Euro-phoria! Le Continent Is Back

Turn back, Columbus.

The Old World you left behind is now a New World of economic growth and equity profit.

Across the Continent inflation, interest rates, and chronic double-digit unemployment are giving way to economic growth and rising earnings.

The result: beguiling, crown-jewel stock markets. By mid-April this year, France's rose 28 percent, Germany's 26 percent, Italy's 53 percent, and Portugal's 61 percent.

The rediscovery of Europe has apparently just begun.

"We are beginning to see signs that the current [European] recovery is becoming wider and deeper," US Treasury Secretary Robert Rubin said recently.

Wall Street analysts agree. Europe "is about to enjoy a cyclical pickup that should gather strength going into 1999," says Bruce Steinberg, chief economist at Merrill Lynch & Co.

"Europe is our top region right now," says Lorretta Morris, manager of Nicholas Applegate International Core Fund in San Diego.

The cradle of capitalism is reviving because it has rediscovered what makes a free market thrive: cheap credit and less government meddling in the economy.

Thank peer pressure. Eleven members of the European Union have drastically reduced public debt and interest rates to meet requirements for monetary union, one of history's most profound economic initiatives.

The 11 countries plan in January to surrender part of their economic sovereignty to a regional bank and launch a common currency. Use of the euro - the new bank note - promises to spur efficiency and industry consolidation throughout Europe, say economists.

While France and Germany remain Europe's economic linchpins, peripheral countries such as Finland, Ireland, Portugal, Spain, and Italy are likely to benefit the most from currency union, because they have cut interest rates furthest in order to join, analysts say.

Meanwhile, many European companies are undertaking the same harsh but invigorating streamlining that US companies have endured for the past decade. Anticipating a borderless economy, companies are merging in industries ranging from banking to telecommunications to electricity.

And deregulation and privatization of state-owned industries are likely to prod further restructuring.

Among small investors, an equally important change is afoot. Europeans are reconsidering their longstanding embrace of low-risk government bonds and investing in stock markets like never before. Stocks look especially attractive as governments borrow less and interest rates fall, lowering yields on bonds.

The trend apparently has far to go. Whereas about 41 percent of adult Americans invest in equities, only about 16 percent of the French and 6 percent of Germans do so.

Still, for New Worlders looking to invest in Europe, this is no time for innocents abroad.

Not all analysts are raging bulls.

"Stock valuations are stretched," says Michael Porter, analyst of closed-end mutual funds at Soloman Smith Barney. Still, he favors European stock markets, because they are not as pricey as US markets or as risky as East Asian ones.

Also, the months after the euro launches will probably be rough, some economists predict.

"The question is how long will monetary union last, and what kind of problems will strain the transition," says Paolo Presenti, assistant professor of economics at Princeton University.

Member nations of the European Economic and Monetary Union (EMU) will probably chafe at restrictions on government credit and budgetary freedoms.

A recession would harm some countries much more than others, straining the union and its commitment to parity in interest rates and budget deficits.

"Economic difficulties in a large country such as Italy could lead to serious policy conflicts and a possible break-up of EMU," says Sung Won Sohn, chief economist at Norwest Corp., a bank based in Minneapolis.

EMU members will no longer be able to devalue their currencies in order to regain competitiveness.

Moreover, double-digit unemployment and ample labor protections will continue to retard growth in many European economies. Layoffs will probably rise as companies confront stiffer competition.

That could strain the euro's popularity. Already, citizens used to welfare-state paternalism express resentment over austere budgets.

"The problem will come when you get disagreement about how much accommodation the new European central bank should allow the member states," says David DeRosa, adjunct professor of international finance at the Yale School of Management.

Champions of EMU say that eventually Europe could come to resemble the United States, with its regional diversity. Market forces - like those that helped revive the Texas and California economies - will help smooth imbalances in Europe.

"We have 50 states, and not all economic conditions are the same in all states," Ms. Santoro says. "But they all function pretty smoothly."

Road To a Single Currency

Who:

Eleven nations in the European Union plan to join together to launch a single regional currency, the euro. They are Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain. The four other members of the union - Britain, Denmark, Greece, and Sweden - have either decided to opt out or have not yet qualified for membership.

When:

* May 2, 1998, the 11 members of monetary union are officially chosen. By end of the year, exchange rates between the members are announced but not enacted.

* Jan. 1, 1999, the euro will begin trading on international exchanges, replacing the 11 national currencies.

* Jan. 1, 2002, the euro bank notes and coins enter circulation and the 11 national currencies are no longer considered legal tender.

Obstacles:

* Between May and January speculators might try to exploit gaps between the current exchange rates and the coming official exchange rates between member currencies.

* Citizens and political leaders might chafe at their governments' loss of full monetary and fiscal freedom. A recession, oil price rise, or similar shock could make such resentment especially sharp.