed to not only thinking in dollar terms, but expecting their trade partners to as well. Previously, many countries realized that they needed to deal in U.S. dollars as one of the costs of dealing globally. Since their local markets were small, dealing in foreign currencies became a necessity. Now, however, the Euro has the potential to become a truly global currency. More companies will likely demand payment in Euros and ask for contract bids denominated in Euros. U.S. companies accustomed to dealing only in dollars may be forced to "internationalize" by entering the currency markets for the first time. Learning about the mechanics of the foreign exchange market and familiarizing oneself with forward exchange contracts and option contracts may prove invaluable when a customer requests a change in billing currency from dollars to the Euro. Billing in Euros rather than dollars may prove to be a marketing advantage for a U.S. company as well.

International banks are now preparing for the introduction of the Euro. Payment system changes should become transparent to the customer. While payments in any of the eleven currencies will still be possible, many banks are re-configuring their payment methods to conform with the Euro. For example, flows may be concentrated to one centralized "Euro-hub" as opposed to being directed to individual countries. The hub would be connected to all the major Euro payment channels, making for an efficient system with centralized control. Companies with multiple accounts denominated in Euros, or multiple accounts maintained in multiple locations will likely see these accounts disappear over time. Otherwise, the full benefits of the Euro will not accrue to the company.

U.S. importers and exporters will, in all likelihood, not be able to detect any difference to payment services than currently exist. This transparency is a goal of international banks involved in Euro-settlements. The SWIFT system of electronic messaging will still be used for initiating foreign currency flows between the U.S. and the European nations adopting the Euro. However, the truly significant changes to impact U. S. businesses, will, ironically, have little to do with the currency change.

What to expect in a post-Euro business environment

European businesses have seen themselves as somewhat provincial in the last twenty years, as U.S. and Japanese multinationals have come to dominate the international business arena. With the advent of the Euro, however, businesses in Europe will consolidate, creating much more formidable competition. There is an aura of anticipation in Europe being fostered by the Euro, and confidence is high for the positive changes the Euro will bring. U.S. companies will face stiffer competition from the European Union in coming years. Being prepared for the changes to the international monetary system and understanding the business power that will be unleashed is the minimum planning U.S. companies need. The introduction of the Euro is but one more step on the road to a more internationally integrated business environment. Common currency areas are being talked about for Asia, and Latin America is finally opening their capital markets to international investments. One thing is for sure, the Euro will help foster a business environment that is more competitive and rewarding for those entities savvy enough to recognize the potential such an historic change will offer.

Robert M. Gruber is Vice President of Foreign Exchange for The Chase Manhattan Bank

Copyright Credit Research Foundation Second Quarter 1998
Provided by ProQuest Information and Learning Company. All rights Reserved