The euro's seemingly inexorable decline since shortly after its introduction has preoccupied policymakers in the euro zone and beyond. The decline has been eyed with particular concern in Ireland. Owing to its unequalled exposure to exchange-rate fluctuations of the EMU participants, the Irish economy is by far the most open to trade with non-euro countries.
As most now agree, price stability in Ireland is largely a function of international inflationary pressures and the exchange rate. As the euro slumps, prices of goods from the UK and US have soared. This could hardly have come at a worse time, adding as it does to still-relevant domestically generated price pressures in the services and non-traded goods sectors, the labour and property markets.
Such bad news requires a revisiting of the reasons for signing up to monetary union.
With a free float advocated by none, the alternative was to peg the pound to the currency of a major trading partner. As sterling and the dollar ruled themselves out, not least for political reasons, a link to the euro was the only choice.
However, in a world where the volume and velocity of mobile capital is ever-growing, exchange rate regimes other than a free float at one extreme and currency union at the other are at increasing risk of being sundered by speculators.
Since the 1992-1993 ERM (Exchange Rate Mechanism) debacle, flows of hot money have grown ceaselessly, heightening further the risk of currency crises. And not only in emerging markets. Look at little Denmark, an EU member-state that rejected EMU but pegged its currency to the euro. In the brief bout of turmoil on international financial markets following the devaluation of the Russian rouble in September 1998, base rates were pushed up to defend the krone from speculative assault, yield spreads widened and foreign currency reserves depleted.
Had squall turned to storm, the consequences would have been dire. This spectre still haunts the Danes. Little wonder almost all interest groups are advocating a yes vote in September when the issue is put to plebiscite.
Such pressures may even render untenable managed float arrangements, such as Ireland's regime in the 1993-1998 period, particularly as there are now fewer currencies with such regimes, a fact which makes those that do more vulnerable to being picked off.
But even if this were not the case, the introduction of the euro has changed the cost/benefit calculus of such an arrangement.
For foreign direct investors, exchange-rate stability with major EU markets is a key consideration. In the UK, for example, hardly a week now passes without the chief executive of a foreign manufacturer publicly groaning under sterling's unbearable strength.
With greater exchange rate risk for EMU "outs" and less for "ins", Ireland's attractiveness has increased relative to non-participants. Given the importance of foreign direct investment to the Irish economy, in particular as a source of intellectual and fixed capital formation - cornerstones of sustained wealth creation - what is good for foreign direct investors is good for Ireland.
In sum, while EMU participation is far from perfect, it may only be the least worst solution. Once the project went ahead Ireland had little choice but to join. This is still true today and will remain so for the foreseeable future.
But there is also good news. Without in any way downplaying the negative impact of current levels of price instability (inflation is touching 5 per cent), the surprise is that it is not higher given the euro depreciation. Although likely to feed through when firms' forex reserves are depleted and the replenishing of inventories can be postponed no longer, there may be a more optimistic explanation.
According to the ESRI, a growing number of Irish firms are now able to demand of their UK suppliers the invoicing of goods in euros. By so doing, they pass on the exchange rate risk, doing much to insulate the economy from imported inflation. Few would claim that such an exorbitant privilege would have been available had we retained the puny pound.
A further, and less talked off, benefit is the lifting of the balance-of-payments constraint. In times past, politicians and bureaucrats carefully considered their words and deeds lest they induce a rush to the exit by investors. As the recent Committee of Public Accounts into non-payment of DIRT heard, the law was not enforced for fear that flight of capital would precipitate a currency crisis. Such crises caused real pain, as mortgage holders remember from the futile attempt to protect the pound in 19921993. Thanks to the euro, they can never happen again.
As for calls for withdrawal. Not only would such a course lead to unprecedented economic uncertainty, the political consequences would be incalculable. With the euro as weak as it is now, the announcement by a participating state that it intended pulling out would, at the very least, cause a further sharp depreciation of the fledgling currency. Such an act would never be forgiven.
But before such apocalyptic vistas are even pondered, perspective in the debate needs to be regained. When the currency was introduced, analysts everywhere expected a gradual appreciation as it took on the mantle of an alternative reserve currency to the dollar. It is only with weakness that commentators cast round for explanations. In France, some normally sensible newspapers suggest a British plot.
Cross the channel and "Anglo-Saxon model good, Rhine model bad" summarises much of the simplistic talk about euro depreciation. Despite the predilection of anglophone commentators to disparage supposedly sclerotic European economies, the euro area outlook is bright, with forecasts of higher growth, lower unemployment and corporate restructuring boosting profits across the zone. In contrast, and without gainsaying the phenomenal performance of the US over the past decade, that country's prospects are now finely balanced. Should the willingness of foreigners to hold over-valued US assets evaporate suddenly, a sharp reversal in foreign exchange markets is in store.
The reality is that few prices are as prone to wild and groundless fluctuations as those of currencies, and the euro's weakness is as clear a case of an undershooting exchange rate as one is likely to find. Sooner than some might expect, this will be reversed and the euro's real value will be reflected in its price.
Dan O'Brien is Europe editor at the Economist Intelligence Unit in London. He can be contacted at danobrien@eiu.com
