Nineteen nations in the European Union utilize the Euro as their Currency. How did this come to be, and was this a good idea?
The Story Goes back to the end of World War 2. After the war, the economies of many countries were in an unpleasant condition. A few European countries decided that the only way to achieve growth was to come together and cooperate.
Formed the European steel and coal community to regulate production to achieve growth and overcome the war’s negative economic impact. This centralized European body later evolved into the European Union.
At that time, the European Union’s main aim was to help grow the economies of the countries that were part of it. After the war, inflation was too high, and currency exchange rates were fluctuating. When currency exchange rates fluctuate, trade is also affected. Let’s say if France trades with Italy.
The Currency of France is Francs, and that of Italy is Lira. Let’s say the exchange rate is 1 Franc is 2 Liras. Now let’s say there’s a shipment coming from Italy to France and the shipment costs 1000 Francs. So Italy is paid 2000 Liras. Now Imagine if the value of the Lira drops by 20%. So the package in Italy is only worth 1600 Liras.
That means France has paid for the parcel at a higher rate and missed out on potential profits. With the fluctuating exchange rate, it isn’t easy to make business decisions. So to stabilize trade, in 1970, the European Union fixed the exchange rates.
This means that no matter how inflation rates might fluctuate or how much ever tastes and preferences of customers change, the exchange rates of these countries in the EU would remain fixed. Now, these countries had based the value of their currencies on the American Dollar.
Since the dollar is rarely varied, the European currencies didn’t vary too, and trade was more or less stable. Now you may ask, where does the American Dollar get its value.
From gold, Since the price of gold is relatively stable, the dollar value doesn’t fluctuate too much. But this changed when Richard Nixon became the president of the US. Nixon abandoned the Gold Standard, and the US dollar now relied on the markets, which means that the dollar rate started fluctuating wildly. With it, all other currencies that relied on the dollar started fluctuating too. So countries in the European Union had to think of something better.
So in 1991, the European Union decided that it would adopt a common currency – The Euro. Not all countries could adopt this Currency. The government had to have low inflation and interest rates, expenditure less than 103% of its income, and debt less than 60% of the country’s GDP to adopt the Euro.
Now it does sound like a novel idea. After all, a common currency will be way easier to deal with market fluctuations and impeccably improve trade. But things got slightly complicated soon later. Few countries in the EU were brought into a debt crisis.
Once the EU is formed, it becomes easier for poorer and economically weaker countries to borrow money quickly. Because the EU is one group, it’s one family. So, even if one country defaults, you have the backing of other economically strong countries like Germany, France, etc. Debt or borrowed money plays a significant role in driving the economy forward.
Governments often borrow money in a bid to increase Govt spending. E.g., if a govt spends some money on building roads and other infrastructure, it will employ thousands of people, meaning more employment, more income in people’s hands; when they go out and spend their money, it generates revenues for someone else. It’s a nice flywheel that can propel the economy of any country. Many countries in the EU started borrowing and were unable to pay back their debt. To give you a specific example, consider Greece. Greece was in a severe debt crisis. For Greece to increase spending, it went on a borrowing spree and, after a while, could not repay its debt.
Eventually, it bailed Greece out of its massive burden by the IMF, the European Union, and Mainly Germany.
Similarly, the European Union told Germany to pay off everyone’s debt.
Consequently, these indebted countries bailed out by Germany had to adopt Germany’s stringent spending policies. So many of these indebted countries had to reduce government spending. As a result of this, demand decreased, and many jobs were lost, and the economies of these countries started to suffer.
So how did the European Union solve this? A couple of steps.
- They Set up a 200 Billion Euro fund to save companies from going bankrupt
- To start and run a business to help kickstart the economy, it reduced the minimum capital to start a business.
- It also gave the option to investors who lent money and didn’t have their loans repaid to sell their debt to the European Central Bank, which is the central bank of the European Union, to get some of their investment back.
- They Suggested indebted countries to dis-invest or sold their government companies
- They limit how much these countries could spend to prevent them from overspending and going bankrupt again. So with these measures in place, this crisis is unlikely to happen again, and that’s the Story of Countries adopting the Euro.