How the Euro Works

The European Commission (EC) was given the task of creating the euro symbol as part of its communications work. There were three things the design had to accomplish:

The EC had more than 30 designs drawn up. They selected 10 from those and let the public vote, which narrowed those 10 down to two. From there they made their final selection. The design that was selected is based on the Greek letter epsilon, and also resembles the "e" as the first letter of the word "Europe." The two parallel lines through the center of the "c" represent stability.

The euro is abbreviated as EUR. This was established through the International Organization for Standardization (ISO).

There are seven euro bank notes. Their design was also the result of a contest. Designers were nominated by the national central banks, and the competitors turned out designs for the seven bank notes based on either the theme of "Ages and Styles of Europe" or an abstract modern theme.

Robert Kalina of the Oesterreichische Nationalbank won the competition. His designs were selected at the Dublin European Council in December of 1996. He based his designs on the theme of seven important architectural periods in Europe's cultural history.

The seven bank notes are printed in different sizes and shapes for easier identification. Here is what they look like:

There are eight euro coins ranging in value from 1 cent to 2 euros. They also vary in size and thickness according to their values to promote easier identification. As with the bank notes, there was a Europe-wide competition for the coin design. Luc Luycx of the Royal Belgium Mint had the winning designs for the side of the coins that is common to all 12 member states.

The design features one of three maps of Europe surrounded by the 12 stars representing the Euro member states. The opposite side of the coins has designs specific to each country, also surrounded by the 12 stars. Although each country has its own coin design, each coin is accepted in any member state.

Here is what the common side of the coins looks like:

To see each of the member states' designs, click here (then click on the map for the country whose coin you wish to see).

The European central banks paid for the initial supply of currency to be produced -- a staggering 50 billion euro coins and 14.5 billion euro bank notes!

The original seed was planted in 1946 when Winston Churchill suggested the creation of the "United States of Europe." His goals were primarily political, in that he hoped a unified government would bring about peace for a continent that had been torn apart by two world wars.

Then, in 1952, six west-European countries took Churchill's suggestion and created the European Coal and Steel Community (ECSC). These resources were quite strategic to the power of each country, so a requirement of the ECSC was that each country allow their resources to be controlled by an independent authority. Their goal, just as Churchill had intended, was to help prevent military conflict between France and Germany.

In 1957, the Treaty of Rome was signed, declaring the goal of creating a common European market. It was signed by France, Germany, Italy, Belgium, the Netherlands, and Luxembourg.

After many false starts, the process of creating the Euro got its real start in 1989, when the Delors Report was published by Jacques Delors, president of the European Commission. This important report outlined a three-stage transition plan that would create a single European currency. In the next section, we'll look at the stages.

As outlined in the Delors Report, the transition to a single European currency followed a three-stage plan:

For more details on the events occurring between 1957 and 1989, see the More Euro History section.

There are currently 13 member states of the European Union utilizing the euro:

Additionally, six non-EU countries and territories use the euro as a form of payment:

To participate, countries must meet the requirements that were set up in the Maastricht Treaty, drafted in 1991.

Countries that meet the criteria but did not wish to participate include Great Britain, Denmark and Sweden.

In addition to the membership requirements of the EU, countries who wished to participate in the euro and be a part of "Euroland" had to pass some economic tests referred to as convergence criteria:

While there was much debate over how strictly these requirements must be upheld, it was finally determined that participating countries must show that they are at least "on course" to meet the requirements.

Meeting the initial requirements, however, is not a one-time thing. The Stability and Growth Pact, which was drafted in 1996, established an agreement stating that fines would be charged to countries who have excessive deficits. Member states cannot run a budget deficit that is greater than 3.0 percent of the GDP. If they do, they will be charged 0.2 percent of their GDP, plus 0.1 percent of the GDP for every percentage point of deficit above 3.0 percent. The Pact does not automatically impose these fines, however. Countries that are in recession, which is defined as a fall by at least 2.0 percent for four fiscal quarters, may automatically be exempt. A fall by any amount from 0.75 to 2.0 percent requires a vote by the EU to impose the fine.

While the Pact is structured as a stabilizer for the economy, there are still those who argue that it can be damaging to economies in that governments can adopt a loose fiscal stance during times of fast growth, but put the brakes on excessively during slowdowns.

The European Central Bank (ECB) was established in 1998. Its job is to make sure that the European System of Central Banks (ESCB) implemented the changeover required by the euro statutes and generally carries out its duties. The General Council of the ECB was responsible for setting the conversion rate for the euro for each participating country. Those rates were established in January 1999, and are "irrevocably fixed." The conversion was based on the existing currency so that the euro is simply an expression of the previous national currency.

The ECB used guidelines established in a Joint Communique that was issued on May 2, 1998, by the ministers of the member states who were adopting the euro. In order not to modify the external value of the European Currency Unit (ECU), they used the bilateral rates of the Exchange Rate Mechanism (ERM) to establish the fixed conversion rate for each national currency. The calculation of the exchange rates followed the regular daily concertation procedure, which used the representative exchange rate for each nation's currency against the U.S. dollar as of December 31, 1998.

Here are the established values. One euro equals:

On January 1, 1999, the euro was established as the official currency of the 12 participating member states of the European Union. The conversion rates were "irrevocably fixed," and the euro officially "existed." At that point, the euro could be used for non-cash transactions, such as making electronic payments, writing checks, or credit transactions. Although this sounds confusing, in most cases the balances were shown both in the national currency as well as in the converted euro amounts. The currency changed, but because of the established conversion rate, the value remained the same.

The euro currency was introduced on January 1, 2002. Some countries had slightly different schedules for the end of circulation of their existing national currency. This is the schedule for the euro introduction and endings for national currencies:

When items were purchased with national currency, the change was given in euros. Exchange of cash was also done in banks. Automated teller machines (ATMs) began distributing only euros on January 1, 2002. During the "dual circulation period," until the final deadlines were reached for changeover, both national currencies and the euro were accepted, but after that point only the euro was acceptable legal tender. Banks will still be able to exchange old currency for new currency until approximately 2012.

The euro is fundamentally a tool to enhance political solidarity. This political motivation began when the idea of the European Union and a single currency was first conceived. While it also has the economic effect of unifying the economies of participating countries, it ultimately does much more for the European Union.

Economically, the euro's advantages include:

While there are many advantages to the euro, there are also some disadvantages. The cost of transitioning 12 countries' currencies over to a single currency could in itself be considered a disadvantage. Billions were spent not only producing the new currency, but in changing over accounting systems, software, printed materials, signs, vending machines, parking meters, phone booths, and every other type of machine that accepts currency.

In addition, there were hours of training necessary for employees, managers, and even consumers. Every government from national to local had impact costs of the transition. This enormous task required many hours of organization, planning, and implementation, which fell on the shoulders of government agencies.

The chance of economic shock is another risk that comes along with the introduction of a single currency. On a macroeconomic level, fluctuations have in the past been controllable by each country.

In addition to the chance of economic shock within Euroland countries, there is also the chance of political shock. The lack of a single voice to speak for all euro countries could cause problems and tension among participants. There will always be the potential risk that a member country could collapse financially and adversely affect the entire system.

The Treaty of Rome was ratified in 1958, establishing the European Economic Community (EEC). The goal of the EEC was to reduce trade barriers, streamline economic policies, coordinate transportation and agriculture policies, remove measures restricting free competition, and promote the mobility of labor and capital among member nations. It was very successful, but just as with the ECSC, it served more of a peacemaking role between the European nations than an economic role.

At this time, the monetary exchange rate between countries was controlled by the Bretton Woods system, which connected currencies to the U.S. dollar, allowing for only a one point fluctuation around designated values. This was referred to as the "pegged rate" and was based partly on the gold backing of the dollar. This system worked well for 20 years, helping to stabilize exchange rates and restore economic growth in the postwar period. By 1960, however, the system began to fail, and exchange-rate agreements became the prevalent topic among European political and economic leaders.

By December 1969, Luxembourg's Prime Minister, Pierre Werner, was asked to write an EC (European Community) report covering the need for a complete monetary union among the European economies. The Werner Report came out in 1970 and specifically brought up the idea of a single European currency as part of a cooperative monetary effort. The report was the first to use the term Economic and Monetary Union.

Although this plan seemed promising, it lost momentum when President Nixon's 1971 policy of "benign neglect" ended U.S. backing (by its gold reserves) of the predefined exchange rates against the dollar, collapsing the Bretton Woods system. Other foreign central banks were not willing to support the dollar, which would have provided the equivalent of deposit insurance.

So where did that leave the European countries when it came to the stability of their currencies? It brought about the development in 1979 of the European Monetary System (EMS), which locked exchange rates among the participating countries into predefined trading zones. This was known as the Exchange Rate Mechanism (EMS). This move, in itself, stabilized the economy by creating predictable trading zones.

The next move toward a unified European economy came with the 1987 Single European Act. This act called for the systematic removal of barriers and restrictions that hampered trade between European countries. As a result, border checks, tariffs, customs, labor restrictions and other barriers to free trade were dismantled.

For more information on the euro and related topics, check out the links on the next page.