The Euro: Creation and Current Crisis
by Hank Taylor, 2012
The creation of the euro is less subjective than the current crisis, thus the first section of this paper is more factual and straightforward. The current euro crisis has stirred great debate and rhetoric concerning causes of the ailing euro and what should be done. Since I have found objectivity harder to maintain in my research and writing on that topic, I recommend you seek out my cited sources to gain a greater perspective on the euro crisis.
Creation of the Euro
The euro was launched on 1 January 1999 as "an invisible currency, only used for accounting purposes, e.g. in electronic payments" for more than 300 million people in 11 nations in Europe.4 On 1 January 2002, euro cash replaced the banknotes and coins of 12 European nations (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain).1
Today, the euro is the legal currency in the euro area, commonly referred to as the Eurozone, formed out of 17 of the 27 Member States of the European Union (EU). Approximately €880 billion in cash is in circulation in the Eurozone.4
History, Politics, and Institutions
The creation of the euro has an extensive historical and political background. Ideas of an economic and monetary union in Europe were raised well before establishing the European Communities (e.g. in 1929, Gustav Stresemann asked for a European currency in the League of Nations).5 However, this document will only address recent events of more direct impact on the euro’s establishment.
President Nixon moved the US off the gold standard in 1971, "ultimately resulting in widespread currency floats and devaluations, the breakdown… dealt a serious blow to hopes for a shift to a European monetary union." The European Monetary Cooperation Fund (EMCF) was created in 1973 to stabilize exchange rates (EMCF is later succeeded by the European Monetary Institute, created 1 January 1994, which was dissolved with the creation of the European Central Bank on 1 June 1998). In March 1979, the European Monetary System (EMS) was created, fixing exchange rates onto the European Currency Unit (ECU – an accounting currency) through the European Exchange Rate Mechanism (ERM, replaced by the "ERM II" on 31 December 1998) to counter inflation and further stabilize exchange rates.6
At the European Council summit on 14 June 1988, an outline of monetary cooperation began; France, Italy and the leaders of the European Community backed a fully monetary union with a central bank, opposed heavily by British Prime Minister Margaret Thatcher.7 By 7 February 1992, the Maastricht Treaty was signed, elevating the idea of European monetary cooperation to a new and far more ambitious level by setting a firm date - January 1999 at the latest - for the replacement of national currencies by a single, currency, shared by those nations which met certain criteria.8
Original Obligations of Countries in the Eurozone
The euro convergence criteria (also known as the Maastricht criteria) are the original obligations for EU member states adopt the euro as their currency.8
In 2009 the International Monetary Fund suggested that countries be allowed to "partially adopt" the euro - adopting the currency but not qualifying for a seat on the European Central Bank (ECB). Monaco, San Marino and the Vatican City State are in a similar situation: they have adopted the euro and mint their own coins, but they do not have ECB seats.9
Summary of the Euro Convergence Criteria:
Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing member states of the EU.
Exchange rate: Applicant countries should have joined ERM II for two consecutive years and should not have devalued its currency during the period.
Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states.
- Annual government deficit:
The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.
- Government debt:
The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.
The criteria are meant to maintain the price stability within the Eurozone even with the inclusion of new member states.8 The European Monetary Institute (EMI) was created 1 January 1994 to prepare the creation of the euro (so named in 1995); as aforementioned, the EMI was dissolved with the creation of the European Central Bank on 1 June 1998.
The ECB, headquartered in Frankfurt, Germany, oversees the activities of the national central banks (NCBs) and initiates further harmonizing of cash services within the Eurozone. The NCBs are responsible for the functioning of their national cash-distribution systems.4
The euro slumped the first couple years after its launch, with a brief crash to $0.8115 on 15 January 2002. However, its value last closed under $1.00 on 6 November 2002 (at $0.9971); thereafter, the euro’s value increased quickly, peaking at $1.35 in 2004 and reaching its highest value (versus the USD) at $1.5916 on 14 July 2008.10 International usage grew more as the euro increased against the British pound sterling in the late 2000s.12
Member of the Eurozone must abide by a Stability and Growth Pact, which has similar requirements for budget deficit and debt as the Maastricht criteria. However some Eurozone countries have, without action from the EU, severely violated these criteria, resulting in a continental sovereign debt crisis.
The Eurozone did not enter its first official recession until the third quarter of 2008. The EU had negative growth for the second, third, and fourth quarters of 2008 and the first quarter of 2009. In late 2009, it became apparent that a few nations in the Eurozone were in severe financial trouble, and, due to the unified nature of the Eurozone and EU, were thereby affecting the entire EU negatively.
The Greek economy grew at a fast annual rate of 4.2 percent from 2000 to 2007; falling bond yields allowed Greece to run large structural deficits. Furthermore, since its adoption of the euro, Greece’s debt to GDP has remained above 100 percent.13
Greece was affected substantially by the global financial crisis which began in 2008; two of the nation’s largest industries are tourism and shipping, which were both badly affected by the downturn. In 2010, the EU discovered that Greece had effectively hidden its actual level of borrowing to enable Greek governments to spend "beyond their means" and appear to maintain the required criteria to remain in the Eurozone. Standard & Poor’s slashed the nation’s credit rating to BB+ (also known as "junk") status due to fears of default.13, 14
"The concern has spread from Greece to other highly indebted countries."15 Within the Maastricht criteria are rules such that a nation in the Eurozone should have a budget deficit below 3 percent, but in 2010, Greece’s was 13 percent, Spain’s was 11.4 percent, and Portugal’s was 9.3 percent. In May 2010, Greece asked for a €45 billion loan from the EU and International Monetary Fund (IMF) to cover its budget needs for the rest of 2010. The EU had to consider what precedent it would set with Greece and how other nations in the Eurozone might follow suit. Greece took austerity measures (policies of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided) to qualify for a three year €110 billion loan.15, 16
These implemented measures were able to help Greece bring down its primary deficit before interest payments from €24.7bn (10.6% of GDP) in 2009 to just €5.2bn (2.4% of GDP) in 2011; however, it is believed that a side-effect was contribution to a worsening of the Greek recession, including contribution to the Greek GDP’s decline of -6.9 percent and record high of 19.9 percent seasonal adjusted unemployment rate.17, 18 While Greek Prime Minister George Papandreou has repeatedly reported that "Greece will not default on its debt payment obligations," Greece has, in December 2011, been "working with creditors to wipe out 50 [percent] of their debt obligations" in "voluntary restructuring."19 Some have suggested that the loans and austerity measures are only prolonging the problem – that restructuring, default, or even leaving the Eurozone is necessary to move forward.20, 21
Dissimilar to Greece’s sovereign debt crisis, the Irish crisis has not been based on government over-spending, but from poor investments. The six major Irish-based banks financed a property bubble and were issued a one-year guarantee in September 2008 to the depositors and bond-holders of the banks, which was renewed a year later. Ireland, however, had a debt that was about 43 times its government’s annual revenue; compared with Greece’s debt of 8.5 times its government’s annual revenue, it was on a fast-track to defaulting.
It was impossible for the Irish government to bailout its banking system on without aid. Like Greece, Ireland received a "bailout" agreement on 29 November 2010, obtaining €67.5 billion and agreeing to austerity measures. Again, like Greece, Ireland’s banks’ debt was downgraded to junk status, making the situation for the banks considerably harder.22, 23
When does Debt Become a Big Problem?
All nations and their banking systems deal with differing amounts of debt and revenue. Research has shown that "when… [the sum of] government debt levels and size of [the nation’s] banking system is five times bigger than government revenue," debt becomes a big problem with limited solutions, sometimes limited completely default. When debts grow to a size that interest payments are being made without paying off principle, a solution must be found, or there will be a default.19 As seen in both Greece and Ireland, solutions to escape severe debt are hard to create, and current solutions provide little help and often add to the harm done.
France and Germany
France and Germany have maintained relatively efficient economies through the crisis, which has caused some to ask why "There have been no conversations between French and German authorities at any level on decreasing the size of the euro zone."23 The French and Germans seem to insist on maintaining the Eurozone when it appears they could benefit by dropping the weaker links. In addition, while the ECB, Greece, France, and Germany continue to attest that Greece will not and should not leave the Eurozone, certain people believe that such statements should be taken with a grain of salt.
In trying to avert market crisis, if Greece were to leave the Eurozone, the best interest of the ECB, France, Germany, and, especially, Greece, would be to avoid giving away their plans until the last possible moment. "Even if you believe that you will devalue your currency or someone will leave the currency, you can’t tip your hand because the markets will get ahead of you."19 Greece’s weakness has brought the euro down, but Germany and France want to keep it as strong as possible.
No matter what the advantages are, any nation leaving the Eurozone will shake confidence in the euro and devalue it, along with the new currency the leaving nation adopts. If France and Germany want to maintain their economic power, they must continue to persuade Greece (and others) to stick with the euro; if they can’t, they must put off reports and rumors of a nation leaving the Eurozone so that the market doesn’t get ahead.19,21
As mentioned before, the value of the euro has not yet gone under $1.00, even in this crisis. This may be due in part to the dollar’s weakness, but it could also be due in part to the determination and actions of the nations in the EU. Again, many believe that nations in the Eurozone are postponing their inevitable defaults through bailouts and taking on more debts, but thus far no nations in the Eurozone, most notably Greece, have defaulted or gone completely bankrupt.
Below is a table of the nations currently in the Eurozone. Inclusive is the determined exchange rate of the national currency to the euro, the date that the exchange rate was fixed (to fulfill requirement 3 above), and the date when the nation started using the euro and phasing out its native currency.
Table data from European Central Bank
|Preceding National Currencies of the Eurozone|
- Central News Network. 1 January 2002. "Euro Facing Post-holiday Test". http://articles.cnn.com/2002-01-01/world/euro.wrap_1_guilders-and-lire-national-currencies-euro-marks?_s=PM:WORLD. Retrieved 13 March 2012.
- European Central Bank. "Use of the Euro". http://www.ecb.int/euro/intro/html/index.en.html. Retrieved 13 March 2012.
- European Central Bank. "Convergence Criteria". http://www.ecb.int/ecb/orga/escb/html/convergence-criteria.en.html. Retrieved 20 March 2012.
- European Central Bank. "Issuance and Responsibilities". http://www.ecb.int/euro/intro/html/index.en.html. Retrieved 19 March 2012.
- Stresemann, Gustav. http://ec.europa.eu/economy_finance/emu_history/documentation/chapter1/19290909fr06speechofgustavstresemann.pdf. Retrieved 19 March 2012.
- (12 July 2001) "The History of the Euro" Euro Homepage. http://specials.ft.com/euro/FT3O9H0O2PC.html. Retrieved 17 March 2012.
- Marsh, David, David Buchan and Will Dawkins (31 July 2001). "EC Leaders Move Nearer to Monetary Study Plan" http://specials.ft.com/euro/FT3XEZDUTPC.html. Retrieved 17 March 2012.
- (7 February 1992) "The Maastricht Treaty: Provisions Amending the Treaty Establishing the European Economic Community with a View to Establishing the European Community" http://www.eurotreaties.com/maastrichtec.pdf. Retrieved 13 March 2012
- Rana, Yogesh (11 April 2011). "Euro Zone Crisis" http://www.scribd.com/doc/52777765/euro-zone-crisis. Retrieved 13 March 2012
- European Central Bank. "Euro Foreign Exchange Reference Rates" http://www.ecb.int/stats/exchange/eurofxref/html/eurofxref-graph-usd.en.html. Retrieved 19 March 2012.
- (4 May 2007) "Euro Riding High as an International Reserve Currency" Deutsche Bank Research. http://www.dbresearch.com/PROD/DBR_INTERNET_DE-PROD/PROD0000000000209994.PDF. Retireved 13 March 2012.
- Vandore, Emma (23 November 2007). "Euro is Becoming the "it" Currency" USA Today. http://www.usatoday.com/money/markets/2007-11-23-dollar-fri_N.htm. Retrieved 13 March 2012.
- "Crisis in Euro-Zone--Next Phase of Global Economic Turmoil" http://www.competitionmaster.com/ArticleDetail.aspx?ID=4546e4b3-8b0c-465b-b2b8-46ef69cc14f3. Retrieved 19 March 2012.
- Jack Ewing. "Cuts to Debt Rating Stir Anxiety in Europe". http://www.nytimes.com/2010/04/28/business/global/28drachma.html?_r=1. Retrieved 21 March 2012.
- "The Coming Euro Collapse". http://www.youtube.com/watch?v=32Lor1YfCGM. Retrieved 21 March 2012.
- Michael Ubriaco. "Revisiting Greece". http://www.thebcobserver.com/2011/11/02/revisiting-greece/. Retrieved 21 March 2012.
- Helena Smith. (1 February 2012). http://www.guardian.co.uk/business/2012/feb/01/imf-austerity-harming-greeve. Retrieved 20 March 2012.
- Eurostat. "December 2011 compared with November 2011". http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-14022012-AP/EN/4-14022012-AP-EN.PDF. Retrieved 20 March 2012.
- Kyle Bass (18 December 2011). "European Debt Crisis Explained". http://www.youtube.com/watch?v=LKsZ1hqHBHU&feature=endscreen&NR=1. Retrieved
- Nouriel Roubini (28 June 2010). "Greece’s best option is an orderly default". Financial Times. Retrieved 24 September 2011.
- "Pondering a Dire Day: Leaving the Euro". New York Times. 2011-12-12. Retrieved 20 March 2012.
- (30 September 2010). "Ireland’s Economy: The Money Pit". http://www.economist.com/blogs/freeexchange/2010/09/irelands_economy_0. Retrieved 20 March 2012.
- Julien Toyer. "French and Germans explore idea of smaller euro zone". http://www.reuters.com/article/2011/11/09/us-eurozone-future-sarkozy-idUSTRE7A85VV20111109. Retrieved 21 March 2012.