The Euro: Will Its Dominance Continue?

Saturday July 4, 2009

The Euro is very new, having come into existence in the year 2002.  Yet for all that it is a very dominant currency and is actually set get bigger and more influential as time goes on.  This would appear to be one currency that will survive and simply go from strength to strength.  All the more remarkable, given that it is such a recent currency.

It is currently being used in 15 states in Europe.  These are collectively called the Eurozone.  It is also used as a currency in 9 other countries of the world, 7 of which are in Europe.

This makes it the official currency for a total of 320 million Europeans, so it is a significant currency and all the countries that use it are developed countries, so it is a relatively stable currency.

Recently countries have started to use the euro as their peg, which has rocked the US dollar somewhat.  The US dollar was always the currency of choice, but that has now changed and the euro is looking increasingly popular.

The euro was introduced by the European Central Bank, which is a bank that was only created in 1998.  Now it governs the monetary policy of 15 states in Europe.

This really is an astonishing rate of growth.  Europe has gone from having no central bank, no central monetary policy and no single European currency, to having established a bank and issued a currency and kept that currency strong, even when all around it, other currencies were experiencing some spectacular dips or rollercoasters.

So it would be very easy for the Euoropean Union and the European Bank to simply be complacent and sit back and think that it has achieved a great deal, but it doesn’t really need to bother now.  After all, the euro is already becoming the main rival to the dollar in terms of being the most accumulated world reserve currency and different countries want to use it as the standard against which they want to base themselves.

But can the European Central Bank be complacent?  Is there a danger that it has achieved too much too quickly and will cracks soon start to show on the shiny new euro?

History of the Euro

Before examining whether the euro has potentially peaked too soon, it is necessary to look at how Europe has arrived at the place it is now. 

Prior to the European Central Bank being created, the overall monetary policy maker in Europe was the European Monetary Institute.

This was an institution that was only founded in 1994 and then reinvented in 1998 as the European Central Bank. 

Central to the policies of the European Union at that time was the policy aim of uniting Europe through making it use one currency.  To do this a new currency would have to be created, since if just one currency such as the French franc, British pound etc, this would undoubtedly cause offence to some other member states.  The choosing of a currency could therefore be a very tricky business in terms of international diplomacy, so the easiest option by far was simply to opt out and create a new currency.

Even the name had to be carefully chosen.  Anything that sounded too
German, too English or too Dutch and so on, would simply not have been acceptable.  So it made sense to use part of the European name and euro fitted with this nicely.

Interestingly, it was also relatively easy to say.  Due to the different languages spoken throughout Europe there are few words that all member states actually find easy to pronounce.  So euro, whilst not being instantly accessible to all peoples of the EU, was certainly a name that wasn’t too difficult for them to say.  (Cents on the other hand, 100 of which makes up 1 euro has proved somewhat of a challenge for some of the newer states in particular).

So, the aim was clear a new currency was to be devised and it was to be circulated throughout Europe.  But how is this done in practice? 

Well the creation of any new currency has to be carefully regulated by the International Monetary Fund, who will ensure that it is carefully drafted and that all the right checks and measures in place, so that it can become an official currency.

Obviously it is not possible just to buy a printing press, roll out some banknotes and then declare them as official currency.  The whole issue of establishing and drafting a currency is something of a bureaucratic nightmare with lots of different aspects to it.

However, if there is one challenge that the European Union seems ready to take on and embrace it is bureaucracy and sure enough, it certainly was able to take on the challenges set down by the IMF and get round them.

But partly this willingness to create a new currency was something that was not new, but it had actually first been talked about in the 1920’s.  Thus the main drive to create the currency was a fervent belief that it had to happen.  The euro was actually not just about money but also about international trade, meaning that all trade in Europe could be made with the one currency.

And it was about the pride of Europe, a way of making sure that currency was standard throughout Europe, that people were unified as one, with a common goal and that dissent could be quashed.

And so, less than 5 years after the European Central Bank had hit the scene, the euro was born.

The launch of the euro

Many on the edges of financial markets viewed the launch of the euro as something that would end in tears and indeed for the first few days and weeks, it was not the most successful of currencies. 

There were operational problems.  Tills didn’t work with the euro system despite the fact that there had been a massive information and training campaign.  People complained that since the euro had been introduced prices had gone up.  Elderly people lamented the demise of their national currency and countries such as the UK, looked on smugly.  It had chosen not to join and now it looked as if the right decision had been made.

However, this smugness was somewhat misplaced.  Soon the euro started to gain popularity.  The complaints stopped.  People were getting used to it.  By February 2002, the European Central Bank issued a statement saying that it had successfully launched the euro and what is more they wanted it to go from strength to strength and start to rival the US dollar.

Still no one really believed that the euro would actually ever pose a threat to the US dollar.  After all that had been around for years and this was basically a very new currency, almost an upstart in terms of financial systems.

Critics were quick to point out that the euro would never be able to rival the dollar because the European Central Bank itself was a threat to its long term success.  Driven by a kind of splendid isolationist thinking, combined with members from member states who also had their own national interests at heart, this was going to be a bank that would simply lose itself in bureaucracy. 

Moreover, those outside the EU felt that the states may pay lipservice to the concept of a single economic policy, but again it would prove too bureaucratic in practice and the end result would be a system that simply got bogged down in red tape and national interests.

And so, confident that the euro would know its place and just settle down and be a mediocre currency at best, the rest of the world sat back and did little, except think that it had probably run its course and it wouldn’t be too long before it hit some problems. 

The euro ploughed on, relatively unconcerned about what the rest of the world thought.  It had a job to do and that was to become a stable and secure currency. 

The Ascendancy of the Euro

By 2003, the euro was gaining strength and it was increasingly more desirable as a currency for world reserves.  At this point it started to be viewed as something that could actually evolve into a serious currency.

At this point, several states dotted around Europe and from the Eastern Block, started to become interested in joining the EU.

The European Central Bank was on the one hand delighted that more states wanted to join, since this would give the euro even greater strength and it would be used more widely.  However, if it let any old state in and their economy went bust, then this would significantly impact on the euro.

And so the EU devised a very stringent set of criteria that must be met, before any state can adopt the euro as its official currency.

This was a stroke of genius on behalf of the EU, since it meant that it could ensure that only stable and relatively secure economies could use the euro.  This would alleviate many of the risks associated with letting in the smaller countries and it would, at the same time, provide an expansion for the Eurozone.  It was a win-win situation for the EU.

The Future of the Euro

Given that the dollar is weak and British Sterling is now a currency that is isolated, instead of the euro being in danger of having peaked too soon, we could well find that the euro simply has not peaked at all, it will continue to rise and to become a currency that really does take precedence over the dollar.

Despite the reservations that were expressed about the European Central Bank, it has proved itself to be a bank that is prudent and has exercised caution, but still plans rapid expansion into the world currency markets.

It has also consistently worked hard to ensure that the euro is kept strong, even when it looked for a time as if it were too strong and trade would be affected.  The Bank held its nerve and kept its cool and the ends result has certainly paid off.

Although it is easy to speculate that the euro will never enjoy the same status as the dollar, there are pointers that its expansion may lead it into other countries and indeed continents. 

It is anticipated that some African countries, some of whom already have their currencies pegged to the euro, will actually adopt this as their official currency or at least attempt to.

This would prove a major coup for the euro, which would then start to be used in different continents.  However, there is also a risk associated with this and that is the precarious nature of some African countries.  Even if the EU makes all countries fulfil its criteria before they can use the euro, there is still a danger, given the volatility of some countries throughout the world, that ultimately one day, an economy will collapse and the euro will take its first serious knock.

However, the role of the Central Bank will be to try and ensure that this cannot happen.  The bank also has to keep a firm grip on inflation and whilst it has been successful so far, if it did slip up and let inflation get a hold of the economy then there would be serious implications throughout the world.  The bigger a currency is and the more powerful it is, the more the rest of the world suffers if inflation adversely affects the economy.  Thus the Central Bank in Europe really does have a lot of responsibility.

Various states will have adopted the euro by the year 2015, these are Lithuania, Estonia, Slovakia, Bulgaria, Latvia, Hungary, the Czech Republic, Romania and Poland.  These are in addition to the 15 states that already use the euro.  So its influence is likely to continue to grow and develop.  Meanwhile other currencies that are doing less well can only sit and look on with envy and be jealous of its success.  Or they may even consider adopting the euro, after all no one likes to be left out.

Behind the Scenes

The real problem with making any predictions about the euro is to some extent the fact that it has been so successful.  Most currencies experience some knocks, bruises, bad times and the real test of whether they are durable is when they pick themselves up and get back to being a successful currency.  The dollar has certainly experienced a few knocks in its time, as have all major currencies at one point or another.

So far the euro has really only enjoyed success.  It has never experienced a real down turn in its fortunes, where businesses are losing confidence in it, the people are losing faith in it.  This means that it is very difficult to say whether or not it will recover from any serious knock that it may take.

The only yardstick really is the credit crunch.  Although the US was worst hit by the credit crunch, Europe had ploughed a lot of money into the deals that started to go sour in America.

Yet the effect on the euro was not substantial, certainly nowhere near as substantial as experienced by the dollar.  Perhaps then, it is actually quite reasonable to assume that the euro can weather storms and is not just a ‘fair weather’ currency.  This does give the euro a slight depth and substance that was lacking before, but until it is truly tested, its true strength and ability to cope with the bad times, are relatively unknown quantities.

Whatever its future it is likely that expansion will continue until the euro is used as widely as the dollar.  The dollar probably will continue as a means of costing certain prices, such as gold, but the euro will probably be quoted alongside the dollar.  China and Russia now prefer to stockpile euros rather than dollars and many other countries are following suit. 

The coming of the euro also provides foreign countries with a choice of which currency to buy and use for their stockpiles.  Previously there was really only the dollar.  Now they can choose between the dollar and the euro.  This may not be a bad thing, because it means that all a country’s reserves will not be placed in just one currency.  So if disaster hits one currency say the euro, they will still have some dollars, to fall back on and if disaster hits the dollar, then they would still have the euros as a back up.

The euro then may only be a very juvenile currency but it has already had quite and impact and it is likely that this impact will simply increase as time goes on.  Who knows, the euro may eventually end up being the single currency left?  But more likely it will simply be a rival to, or on a par with, the US dollar.