The euro-the new European currency adopted by 11 countries Friday-may pose a serious challenge to the U.S. dollar's hegemony in world trade and global capital markets, experts on both sides of the Atlantic say. Some believe euro-denominated credit and equity markets could resemble the dynamic U.S. capital markets in as few as three to five years. "I think the euro market will be greater than the sum of its parts," said Paul Mortimer-Lee, chief capital markets economist with the Paris- based bank Compagnie Financiere de Paribas. "Clearly, overnight you create the world's second-largest market after the United States, with the second-largest bond market, offering investors a much more serious alternative," he said. Euroland-as the region has affectionately been dubbed-has a population larger than the United States. It has a slightly bigger chunk of world trade and a slightly smaller gross domestic product. What Euroland does not have are capital markets of the scope and complexity of those in the United States. Government, not corporate, issues dominate the Continent's bond market, and high-yield bond issuance barely exists. And the domestic investor base for equity issues, while growing rapidly, has long been concentrated in just three countries: Germany, France, and Italy. The other countries converting to euro are Austria, Belgium, Finland, Ireland, Luxembourg, the Netherlands, Portugal, and Spain. Euroland's combined stock market will be only about one-third the size of the U.S. stock market, though it will be larger than Japan's. Some observers are predicting that many institutional investors and central bankers will decide they are under-invested in Euroland. But there are nay-sayers. "There may be some kind of novelty effect," said Harvard economist Benjamin M. Friedman. "But it's not as if everybody starts out owning zero euro issues." Though euro-denominated bank notes and coinage won't be circulated in these countries until Jan. 1, 2002, stocks and most bonds are now listed in euro. Banks and brokerages have converted their accounting to euro, though other companies will be able to do so any time over the next three years. Of worldwide government debt, Euroland countries account for about 35%, and the United States accounts for about 33%, according to Barclays Capital. Nonfinancial European companies make up only about 5% of the euro-bond market, according to Barclays Capital. Historically these companies have relied on bank financing more than their American counterparts. Though new issuance this year has been weighted toward corporate debt, only France has a somewhat liquid corporate bond market. About 30% of French corporate long-term borrowing is done in bonds, according to Deutsche Bank. But greater liquidity and pent-up investor demand may drive down euro- bond prices enough to make them more competitive with bank financing. Scott Moeller, managing director of Deutsche Bank's European Monetary Union project, predicts that pricing on euro-bonds will be tighter than on dollar-denominated bonds for the next six to 18 months. "Initially, euro-denominated paper will be in very short supply," Mr. Moeller said. There have already been tremors from Asia. In October, Japanese investors sold a net $70 million in U.S. Treasuries and bought a net $7.45 billion worth of German mark- and French franc-denominated bonds, which have now converted to euro, according to Paribas. Central bankers are also widely expected to re-apportion some of their reserves to increase their stake in the euro, though not as expeditiously as institutional investors. Once again, all eyes are on Asia, where reserves are heavily concentrated in dollars, observers say. But economists say the most dramatic scenario, a huge dollar selloff by Asian central banks, is unlikely. "Taiwan and Singapore reserves are overweighted in dollars. But those countries have long political and military ties with the U.S.," said Adam Posen, an economist with the Washington-based Institute for International Economics. Several large European banks have been trying to convince American corporations, particularly those with a European presence, to issue debt in euro. "It only makes sense to have their credit and receivables in the same currency," said Thomas L. Kolaris, chief executive officer of Barclays Capital Americas. But Mr. Kolaris said he thought most U.S. companies were still in the "study mode." In 1998 several U.S. companies with multinational operations issued debt in the European Currency Unit, a basket of currencies introduced in 1983 that converted to euro on a one-to-one basis over the weekend. Most of these were large financial institutions, such as Merrill Lynch & Co. Others included Dow Chemical Co., which issued $161.5 million in notes; Cellular Communications Inc., which issued $216.3 million; and General Motors Acceptance, which had two issues totaling more than $1.1 billion. In 1989, General Electric Capital Corp., GE's Connecticut-based finance company, made one of the first ECU issues by a U.S. corporation. It has issued 29 ECU bonds and notes worth $5.6 billion, according to Securities Data Co. "That's where we felt we got the best pricing," said General Electric Capital spokeswoman Mary Horne. But David Ovenden, head of global debt syndication for Paribas, said it may still be cheaper for lower-rated U.S. companies doing business in Euroland to issue debt in dollars. Historically, only European companies with the highest ratings have issued debt, and the junk-bond market in Europe is tiny compared with the one in the United States. Current interest rates in Europe may stave off even highly rated U.S. issuers in the near term, Mr. Ovenden said. "While they would clearly like to diversify their funding by tapping a new investor base in euro, the relative efficiency after swaps of that funding is unattractive when compared with the dollar market for the last year," he said. So far, interest from large U.S. investors in euro-denominated issues has been scant. Unlike European and Asian investors, they view Euroland as comparatively riskier than their home market. Thomas S. White Jr., a Chicago-based portfolio manager for a $63 million global asset fund, said country selection drives his decisions. Unlike many of his European counterparts, he sees no particular advantage in the broader-based currency. "The positive aspects of the euro have already been factored into the common stock pricing," said Mr. White, who is about 43% invested in the European Union, including the United Kingdom, which has not converted to euro. Many American economists caution not to make too much of the euro's potential challenge to the dollar. They say the euro will probably become a strong regional currency-similar to the Japanese yen or the German mark-and that the dollar will remain the only true "global currency." Even if the euro puts strain on overseas demand for dollars, the U.S. currency has historical precedence as the benchmark for foreign exchange rates and international trade, and should continue in that role for the foreseeable future, they say. The euro could pose a more serious threat to the Japanese yen's status, particularly in light of that country's current economic problems, some market observers say. Euroland should fill many of the requirements for a strong currency, including a large economy and a significant stake in world trade; relative political stability; and developed capital markets. One thing that could hamper development of the euro-bond market is the region's lack of a large sovereign market similar to the U.S. Treasury market, though European and American economists generally differ in the importance they see in this. Paribas' Mr. Mortimer-Lee said he does not think this will matter too much. "It's true that you now have several nations with one currency, but I don't think that will affect the development of the market," he said. "There's not much difference between the large countries, like Germany and France." But Harvard's Mr. Friedman said he does not think investors will equate Portugal's debt, with an AA-minus rating from Moody's, with French or German debt, which both have an AAA rating. Mr. Posen said the U.S. Treasury market has taught us something important. "You have to have a sovereign government actively developing a deep, liquid bond market," he said. He predicted that it could become slightly more expensive for the Treasury to issue debt in the long term. "But it's not going to put the U.S. government out of business," he said. Looking beyond the three-year phase-in of the euro, the current U.K. government has said it favors converting if the idea finds approval in a national referendum. But it rules out euro conversion before midyear 2002. Among other European Union countries, Sweden and Denmark opted out of the euro for political reasons, and Greece failed to pass the strict economic requirements. Several former Eastern Bloc countries have indicated their desire to join the European Union-among them Poland, the Czech Republic, Hungary, Romania, and the Baltic States. But any possible euro conversion in these countries would be years away.
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