The rise of the euro

What is the Euro?

The Euro is the official currency of the European Union's Eurozone which consists of 15 countries. (Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, Spain)
Currency for more than 320 million Europeans affects 500 million world wide with more than 610 billion euros in circulation - equivalent to 802 billion dollars at the exchange rates at the time. 
The name "euro" was introduced in 1995. People ages eighteen through seventy-five voted between eight different symbols. The symbol that was chosen was picked for its strong design and modern looks.
The Euro was first introduced as a virtual currency for cash-less payments and accounting purposes, while the old currencies continued to be used for cash payments and considered as 'sub-units' of the euro, it then appeared in physical form, as banknotes and coins, on 1 January 2002.
The euro is managed and administered by the Frankfurt based European central bank (ECB) and the European System of Central Banks (ESCB).  The ECB was orginally set up in 1998 by the European Union (EU) and its current headquarters is located in Frankfurt, Germany.  As one of the worlds most important independent central bank, the ECB has sole authority to set monetary policy for the 15 countries of the Eurozone.  The ESCB is made up of the ECB and the National Central Banks of all 27 European Unions.  The ESCB is responsible for the printing, minting and distribution of notes and coins in all member states. 
The euro comes in seven different bills and eight different coins. The bills come in 5, 10, 20, 50, 100, 200, and 500 euro denominations. The bills are different sizes. There are 8 coins. The values of the coins are 1, 2, 5, 10, 20, and 50 euro cents. There are also coins that are 1 and 2 euros.  Each of the eight euro coins will look the same on the European side, but each country will choose what to put on the national face of those coins they make in their own country.

 
Criteria to become eligible for the European currency:
The Maastricht Treaty stipulates five criteria that countries must meet to become eligible for the single European currency, the euro. These criteria must be achieved over the year before the date of examination. As membership will be determined in early 1998, the criteria thus apply to 1997.
The Maastrict Criteria is:
Price stability:  Inflation rate must not exceed the average inflation rate of the three best performing Member states by more that 1-1/2 percent.
Fiscal Prudence: A country must not exceed either of the following two reference values relative to its gross domestic product at market prices:
1.      3 percent for the ratio of the planned or actual government deficit to GDP
2.      60 percent for the ratio of government debt to GDP.
Successful EMS Membership: A country must have stayed within the normal fluctuation margins provided for by the Exchange Rate Mechanism of the European Monetary System, for at least two years, without devaluing against the currency of any other Member State.
Interest-Rate Convergence: The durability of convergence must be reflected in the long-term interest rate levels. A Member State must have had an average nominal long-term interest rate that does not exceed by more than 2 percentage points that of, at most, the three best performing Member States in terms of price stability. (Interest rates are measured on the basis of long term government bonds or comparable securities.)

All European Union member states are eligible to join if they comply with these monetary requirements, not all EU members have chosen to adopt the currency.  For example, the UK and Denmark negotiated exemptions from the requirements for themselves.

Benefits:
Transaction costs:  One currency will reduce the cost of converting one currency into another. The benefits of a single currency are beneficial to both businesses and to tourists/tourism. This also eliminates exchange rate volatility between member nations.

No exchange Rate Uncertainty:  Eliminating Exchange rates between European countries eliminates the risks of unforeseen exchange rate revaluations or devaluations. The elimination of this risk in turn helps international trade, giving advantages to all EMU countries.
Transparency and Competition:  Comparability of prices and wages will increase competition across Europe, leading to lower prices for consumers and improved investment opportunities for businesses. 
Capital Market:  The large Euro zone will integrate the national financial markets, leading to higher efficiency in the allocation of capital in Europe.
No competitive Devaluations:  One country can no longer devalue its currency against another.
Fiscal Discipline:  With a single currency, other governments have an interest in bringing countries with a lack of fiscal discipline into line. 
European Identity:  A European currency will strengthen European identity.

Costs:

Economic problems at home: The biggest cost of switching to a common currency is that each member loses its right to change monetary and economic policies in order to respond to economic problems at home. Exchange rates between countries are no longer adjusted by the individual country to help regional economic slumps.

Recessions: If one country were to be in a recession, they would have no choice but to wait it out. That country would have to wait because changing the monetary policy of the whole EMU would hurt more countries than it would help.

Cost of introduction:  Residents of the country adopting the Euro will have to trade in all their current bills and coins into Euros. Businesses will need to convert all their wages and prices into Euros, as well as update or change their software for accounting purposes. 

Countries with in the European Union: An economically strong and stable country will have to operate in a field with weaker countries, who may be more tolerant to high inflation. Countries essentially loose their sovernigty when adopting the euro as their currency. This is part of the reason that the UK has not adopted the euro as their primary currency.

The Euro in Relation to the U.S. Dollar

Upon introduction of the euro into world financial markets in January 1999, 1 Euro was approximately equal to 1 USD.

However, many in the Eurozone and economists alike had their expectations crushed when soon after the Euro was introduced it began to fall in international markets.

It fell for two main reasons:

1.)     The euro was unable to compete with the USD which had been boosted by a booming US stock market and economy at that time.

2.)      There was growing uncertainty over the role of the European Central Bank with relation to the euro.

In September 2000, despite the Central Banks efforts' to help, the euro reached its lowest point to date.

At that time, 1 € = ~$0.82.

This was good news for the United States, as the dollar was now worth more with respect to the Euro, and therefore, we were able to import more goods from the Eurozone.

Between 1999 and 2001, the Euro's exchange rate had been persistently weak, falling by about 24% overall.

In January 2001, George W. Bush became President in the United States. At that time, the U.S. economy was facing the prospect of a recession and in an attempt to pull the economy out of this looming recession:

•          The Federal Reserve cut interest rates in the United States.
  These cuts made (foreign) investors less likely to move additional money into U.S. markets since interest rates were higher elsewhere.

As a result, the euro stabilized, and then began rising, against the dollar.

By 2002, the Euro was beginning to gain strength in the market and the launch of the euro as a cash currency went smoothly.

Unfortunately for the United States, growing trade deficits have caused concerns in international currency markets resulting in a weakening the U.S. dollar.

Since 2002, the euro has appreciated with respect to the Dollar, as the table below shows:

US Dollars per Euro

The Euro in the UK     
Even though England is a member of the European Union, the country uses the pound sterling instead of the euro as its currency.  The United Kingdom has an opt-out from the Eurozone under the Maastricht Treaty and has no obligation to join the euro.  The obvious reason behind the opt-out lies in the fact that the pound is stronger than the euro and has been since the euro was introduced.  The government of the United Kingdom claims that it favors Eurozone membership if the economic conditions are right but the general public opposes membership.  The question of membership has never been put into referendum.

England currently meets the criteria to adopt the euro with the exception of its ERM II membership, as outlined by the European Monetary Union.  Based on May 2007 statistics, the UK's 2.1% inflation rate, 2.5% annual government deficit to GDP, 42.6% annual government debt to GDP, and 5.75% interest rate all fall below the maximum requirements for membership.  The United Kingdom, however, does not exhibit membership to the ERM II and would need to join in order to convert its currency.    

Although the United Kingdom satisfies the Eurozone's requirements, the British Government has its own criteria to determine if Eurozone membership provides the right fit for the country's economy.  When the euro was first introduced, the British government designed five economic tests that the country's economy must satisfy in order to convert the currency.

1. Is there sustainable convergence between Britain and the economies of a single currency?
2. Is there sufficient flexibility to cope with economic change?
3. How would use of the the euro affect investment? 
4. What impact would the euro have on the financial services industry? 
5. Would the euro be good for employment?

The UK Treasury first assessed these economic conditions in 1997 and determined that the British economy was not sufficiently converged with the rest of the European Union.  The Treasury reassessed the conditions again in 2003 and concluded that only the fourth condition was satisfied. 

The British economy satisfies the fourth requirement because the UK is the home to one of the world's financial centers---London.  If England ruled out the euro entirely, the booming financial service industry would suffer deeply in trading with Eurozone countries.

The underlying issue that keeps the UK out of the Eurozone is the large structural difference between the UK housing market and the rest of Europe.  Typically, the British own their own homes and fixed-rate mortgages are scarce throughout the country.  Therefore, the average Briton carries a large amount of variable-rate debt and the consumer spending among the British is more sensitive to sub-prime mortgage rates.  This situation creates a lack of convergence in both the interest rates and the economy as a whole.  Adoption of the euro under these conditions could create a detrimental effect on the British economy.

While rare, one can still use the euro in some shops in England.  Usually the shops charge a commission for the transaction and will give change in pounds.

Enlargement of the Eurozone

A current policy of the ECB is the enlargement of the Eurozone, which is enforced by EU treaties.  In order to officially join the Eurozone and thus having the ability to mint coins separately, a country must first be a member of the EU.  These countries must meet certain economic criteria, including accession to the European Exchange Rate Mechanism (ERM II), which fixes the acceding country's national currency's exchange rate to the euro within a particular range.  A state must spend two years in ERM II before joining the Eurozone.

The first expansion was technically that of Greece, but its currency was exchanged on the same day as the founding countries on January 1, 2002.  The first true expansion, therefore, was the addition of Slovenia to the Eurozone on January 1, 2007.  Cyprus and Malta recently joined the Eurozone on January 1, 2008.

There are twelve countries of the EU that do not currently use the euro.  They include: Denmark, Sweden, the United Kingdom, the Czech Republic, Bulgaria, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Slovakia.  The following members must join ERM II before they can adopt the euro: Bulgaria, the Czech Republic, Hungary, Poland, Romania, and Sweden.  Slovakia is the next expected enlargement of the Eurozone in 2009, but the proposed entry date will be assessed in May 2008.  Denmark and the UK obtained special derogations in the original Maastricht Treaty of the EU.  Both countries are not legally required to join the Eurozone unless their governments decide otherwise, either by referendum or parliamentary vote.

The new member state should be adopting the euro as soon as the certain convergence criteria are met.  For these new member states, the single currency was included in their EU membership.  Unlike the UK and Denmark, opting-out is not permitted.  The dates the remaining states are expected to enter the third stage of the EMU and adopt the euro vary: 2009 for Slovakia; early 2010 for Lithuania; 2011 for Estonia; 2012 for Bulgaria and Latvia; 2013 or 2014 for Poland; and 2014 for Romania.  The Czech Republic was prepared to join on January 1, 2010, but can no longer do so due to economic conditions.  Hungary has also discarded its original target date of 2010 without setting a new date.  The European Commission and ECB produce reports every two years analyzing the economic and other conditions of non-Eurozone EU members, reporting on their suitability for joining the Eurozone.

Currently there are 15 member states which include over 300 million people. The Eurozone was established on the first of January in 1999. Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain were the first to join the Eurozone in 1999. In 2001, Greece also joined, followed by Slovenia in 2007. Most recently, Malta and Cyprus have met guidelines to become members at the beginning of 2008.

Citizens of countries who have met guidelines to join the Eurozone are faced with a few challenges when switching currencies. The European Commission identifies timely and effective communication as the most effective way to have a successful currency conversion. The EC reports transparency and fair price conversion as very important keeping consumer's confidences high in the switch to the Euro. Information campaigns are used to inform consumers of the changes and how they will affect everyday commerce. The European Commission recognized the needs to assist the newest countries of the Eurozone in a successful changeover in 2004. As a result, the EC created COM2004 to address these concerns. COM2004 believes it's important for the member states to play a large role in creating and implementing the information campaigns designed to help inform and assist citizens during the switch from their old currency to the Euro. COM2004 creates a partnership with new member states and provides financial support for certain activities, including public surveys, advertising campaigns, hotlines, and technical support.

 The Euro Today

Since the introduction of the Euro in 1999, it has been the second most held reserve currency worldwide behind the USD. This is largely due to the fact that it replaced the German Deutsche Mark which at the time was the second most held reserve currency. Since then it has been steadily rising in popularity. In late 2007 26.4% of the world's reserve currency was in Euros, which is the highest it's ever been.  All though the dollar is still the primary reserve currency at 64.8% it has been dropping in popularity due to the instability of the US economy in recent years. Some economists believe that the Euro could replace the dollar as the world's primary reserve currency by 2020 if the dollar continues to depreciate at the rate it has been or if the remaining European Union members including the U.K. adopt the Euro.

In the beginning of January 2007 1 Euro was equal to approximately 1.3 USD. As of Jan 08, 2008 1 Euro is equal to about 1.47 USD, which means an appreciation of about 13% on the USD in just one year. This is mostly due to the poor economic state the U.S. is in right now. Although the Euro and the pound have been relatively stable in comparison with each other, in the past year the Euro has been steadily appreciating on the pound as well. On  Jan 08, 2007 1 Euro was equal to about .67 pounds and as of Jan 08, 2008 1 Euro is equal to about .74 pounds which as an increase of about 10%. 

Forecasting the Value of the Euro

For additional information on comparing the Euro to the U.S. dollar, as well as currency exchange forecasting with the value of the Euro, check out this website: http://www.forecasts.org/euro.htm