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What Is the Euro?


What Is the Euro?

The euro is the world's second most popular currency. (Photo Credit Jasper Juinen / Getty Images)

Definition: The euro is the form of money for 332 million Europeans, just like the dollar is for the U.S. It was meant to be the currency that unified the entire 27-member European Union (EU). All members pledge to adopt the euro when they join the EU. However, they have to meet budget and other criteria, as set out by the Maastricht Treaty, before they can join.

Eurozone Countries

Eleven countries adopted the euro when it was introduced in 1999. By 2011, there were 17 members: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Many non-EU countries have traded their own currencies for the euro, including Montenegro, Vatican City, and Monaco. In addition, 14 African countries that were former French colonies adopted the euro when the franc went away. Iran, the world's fourth largest oil producer, uses euros for all foreign transactions, including oil. Iran has converted all dollar-denominated assets held in foreign countries to the euro.

Euro Advantages

Countries receive many benefits to adopting the euro. Smaller countries have the advantage of being backed by Europe's powerhouse economies, Germany and France. The euro allows these weaker countries to enjoy lower interest rates, since the euro is perceived as less risky to investors than a currency with less demand from users and traders.Over the years, these lower interest rates have led to more foreign investment. This boosted the smaller countries' economies.

Some say the larger countries benefited even more from the euro. Their companies were larger, and so could produce more at a lower cost. They exported these cheap goods to the smaller eurozone countries, which couldn't compete. These companies also profited from investing cheaply in the smaller economies. This increased investment meant prices and wages rose in the smaller countries, but not the larger ones. This only made the businesses in the larger countries even more competitive. In a sense, the euro allowed them to export the inflation that typically comes with the expansionary phase of the business cycle to the smaller countries. They enjoyed the benefits of strong demand and production without paying the higher price.

Euro Disadvantages

With all these advantages, why haven't the remaining EU members adopted the euro? (As of 2011, these countries were: Bulgaria, Czech Republic, Denmark, Latvia, Lithuania, Hungary, Poland, Romania, Sweden and the United Kingdom.) Some countries are reluctant to give up some authority over their monetary and fiscal policies when they join the eurozone. They must keep their annual deficits less than 3% of their GDP, and their debt-to-GDP ratio must be less than 60%. Others simply haven't been able to cut spending enough to meet this criteria.

By adopting the euro, countries also lose the ability to print their own currency. This ability allows them to control inflation by raising interest rates or limiting the money supply.

Euro Conversion

The value of the euro depends on how many dollars, pounds or other currency it can be converted to. This value depends on the current exchange rate. That is determined by currency traders on the foreign exchange market, known as forex. These rates change on a moment-by-moment basis, depending on how traders assess the risk vs the rewards for holding the currency. They base this assessment on a number of factors, including central bank interest rates, sovereign debt levels, and the strength of the country's economy. To find out the current exchange rate for the euro, visit the ECB web site.

Euro vs Dollar

The euro to U.S. dollar conversion means exactly how many dollars the euro can buy at any given time. When the euro was completely launched in 2002, it was worth $.87. Its value grew as more people used it through the years. It reached its maximum value of $1.60 on April 22, 2008 as investors fled from dollar-denominated investments during the near-bankruptcy of investment bank Bear Stearns. As it became apparent the U.S.-based subprime mortgage crisis had spread to a global recession, investors fled back to the relative safety of the dollar. By June 2010, the euro was only worth $1.20. Its value increased to $1.45 during the U.S. debt crisis in the summer of 2011. However, the eurozone crisis drove it value down again, to $1.33 by the end of that year. (Source: Federal Reserve)

Eurozone Crisis

In 2009, Greece announced it might default on its debt. Ever since then, the EU leaders have been trying to reassure investors that they will guarantee the debt of all eurozone members. At the same time, they want indebted countries to install austerity measures, and start to ratchet down their debt. In two years it's taken for the EU to develop a response to the crisis, the Greek debt crisis escalated into the potential for sovereign debt defaults from Portugal, Italy, Ireland and Spain. Some say the future of the euro and the EU itself is at risk.

Euro History

The euro was launched in 1999. It was first introduced as the currency for electronic payments, including credit and debit cards, loans and for accounting purposes. During this initial phase, old currencies were used for cash only. The second phase was launched in 2002, when euro coins and banknotes appeared in physical form. Each country has its own distinct form of the euro coin.

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