The euro is the form of money for the 19 member countries of the eurozone. It's the second-most widely used currency in foreign exchange (forex) trading after the U.S. dollar and the second-most widely held foreign exchange reserve used by central banks.
Because the euro is used in so many countries, how it performs in the open market not only affects those countries but has a ripple effect across other economies as well. Learn the history of the euro, why so many countries use it, and the advantages and disadvantages of one form of currency being used by so many countries.
Definitions and Examples of the Euro
The euro was initially proposed as the official currency of the entire European Union in order to unify the countries. All 28 member nations pledged to adopt the euro when they joined the EU, but they must meet budget and other criteria before they can officially switch currencies. These were set out by the Maastricht Treaty. As a result, seven EU members have not adopted the euro. As of 2021, they were Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, and Sweden. Denmark has opted out.
As of 2021, there are 19 member countries of the European Union that use the euro as the official currency. They are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. Four non-EU territories also use the euro; they are Andorra, Vatican City, Monaco, and San Marino.
Fourteen African nations peg their currency to the euro. These are former French colonies that adopted the CFA franc when France switched to the euro: Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Republic of Congo, Côte D’Ivoire, Equatorial Guinea, Gabon, Guinea-Bissau, Mali, Niger, Senegal, and Togo.
Iran prefers euros for all foreign transactions, including oil, of which Iran has the fourth-largest reserves in the world. It has converted all dollar-denominated assets held in foreign countries to the euro.
How the Euro Works
Like the dollar, the euro is managed by one central bank, the European Central Bank (ECB). Being shared by 19 countries complicates its management, as each country sets its own fiscal policy that affects the euro's value.
As of the first quarter of 2021, foreign governments held 2.4 trillion in euros compared to $6.9 trillion in U.S. dollar reserves. The International Monetary Fund (IMF) reports this quarterly in its COFER Table.
The euro symbol is €. Euros are divided into euro cents, each euro cent is one one-hundredth of a euro. There are seven denominations: €5, €10, €20, €50, €100, €200, and €500. Each bill and coin is a different size. The bills also have raised print, while the coins have distinct edges. These features allow the visually impaired to distinguish one denomination from another.
The euro-to-dollar conversion is how many dollars the euro can buy at any given time, as measured by the current exchange rate. Forex traders on the foreign exchange market determine exchange rates, which change on a moment-by-moment basis, depending on how traders assess the risk vs. the reward for holding the currency.
Traders base their assessment on a number of factors. These include central bank interest rates, sovereign debt levels, and the strength of the country's economy.
Advantages and Disadvantages of the Euro
Financially weak countries are backed by stronger ones
Large companies in bigger countries can produce more at a lower cost
Big companies enjoy high demand and production
Countries can't print their own currency
Countries give up fiscal autonomy
Countries must keep their budget deficit low and dramatically cut spending
Financially weak countries are backed by stronger ones: 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 because the euro isn't as risky to investors as a currency with less demand from users and traders. Over the years, these lower interest rates have led to more foreign investment, which has boosted the smaller nations' economies.
Large companies in bigger countries can produce more at a lower cost: Some experts say more developed countries have reaped greater rewards from the euro. Their larger companies can produce more at a lower cost, thus benefiting from economies of scale. They can export their cheap goods to the less-developed eurozone nations, and smaller companies can't compete.
Big companies enjoy high demand and production: Larger companies have also profited from investing cheaply in the less-developed economies. That increased prices and wages in the smaller countries, but not the larger ones. The larger businesses gained even more of a competitive advantage. In a sense, the euro allowed them to export the inflation that typically comes with the expansionary phase of the business cycle. They enjoyed the benefits of high demand and production without paying the higher price.
Countries can't print their own currency: Adopting the euro means countries also lose the ability to print their currency. That ability allows them to control inflation by raising interest rates or limiting the money supply.
Countries give up fiscal autonomy: Some countries are reluctant to give up some authority over their monetary and fiscal policies when they join the eurozone.
Countries must keep their budget deficit low and dramatically cut spending: Countries that adopt the euro must keep their annual budget deficits less than 3% of their gross domestic product. Their debt-to-GDP ratio must be less than 60%. Many simply haven't been able to cut spending enough to meet this criterion.
The European Central Bank provides the current exchange rate for the euro.
The first phase of the euro launch occurred in 1999 when it was introduced as the currency for electronic payments. These included credit and debit cards, loans, and other uses for accounting purposes. During this initial phase, old currencies were used for cash only. Eleven nations adopted it right away.
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.
When the euro launched in 2002, it was worth $0.87. Its value grew as more people used it through the years, and it reached its record high of $1.60 on April 22, 2008. 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 globally, investors fled back to the relative safety of the dollar. By June 2010, the euro was only worth $1.20. Its value rose to $1.45 during the U.S. debt crisis in the summer of 2011.
By December 2016, it had fallen to $1.03 as traders worried over the consequences of Brexit. It rebounded to $1.20 in September 2017 after traders grew frustrated with the lack of progress on President Trump's economic policies. It stood at $1.21 as of January 2021.
In 2009, Greece announced it might default on its debt. The EU reassured investors that it would guarantee the debt of all eurozone members. At the same time, it asked indebted countries to install austerity measures to ratchet down their spending.
The Greek debt crisis threatened to spread to Portugal, Italy, Ireland, and Spain. The European economy has rebounded since then, but some say the eurozone crisis still threatens the future of the euro and the EU itself.
- After the U.S. dollar, the euro is the second-most traded currency in the world.
- It is the official currency of 19 countries in the European Union, as well as four non-EU territories.
- The euro was created to facilitate and integrate the European economy, and it is managed by the ECB.
- The Greek debt crisis threatened other EU countries, showing that the interdependency on currency does have a downside.
- Other European countries such as Denmark use their own currency. They have opted to set their own interest rates and monetary policies and maintain the independence of their own economies.