010315-1 10.1038/nsu010315-1 9 March 2001 physics The euro: a false economy? PhilipBall Physicists are pitching in to the debate about the Deutschmark's influence on the euro.

The single life: risky or rewarding?
Critics of the euro, the transnational European single currency, say it is a glorified Deutschmark, confined by the vicissitudes of the strong German economy. Lesser European economies, according to this view, put themselves at the mercy of the Deutschmark by joining the euro scheme. Now two mathematical physicists show that there could just be some truth in this idea1.

The value of the euro, launched on 1 January 1999, is determined by averaging the conversion rates of the 11 participating countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain.

In their investigations, Kristinka Ivanona of Pennsylvania State University in the United States and Marcel Ausloos of the University of Liège in Belgium got around the euro's youthfulness as a currency by constructing a predated 'false' euro stretching back to 1993. Using statistical tools more familiar to physicists than economists, they compared the performance of this virtual euro with that of its 11 component currencies and with other currencies before the European financial systems were bound together in 1999.

Unsurprisingly, the inception of the real euro in 1999 had a strong impact on this partially artificial history. Before 1999, the 'false euro' fluctuated erratically against the Japanese yen and the US dollar. From 1999 onwards the euro fell suddenly and thereafter steadily relative to these two -- as the market responded to the appearance of the new currency.

But the exchange rate of the euro relative to another, non-participating European currency, the Danish kroner, remained stable both before and after January 1999, suggesting that only the money markets outside the European Community registered its appearance.

The fact that the real and false euros showed this differing behaviour against international currencies might seem to imply that it is meaningless to construct a pre-1999 'history'. But the real clues to the internal factors controlling the euro's value lie, not in the long-term trends, but in the ups and downs of the exchange rate over weeks and months.

Economists have long assumed that fluctuations in exchange rates or other economic indices are random in the short term. But recent work on the physics of complex systems, in which many components interact all at once, shows that the fluctuations, although unpredictable, are not random. Rather, they have the kind of statistical behaviour displayed by earthquake probabilities, with an unusually large odds of big fluctuations.

Analysing the statistics of the false euro's fluctuations, the researchers found that the Deutschmark had the most pronounced influence. The fluctuations of the euro against, say, the US dollar or the yen before 1999 more closely resembled those of the German currency than those of the other member nations.

The Belgian, French, Italian and Dutch currencies also showed some influence on the behaviour of this virtual euro, whereas the Portuguese escudo had very little influence. So one could argue that by joining the single European currency system in 1999, Portugal did indeed tie its exchange rate to that of Germany. Of course, there may be a case for Portugal to argue that this is no bad thing.

Ivanova, K. & Ausloos, M. False EUR exchange rates vs DKK, CHF, JPY and USD. What is a strong currency? Los Alamos preprint cond-mat/0103033.