I still remember as vividly and if it were yesterday a lunch conversation with my colleagues at the Yale School of Management in late 2001. It was just a few months before the euro was introduced as the common currency of 12 European countries. The changeover rate between the new currency and the legacy currencies of these countries had already been fixed, on 1 January, 1999, and by then the EUR-USD exchange rate was about 0.85, meaning you would receive 0.85 USD per euro. Laughter rocked the table when someone entertained the hypothesis that one day there would be parity between the two currencies.
But by July 2002, the euro was already more expensive than the dollar. The relative price of both currencies is by no means an indication of which one dominates. Still, it remains interesting to recall the original skepticism with which the new currency was welcomed, especially outside of the euro area.
We are, today, living through the most difficult times in Europe since 1945. How different might history have panned out if Ukraine had been a member of the EU and had it adopted the euro? Perhaps it is also useful to reflect on the reasons why the country’s accession to the EU and the euro is only being considered now that Ukraine has been invaded by Russia. We must learn from the experience of other euro members as we imagine the best possible scenario for a future Ukraine.
“When capital is cheaper, companies are worth more. That is why euro-area stock markets displayed such a strong performance in the years following 2002”
I have written before about how the euro is one of the greatest experiments in our financial history. Let me add now, in 2022 – the 20th anniversary of its introduction – that there are clear positive results of this experiment.
Most notably, without the euro, the economic conditions of all euro members would today be much worse, in general terms.
Remember that in 1999, the monetary conditions of Europe were characterized by a set of strong currencies – particularly the German mark – in heavily exporting countries, and weak currencies in peripheral, importing ones. The Italian lira had been devalued 13 times against the German mark between 1979 and 1992 within the European Monetary System (EMS) introduced in 1979.
In both cases, realignment was necessary because expensive currencies damage exporting economies, and weak currencies damage importing ones. In that sense, the European Union was a natural candidate for a common currency. It allowed Germany to gain a profitable market for its cars, while making it easy for Spaniards and Greeks to offer their services to other European countries and to buy their products.
If we look back and measure the impact that two decades of the common currency has had on European citizens and companies, we can identify five major trends:
I illustrated the early inflationary impact of the changeover in my working paper “Separated by A Common Currency: Evidence from the Euro Changeover.” This impact was a novel and interesting psychological effect of introducing a new currency with a difficult conversion for some legacy currencies, such as the peseta and the lira. My research, which I carried out with the late Augusto Rupérez Micola, provided evidence of the significant price increases that happened as a result of rounding (typically up) to the closest cent. For instance, before 1999 the normal price for a newspaper in Spain was 100 pesetas (the equivalent to 0.602 euros after changeover). Prices rapidly increased to one euro in less than five years.
This early impact of the euro overshadowed the important effects of the single currency at a corporate level: by reducing currency risk and increasing the availability of funds, the euro significantly reduced firms’ costs of capital. A lower cost of capital has direct and indirect effects.
Directly, when capital is cheaper, companies are worth more. That is why euro-area stock markets displayed such a strong performance in the years following 2002. By 2007, both the Italian and Spanish stock markets had outperformed their German and US counterparts. With the emergence and dominance of digital platforms since then, this is no longer the case. Yet the original push to valuations caused by the euro was an important driver of capital attraction for some countries, especially those that had weaker currencies before the euro.
As for indirect effects of the reduction in firms’ cost of capital, my research has also shown that a very important consequence of the euro, especially prior to the 2008 crisis, was a significant increase in corporate investment. As a result, European companies have caught up with those from the US and China.
What about the “strong-currency” countries? Even without taking into account the reduction in currency risk that using the euro implies for these countries (which is, in any case, small), its very introduction has integrated European capital markets in such a way that a German company, say, could tap investors in France or in Italy.
That is to say, the euro facilitated the integration of stock exchanges. Euronext, for example, was founded in 2000 by the merger of the Amsterdam, Paris and Brussels exchanges. To date, markets in Lisbon, Dublin, Milan and Oslo have also been integrated within it.
“Realignment was necessary because expensive currencies damage exporting economies, and weak currencies damage importing ones”
For all countries in the Euroland, the period after 2000 has been characterized by an increase in debt financing, both at the corporate and country levels. This is good news because European institutions were previously more reliant than their US counterparts on bank loans as opposed to corporate debt – the cheaper option. The development of European debt markets is a legacy of the euro.
The cost-of-capital effect for companies can also be extended to countries. Not surprisingly, the 2009 European debt crisis was caused by excessive borrowing on the part of some countries. Nevertheless, the increase in capital availability it engendered facilitated domestic investments in education, infrastructure and health, thus driving the competitiveness of euro-area country members. Today, we could not explain the impressive quality of transport infrastructure in Southern and Eastern European countries without referring to the role of the European Central Bank and the euro, in terms of financing.
The EU is an imperfect union, it regularly confronts crises ranging from populism and refugee movement to debt and unemployment. But had it not been for the euro, these would have been far worse. Imagine how Russia might entertain treating Latvia, Lithuania and Estonia if they were not members of the EU and of the euro? Would Russia have invaded a member of the eurozone?
Now, more than ever, those countries on the eurozone’s periphery – which are still in the early process of euro adoption – must accelerate their integration. The potential benefits of the currency are today even greater than what they were for early members. It has become paramount that Poland, Romania, Bulgaria, the Czech Republic and other European countries accelerate their convergence process because a euro that spreads wider will make Europe safer and more stable economically.
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