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Thursday, 31 May, 2001, 14:53 GMT 15:53 UK
Q&A: Euro basics
Graph: Euro's decline against the dollar since spring 1999
Europe's single currency, the euro, is on the slide again, as a brief recovery at the beginning of the year has begun to fizzle out. But what is the EU's Economic and Monetary Union - to give it its full name - all about? BBC News Online explains the euro basics.

What is the euro, and who is a member?

The euro is the European Union's single currency.

It took more than 15 years of negotiations, planning and preparation, before the single currency was launched on 1 January 1999.

Twelve members of the European Union have now ditched their own currencies and created a monetary union. Three countries - Denmark, Sweden, and the UK - have decided to stay out, at least for now.

Current members of the eurozone are Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Spain and Portugal.

So how does it work?

Europe's monetary union works a bit like all states in the United States sharing the US dollar and having the same key interest rate. For the eurozone, the interest rate is set by the European Central Bank (ECB).

Even though the eurozone's citizens are still using their old coins and bank notes, the exchange rates between member currencies are already fixed - so that the euro represents a fixed percentage of one Deutschmark or franc.

Banks and many companies are already using the euro for internal book keeping and electronic money transactions.

And foreign exchange dealers now trade the euro, rather than francs or lira, against other currencies.

Consumers will receive their first euro banknotes and coins in January 2002. There are 100 cents to one euro.

Why is the euro in trouble?

When the euro was launched, it bought $1.17. In the following 22 months, it lost about 30% of its value against the US dollar, trading as low as $0.82. After hitting that low in October 2000, the euro recoverd for a while, even getting close to parity with the dollar.

However, it has since slipped once again close to its historic low.

EU officials still argue that the euro is "markedly" undervalued and say the economic fundamentals should soon push up the single currency again.

Why did the euro get so weak?

During the first two years of the euro's life, the US economy strongly outperformed most eurozone economies.

This, and the fact that productivity growth in the US was much higher, persuaded eurozone companies to make large investments in the United States.

To invest in US companies, they had to sell euros and buy dollars, which drove down the euro's value on the market.

Another factor were stock market investment flows. Higher productivity of US firms resulted in higher company earnings. Coupled with high interest rates, this made the United States a preferred destination for European stock market investors.

Once again, the euro was sold in favour of dollar investments.

At the beginning of the year, the picture changed. The US economy slowed down sharply, while eurozone kept posting strong growth.

US stockmarkets, meanwhile, were in deep trouble. Both factors boosted the euro - but not enough to push it to its launch value.

As a matter of fact, as signs of a slowdown of the eurozone emerged, investors fled yet again into the dollar, even though the economic prospects of the US economy are still markedly worse than those of the 12 countries using the euro.

Why does everybody criticise the European Central Bank?

It's a question of market confidence. Currency traders are still unhappy with how the ECB conducts its monetary policy.

The ECB is controlled by a board made up of all 11 central bank governors, who still may represent the interests of their countries rather than of the eurozone as a whole.

There is a feeling that a sense of direction is lacking, and that not only EU politicians but even central bank officials are not always singing from the same hymn sheet.

Unlike the US Federal Reserve, the ECB has not yet mastered the fine art of keeping the markets guessing about what it is up to, while providing some clarity about the direction of monetary policy at the same time.

As a new currency, the euro must prove itself attractive to international investors.

The uncertainty means that many investors prefer to buy dollars rather than euros in a time of crisis.

A fine example was the run-up to the ECB's decision in May to cut interest rates. Until a day before the rate cut, ECB officials had warned of inflationary pressures.

On the day of the rate cut, the bank argued that inflation was not a threat anymore.

The next day official figures showed inflation figures surging in three key eurozone economies.

So that's it for the euro, then?

Not so fast. Have a look at the broader picture: Currency swings can be very violent and take a long time to ride out.

Graph: Dollar against the Deutschmark since 1985
If you look at how the mighty Deutschmark, now part of the puny euro, has done over the past 15 years, you will see that it dropped even faster against the US dollar between 1995 and 1997 then it did as part of the euro during the past two years.

And compared to 1985 - when the dollar was at its strongest, the euro is still in pretty good shape.

However, investor and market confidence is not an exact science that can be expressed in numbers. The euro's fall is an embarrassment for politicians who predicted a single currency strong enough to challenge the dollar.

And it has left many of the European Union's voters seriously disenchanted with the euro.

The latest example is the clear no in the Danish referendum on whether to join the single currency.

Most companies, all trade unions and all the big parties in Denmark were in favour of the euro. The euro's weakness - and worries about national sovereignty - persuaded many people to vote against joining.

Does monetary union bring any advantages at all?

Yes, it does. First of all, firms that export a lot to other countries within the eurozone don't have to bear the costs of exchanging profits into their home currency anymore.

Multinationals also save a lot of money if all their subsidiaries trade in the same currency. Smaller firms suddenly are finding customers in regions they thought they could never be bothered to export to.

The disappearance of these transaction costs is bound to boost economic growth, and will make goods cheaper for consumers.

And even the weak euro has been a boon for the eurozone, as its exports to the United States and the UK have become more competitive.

Once euro coins and bank notes are available, consumers and tourists in the eurozone will feel the benefit as well.

Travelling in the eurozone will become cheaper, and competition could drive down prices - at least in border areas.

And what do the euro's critics say?

Some say that monetary union on such a large scale does not make economic sense.

They argue that an interest rate suitable for Italy or France may actually do harm for the economies of Ireland or Finland.

They argue that the economic cycles of countries that want to join the euro should be in step with that of the eurozone.

Low eurozone interest rates, for example, could overheat the already strong economy of a new member state - or high euro rates could damage an already struggling country.

However, the same holds true for the United States - or even the UK, where Midlands firms are complaining about rates that benefit the south-east.

But the euro critics say that economic cycles there are much more in tune with each other than those of various European states.

The biggest criticism, though, is not one of economics, but politics. Joining the euro means pooling a country's control over its monetary policy with that of other states.

Could small states be outvoted by big economies? Will large countries outmanoeuvred by the small nations ganging up against them?

Will economic and monetary union not ultimately force all members to harmonise taxes and other policies, thus eroding political sovereignty?

And what happens during a serious economic crunch?

Competitive devaluation - as Brazil's government did during its economic crisis in 1999 - would not be an option anymore.

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