History of Euro

8/13/2019 History of Euro

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Behind The Euro: History And Future

Theeuro is the commonly accepted currency for 17 of the 27 member states of the

European Union ; these countries combine to create the eurozone. To truly understand the

euro as a currency is to understand the history of the eurozone.

An Introduction To The PIIGS

The Positives

The eurozone is a negotiated partnership between participating countries of the European

Union (EU), to share the economic and political benefits typically only associated with larger

countries. Thesynergistic expectations andeconomies of scale projections from the

agreements made between these countries, were expected to have a positive, long-lasting

impact for all member nations. The European Union itself began developing just after WWII

as a way to foster a peaceful and economically stable Europe.

The European Union offered: peaceful coexistence; the reduction of border restrictions,

allowing for free travel; combined strength and influence on a global scale; increased

prosperity (though not equally among countries); a multilateral promotion of human rights;

the promotion of new ideas to reduce global warming, and most notably, the use of a single

European currency - the euro.

The euro was designed to ease the process of providing services, transporting goods and

moving capital between euro-using nations. The goals of the euro were well thought-out

with the highest of hopes, but the results have been mixed.

The initial rules regarding the requirements for a country to migrate from its home currency

to the euro were well-defined and meant to exclude weaker countries, while creating a

relatively stable relationship between countries meeting similar criteria. The official rules

were spelled out in theMaastricht Treaty of 1992, that defined how members of the

European Union could move into theEuropean Economic and Monetary Union (EMU) and

ultimately, the euro.
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The Maastricht criteria, as they were coined, consisted of:inflation,a maximum of 1.5%

above the average of all members; government debt and deficit restrictions; exchange rate

rules and long-term interest rate level restrictions. Once all of the kinks were ironed out, the

euro came to life in 2002 (although dates vary for a few countries) and is now the second-

most traded currency behind the U.S. dollar, with which it was pegged at par at issuance.

Problems with the Countries Using the Euro

Part of the problem associated with the euro is the divergence from the original criteria for

participation in the EMU. The most problematic issue has been debt. The original restrictions

were set at a maximum of 60% of government debt as a ratio togross domestic

product (GDP); some countries (with thePIIGS as the worst offenders) have debt-to-GDP

ratios reaching over 100% of GDP (see graph).

Source: European Commission Q2 2011

The irony is that the agreement between the EU countries and ultimately the EMU was to

increase borrowing limits with the expectations that the leverage could be used to advance

each country's specific needs. Debt always has a double-edged sword as its powers can be

magical when used correctly. Italy, for example, was able to use its increased borrowing

powers to increase both its nationalstandard of living and its nationwide education level to

become competitive in the global economy. However, this success has come at a serious

long-term financial cost and may ultimately lead to Italy being required to restructure,

redesign or possibly default on its debt.

Greece has a debt-to-GDP ratio similar to Italy and found its way into the doldrums by

supporting its massive sovereign infrastructure through employing more than half of the

population and taxing them at minimal levels.
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Spain has not accumulated as much debt as Greece since it began using the euro, and has

experienced rapid internal growth with its newfound access to capital. They chose yet

another path; primarily in the form of private sector construction that had lain stagnant

since the end of WWII. In Spain's case, instead of running an excessive debt-to-GDP ratio,

itstrade deficit ballooned since the construction pace was not sustainable and not a cross-

border traded good. Spain faces the challenge of redirecting its efforts to a more balanced

economy, including higher levels of exports that may take years to fine tune the balance.

Whatever the road traveled to, these debt levels have cast a shadow on the euro. The grand

plan to provide some sort of simplicity and reversion towards the mean for the criteria on

which the EMU and the euro were based on, seems to have actually had a reverse effect. In

hindsight, one might easily wonder why and how so many different countries with so many

different languages, customs and histories could ever share a common currency and beexpected to progress and age at the same rate.

The Euro's Path

The euro was pegged inparity (1:1) with the U.S. dollar during its onset. At this point, all

previous home currencies were abolished and the new euro was established and allowed to

float with other currencies. While there were years ofvolatility,the immediate move was a

divergence in price in favor of the euro, as the U.S. dollar weakened annually, peaking

during the economic banking crisis at around 1.6:1. Since the 2008 crisis, volatility has

continued but the general trend has been a stronger euro, even as debt and deficit levels

have increased.

The Bottom Line

While the evolution of the EU seems to have been beneficial for the most part, the debate

will rage on as to whether the assumption of a single currency for only part of the EU was

the best idea. The ability for its participants to borrow more money at lower rates has

helped each country in its own way to develop and grow, but at a great price.

The value of the euro has been high since its inception, and during the banking crisis it was

considered a safe haven while investors fled from the U.S. dollar. Many countries have

learned over the years that a strong currency is not always as good as it sounds. It can

make your exportable goods more expensive, creating trade imbalances, which does not

combine well with ever-expanding debt levels. Only time will tell the fate of the euro. While
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it is still one of the most attractive-looking currencies in the world, the grand design may be

fading after over a decade of life.

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History of Euro