On New Year's the euro completes its phase-in by becoming the physical currency of the 12-nation European Monetary Union. French franc, German deutschmark, Greek drachma, Italian lira etc. will be traded in for euro coins and notes. Until now, the euro has been a virtual currency and nothing that people could hold in their hands. But now, in Europe's biggest logistical effort since WWII, trucks are rumbling to banks laden with more than 50 billion coins and 15 billion notes. Beginning on January 1, all residents of EMU countries must trade in their legacy currencies at exchange rates that were established prior to the euro's introduction.

Since January 1, 1999, the euro has been used as virtual money for credit card purchases, international transactions, denominating stock prices, and for paychecks in some multinational firms. The national or legacy currencies lost independence. They became odd sub-denominations of the euro, with their exchange rates against each other fixed for all time and with their governing interest rate set by the European Central Bank (ECB).

But the change that will affect ordinary life is about to begin - the appearance of the euro in physical form. The European Central Bank is in charge of all facets of the conversion, from printing and minting the currency to distribution throughout the eurozone. Generally, national currencies and the euro will be accepted as legal tender during the first two months of the year. After that - and it varies between countries - the national currencies will no longer be accepted. However, most will convert currencies in specified banks indefinitely.

The original idea was developed shortly after the end of World War II as a political move - and it remains a political move even though the impact will be economic. The goal was to link the European countries so closely that another war would be impossible. But political unity proved difficult with countries refusing to give up their national sovereignty. Political union would have meant a common government budget, common foreign affairs and social policy. In contrast, monetary union allows countries to have control over their national budgets while benefiting from reduced trade friction and a vastly larger marketplace. Yet, the countries acknowledge that some economic objectives, like lowering unemployment, may be more difficult under the constraints of the union.

The new math
In compliance with the rules set down during the evolution of the EMU, final and irrevocable conversion rates between the euro and each participating currency were announced amid much pomp on December 31, 1998. The rates listed below are the only rates that will be used for conversion. In addition to the rates for the original EMU-11, reference rates were calculated for the United States, United Kingdom, Japan and Switzerland. Greece was added when the country joined EMU on January 1, 2001.

Below are the euro conversion rates established as of January 1, 1999 by the European Union (EU) national banks -

Are new notes and coins inflationary?
To round up - or to round down, that is the question
Eurozone finance ministers do not believe there will be any upward inflationary pressure from the introduction of euro notes and coins. The general opinion is that the upward rounding by some would offset the downward rounding by others. However, anecdotal evidence shows some prices have already risen in anticipation of the conversion, and no goods or services appear to be immune. Some modest price increases are justified. Businesses are facing higher costs from the conversion to euros, including staff training or even adding employees, as well as upgrading computer systems and cash registers. About 95 percent of conversion costs are being absorbed by business.

There are scores of anecdotal stories about price increases and about how old habits die hard. For example, I am told that some vendors in the Paris farmers' market use old francs rather than the new franc, which has been around for years, making a double conversion to the euro necessary. Stories are rife about price increases in legacy currencies so that prices will seem cheaper when the official conversion dates arrives. And the travelers among you will be happy to hear that European taxi drivers are carrying hand held calculators to figure out fares.

Somewhat problematic is what will happen to mattress money. Traditionally residents of EMU countries and those in eastern Europe preferred to save cash rather than deposit money in banks, in part to avoid paying taxes. The sums are thought to be huge. Some analysts think the money is being converted into U.S. dollars, others think it is being spent. And because of the relatively short conversion timetable - all use of legacy currencies in ordinary transactions ends February 28 - people must dispose of these currencies as soon as possible or go to their designated central bank facility to change their money - something they may not want to do.

Euro scorecard since introduction
The graph below shows how the euro has fared in its short life against the U.S. dollar, pound sterling and yen. It has lost ground to all three. Against the dollar, the euro has lost 24.4 percent of its value, 12.2 percent against the pound, and 15.5 percent against the yen.

Expectations were high that the euro would provide the catalyst for the revitalization of the continent's capital markets. Market players however, remain leery of the ECB and punish the euro at every opportunity for the Bank's blunders. And although progress has been made, political obstacles continue to present barriers for true economic integration. Yet the goal of transparent pricing is to increase competition, making it easier for companies to sell across the eurozone and for consumers to find the best price. Unified pricing in one currency should push this goal forward at an accelerated rate. Businesses and individuals will save foreign exchange uncertainties and transactions costs by doing business in one currency.

Bottom Line
The euro should make it easier and less expensive for American companies to sell their products and services in the Eurozone. With the arrival of euro cash, competitive pressures should narrow price variations among countries. This should favor cost conscious American companies which have already cut costs through restructuring.

In a broader sense, if the euro is successful - and the jury is still out - it can pose a threat to the dollar's supremacy and dominance as the world's primary reserve currency. If the euro is unsuccessful, it could endanger the progress made by Europe in melding its diverse economies into a single market and subduing historical antagonisms with the help of economic engineering. In the past year, the eurozone and the ECB have learned to their dismay that its economy remains vulnerable to events in the outside world. A single currency has not made it recession resistant and immune to U.S. economic slowdowns.

The ECB is running the conversion show. There are continuing concerns about counterfeiting and theft especially during the introductory period. Worries range from a shortage of armored cars to deliver the cash, to the conversion of cash machines, to making sure there is an ample amount of cash to meet demand. It is critical for the ECB to get this right. Yet even if there are enough euros to go around on January 1 and 2, one last potential hurdle remains - conversions. Conversion rates such as E1 = 0.787 Irish pounds are far from intuitively obvious. Although a recent poll said 70 percent of eurozone citizens knew the exchange rate for their currency to within a euro-cent, 64 percent are afraid of price cheating as the new notes and coins are introduced. And since pro-euro politicians hail the single currency as a symbol of European unity in 300 million pockets, it would be all the more awkward if confusion and dissension marked the new currency's debut.

Anne D. Picker, International Economist, Econoday