Everything you always wanted to know about the euro - but were afraid to ask

Confused at the single currency's crisis? Who wouldn't be? Don't worry. Our guide empowers you to bluff through any dinner party

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The Independent Online

Q&A: Your guide to Europe's financial situation:

What was the original idea behind the euro and its zone?

The idea dates back to 1969, when a European summit at The Hague made its creation an official ambition. However, it took 20 years for the plans to be properly prepared, when European Commission president Jacques Delors came up with a three-stage plan that, after a further delay, led to the then 12-strong eurozone in 1999. European politicians originally wanted a strong political and economic bloc to ensure that great wars were avoided. There was belief that the euro would be strong enough to avoid devaluation and compete with the mighty US dollar.

What did participating countries have to give up in order to join?

Apart from the obvious – the abolition of domestic banknotes by 2002 – the countries had to meet four key criteria, some of which could be painful depending on a state's economics. For example, government debt had to be below 60 per cent of GDP, or at least moving towards that level. Governments fudged the figures in order to join: Greece later admitted that it massively understated its budget deficit, so didn't make the public sector spending sacrifices that were necessary. The eurozone countries have given up control of monetary policy, with the European Central Bank deciding interest rates in much the same way as the Bank of England does for the UK.

Is there an inherent flaw in roping together national economies, all of which have their own idiosyncrasies and cycles?

Ever since the euro was formed, some economists have been warning of just this scenario. How is it possible, they argue, to have an interest rate and currency value that is appropriate for the productive and relatively debt-free Germans as well as for the less productive and public sector-dominated "Pigs" – Portugal, Ireland, Greece and Spain? In response, euro enthusiasts have said that the single currency will bring these nations into line so they become more like the Germans – borrowing less and producing more. The current crisis is the ultimate test of this and at the moment the euro is failing.

Are the euro and its zone really doomed?

It depends whom you listen to, but clearly the single currency is under threat, while the political union is facing its toughest test since it was formed nearly 60 years ago. The euro plunged in value last week prompting stock markets across the region to dive too. The crisis has been brewing for some time, beginning with Greece, but a single state failure won't be enough to bring the curtain down on the currency. The euro may be doomed if the crisis spreads. Politicians are continuing to work on a plan to stop contagion engulfing Europe.

What are the problems?

The problem is pretty simple: countries such as Greece simply borrowed too much money during the bull years from 2001 to 2007. Ireland is also in a similar mess. Now conditions have turned sour they are in trouble. Financial speculators such as hedge funds, many based in London, have been placing hefty bets that the Greeks will default on paying back their debt, ie that they go bust. Alongside the financial dynamics there is clearly an absence of a political consensus to sort this out. Many Germans are rightly asking why they should bail out the Greeks for their profligacy. Unfortunately, that seems to be the price to pay for being the strongest economy within the currency membership.

Can they be overcome?

That remains to be seen. Certainly survival of the euro – at least in the short term – looks more likely after Germany's politicians gave their backing to pay for a large chunk of a $1 trillion bill to help out the ailing member states. But it was passed by only seven votes. Whether the euro is held together depends on the awkward coalition between Berlin, Paris and other capitals staying firm.

How would Greece, or any other country, drop out of the zone?

Until now there has been no get-out-of-jail-free card for any of the 16 countries in the zone. But new plans from the Germans, discussed last Friday in Brussels by finance ministers, includes for the first time an opt-out which is being described as an "orderly state insolvency". This would allow a country that is close to defaulting on its debts the choice of getting out or restructuring; rather like the living wills being debated for the orderly wind-up of banks.

Isn't this just a belated effect of the 2007-08 financial crisis?

Sort of – but only in part. The real problem is that when the euro was launched in 1999, rules were set for the maximum size of budget deficits – 3 per cent of GDP – with public debts at 60 per cent. France and Germany were surprisingly the first to break the rules, but then when the recession erupted, the southern European countries found themselves in trouble and started borrowing more. Greece went for broke, literally, borrowing twice its limit so that when the time came for it to repay its debts, it found it didn't have the money. And it's the French and German banks that lent most of the money – one of the reasons why the real fear now is that the sovereign debt crisis will provoke another banking crisis.

What's the upside – and the downside – for Britain?

There's not much of an upside for the UK as we are so closely linked to Europe because of trade, but we have devalued the pound to make us more competitive. Over the past year, sterling has weakened against the euro by about 25 per cent, making it more expensive to travel but cheaper for Europe to buy our goods. That's important because more than half of our exports are with the eurozone trading partners. So if they are in trouble and have no money to spend, then that hits us, too.

How will it affect my holiday pound?

In recent weeks the pound has increased in value against the euro, meaning that your UK cash buys you more in the eurozone. However, we are a long way from the situation in 2007 (and for years before) when the pound was very strong and the euro weak. The reason for this? We too have our own fiscal crisis – government borrowing is £163bn this year alone – so international investors are not so confident of our prospects either. If the euro fragments and is replaced by national currencies, then it's likely that the pound will buy you much more in big debtor nations such as Greece, Spain, Italy and Portugal – but probably not this summer holiday.

Questions answered by Simon Evans, Julian Knight, Mark Leftly and Margareta Pagano

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