So many bad replies in this thread.

The concept of Caucasian as an identity is tied into racist psuedo-scientific concepts intended to develop biological proof of "race". This is documented quite thoroughly in Nell Irvine Painter's work "The History of White People".

As explained briefly by /u/bessert, Christoph Meiners, a practitioner of racist pseudo-science, coined the term during his efforts to establish biological proof of differences between "beautiful whites" and "ugly blacks".

EDIT:formatting

In Eastern Europe, "Caucasian" refers to people living in and around the Caucasus mountains: Chechens, Georgians, Armenians, and so on. Incidentally, they have relatively darker features (dark eye and hair colour, etc.), and are often called "black".

Racial theorists were influenced a lot by linguistics. Proto-Indo-European is the mother language of a huge family of languages that stretch from northern India (Hindi/Urdu) to Europe, including the Slavic, Greek, Romance and Germanic languages... Essentially everything in Europe that isn't Finnish or Basque.

The theory is that this language was spread by groups that had emerged from somewhere in Central Asia (where horses could be raised/domesticated) and that the domestication of the horse led to their dominance. This is largely based upon the huge number of cognates (related words in different languages) centred around horses, wheels, carts, etc.

This was catnip for racial theorists (European/white races showing their all-conquering strength from pre-history) and since the Caucasus mountains are near to where this group supposedly emerged... Caucasians. It is also why the term "Aryan" became fashionable (it stems from a Sanskrit [proto Hindi] word meaning "noble"). It also accounts for the Nazi idea that northern Indians were included under the label "Aryan".

Of course, there are many problems with this... First and foremost, this is based on language spread, not genetics or some kind of racial superiority. Needless to say, you can learn a new language, but cannot flip your genes - and it is very common for large areas to adopt different tongues in the face of changed economic or political situations.

Keep in mind, these people were operating in an era before any real understanding of the human genome, basically just looking at facial features and deciding the group they had grown up with were prettier than the group they had never previously seen. They then looked for scientific labels for this. To them, the idea of an all-conquering "white" Indo-European "race" must have seemed to confirm all their theories.

TL;DR: Racial theorists steal linguistic evidence to make their theories seem legitimate.

Also, is the term 'caucasian' limited only to north america? Or is it being used in other places as well?