The euro (symbol: €; banking code: EUR) is the single 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.
The euro is the official currency of the European Union. It was introduced to world financial markets in 1999 and launched as a currency in 2002. The euro is strongly advancing both economic and political integration among the participating EU member states. All EU member states are eligible to join if they comply to certain monetary requirements.
The euro is managed and administered by the European Central Bank (ECB) (headquartered in Frankfurt, Germany) 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.
History (1990-1999)
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 and Neil Dowling. (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 as follows:
13.7603 Austrian schillings (ATS)
40.3399 Belgian francs (BEF)
2.20371 Dutch gulden (NLG)
5.94573 Finnish markkaa (FIM)
6.55957 French francs (FRF)
1.95583 German mark (DEM)
0.787564 Irish pounds (IEP)
1936.27 Italian lire (ITL)
40.3399 Luxembourg francs (LUF)
200.482 Portuguese escudos (PTE)
166.386 Spanish pesetas (ESP)
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, at the following exchange rate:
340.750 Greek drachmas (GRD)
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 do 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. All cash transactions in Finland 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 in Finland.
Current eurozone (1999-2007)
Main article: Eurozone
██ Eurozone countries
██ ERM II countries
██ other EU countries
██ unilaterally adopted euro
The euro is sole currency in the following EU member states: Austria, Belgium, France, Finland, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. These 12 countries together are frequently referred to as the "eurozone", or more infomally "euroland" or the "eurogroup". The euro is also legal currency in the eurozone overseas territories of French Guiana, Réunion, Saint-Pierre et Miquelon and Martinique.
By virtue of some bilateral agreements the European mini states of Monaco, San Marino, and Vatican City mint their own euro coins on behalf of the European Central Bank.
Andorra, Montenegro and Kosovo adapted 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 the Vatican City.
Future prospects (2007-)
Pre-2004 EU members
From the launch of the euro in 1999 until 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 than for the ten new EU members; all three have no clear roadmap for adopting the euro:
Swedish anti-euro propaganda from 2003 by the Green Party's youth organization. The text translates as "EMU and solidarity".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 a rejection of the common currency. 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. 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. An interesting parallel can be seen in the 19th century discussions concerning the possibility of the UK joining the Latin Monetary Union [2]. 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. In 2000, another referendum was held in Denmark regarding the euro; once more, the population decided to stay outside the eurozone for now. 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%).
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. Since some of them already comply with the convergence criteria, these countries have already joint the European Exchange Rate Mechanism, ERM II and are set to join the euro (EMU III) as follows:
1 January 2007 for Estonia, Slovenia and Lithuania.
1 January 2008 for Cyprus, Latvia and Malta
1 January 2009 for Slovakia
Mid-january 2009 for Bulgaria
1 January 2010 for the Czech Republic and Hungary.
2011 or later for Poland and Romania
(1; Estonia, Lithuania, Slovakia and Slovenia have already finalised the design for the country's coins' obverse side.1 2 3 4).
Bulgaria and Romania are not yet members of the EU, but being scheduled to enter on January 1, 2007.
The Bulgarian National Bank and the Bulgarian government have agreed on the introduction of the euro in mid-2009, 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 after the European Constitution referenda
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. [3]
Members of the Northern League Italian nationalist political party have discussed calling a referendum to return Italy to the Lira. [4]
Members of the Movement for France political party have proposed holding a referendum to return France to the Franc. [5]
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. [6]
However, soon after these suggestions were made, the European Commission issued a statement denying any possibility of this, stating "the euro is here to stay".
Eurozone as an Optimal Currency Area?
Main article: Optimal Currency Area - Eurozone
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 Optimal 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 USA 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, and all evidence so far seems to indicate that the monetary union has at least doubled trade between members.
The term fiscal transfers refer 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 reality however there is a no-bail out clause in the Stability and Growth Pact, meaning that fiscal transfers are not allowed.
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 the single currency
The euro Light Sculpture in FrankfurtThe 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.[citation needed]
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 is said to benefit consumers find lower cost goods or services. There is no universally accepted scientific theory based on firm evidence that this is an inevitable consequence, but rather is more likely to come about, if and when it does, due to popular belief in this system.
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 significicantly 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, is independent of the pressures of national governments. Since it has a mandate to keep inflationary pressures low, prices in Europe have been after the euro’s introduction. (Eurostat data confirms this, nevertheless many citizens perceive it not to be the case). Unlike the Federal Reserve in the USA, it does not have a second objective to sustain growth and employment and consequently seems too conservative. This is discussed further in article ECB.
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 rates 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 USA 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 US 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 USA.
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 USA 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 American dollar. The dollar is used by banks as a stable reserve on which to ensure their liquidity and international transactions and investments are often made in 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 American 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 United States. 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 holds 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 euro, a few months prior to the 2003 invasion of Iraq. If implemented by the 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.
On March 20, 2006, Iran is planning to open an International Oil Bourse (IOB, exchange) for the express purpose of trading oil priced in other currencies, including euros.
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.
Against other major currencies
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. In the wake of U.S. corporate scandals, 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.
Current and historical exchange rates against 29 other currencies (European Central Bank)
Current dollar/euro exchange rates (BBC)
Historical exchange rate from 1971 till now
Currencies pegged to the euro
Main article: Currencies related 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 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.[citation needed]
Consequences
Despite the euro's rise in 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 improvement 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 dollar as the world's de facto reserve currency helps support both the 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 dollar might encourage the use of the euro as an alternative reserve currency; Saddam Hussein's Iraq switched its currency reserves from 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 dollars to euros, or even of OPEC countries to switch the currency they trade in from dollars to euros, will further reinforce the 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 Euroland's major world-wide customers are also seeing their currencies rise relative to the 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.
Name and linguistic issues
Main article: Linguistic issues concerning the euro
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.