The euro was fully adopted by twelve members of the European Union on January 1st 2002. The currency has proved remarkably robust on the international markets and 36% of foreign exchange transactions involve euros (second only to USD). Whilst the euro has proved stable internationally economic problems within the member countries continue to cause problems, most noticeably for the European Central Bank (ECB) which determines interest rates for the Eurozone.
The adoption of the euro in 2002 followed a period of three years between January 1999 and 2002 when exchange rates between the Eurozone countries were fixed and use of the euro in banking financial markets was introduced. From 1999 debt began to be issued in euros as well. However the planning for a single currency in Europe goes back much further.
L'Europe se fera par la monnaie, ou elle ne se fera pas - Jacques Rueff, 19501
Roughly translated the above says that Europe is about currency (a single one), or nothing at all. Although Rueff was putting forward this view as early as 1950 it wasn't until the Werner Plan
in 1970 that the European Economic Community
(as it then was) made its first official moves towards economic and monetary union
(EMU). Werner had been asked to head a committed investigating the possibilities of EMU by the heads of state of the member countries, a group which no longer included the obstinately anti-integrationist French President Charles De Gaulle
. Werner presented a three stage plan which would lead to EMU by 1980. However the oil crisis
, the collapse of the Dollar and more pressing economic concerns meant that the Plan was essentially scrapped by 1974 as the European countries channeled all their energy into reining in the high inflation and moving back towards economic stability.
It was in 1979 that EMU worked its way back onto the agenda with the European Monetary System (EMS). The EMS replaced the 'snake in the tunnel' system that had been in place since the collapse of the Bretton-Woods Agreement on exchange rates in 1971. Under the EMS a European wide Exchange Rate Mechanism (ERM) was introduced. Each country in the EEC (which now also included the UK, Ireland and Denmark) had to keep their currency within +/- 2.25% of the European Currency Unit or ecu. The ecu was a combination currency made up of a basket of all the EEC currencies. Under this system the German central bank, the Bundesbank, essentially controlled European monetary policy.
The next stage towards EMU came in 1989 with the Delors report into the creation of a single currency. The report laid out the final steps that would lead to the EMU and established the institutional framework that would govern it. In 1992 the plan was formally adopted in the Maastricht treaty. The Maastricht convergence criteria specified certain conditions that potential members had to fulfill to join the new currency;
- Inflation less than 1.5% above the average of the three lowest member states
- Interest rates no more than 2% above the average of the three lowest inflation member states
- Current budget deficit of less that 3% of GDP
- Total public debt of less than 60% of GDP
- No move from the ERM bands for previous two years
The final condition, keeping within the ERM bands for two years, became a lot less exacting following Black Wednesday
. On Black Wednesday the UK and Italy were forced to leave the ERM due to persistent speculation by currency traders. Following this the currency bands were increased to +/- 15% and the ERM became much more flexible.
Finally in 1998 eleven of the fifteen EU member states decided to go ahead with EMU. The UK, Denmark and Sweden negotiated opt-outs and Greece did not meet the convergence criteria. In 2001 Greece joined the eleven in trading in euros on the financial markets having met the criteria. The criteria themselves were somewhat fudged, in 1999 Italy introduced a one off 'euro tax' to bring its budget deficit into line and Belgium, Greece and Italy all still have total public debt of over 100% of GDP. The wording of the criteria was changed to allow countries 'moving in the right direction' to join the euro.
The Ups and Downs of a New Currency
In the first 3 years of the euro the currency lost 30% of its value against the US Dollar. Despite this large fall the euro did not come under any sustained speculation as many had predicted it would. Additionally there was still considerable faith amongst the international financial community in the currency, where its weakness was viewed as an indicator of the comparative strength of the US economy compared to Europe. This faith proved well founded and between 2002 and 2003 the euro rose 50% against the USD as the US budget deficit soared, war on Iraq cost billions of Dollars and the Fed made it clear that a strong Dollar was no longer one of its priorities.
Despite this impressive performance on the FX markets the problems on centrally managing twelve disparate economies are beginning to tell. Germany2, still struggling with the problems caused by unification over a decade ago, and France continue to suffer from high unemployment and very low growth. Meanwhile Greece, Spain and Ireland all continue to experience high levels of growth. The ECB must manage these competing pressures to try and maintain Eurozone inflation at 2%, the stated target level. Germany and France are both clamoring for lower interest rates to stimulate their faltering economies whilst the ECB must be watchful of high inflation in other countries, a situation that would become even worse with the possible addition of the any of the ten new member states that joined in May 1st.
In 2003 both Germany and France managed to avoid sanctions for their continued flouting of the Stability and Growth Pact (SGP). The SGP takes the two Maastricht convergence criteria relating to member state's budgets (budget deficit of 3% and total public debt of less than 60%) and requires their continued observance for all countries within the Eurozone. The Commission began the excessive deficit reporting procedure against France and Germany in 2002 but to little effect. In November 2003 the Commission requested that the Council confirm enforced deficit reductions on France and Germany, the final step before sanctions that can reach 0.5% of GDP. France and Germany persuaded a sufficient number of EU states to back them in refusing to confirm the procedure and so placed the SGP into 'abeyance'. Regardless of the outcome of a legal challenge from the Commission this decision shows that there is still considerable division within Europe over the governance of the euro.
Expansion and a Federal Europe?
Of the three EU countries that had the opportunity to join the euro and didn't only the UK has not had a referendum on the issue (as of May 2004). The public in Sweden and Denmark rejected entry to the Euro although future membership remains on the agenda. In the UK the government is committed to a referendum should Gordon Brown's five tests be met. At the last full assessment in 2003 Brown said the tests were still not met and indicated a similar position in this year's budget. Many in the UK fear that the loss of sovereignty engendered by a single currency would be merely the beginning of a transition to a federal European 'superstate' that would supersede national governments. This battle is currently being fought over the UK's possible acceptance of the European Constitution and as such the euro question has taken a back seat for at least the next two or three years.
Perhaps of more significance for the current Eurozone countries is the possible membership of the some of the new Central and Eastern European Countries (CEECs) that have joined the EU as of May 1st. These countries represent great possibilities for expansion and growth but they also hold the dangers of inflationary pressures and economic instability.
1 - Jacques Rueff was a French economist and politician who served with various French governments following World War II.
2 - Figures from Eurostat - http://europa.eu.int/comm/eurostat/Public/datashop/print-product/EN?catalogue=Eurostat&product=2-16042004-EN-AP-EN&mode=download
Germany: GDP growth of 0% in Q4 of 2003 compared to Q4 2002
France: GDP growth of 0.6% in Q4 of 2003 compared to Q4 2002
Greece: GDP growth of 5% in Q4 of 2003 compared to Q4 2002
Ireland: GDP growth of 2.7% in Q4 of 2003 compared to Q4 2002
Spain: GDP growth of 2.7% in Q4 of 2003 compared to Q4 2002
The History of the Euro - http://www.ust.hk/~webeu/news/win983.htm
BBC News Online: A-Z of Europe - http://news.bbc.co.uk/1/hi/in_depth/europe/euro-glossary/default.stm
FX Outlook - EUR/USD at a Crossword, Neils Christensen, Senior Currency Strategist, SG Corporate & Investment Banking - http://www.eqonline.fi/docs/sg/FX_outlook_010404.ppt