The Birth of the Euro: Eleven Currencies Fixed on One Night, 1999

On the afternoon of 31 December 1998, finance ministers and central bank governors from eleven countries sat in Brussels and agreed a short list of numbers that could never be altered. One euro would be worth 1.95583 Deutsche Mark. It would also be worth 6.55957 French francs, 1,936.27 Italian lire, 2.20371 Dutch guilders and 40.3399 Belgian francs. Six significant figures were not decoration. Every bank deposit, mortgage, pension contract and government bond in eleven countries was about to be redenominated by arithmetic, and a discrepancy in the sixth digit would have moved billions.

Foreign exchange desks shut early. When they reopened on Monday 4 January 1999, the currencies in which most of continental Europe had been paid, taxed and indebted for generations had become denominations of a single unit that existed nowhere in physical form. No euro notes, no euro coins, no tills. There would be none for three more years — only a number on a screen, quoted that first morning at $1.1789.

What the Mark Was For

Any account of the euro that begins with economics has begun in the wrong place. Jacques Delors, who chaired the committee that designed monetary union, put the obstacle more accurately than any convergence report: "Not all Germans believe in God, but they all believe in the Bundesbank."

He was describing an institution built out of a specific memory. Germany had destroyed its currency twice in thirty years, and the second destruction was still within living memory of the men running the Bundesbank in the 1990s. The link between that experience and the statutory independence of German monetary policy is direct, and it is why the price of German participation in any single currency was a central bank modelled on the Bundesbank rather than on the Banque de France — a lineage that runs back through the Weimar hyperinflation of 1921–1923.

France wanted monetary union for close to the opposite reason. Under the European Monetary System established in 1979, the mark had become the anchor and the Bundesbank set the region's interest rates while answering to a German electorate alone. Paris called the arrangement asymmetric, which it was. A shared currency with a shared central bank would replace a German monetary policy that France had to import with a European one in which France had a vote.

Helmut Kohl's argument was neither of these. Speaking at the Catholic University of Leuven in February 1996, the German chancellor told his audience that "the policy of European integration is in reality a question of war and peace in the twenty-first century." He was proposing to surrender the Deutsche Mark — the most popular institution in the Federal Republic, more trusted than its parliament — and he never once pretended the case was commercial.

Academic opinion was considerably colder. Robert Mundell's theory of optimum currency areas set out the conditions under which regions benefit from sharing money: labour mobility, fiscal transfers, correlated shocks (Mundell, 1961). Europe in 1998 had little of the first, almost none of the second, and a poor record on the third. Milton Friedman wrote in 1997 that Europe's common market "exemplifies a situation that is unfavourable to a common currency" and predicted that the absence of a shared budget would turn economic divergence into political conflict (Friedman, 1997). Martin Feldstein went further in the same year, arguing in Foreign Affairs that monetary union could raise the risk of intra-European war (Feldstein, 1997). Mundell himself supported the project.

Delors and the Three Stages

Pierre Werner, Luxembourg's prime minister, had proposed a monetary union in 1970 and watched it dissolve when Bretton Woods did, a collapse traced in the post-war monetary order of 1944–1971. What replaced Werner's plan was the currency snake, then the European Monetary System, then a report delivered in April 1989 by a committee of central bank governors chaired by Delors, which laid out three stages and refused to put dates on the last two (Delors, 1989).

Stage one opened on 1 July 1990 with the removal of capital controls. Stage two began on 1 January 1994 with the creation of the European Monetary Institute in Frankfurt under Alexandre Lamfalussy, a central bank without a currency whose job was to build the plumbing. Stage three was the currency itself.

The Maastricht Treaty, signed on 7 February 1992 and in force from 1 November 1993, supplied the entry conditions. A candidate needed a budget deficit no greater than 3 per cent of GDP and public debt no greater than 60 per cent, inflation within 1.5 percentage points of the three best-performing member states, long-term bond yields within 2 points of the same three, and two years inside the exchange rate mechanism without devaluation. Britain and Denmark negotiated opt-outs. Denmark's voters rejected the treaty in June 1992 and accepted an amended version in May 1993.

Within months the exchange rate mechanism came apart. Sterling and the lira were forced out in September 1992, in a sequence recounted in the 1992 attack on the Bank of England, and in August 1993 the permitted fluctuation bands were widened to 15 per cent — wide enough that the mechanism barely constrained anything. Convergence had been written into law in the same eighteen months in which convergence visibly failed. Harold James's archival history of the negotiations argues the crisis paradoxically accelerated the project, because a currency that no longer needed defending was a currency that could not be attacked (James, 2012).

The Arithmetic of Convergence

Getting eleven budgets under 3 per cent in five years required measures that ranged from the orthodox to the inventive. Italy's deficit had been 7.1 per cent of GDP in 1995. Romano Prodi's government imposed a one-off levy formally called the tax for Europe and known to everyone as the eurotassa, refundable in part, and brought the 1997 deficit in at 2.7 per cent.

Germany tried something similar and was publicly refused by its own central bank. In May 1997 Finance Minister Theo Waigel proposed revaluing the Bundesbank's gold reserves, which were carried on the books at well below market price, and transferring the accounting profit to the federal budget. Hans Tietmeyer's Bundesbank Council objected in terms that left no room for negotiation, on the grounds that a central bank manufacturing a windfall to help its government pass a fiscal test would destroy the credibility the test existed to protect. Waigel withdrew the plan in June. Germany's deficit came in at 2.7 per cent anyway.

Debt was the criterion that could not be met, so it was reinterpreted. Belgium and Italy each carried public debt above 120 per cent of GDP against a ceiling of 60. The treaty permitted a ratio above the reference value if it was "sufficiently diminishing and approaching the reference value at a satisfactory pace", and in the spring of 1998 that clause did a great deal of work.

Reference values that year were 2.7 per cent for inflation and 7.8 per cent for long-term yields. Southern European bond markets had done most of the convergence work themselves: Italian ten-year yields, above 13 per cent in early 1995, had fallen to around 5.6 per cent by the end of 1997 as investors priced in the probability of membership. Markets were front-running the decision that markets would then have to live with.

Eleven Names, and a Twelve-Hour Argument

Heads of government met in Brussels over the weekend of 1–3 May 1998 to name the founding members. Eleven qualified: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. Greece did not, Sweden had stayed outside the exchange rate mechanism, and Britain and Denmark had their opt-outs. The formal Council decision carries the date 3 May 1998.

Most of the weekend went on a personnel dispute. Wim Duisenberg, the Dutch central bank governor, was the consensus candidate to run the European Central Bank; Jacques Chirac insisted on Jean-Claude Trichet, the governor of the Banque de France, and would not move. The summit ran close to twelve hours past its schedule before producing a formula nobody would put in writing: Duisenberg would take the eight-year term the treaty prescribed and issue a personal statement that he did not intend to serve all of it. Trichet succeeded him on 1 November 2003. Otmar Issing, who became the ECB's first chief economist, describes the episode in his account of the launch as a self-inflicted wound to an institution whose only asset on day one was credibility (Issing, 2008).

The European Central Bank came into being on 1 June 1998 with a mandate written to German specification: price stability first, independence entrenched in treaty rather than statute, and no monetary financing of governments. Article 104b forbade the Union and member states from assuming one another's debts — the no-bailout clause, which would be read very closely a decade later during the Greek debt crisis of 2009–2018.

The Night the Rates Were Fixed

Conversion rates were not negotiated. Heads of government had agreed in December 1996 that the irrevocable rates would be the existing central rates of the exchange rate mechanism, announced in advance precisely so that no trader could profit from guessing them. What happened in Brussels on 31 December 1998 was therefore a computation rather than a bargain: the eleven bilateral central rates were converted into rates against the European Currency Unit, whose basket value was calculated from the market at 11.30 that morning, and the euro replaced the ECU one-for-one at midnight.

Over the weekend of 1–3 January 1999, some 50,000 people worked through what the industry called the conversion weekend, rewriting the denomination of every security, account and payment instruction inside eleven financial systems. TARGET, the real-time settlement system linking the national central banks, went live on 4 January. Stock exchanges in Frankfurt, Paris and Milan opened quoting in euro. The switch functioned, which in retrospect is the most surprising fact about it.

The Currency Nobody Wanted

Then the new money fell for twenty-two months.

Parity went on 3 December 1999, eleven months after launch. The low came on 26 October 2000, when the ECB's reference rate printed $0.8252, a fall of about 30 per cent from the opening quote. Nothing in the euro area's fundamentals explained it: growth was reasonable, inflation was near target, the current account was close to balance. Capital was simply leaving for American technology stocks, and European direct investment into the United States — Daimler's purchase of Chrysler in 1998, Vodafone's of Mannesmann in 2000 — was itself a persistent bid for dollars.

Duisenberg made it worse by talking. Asked repeatedly in 2000 whether the ECB would intervene, he gave answers that traders read as an admission of indifference, including a remark to a newspaper in October that the bank would not intervene because of a speech by an American official. His summary of how he treated political advice on interest rates became the line he is best remembered for: "I hear, but I do not listen." The independence was genuine. The communication was not yet a craft.

On 22 September 2000 the ECB secured coordinated intervention with the Federal Reserve and the Bank of Japan, the first joint operation in support of the euro; the currency jumped roughly four cents and resumed falling. Three further unilateral ECB operations followed in early November. David Marsh's political history of the currency notes that the episode taught the bank a lesson it applied for the next decade, which was that intervention without a change in interest rates buys days (Marsh, 2009).

Recovery came from the other side of the Atlantic. As the American technology bubble deflated and the Federal Reserve cut rates through 2001, the capital flow reversed. The euro regained parity on 15 July 2002 and closed that year at $1.0487.

Fourteen Billion Pieces of Paper

Physical euros arrived on 1 January 2002 in the largest cash operation ever attempted. Roughly 14.9 billion banknotes had been printed and some 52 billion coins minted, weighing around a quarter of a million tonnes, and armoured deliveries to banks and retailers had been running since September 2001. Twelve countries and more than 300 million people changed their money in a matter of weeks. National notes and coins ceased to be legal tender by 28 February 2002 at the latest, and in Germany the mark's status ended on 31 December 2001.

Robert Kalina, a designer at the Austrian National Bank, had won the 1996 competition for the notes with a solution to an intractable political problem. Any real bridge, gateway or building would belong to one country. Kalina drew seven architectural periods and no actual structures — invented Romanesque windows, invented Gothic gateways, invented modern bridges — so that the money of a continent that had spent centuries fighting over territory depicted no territory at all.

Greece, admitted on 1 January 2001 at 340.750 drachmas, had submitted deficit figures that were revised sharply upward in 2004 once Eurostat examined them properly. The convergence criteria had been treated as a hurdle to clear at a moment in time rather than a condition to maintain, and the Stability and Growth Pact agreed in 1997 to police the difference was itself suspended in 2003 when France and Germany breached it and declined to be fined. What the euro area had built was a central bank with a single mandate sitting above national treasuries that shared no budget, a design whose stresses appeared in 2010 and reappeared whenever a peripheral spread widened, including in the aftermath of the Swiss National Bank's abandonment of its euro floor in 2015.

The rates fixed that afternoon in Brussels remain in force. Anyone who still holds Deutsche Mark can walk into a Bundesbank branch and exchange them at 1.95583 to the euro, with no deadline and no expiry — a currency that was retired but never quite allowed to die, converted at a number six digits long that was settled in an afternoon and has not been touched since.