The Euro was launched as an electronic currency in the beginning of 1999 and then became the official legal tender early January. It has been called “the single currency” and has been touted as the “new” reserve currency of the world, supposedly the candidate to replace the dollar as the world’s preferred currency. Given the depreciation of the dollar over the last two years, this lent further credibility to the Euro. The Euro is now as ubiquitous as the dollar, but is it really all its cracked up to be?

 What few realize is that the Euro is not the first attempt by the Euro zone to create a single monetary currency. In the late 70’s, the system of pegging currencies to the dollar was abandoned and the EU leaders attempted to created a new monetary system by “interleaving” the European currencies called the Exchange Rate Mechanism (ERM). Britain was a member of this system, however, it was Germany that was the dominant player based on its strong hand towards inflation. This system however came under immense pressure due to a particularly strong dollar and caused significant problems for the weaker European countries. The ERM required that the pound appreciate against the Dollar which was fatal for a struggling UK economy. George Soros forsaw this and shorted the pound forcing Britain to leave the ERM and forced to devalue the pound, in addition to other EU members forcing devaluation of their currencies too.

 In 1991 the Maastricht treaty was signed, forming the basis for the Euro. Although 15 countries joined, Britain conspicuously opted out. Not just anybody could join – you had to be approved based on your budget, inflation targets and interest rates. In order to administer this, a new European Central Bank (ECB) was formed.

 After around 20 months, the Euro had lost nearly 30% of its value when compared to the dollar. This caused the ECB to work with other central banks in an attempt to boost the value of the Euro.  Then, the terrible terrorist attacks of Sept 11th changed the dynamic: Money left the dollar and went to ‘safer’ currencies such as the Swiss Franc, and for the first time, to the Euro. This was the first time the Euro started to take its place as an alternate reserve currency to the dollar.

 The rise of the Euro, both in value and popularity, is now legendary. Part of this has been due to the role of the Euro as an alternative to the dollar, and part of it has been due to dollar depreciation. However, the strong Euro comes at a price to the EU zone. And with the first global financial crisis the Euro has to contend with, it remains to be seen how it functions. The dollar is enjoying renewed interest as nervous investors retreat to the historically safe haven: the dollar. Compound this with the fact that many of the EU countries will now face their own crisis.

 The leader of the EU pack, Germany, is now officially in a recession. It remains to be seen if they will continue to support the poorer EU countries when they themselves are fighting of a deepening financial crisis. One of the major problems with the Euro is a centralized interest rate. How can one interest rate be applicable for countries of differing economic strength? During boom times, this may have worked.

 Now that countries are being bought to their knees, each needs to adopt to its own particular problems with unique solutions. Spain has a housing crisis and ideally would need to set its own interest rate policies, not adhere to some centralized rate. In addition, these countries are supposed to adhere to specific budget deficits – criteria they met for joining the EU in the first place – but now face pressure to deviate. Either they will be allowed to “relax the rules” or suffer through a severe depression. It is likely they will be allowed to break the rules but this will harm the very fabric and integrity of the currency. What this means is that it will have failed its first test in its first crisis, whereas the dollar has weathered many crisis in the past.

This will be an interesting time over the next 24 months to see how this plays out. It is quite possible we see a major relaxation in the rules of the member countries, and even the possibility of some member countries leaving the EU. If these things happen, the Euro will be bruised – and the dollar, for all its problems, will continue to be viewed by investors as the reserve currency of the world.