Betting on The New Euro

By THOMAS SANCTON/PARIS

Wake up and smell the espresso, America. There's a revolution brewing in Europe, and it could hit you right where it counts: in the pocketbook. On Jan. 1, the currencies of 11 European Union countries will be officially replaced by a central monetary unit called the euro. It will take three years for the old deutsche mark, franc and lira coins and bank notes to disappear, but in less than two months their values will be pegged to that of the euro. And savvy U.S. investors are moving to take advantage of investment opportunities offered by the new currency.

Euroland's newly unified financial markets--highly liquid and investor friendly--will rival those of Wall Street. Meanwhile, greater ease of movement for factories and goods will force euro-zone companies to become more competitive and attractive to investors. And with the euro, American businesses and travelers could save as much as 50% of the transaction costs they now pay to convert dollars into multiple European currencies. Says David Bowers, a European investment strategist with Merrill Lynch in London: "This will be the biggest shock to the global financial system since the move away from fixed exchange rates in the '70s."

For starters, the euro will become a serious challenger to the dollar as a medium of global commerce. Although Europe and the U.S. represent roughly similar economic blocs, with comparable populations, incomes and exports, the dollar accounts for 62% of the world's currency reserves, in contrast to 20% for the European currencies, and is used to buy and sell nearly half the world's exports. That's about to change. "There will be a reallocation, because the dollar is currently overused with respect to the size of the American economy," says Bruno Leresche, head of asset management at Paribas, a leading French investment bank.

A strong alternative to the dollar could inject more balance and stability into the world's often turbulent monetary system. Moreover, the euro is widely expected to debut as a very strong currency (estimated conversion rate: 1 euro to $1.20) at a time when the value of the U.S. currency has been sliding. That could help the American economy, at least initially, by boosting its exports. But if the dollar falls too far, that would make it harder to fund the swelling U.S. trade deficit and could force the Federal Reserve to keep interest rates higher than it would otherwise. That, in turn, could slow U.S. economic growth.

Already, European officials and business leaders fear that an overvalued euro could hinder their exports, while higher interest rates and slower growth in the U.S. would deprive the world economy of its most dynamic engine. "We all need to see the U.S. growing," says Jean-Pierre Hellebuyck, European equity strategist at insurance group AXA Asset Management. "Europeans can't afford to see the collapse of the dollar."

One of the biggest winners in all this could be the U.S. investor who bets on the euro's boost to European growth. "For the American investor," says J. Paul Horne, equity-market economist with Salomon Smith Barney in London, "the euro zone will be one of the few places in the world with risk comparable to that in the U.S. and with the kinds of structural changes that we saw in the U.S. over the past five years: balanced budgets, increased competitiveness, productivity gains."

At the moment, shares of European companies are priced as bargains, relative to those of American firms with comparable earnings growth. But the European market is likely to boom as new money flows in. And the probability of a weakening dollar means Americans who move money into Euroland now might lock in exchange-rate profits. "There is a case for diversifying your portfolio into a currency area that provides an alternative to the U.S.," says Merrill Lynch's Bowers. "But there's no shortcut: you still have to find good companies." In the current European climate, the most promising sectors include consumer products, distribution, high tech, health care, insurance and telecommunications.

For most individual American investors, the best way to invest in Europe is through mutual funds. Paribas' Leresche, however, offers this caveat: any fund limited to the euro zone will miss some great companies in Britain, Switzerland and Sweden. These countries are not participating in the single currency, but their stocks account for nearly half the equity value in Europe. Leresche's advice: "Choose a fund that has euro-denominated investments but a Europe-wide view." He recommends the Luxembourg-based Parvest fund, which boasts relatively low fees, superior long-term performance and stable management. Other experts on the European market recommend Fidelity's Europe fund, the Lipper Premium Euro Equity Fund and the Scudder Greater Europe Fund.

While Americans lately have seen how currency crises abroad can hammer their investments, the advent of the euro serves as a reminder that the global economy also offers bright opportunities.