Euro Performance 2002-Present

When one looks at a graph of the Euro's performance in comparison to the US dollar, one sees an enormous increase in value beginning on almost exactly January 1, 2002. This, of course, is the day that the Euro was officially released as a hard currency - in the form of more than 15 billion notes and 60 billion coins. Formerly, beginning on January 1, 1999, the Euro had become the official accounting currency of the Euro Zone and had suffered because of concerns addressed previously. I would like to examine today why the Euro increased in value so much following its public release.

What were the concerns about the Euro?

1. Proctor and Gamble feared that their international market would tank because people would not be prepared for the changeover. They anticipated "long lines and confused consumers". They ran ads in Europe encouraging people to change their money to Euros early, and to stock up on soap and diapers. Whether this was a marketing campaign or a genuine concern, it indicates that at least some major players were paying attention.

2. The Dutch finance minister put voice to a minor concern when he stated that he worried that bad weather might prevent people from venturing to the bank to exchange their currencies. One might dismiss this as negligible, until one considers that a big snowstorm (properly timed) could have put a stop to all financial activities in a small country a day or more.

3. The plates used to make the Euros were stolen just a few weeks before the official release. Many officials were extremely concerned that on opening day, the market would be flooded with counterfeit Euros.

4. There was little consumer education about the Euro outside of the Euro Zone. Some individuals were concerned that money laundering or even amateur counterfeiting could take place in foreign countries. I certainly wouldn't have known what a Euro looked like if someone tried to sell me one pre-2002 - I'd have to trust them that they were handing me the correct bill.

5. Working with a whole new currency imposes a cost on European businesses. Changes in currency must be accounted for within a business, which creates more work to be done, which equates to more man-hours, and more expense. If changing accounting procedures proved to be too costly or too difficult, confidence in the Euro would decrease.

Why has the Euro increased in value since 2002?

1. European countries trade extensively with each other. When each country had a different currency, the cost of trade was very high because of the necessity of changing currency at least once. Anyone who has had experience with international travel can relate that currency conversion is an expensive proposition, if only because the rates charged are so high. If a German company buys French goods, the French company wants Francs, not Marks. It costs the German company to change some of their money into Francs for the purchase, effectively increasing the cost of the French goods and encouraging the Germans to look elsewhere for their purchases.

One important factor here is "exchange rate uncertainty" - this is the uncertainty that forces the questions, "Am I getting a good deal on this exchange? The value of this currency changes every day - how do I know that tomorrow my money will be worth the same amount?" If one imagines that the price of bread varied daily between $1 and $2, one begins to understand the reason for this uncertainty. You want to buy bread on cheap days, but who's to say that it won't be cheaper (or more expensive) tomorrow? Should you wait, or buy now? This hesitation adds up to missed opportunities, which can be equated to inefficiency.

By having a single currency, the Germans are just as inclined to buy French goods as German goods, or Italian goods, or Spanish goods. This increases the amount of competition in any given market, because it increases the number of suppliers - always a good thing. Consider that with the adoption of the Euro, every international business transaction in Europe suddenly became 3% less expensive. That adds up to a lot of money very quickly.

2. Several major central banks were persuaded to buy large quantities of Euros. More importantly, they advertised their purchases to the public. Specifically, the People's Bank of China, the Bank of Japan, the Central Bank of Taiwan, and the Bank of England all made large Euro purchases in early January 2002. When people see large and trustworthy banks investing in a currency, they gain confidence in the currency and its ability to enable trade. After all, the People's Bank of China would not spend all that money if there was any uncertainty about the Euro's viability, right?

3. In modern America, the magic word is "IPO" - a result of the 90s stock market explosion. So many initial public offerings in that decade were hugely succesful that even into the 21st century, individuals who know nothing about stock markets or trading are suddenly willing to invest fortunes when an IPO is made. Sadly, the European investment market is no more intelligent than that of the US. The Euro promised to be one of the biggest "IPOs" that many European investors had ever seen. When studying decision theory, economists sometimes divide people into risk-takers and risk-averse individuals. It's no surprise that the risk-takers (usually young professionals with few financial obligations) jumped on the Euro as an investment and inflated its value - possibly too much. Nevertheless, the enthusiasm surrounding a new currency certainly helped the Euro find success.

4. Said one Frankfurt-based currency trader, "You can now hold the euro in your hands, you know it is a real currency with intrinsic value. The successful introduction of the notes and coins is of immense psychological importance and could change people's attitudes towards the currency." Enough said.

5. The European economy experienced a slowdown in the first two quarters of 2001, experiencing just 1.2% annualized growth. An increase in foreign aquisition of European-based companies and the economic recovery of 1st quarter 2002 provided an excellent boost to the new currency.

6. One economist describes that the Euro's "basic balance" - the sum of current-account balances plus long-term capital flow - is growing. She indicates that, "This indicates that during the course of 2002, the Euro might at last have the opportunity to appreciate."

7. When talking about an increase in the Euro's value, it's important to realize that we're measuring its value against our own currency, the US dollar. One of the reasons for the Euro's "increase in value" can actually be attributed to the declining value of the dollar. A report from the WSJ in November 2002 reminds us of the very serious recession that the United States was encountering during that time: "The official US unemployment rate increased slightly to 5.7 percent in October (from 5.6 percent the month before) as businesses continued to carry out substantial layoffs, resulting in a net loss of 5,000 jobs. More than 8 million people are currently registered as unemployed, while another 4.3 million work part-time although they would prefer full-time employment."

Clearly the Euro has had a number of reasons to increase in value, and it's no surprise that it's done so. Next I'm going to look at whether or not these trends are likely to continue into the future.