After the briefest of honeymoons, the euro soon began sinking against the U.S. dollar in world currency markets. Many skeptics of the marriage of the 11 Euroland currencies thought the groom (the rock-hard German mark) and the bride (la belle franc Française) were incompatible, especially since the bride brought her weak sisters (lira and peseta) into the marriage. Even though the whole family worked to make them fiscally fit and attractive by the wedding date, just one month after the wedding the Italians were put on notice that their fiscal health was slipping.

Behind these problems lies a tension common to most currencies: a conflict between central bankers and politicians. The central bankers are seeking a strong currency that can be a global rival to the dollar. The politicians need a weak currency to prop up their sinking economies. This conflict was papered over with promises of large and immediate efficiency gains from the currency wedding. The structural advantages of a single currency are real enough. But they take time to produce their desired effects. Partly this is due to the euro's prenuptial agreement, the Maastricht Treaty. There are no euro notes in circulation and won't be for another two years. So the inefficiency of constantly exchanging currencies lives on. The other potential source of currency-driven efficiency gains—the emergence of a continental capital market to rival New York's—is not something that can be created overnight.

Left-leaning governments with double-digit unemployment rates simply can't stand by and do nothing. They are unwilling to abandon their socialist principles and their electoral bases by cutting tax rates, making their labor markets more flexible or engaging in other supply-side programs. Maastricht, meanwhile, limits their ability to use fiscal stimuli to reflate their economies.

What's left? Monetary policy. Pressure is building for easier money. At 3%, the official overnight euro rate might seem quite low, especially compared with America's 4.75% rate. The claim is that still lower rates will encourage investment. But in the core of Europe, high wage costs and social insurance taxes make new investment uneconomic. Monetary stimulus is unlikely to work.

The more plausible, but unspoken, hope is that lower interest rates will reduce the euro's exchange value vis-à-vis the dollar. A weaker euro is one way of cutting real wage and benefit costs relative to global competition without actually asking workers to take a cut.

But success at making the euro a global reserve currency requires that the currency be trusted as a store of value. To date, holders of the euro have lost both interest income and foreign exchange value relative to holders of the dollar. Political pressure for interest-rate cuts only makes the euro less plausible as something that will hold its value, the more so given the unlikeliness that the U.S. Fed will further reduce rates.

Europe's banking sector has been severely weakened by losses in Eastern Europe, Asia and Latin America. It has also failed to develop the technical sophistication of American banks at constantly monitoring the market value of their assets and liabilities. While American banks poured their information technology budgets into mark-to-market accounting during the past few years, European banks had to invest huge sums to handle conversion to the euro, as well as the multiyear necessity of keeping their books in two currencies.

The result is a lingering fear among European bankers that unanticipated losses might appear LTCM-like to sink a big bank or two. A mild credit crunch is beginning to affect European commercial lending. This makes any economic revival more difficult and means that any rate cuts will work primarily through the exchange rate, not on domestic demand.

For the year ahead the European Central Bank will probably target the dollar/euro exchange rate, creating a trading range between $1.10 and $1.20 (the euro was $1.12 on Feb. 16). Both central bankers and politicians can live with the euro priced between these poles.

Longer term, the euro will almost certainly become a soft currency. Without the tax and labor market reforms required to unleash businesspeople's animal spirits, the Euroland economies are doomed to disappoint.

Lawrence B. Lindsey holds the Arthur F. Burns Chair in economics at the American Enterprise Institute. He is also the author of Economic Puppetmasters: Lessons from the Halls of Power.