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The euro (currency sign: €; banking code: EUR) is the official currency of the following twelve European Union member states: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain; collectively also known as the Eurozone. It is the single currency for over 300 million Europeans.

The euro was introduced to world financial markets as an accounting currency in 1999 and launched as physical coins and banknotes in 2002. All EU member states are eligible to join if they comply with certain monetary requirements and eventual use of the euro is mandatory for all new EU members. The euro will be introduced in Slovenia on 1 January 2007, replacing the tolar.

The euro is managed and administered by the Frankfurt-based European Central Bank (ECB) and the European System of Central Banks (ESCB) (composed of the central banks of its member states). As an independent central bank, the ECB has sole authority to set monetary policy. The ESCB participates in the printing, minting and distribution of notes and coins in all member states, and the operation of the Eurozone payment systems.

Characteristics of the euro

Coins and banknotes

Main articles: euro coins, euro banknotes.

The euro is divided into 100 cents. In each country but Greece, which uses λεπτό and λεπτά on its coins, the form "cent" is officially required to be used in legislation in both the singular and in the plural, though in common usage it is common to translate these into the local language, for example cents in some but not all English-speaking countries and centesimo-centesimi in Italian. (For more information on language and the euro, see Linguistic issues concerning the euro.)

All euro coins (including the €2 commemorative coins) have a common side showing the denomination (value) with the EU-countries in the background and a national side showing an image specifically chosen by the country that issued the coin; the monarchies often have a picture of their reigning monarch, while other countries usually have their national symbols. Most member states use only one or up to three different symbols, whereas Austria, Greece, Italy and San Marino have chosen individual depictions for every coin. All coins can be used in all member states: for example, a euro coin bearing the image of the Spanish King is legal tender not only in Spain, but also in all other member states where the euro is in use. There are €2 (silver-coloured enclosure with gold-coloured centrepiece), €1 (gold-coloured enclosure with silver-coloured centrepiece), 50c (gold-coloured), 20c (gold-coloured), 10c (gold-coloured), 5c (copper-coloured), 2c (copper-coloured) and 1c (copper-coloured) coins, though the latter two are not generally used in Finland or the Netherlands (but are still legal tender). In Greece, often cashiers omit the 1c and 2c from the change they give to customers. Many shop owners in all of the Eurozone prefer having all their prices end in 0 or 5 cents, so that 1c and 2c coins are not needed. Many people do not consider them worth the effort of counting them when paying.

All euro banknotes have a common design for each denomination on both sides. Notes are issued in the following values: €500, €200, €100, €50, €20, €10, €5. Some of the higher denominations are not issued in a few countries, though again, are legal tender.

Both euro coins and banknotes are designed from the start in consultation with organisations representing people suffering from blindness or other vision impairments. Both have been designed to facilitate their use by people who may not be able to see the currency very well (or at all). Cues to aid in identification include gross differences in appearance (colour, size) for banknotes and coins, and tactile cues such as thickness and edge decoration for coins in particular. Although there have been other currencies predating the euro that were specifically designed in similar ways (different sizes, colours, and ridges) to aid the visually impaired, the introduction of the euro constitutes the first time that authorities have consulted associations representing the blind before, rather than after, the event. For details, see the euro coins and euro banknotes articles.

The ECB has set up a clearing system for large euro transactions (TARGET). All intra-Eurozone transfers shall cost the same as a domestic one. This is true for retail payments, although several ECB payment methods can be used. Credit card charging and ATM withdrawals within the Eurozone are also charged as if they were domestic. The ECB hasn't standardized paper based payment orders, such as cheques; these are still domestic-based.

The currency sign €

A special euro currency sign (€) was designed, after a public survey had narrowed the original ten proposals down to just two. The European Commission then chose the final design. The eventual winner was a design allegedly created by a team of four experts who have not, however, been officially named. The official story of the design history of the euro sign is disputed by Arthur Eisenmenger, a former chief graphic designer for the EEC, who claims to have created it as a generic symbol of Europe.

The glyph is (according to the European Commission) "a combination of the Greek epsilon, as a sign of the weight of European civilization; an E for Europe; and the parallel lines crossing through standing for the stability of the euro".

The European Commission also specified a euro logo with exact proportions and foreground/background colour tones http://europa.eu.int/comm/economy_finance/euro/notes_and_coins/symbol_en.htm. Although some font designers simply copied the exact shape of this logo as the euro sign in their fonts, most designed their own variants, often based upon the capital letter C in the respective font so that currency signs have the same width as Arabic numerals http://www.fontshop.com/virtual/features/eng/fontmag/002/02_euro/index.htm. The illustration at the top of this section shows the official euro logo.

No "official" recommendation is made with regard to the use of a cent sign, and sums are often expressed as decimals of the euro (for example €0.05 or even €–.05 rather than 5c). As a result the abbreviations differ between Eurozone members. The most used abbreviation is "c", but other abbreviations also exist, like "ct" (among others: Germany), snt (Finland), the capital letter lambda (Λ) (Greece). In Ireland, "c" is used, but the American-style "¢" is occasionally seen.

Placement of the currency sign varies from nation to nation. While the official recommendation is to place it before the number, people in many countries have kept the placement of their former currencies.

Economic and Monetary Union

History (1990-2006)

''Main article: Economic and Monetary Union of the European Union. For earlier monetary history in Europe, see: European Monetary System.
The euro was established by the provisions in the 1992 Maastricht Treaty on European Union that was used to establish an economic and monetary union. In order to participate in the new currency, member states had to meet strict criteria such as a budget deficit of less than three per cent of GDP, a debt ratio of less than sixty per cent of GDP, combined with low inflation and interest rates close to the EU average.

Economist Robert Mundell is sometimes referred to as the father of the euro. Other economists that helped include Wim Duisenberg, Robert Tollison, Neil Dowling and Tommaso Padoa-Schioppa. (For macro-economic theory, see below.)

Due to differences in national conventions for rounding and significant digits, all conversion between the national currencies had to be carried out using the process of triangulation via the euro. The definitive values in euro of these subdivisions (which represent the exchange rates at which the currency entered the euro) are shown at right.

Currency Abbr. Rate
Austrian schillings (ATS) 13.7603
Belgian francs (BEF) 40.3399
Dutch gulden (NLG) 2.20371
Finnish markka (FIM) 5.94573
French francs (FRF) 6.55957
German mark (DEM) 1.95583
Irish punts (IEP) 0.787564
Italian lire (ITL) 1936.27
Luxembourg francs (LUF) 40.3399
Portuguese escudos (PTE) 200.482
Spanish pesetas (ESP) 166.386
Greek drachmas (GRD) 340.750*
Slovenian tolars (SIT) 239.640**

The above rates were determined by the Council of the European Union, based on a recommendation from the European Commission based on the market rates on 31 December 1998, so that one ECU (European Currency Unit) would equal one euro. (The European Currency Unit was an accounting unit used by the EU, based on the currencies of the member states; it was not a currency in its own right.) These rates were set by Council Regulation 2866/98 (EC), of 31 December 1998. They could not be set earlier, because the ECU depended on the closing exchange rate of the non-euro currencies (principally the pound sterling) that day.

*Greece failed to meet the criteria for joining initially, so it did not join the common currency on 1 January 1999. It was admitted two years later, on 1 January 2001, with a Greek drachma (GRD) exchange rate of 340.750.

**Slovenia will join the Eurozone on 2007-01-01. The final exchange rate was fixed on 2006-07-11.

The procedure used to fix the irrevocable conversion rate between the drachma and the euro was different, since the euro by then was already two years old. While the conversion rates for the initial eleven currencies were determined only hours before the euro was introduced, the conversion rate for the Greek drachma was fixed several months beforehand, in Council Regulation 1478/2000 (EC), of 19 June 2000.

The currency was introduced in non-physical form (travellers' cheques, electronic transfers, banking, etc.) at midnight on 1 January 1999, when the national currencies of participating countries (the Eurozone) ceased to exist independently in that their exchange rates were locked at fixed rates against each other, effectively making them mere non-decimal subdivisions of the euro. The euro thus became the successor to the European Currency Unit (ECU). The notes and coins for the old currencies, however, continued to be used as legal tender until new notes and coins were introduced on 1 January 2002.

The changeover period during which the former currencies' notes and coins were exchanged for those of the euro lasted about two months, until 28 February 2002. The official date on which the national currencies ceased to be legal tender varied from member state to member state. The earliest date was in Germany; the mark officially ceased to be legal tender on 31 December 2001, though the exchange period lasted two months. The final date was 28 February 2002, by which all national currencies ceased to be legal tender in their respective member states. (Note that some of these dates were earlier than was originally planned.) However, even after the official date, they continued to be accepted by national central banks for several years up to forever (Austria, Germany, Ireland, Spain). The earliest coins to become non-convertible were the Portuguese escudos, which ceased to have monetary value after 31 December 2002, although banknotes remain exchangeable until 2022.

Although some countries are not printing the €500 and €200 banknotes, all banknotes are legal tender throughout the Eurozone. Finland decided not to mint or circulate one-cent and two-cent coins, except in small numbers for collectors. The Netherlands stopped minting these on 1 September 2004. All cash transactions in these countries ending in one, two, six or seven cents are rounded down, and those ending in three, four, eight or nine cents are rounded up. Despite this convention, the one-cent and two-cent coins are still legal tender.

Current Eurozone (2002-2006)

European union emu map en.png|thumb|right|300px|

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  • Andorra, Montenegro and Kosovo adopted the foreign euro as their legal currency for movement of capital and payments without participation in the ESCB or the right to mint coins. Andorra is in the process of entering a monetary agreement similar to Monaco, San Marino, and Vatican City.

Future prospects (2007-)

Pre-2004 EU members
From the launch of the euro in 1999 until the EU enlargement in 2004, Denmark, Sweden and the United Kingdom were the only EU member states outside the monetary union. The situation for the three older member states also looks different from that of the ten new EU members; all three have no clear roadmap for adopting the euro:

  • Sweden: According to the 1995 accession treaty, Sweden is required to join the euro and therefore must convert to the euro at some point. Notwithstanding this, on 14 September 2003, a consultative Swedish referendum was held on the euro, the result of which was 55.9% against adopting the common currency versus 42.0% in favour. The Swedish government has argued that such a line of action is possible since one of the requirements for Eurozone membership is a prior two-year membership of the ERM II. By simply choosing to stay outside the exchange rate mechanism, the Swedish government is provided a formal loophole avoiding the theoretical requirement of adopting the euro. Some of Sweden's major parties continue to believe that it would be in the national interest to join, but they have all pledged to abide by the results for the time being and show no interest in raising the issue again.

  • The United Kingdom's eurosceptics believe that the single currency is merely a stepping stone to the formation of a unified European superstate, and that removing Britain's ability to set its own interest rates will have detrimental effects on its economy. Others in the UK, usually joined by eurosceptics, advance several economic arguments against membership: the most cited one concerns the large unfunded pension liabilities of many continental European governments (unlike in the UK) which would, with a greying population, depress the currency in the future against the UK's interests. The contrary view is that, since intra-European exports make up to 50% of the UK's total, it eases the Single Market by removing currency risk, although financial derivatives are becoming more accessible to small UK businesses thereby allowing businesses to offset this risk. An interesting parallel can be seen in the 19th century discussions concerning the possibility of the UK joining the Latin Monetary Union *. Many British people also simply like Sterling as a currency as it is part of British heritage. The UK government has set five economic tests that must be passed before it can recommend that the UK join the euro; however, given the relatively subjective nature of these tests it seems unlikely that they would be held to be fulfilled whilst public opinion remains so strongly against participation.

  • Denmark negotiated a number of opt-out clauses from the Maastricht treaty after it had been rejected in a first referendum. On 28 September 2000, another referendum was held in Denmark regarding the euro resulting in a 53.2% vote against joining. However, Danish politicians have suggested that debate on abolishing the four opt-out clauses may possibly be re-opened in 2006. In addition, Denmark has pegged its krone to the euro (€1 = DKr7.460,38 ± 2.25%) as the krone remains in the ERM.

Post-2004 EU members
In 2004 the 10 new EU member states had a currency other than the euro; however, those countries are required by their Accession Treaties to join the euro. Some of the following countries have already joined the European Exchange Rate Mechanism, ERM II. They and the others have set themselves the goal to join the euro (EMU III) as follows:

Currency Abbr. Rate
Slovenia tolars (SIT) 239.640
Cypriot pounds (CYP) 0.585274
Estonian krooni (EEK) 15.6466
Latvian lati (LVL) 0.702804
Maltese lin (MTL) ??
Slovak korunas (SKK) ??
Lithuanian litai (LTL) 3.4528
Czech korunas (CZK) ??
Hungarian forints (HUF) ??
Bulgarian leva (BGN) ??
Polish złote (PLN) ??
Romanian lei (RON) ??

However, a country's entry to the Eurozone is subject to fulfilling the economical convergence criteria during the ERM II stage. For instance, too high an inflation rate postponed the entry of Lithuania as planned on 1 January 2007.

Estonia, Lithuania, Slovakia and Slovenia have already finalised the design for the country's coins' obverse side.

Bulgaria and Romania are not yet members of the EU, but are scheduled to enter on January 1 2007.

  • The Bulgarian National Bank and the Bulgarian government have agreed on the introduction of the euro in 2010, when the Bulgarian National Bank is expected to become part of the EMU and will receive the right to issue Bulgarian euro coins. The early accession to the EMU is due to existing currency board agreement that was signed in 1997 to help put an end to the deep financial crisis and foreign debt reimbursement problems. The agreement effectively binds the Bulgarian lev to the euro (between 1997 and 1999, before the euro came into existence, the lev was bound to the German mark). As a consequence, Bulgaria has fulfilled the great majority of the EMU membership criteria.

  • In Romania, the National Bank retained its monetary policy attributes throughout the financial crisis of the 1990s (which gradually ended). Hence, Romania's accession to the EMU will take more time. It is likely that Romania will join the Eurozone in the 2010–12 period, and strategies have been established to this end. To simplify future adjustments to ATMs at the adoption of the euro, when the Romanian new Leu was adopted in 2005 (at 10,000 old Lei to 1 new Leu) the new banknotes were issued to the same physical proportions as euro banknotes, the old leu notes being substantially longer in relation to their width.

Public opinion on secession from the euro
Although the failure of the European Constitution to be ratified would have no direct impact on the status of the euro, some debate regarding the euro arose after the negative outcome of the French and Dutch referenda in mid 2005.

  • A poll by Stern magazine released 1 June 2005 found that 56% of Germans would favour a return to the mark. http://www.stern.de/presse/vorab/?id=541124&q=eichel%20category:presse
  • Members of the Northern League northern Italian separatist political party, have discussed calling a referendum to return Italy to the Lira. http://washingtontimes.com/world/20050614-114629-8803r.htm
  • Members of the Movement for France political party have proposed holding a referendum to return France to the Franc. http://news.scotsman.com/international.cfm?id=664902005
  • In contrast to Germany a poll in Austria on 7 June 2005 showed the overwhelming support of the euro: 73 percent of the sample said they preferred to keep the common currency with only 21 percent in favour of returning to the old currency the schilling. http://www.vienna.at/engine.aspx/page/vienna-article-detail-page/cn/vol-news-willie-20050607-011305/dc/tp:vol:oesterreich
  • Soon after these suggestions were made, the European Commission issued a statement denying any possibility of this, stating "the euro is here to stay".
  • In Greece, people blame the euro for some price hikes resulting from rounding up (the latter often done by cashiers) and having frozen the pre-2002 prices in their minds, they forget that with the drachma, inflation was about 20%.

More recently, in April 2006, after the Italian elections, the subject once again came up. Again, the EU strongly refuted this, calling the suggestion "impossible".

Eurozone as an optimal currency area?

In economic theory the degree of fullfillment of the following four criteria indicate whether an area is optimal for a monetary union. These criteria are often called the optimum currency area (OCA) criteria. Although these criteria are not exhaustive and far from absolute, they are generally accepted as a sufficient measure. There are three economic criteria (labour and capital mobility, product diversification, and openness) and one political criterion (fiscal transfers). All these criteria stand in relation to the ability to deal with asymmetric shocks (i.e. shocks that only hit one area). Symmetric shocks are less problematic in a currency area as the currency will depreciate or appreciate to the needed level for all areas (as this level is the same for all areas), while asymmetric shocks will create an exchange rate that is too high for one area and one that is too low for the other. This causes wage and price changes and unemployment problems.

  • Robert A. Mundell formulated the idea that perfect capital and labour mobility would mitigate the adverse consequences of asymmetric shocks in a currency area. While capital is quite mobile in the Eurozone, labour mobility is relatively low, especially when compared to the U.S. and Japan.

  • Peter Kenen formulated the idea that widely diversified production and export structures that are similar between the areas that form the currency area lower the effect and probability of asymmetric shocks. The Eurozone scores quite well on this criterion, and monetary integration seems to further improve the diversification of production structures.

  • Ronald McKinnon formulated the idea that areas which are very open to trade and trade heavily with each other form an optimum currency area. This is because the high trade intensity will lower the significance of the distinction between domestic and foreign goods as competition will equalize the prices of most goods, independently of exchange rates. The Eurozone members trade heavily with each other (intra-European trade is greater than international trade), and all evidence so far seems to indicate that the monetary union has at least doubled trade between members.

  • The term "fiscal transfers" refers to the transfer of money between areas. This could decrease the adverse consequences of asymmetric shocks as the areas that are hit, would receive money. This would create a counter cyclical effect and thus lower the price and wage changes and unemployment wouldn't rise as much. In theory however there is a no-bail out clause in the Stability and Growth Pact, meaning that fiscal transfers are not allowed, but it's impossible to know what they will do in practice.

In general, economic research state that is impossible to say whether Eurozone members would benefit from a currency area, as two important criteria support a monetary union, while at the same time two important criteria oppose such an union.

Effects of a single currency

The introduction of a single currency for many separate countries presents a number of advantages and disadvantages for the participating nations. Opinions differ on the actual effects of the euro so far, as most of them will take years to understand. Theories and predictions abound.

Removal of exchange rate risk

One of the most important benefits of the euro will be lowered exchange rate risks, which will make it easier to invest across borders. The risks of changes in the value of respective currencies has always made it risky for companies or individuals to invest or even import/export outside their own currency zone. Profits could be quickly eliminated as a result of exchange rate fluctuations. As a result, most investors and importers/exporters have to either accept the risk or "hedge" their bets, resulting in further costs on the financial markets. Consequently, it is less appealing to invest outside one's own currency zone. The Eurozone greatly increases the potentially "exchange-risk free" investment area. Since Europe's economy is heavily dependent on intra-European exports, the benefits of this effect can hardly be overstated. This is particularly important for countries whose currencies have traditionally fluctuated a great deal such as the Mediterranean nations.

At the same time, this is likely to increase foreign investment in countries with more liberal markets and reduce that in those with rigid markets. Some people worry that thus will see profits flowing away from particular member states to the detriment of their traditional social values. It might also result in the reduction of local decision makers in businesses.

Removal of conversion fees

A benefit is the removal of bank transaction charges that previously were a cost to both individuals and businesses when exchanging from one national currency to another. Although not an enormous cost, multiplied thousands of times, the savings add up across the entire economy.

For electronic payments (e.g. credit cards, debit cards and cash machine withdrawals), banks in the Eurozone must now charge the same for intra-member cross-border transactions as they charge for domestic transactions. Banks in France have attempted to circumvent this regulation by charging for all bank transfers (domestic and cross-border) unless the transfer is instructed via online banking — a method through which they do not offer cross-border payments. In this way, banks in France continue to charge more for cross-border transfers than for domestic transfers.

Deeper financial markets

Another significant advantage of switching to the euro is the creation of deeper financial markets. Financial markets on the continent are expected to be far more liquid and flexible than they were in the past. There will be more competition for, and availability of financial products across the union. This will reduce the financial servicing costs to businesses and possibly even individual consumers across the continent. The costs associated with public debt will also decrease. It is expected that the broader, deeper markets will lead to increased stock market capitalisation and investment. Larger, more internationally competitive financial and business institutions may arise.

Price parity

Another effect of the common European currency is that differences in prices—in particular in price levels—should decrease. Differences in prices can trigger arbitrage, e.g. artificial trade in a commodity between countries purely to exploit the price differential, which will tend to equalise prices across the euro area. It is held that this is supposed to result in increased competition or consolidation of companies, which should help to contain inflation and which therefore will be beneficial to consumers. Similarly, price transparency across borders should help consumers find lower cost goods or services. In reality, the effects of the euro over the level of the prices in Europe is disputable. Despite moderate official statistics, many citizens have stated the strong increase of the prices in the years after the introduction of the euro, and this have been confirmed by field studies.

Competitive funding

Competitive funding is also a benefit for many countries (and companies) that adopted the euro. National and corporate bonds denominated in euro are significantly more liquid and have lower interest rates than was historically the case when denominated in legacy currency. Likewise, companies have greater freedom to borrow competitively from cross-border banks without incurring exchange rate risk. This has forced the incumbent banks to reduce their rates to compete.

Macroeconomic stability

Improved macroeconomic stability is an important benefit of the euro for the entire continent. Much of Europe has been susceptible to economic problems such as inflation throughout the last 50 years. Inflation is a very damaging phenomenon from most of society’s perspective. It discourages investment, can cause social unrest, and causes problems for those on fixed incomes and for taxation. However, many countries have been unable or unwilling to deal with serious inflationary pressures. They often have other priorities that compromise their ability to do so. Sometimes their economic clout is simply insufficient, sometimes their parliamentary seats are at risk if they do. However, there have been models, particularly in those with largely independent central banks, that have successfully countered inflation. One such bank was the Bundesbank in Germany; since the European Central Bank is modeled on the Bundesbank, it is independent of the pressures of national governments and has a mandate to keep inflationary pressures low. However, the context in which the Bundesbank succeeded was quite different. It was a context of a social market economy where the social partners were negotiating and regulating efficiently the economic life through "reasonable" and well applied agreements. The function of the central bank was to let this social market economy work independently of the state interventions. A spirit and a context widely different of the one of the euro project. As a matter of fact, the effect of the euro on prices in Europe is widely disputed. Although the official statistics from Eurostat show a moderate increase in prices, many citizens perceive it not to be the case. They feel that prices have increased strongly and even exploded in the years after the euro, probably because entreprenors rounded up their prices by its introduction, developed new products or services that were not in the official panel, and generally benefited of the weaker control that consumers had over the prices. Also, the ECB unlike the Federal Reserve in the US does not have a second objective to sustain growth and employment and consequently seems too conservative.

Less-specific monetary policy

Some economists are concerned about the possible dangers of adopting a single currency for a large and diverse area. Because the Eurozone has a single monetary policy, and so a single interest rate, set by the ECB, it cannot be fine-tuned for the economic situation in each individual country (however, prior to the introduction of the euro, exchange rate volatility had reduced substantially after the European currency crisis in the early 1990s). Public investment and fiscal policy in each country is thus the only way in which government-led economic stimulus can be introduced specific to each region or nation. This inflexible interest rate might stifle growth in some areas, while over-promoting it in others. The result could be extended periods of economic depression in some areas of the continent, disadvantaged by the central interest rate. Given such a situation resentment and friction within the community, and toward the bank, might well increase. Others point out that in today's globalised economy, individual countries do not really have power to effectively manage their monetary policy, as it creates other imbalances. This effect was already visible in the last European currency crises of 1992, when the Bundesbank was effectively coordinating monetary policy for the whole continent.

Some proponents of the euro point out that the Eurozone is similar in size and population to the United States, which has a single currency and a single monetary policy set by the Federal Reserve. However, the individual states that make up the US have less regional autonomy and a more homogeneous economy than the nations of the EU. Of particular concern in accordance with this theory is the notion that the economies of the EU may not all be 'in sync'— each may be at a different stage in the boom and bust cycle, or just be experiencing different inflationary pressures. Labour mobility is also much lower in the Eurozone than across the United States, largely due to the vast differences in language and culture between European nations, and despite labour, capital and goods full mobility rules.

It can also be argued that a single currency works for the USA because the U.S. dollar is a hegemonic currency. Before the euro, eighty per cent of the world's currency reserves were held in US dollars. This gives the US economy a huge subsidy in that reserve dollars are invested in US institutions or foreign institutions under US control. This subsidy helps cushion the effects of a possible strong dollar hurting certain regions of the US.

If the euro were to become either a hegemonic currency replacing the dollar or a co-hegemonic currency equal in reserve status to the dollar, some of the subsidy the US gains would be transferred to the EU and help balance out some of the problems of the present heterogeneous economic structure still in place.

A new reserve currency?

The euro will probably become one of two, or perhaps three, major global reserve currencies. Currently, international currency exchange is dominated by the U.S. dollar (USD). The U.S. dollar is used by banks world-wide as a stable reserve on which to ensure their liquidity and international transactions and investments are often made in U.S. dollars.

A currency is attractive for foreign transactions when it demonstrates a proven track record of stability, a well-developed financial market to dispose of the currency in, and proven acceptability to others. The euro will almost certainly be able to match these criteria at least as well as the U.S. dollar, so given some time to become accepted, it will likely begin to take its place alongside the dollar as one of the world’s major international currencies.

There are several benefits to reserve currencies of being such an internationally acceptable currency. If the euro were to become a reserve currency it would benefit member countries by lowering the service charges on their debts. Since the currency would be so broadly acceptable it would make the premiums paid to debt holders lower, since the risk to the borrower is lower. It is estimated that the United States government currently saves 10-15 billion dollars a year on 2 trillion dollars of international debt because of this principle. The issuer of the reserve currency is freer to pursue macroeconomic policy adjustments to suit its own needs in terms of financing its debt, or influencing other countries. Reserve status would also lower the cost of many commodities for Europeans.

The euro and oil

The Eurozone consumes more imported petroleum than the US. This would mean that more euros than US dollars would flow into the OPEC nations, but oil is priced by those nations in US dollars only. There have been frequent discussions at OPEC about pricing oil in euros, which would have various effects, among them, requiring nations to hold stores of euros to buy oil, rather than the US dollars that they hold now. Venezuela under Hugo Chávez has been a vocal proponent of this scheme, despite selling most of its own oil to the United States. Another proponent was Saddam Hussein of Iraq, which held the world's second largest oil reserves. Since 2000 Iraq had used the euro as oil export currency. In 2002, Iraq changed its US dollars into euros, a few months prior to the 2003 invasion of Iraq. If implemented by OPEC, the changeover to the euro would be a transfer of a 'float' that presently subsidises the United States to subsidise the European Union instead. Another effect would be that the price of oil in the Eurozone would more closely follow the world price. When oil prices skyrocketed to almost 50 USD/barrel in August 2004, the oil price in euros didn't change nearly as much because of the concurrent rise in the exchange rate of the euro to the US dollar (to an exchange rate of EUR 1.00 = USD 1.33 in December 2004). Similarly, should oil prices lower significantly, together with the USD/EUR exchange rate, the oil price in the Eurozone would not fall as much. On the other hand, if the exchange rate and the oil price move in different directions, oil price changes are magnified. Pricing oil in euros would nullify this dependency of European oil prices on the USD/EUR exchange rate.

In 2006, Iran announced its plans to open an International Oil Bourse for the express purpose of trading oil priced in other currencies, including petroeuros.

Euro exchange rate

Flexible exchange rates

One of the implications of the Mundell-Fleming Model is the fact that when an economy combines international capital mobility with monetary autonomy, it cannot at the same time maintain a fixed exchange rate (as increasing the money supply would result in a depreciation of the currency). In the years following the Single European Act the EU has liberalized its capital markets, and as the ECB has chosen for monetary autonomy, the exchange rate regime of the euro is flexible or floating. In other words, the ECB does not use the exchange rate instrument and in general does not intervene on the foreign exchange rate markets. This explains why the exchange rate of the euro vis-à-vis other currencies is characterized by strong fluctuations. Most notable are the fluctuations of the euro vs. the US dollar, another freely floating currency. However this focus on the dollar-euro parity is partly subjective. It is taken as a reference because the European authorities expect the euro to compete with the dollar. The effect of this selective reference is misleading, as it give to the observers the impression that a rise in the value of the euro vs the dollar is the effect of an increased global strength of the euro, while it may be the effect of an intrinsic weakening of the dollar itself.

Against other major currencies

Euro exchange rate to USD, JPY, and GBP.png|thumb|right|350px||Exchange rate evolution of the euro compared to USD, JPY and GBP. Exchange rate at start is put to 1.
Green: in Jan-1999: 1 € = 1.18 USD ; in May-2006: 1 € = 1.28 USD
Red: in Jan-1999: 1 € = 133 JPY ; in May-2006: 1 € = 144 JPY
Blue: in Jan-1999: 1 € = 0.71 GBP ; in May-2006: 1 € = 0.68 GBP ]] After the introduction of the euro, its exchange rate against other currencies, especially the US dollar, declined heavily. At its introduction in 1999, the euro was traded at USD1.18; on 26 October 2000, it fell to an all time low of $0.8228 per euro. It then began what at the time was thought to be a recovery; by the beginning of 2001 it had risen to nearly $0.96. It declined again, although less than previously, reaching a low of $0.8344 on 6 July 2001 before commencing a steady appreciation. The two currencies reached parity on 15 July 2002, and by the end of 2002 the euro had reached $1.04 as it climbed further.

On 23 May 2003, the euro surpassed its initial ($1.18=€1.00) trading value for the first time. At the end of 2004, it had reached a peak of $1.3668 per euro (€0.7316 per $) as the US dollar fell against all major currencies. At that time, some analysts expected the dollar to continue to fall, a few even suggesting $1.60 per euro by the end of 2005, fuelled by the so called twin deficit of the US accounts. However, the dollar recovered in 2005, rising to $1.18 per euro (€0.85 per $) in July 2005 (and stable throughout the second half of 2005). The fast increase in US interest rates during 2005 had much to do with this trend.

By mid-2006, the euro had risen to $1.28.

Currencies pegged to the euro

There are a number of foreign currencies that were pegged to a European currency and are now currencies related to the euro: the Cape Verdean escudo, the Bosnia and Herzegovina convertible mark, the Bulgarian lev, the CFP franc, the CFA franc and the Comorian franc.

In total, the euro is the official currency in 15 states and territories outside the European Union. In addition, 22 states and territories have a national currency that are directly pegged to the euro including fourteen West African countries, three French Pacific territories, two African island countries and three Balkan countries.

Drivers

Part of the euro's strength in the period 2001-2004 was thought to be due to more attractive interest rates in Europe than in the United States. The US Federal Reserve had maintained lower rates than the ECB for these years, despite key European economies, notably Germany, growing relatively slowly or not at all. This is attributed in part to the ECB's duty to check inflation across the Eurozone, which in high-performing countries such as Republic of Ireland is above the ECB's target.

However, although the interest rate differential formed part of the backdrop, the main a posteriori justification for the euro's continuing ascent against the dollar was the concern over the huge unsustainable US current account deficits. The market has been awash with concerns about the US twin deficits, which have been a key driver of dollar weakness. The US budget deficit is about $427 billion, or 3.7% of gross domestic product (GDP), while the current account—the broadest trade measure since it adds investment flows—hit a record $166.18bn shortfall in the second quarter of 2004.

A key factor is that a number of Asian currencies are rising less against the dollar than is the euro. In the case of China, the renminbi was until recently pegged against the dollar, whilst the Japanese yen is supported by intervention (and the threat of it) by the Bank of Japan. This means much of the pressure from a falling dollar is translated into a rising euro.

The euro's climb from its lows began shortly after it was introduced as a cash currency. In the time between 1999 and 2002, eurosceptics believed that the weak euro was a sign that the euro experiment was doomed to fail. It may be that its weakness in this period was due to low confidence in a currency that did not exist in "real" form. While the overt conversion to notes and coins had not yet occurred, it remained possible that the project could fail. Once the euro became "real" in the sense of existing in the form of cash, confidence in the euro rose and the increasing perception that it was here to stay helped increase its value. This effect was probably significant in the euro's decline and recovery between 1999 and 2002, but other factors are more significant since then.

Another factor in the early decline of the euro was that many investors and central banks sold large portions of their legacy (national) currency holdings once the irrevocable exchange rates were set, as the goal of holding multiple currencies is to dampen losses when one currency falls. Once the exchange rates between Eurozone countries were pegged against each other, holdings in German marks and French francs (for example) became identical. There is also some reason to believe that significant sums of illegally held money were sold for dollars to avoid an official and public exchange for euros..

Another interpretation is that the early weakness of the euro was based on the weakness of the European economies, while the later strength of the euro was not at all based on a prosperous European economy but on the US strategy to let their deficits be absorbed by the euro, so as to be able to fund their expensive foreign and military policy and maintain a fast American growth. A set of elements shows that the Bush administration deliberately considered that a lower dollar was acceptable for a period of time.

Consequences

Despite the euro's rise in US-dollar-denominated value, as well as those of other major and minor currencies, the US trade deficits continue to rise. Economic theory would suggest that a fall in the dollar and a rise in the euro should lead to an increase in US exports and a decline in US imports, as the former becomes cheaper and the latter more expensive. However, this depends to some extent on how currency costs are passed down the supply chain. Furthermore, the declining dollar makes foreign investment in the US cheaper (although also reducing the return), so that continuing foreign investment may underpin the dollar to some extent.

The role of the US dollar as the world's de facto reserve currency helps support both the US dollar and the US budget deficit — but it depends on the continued willingness of foreigners to finance both. Central banks and others finance the budget by acquiring newly-issued, dollar-denominated US government bonds, which they need to acquire dollars for. If at some point foreigners become unwilling to accept new bonds at the prevailing interest rate (perhaps because the falling dollar is reducing the bonds' value too much), the dollar will fall even more — or the US will have to raise interest rates, which would reduce economic growth.

There is speculation that the strength of the euro relative to the US dollar might encourage the use of the euro as an alternative reserve currency; Saddam Hussein's Iraq switched its currency reserves from US dollars to euros in 2000. Moves by central banks with major reserve currency holdings such as those of India or China to switch some of their reserves from US dollars to euros, or even of OPEC countries to switch the currency they trade in from US dollars to euros, will further reinforce the US dollar's decline. In 2004, the Bank for International Settlements reported the proportion of bank deposits held in euros rising to 20%, from 12% in 2001, and it is continuously rising. The falling dollar also raises returns for US investors from investing in foreign stocks, encouraging a switch which further depresses the dollar.

The rise in the euro should dampen Eurozone exports, but there is little sign of this happening yet. The main reason is that the currencies of the Eurozone's major world-wide customers are also seeing their currencies rise relative to the US dollar. As the current account deficits continue to rise and the US plans no austerity measures to curb foreign imports and increase exports, the situation may cause the US dollar to lose its position as a hegemonic currency replaced by either the euro or the euro and a basket of currencies. However, prospects should remain very careful.

Name and linguistic issues

Several linguistic issues have arisen in relation to the spelling of the words euro and cent in the many languages of the member states of the European Union, as well as in relation to grammar and the formation of plurals. Immutable word formations have been encouraged by the European Commission in usage with official EU legislation (originally in order to ensure uniform presentation on the banknotes), but the "unofficial" practice concerning the mutability (or not) of the words differs between the member states and their languages. The subject has led to much debate and controversy.

See also

Euro related

Other

References

  • Baldwin, Richard and Charles Wyplosz, The Economics of European Integration, New York: McGraw Hill, 2004.
  • European Commission, High Level Task Force on Skills and Mobility - Final Report, 14 december 2001.

Inline references

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Currencies of Europe | Economy of the European Union | Monetary unions | Karlspreis laureates

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