A Brief History of the EU/Eurozone (A Very Simple Guide)
December 17, 2011
With the trade of the past several months being all off the European debt crisis and the relative value of the Euro and the dollar, we were curious to brush up a little bit on the history of what is generally called the Eurozone and the performance specifically of the Euro. One of the items which prompted this was our clear recollection that the Euro used to be priced far closer to the dollar back in the day and we wanted to check out a historical perspective on that.
The roots of the Eurozone were first established in 1957 when the Treaty of Rome created the European Economic Community, better known as “The Common Market”. The Euro currency was launched in January, 1999 as an “electronic” or “accounting” currency as an outgrowth of the adoption of the “Masstricht Treaty” in 1992-93, which was also known as the Treaty on European Union. The treaty went far beyond just currency matters, covering a range of issues related to economic cooperation, immigration, legal and criminal justice systems, foreign policy, and national security and military cooperation.
The first official Euro notes and coins were issued with great publicity on January 1 2002, when the Euro became legal tender for all transactions in Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain. Old national currencies were phased out over the next few months during a difficult and emotional transition period. The most notable hold-out was the U.K., which still obviously operates in a bit of maverick fashion within European matters.
The maze of various subsequent treaties, commissions, and agreements is beyond the scope of this simple guide. But the level of confusion and misuse of some terms requires an explanation of two key terms: the European Union (EU) and the Eurozone.
The European Union currently consists of 27 member states. The EU is a single market, meaning that a standardized set of laws applies in all member countries. For the most part travel between member states is free of passport and border restrictions. At the most basic level the intention of the Union is to provide for “the free movement of people, goods, services, and capital.” Common policies are enacted on a wide-range of policy areas including justice and law enforcement, agriculture, health and the environment, regional development, fisheries, energy and climate change. The Union has an area of a little more than 1.5 million square miles and a population of just over 502 million, or about 7% of the world’s people. The Union’s nominal GDP is approximately $US16 trillion, or about 20% of world GDP.
The Eurozone is a subset of those European Union member states that have fully incorporated the euro as their sole national currency. There are currently 17 such states: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. Monetary policy for the Eurozone is under the authority of the European Central Bank. The bank was established by the Treaty of Amsterdam in 1998 and is one of the world’s most important central banks. The Euro itself is, after the USD, the second largest reserve currency and second most traded currency in the world. The Eurozone is sometimes more casually called the Euro Area, but is also more officially known as the EMU (Economic Monetary Union), a relatively little used term in the press.
The most notable nations, then, which are members of the European Union but do not use the Euro as their official currency are: the Czech Republic, Denmark, Poland, Sweden and the United Kingdom. Switzerland stands out as the major holdout to both the EU and the Eurozone.
The New York Times very recently had a major editorial piece which analyzed the sad political irony of the European debt crisis and all the machinations to revise historical treaty relationships. Their main point was that the very creation of the EU which was intended to put nations on a more equal footing has evolved into an organization with Germany in clear control, with France a distant second, and the UK looking in from the outside.
But now on to where this whole project started, namely, the historical relationship of the Euro to the dollar. According to several sources, the Euro’s all-time low vs. USD was in October 2000 at $0.825. All-time highs were at $1.599 in July 2008. We think it is fair to say that the “normal range” of the Euro versus the dollar has historically been between $1.20 and $1.35. This suggests, we think, that the fanfare around the recent break of $1.30 has less to do with a pure currency relationship and more to do with the strong drop in the Euro in recent months and what that says about underlying economic conditions in the Eurozone and fears over recession.
From January, 2002 to December 17, 2011, the mean price of the Euro has been $1.277. During the period of strongest performance of the SPX, 2006-2007, the Euro traded in a range of $1.19-1.45 versus the dollar. When the SPX was making all-time highs in 2007, the Euro was trading $1.32-1.38. During the March 2009 lows for the SPX, the Euro was trading at $1.30. During market highs this year in April-May 2011, the Euro was trading at about $1.43.
Very simple conclusions? Yes, there is no doubt Euro strength over $1.35 has been generally associated with higher levels in the SPX, due to any number of economic factors having to do with the price of imports/exports, commodities, relative interest rates, and many other complicated macro-economic relationships. But it seems to us that there is far more to the story than the recent 1:1 relationship of moves in the Euro to the performance of U.S. equity markets, as we are currently seemingly seeing. We think the relative strength or weakness of the Euro versus the dollar has far more to do with how the market is voting on economic prospects for Europe versus the U.S. than a pure currency play. If not, why were all-time highs in the Euro not associated with all-time highs in the SPX in July 2008? Maybe we are splitting hairs, but the huge question going forward is whether or not a stronger dollar can also be associated with decent U.S. equity market performance? Many economists think it can.
(IMPORTANT NOTE: According
Comments
Peter - Thanks for you insight here - Very informative!
Thanks Peter, agree with Dave on excellent points..we generally do get too much into politics here but think you are right on the mark. When one thinks about it it is astonishing that sovereign nations would be willing to cede so much budgetary control to a "higher authority"..however, one could argue that it is equally astonishing that such very different nations would share a currency and an economic fate without even tighter economic ties...would Germany really care that much about the outcome for Greece if they did not share a currency? you are right on the mark about the difficult, or as you say easy, choice facing Cameron and the UK but we should not forget about the difficult political situation of Ms. Merkel..she is facing outrage on many fronts that Germany is being asked to help bail out weaker Euro nations..we tend to complain a lot that Germany is not stepping up to the plate faster and in a bigger fashion but internal politics have to explain a lot of that, as do legal issues...history books will likely debate forever whether or not the Eurozone and EU went too far in developing intergovernmental dependency or not far enough and speaking of politics, just this week Ben Bernanke had his feet put to the fire by Republican Senators trying to elicit an overt promise that the U.S. would not go too far in contributing to European bailout efforts, either in direct fashion or through the IMF....although it was supposedly a "closed door' meeting the Senators spun it as though they had carried the day..we really do not know what Geithner, Bernanke and the Obama adminsitration will ultimately do if the crisis goes further downhill fast
You US perspective on the position of the United Kingdom relative to Europe is an interesting one. The European experiment was sold, by politicians, to the people of the UK as a common market, not much more than an extension of the European Free Trade Association which already existed. Over the years it has changed not only its name but also its nature. This has resulted in a very substantial transfer of sovereign powers by the members to the unelected (and worse, the unaccountable) bureaucrats who run, what has become, the European Union. The current government of Prime Minister David Cameron has legislated that any further transfer of powers by the UK to Europe can only be effected if approved by the people in a referendum. Therefore when he was asked to agree to a treaty amendment, which would cede further powers to Europe, he had no alternative but to say no. Cameron knew that if, as he was required to do, he held a referendum the people of the United Kingdom would not agree to the transfer of further sovereign powers to Europe and therefore the United Kingdom would not be a party to the new proposals to centralise budget deficits and borrowing by members of the Union. However losing a referendum would result in loss of political capital by Cameron at home.By saying no ab initio he gained political capital at home. In retrospect using the veto was a no brainer.