THE EURO ZONE     Dealing with Deconvergence
	Europe's economies go their separate ways
	By PETER GUMBEL | Paris

Posted Sunday, June 5, 2005; 11.57 BST
Judging by the way the euro tumbled as much as 3% on currency markets last week, you might think that voters in France and the Netherlands had voted against the six-year-old European currency, rather than the planned new E.U. constitution. Propelling the decline was a report — quickly denied — in the German newsmagazine Stern that Finance Minister Hans Eichel and Axel Weber, the head of the German central bank, had discussed the prospect of dissolving Europe's monetary union at a meeting in late May. Weber dismissed the report as "absurd," and most market watchers and economists agreed. "The talk will continue for a week or two then go away; the euro's here to stay," says William Davies, head of European equities for the London-based fund manager Threadneedle Investments.

But in one key respect, the new focus on the euro underscores an increasingly troubling economic reality: the tensions caused by growing economic divergence among the 12 countries that use the euro. This is a sharp reversal from the 1990s, when candidates for the single currency moved aggressively to bring their economies in line by slashing budget deficits and keeping a tight lid on spending to bring down inflation. Now Europe has entered a period of "deconvergence" in the jargon of some economists, as bad habits creep back in. In a scolding report on public finances last week, the European Commission noted that, while Belgium, Finland and Ireland had balanced budgets, four members — Germany, Greece, France and Italy — had allowed their budget deficits to grow beyond the 3% limit laid down in the rules of the single currency, and that the overall debt level of the euro countries is creeping up again from 70.8% of gross domestic product in 2003 to 71.3% in 2004 and a projected 71.7% this year. The debt level isn't supposed to exceed 60% of gdp.

The euro zone is seeing a growing disparity in performance among its members, too. Finland, Greece and Spain are expected to enjoy growth of almost 3% this year, while Ireland is likely to see more than 4%. But Italy is in recession, and most economists have been slashing their forecasts for Germany and France to only a tad over 1% growth this year. Such differences create a dilemma for Jean-Claude Trichet, president of the European Central Bank, the body that sets monetary policy for the entire euro zone.

Economists say that the bank's 2% benchmark interest rate is far too low for the strongest economies, providing them with plentiful cheap money and helping to fuel a credit boom and, especially in Spain, a potential housing bubble. But the same interest rate is almost certainly too high for the weakest economies. Germany's Economics Minister Wolfgang Clement recently urged Trichet to cut rates — so far to no avail — and Italy's Welfare Minister, Roberto Maroni, even suggested that Italy should call a referendum on whether to readopt the lira. But after a meeting of ecb's council last week that left policy unchanged, Trichet said that the current rates were "appropriate" and "fully in line with what would be best to ... foster growth and job creation." The talk about Europe dumping the euro, he added, was as ridiculous as discussing the likelihood of Alaska, California or Florida ditching the dollar.

Some regional variations are usual in a monetary union; not every U.S. state grows at the same rate, for example. "It's no surprise that [monetary union] is not optimal for all countries. That was always going to be the case," says Ian Stewart, chief European economist at Merrill Lynch in London. Still, he adds, the probability of the euro going wrong "is greater than zero. This monetary union doesn't yet have the characteristics of all other durable monetary unions: that they developed into a political union." Switching to a political union with a fully federal government would make it all but impossible for a European country to drop the single currency. Last week's referendums make that prospect much less likely.

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