Euro Performance to 2002

The Euro has only been introduced in the past few years, but economists with bigger calculators than I have devised a method to reverse-predict the Euro's value all the way back to the mid-70s. However, the data can really only be evaluated with any purpose starting at about 1990.

During the period of time from 1990 to 2000, the Euro is considered to be a weak currency. According to the IMF, the exchange rate from Dollars to Euros fluctuated between about 1.05 and 1.30. When the Euro was introduced in 1999, the exchange rate fell to 0.82 at one point, and fluctuated between that low and about 1.17. From 2000 to 2002, the exchange rate was almost continuously below the 1.0 mark.

How do we explain this weakness?

The following data comes mostly from here.

1. The economic performance of the Euro Zone was inferior to that of the United States during this period. The United States experienced an average annual growth rate of 3.3%, whereas the Euro Zone had only a 2.0% growth rate. Further, data from the OECD reveals that the average annual labor productivity growth rate in the United States was positive, while in the Euro Zone it was negative.

2. The Euro Zone countries can be called comparitively inflexible in comparison to the United States. Political necessity has placed a high value on social cohesion and labor force appeasement, significantly decreasing the ability of the French, German, and Italian economies to be flexible.

3. The Euro Zone tried to incorporate too much, too soon. One of the most important parts of the EMU has been the "single (or free) market". In this system, goods and services travel freely without tax within the Euro Zone. This is a necessary step in order to successfully adopt a single currency. However, as of November 2001, it is estimated that 10% of the necessary measures to successfully deploy this system had not been taken. This resulted in enormous price differences (sometimes up to 200% for specific food items) and a lack of confidence in the new currency.

Aside from these clearly economic reasons, I like to think about what investors were probably considering as the Euro was coming to market. People are emotional and compulsive creatures, and this must be taken into account. I'm sure people were thinking two things - on the one hand, they were undoubtedly excited about the prospects of a new currency, and on the other hand they were surely nervous that if they invested and the currency failed, they would lose all their money.

Since most people are risk-averse (and don't fully understand money markets), it makes sense that most people would hold off from investment to see how the currency would perform first before investing. It has been shown that a decrease in the amount of investment undervalues a stock or currency, so it is no surprise that the Euro decreased in value at this time.

It has been suggested that at the end of 2001, the Euro was undervalued by as much as 25%. 6 studies conducted at the time place the appropriate Euro value at somewhere between 1.10 and 1.20 US dollars - indicating a significant devaluation.