The Euro Analysed by Kampamba Shula

The Euro

Introduction

The euro is the single currency shared by (currently) 17 of the European Union's Member States, which together make up the euro area. The introduction of the euro in 1999 was a major step in European integration: around 330 million EU citizens now use it as their currency.

When the euro was launched on 1 January 1999, it became the new official currency of 11 Member States, replacing the old national currencies – such as the Deutschmark and the French franc – in two stages. First the euro was introduced as an accounting currency for cash-less payments and accounting purposes, while the old currencies continued to be used for cash payments. Since 1 January 2002 the euro has been circulating in physical form, as banknotes and coins. The euro is not the currency of all EU Member States. Two countries (Denmark and the United Kingdom) have ‘opt-out’ clauses in the Treaty exempting them from participation, while the remainders (several of the more recently acceded EU members plus Sweden) have yet to meet the conditions for adopting the single currency (European Commission, 2011).

 

All EU Member States form part of Economic and Monetary Union (EMU), which can be described as an advanced stage of economic integration based on a single market. It involves close co-ordination of economic and fiscal policies and, for those countries fulfilling certain conditions, a single monetary policy and a single currency – the euro. The process of economic and monetary integration in the EU parallels the history of the Union itself. When the EU was founded in 1957, the Member States concentrated on building a 'common market'. However, over time it became clear that closer economic and monetary co-operation was desirable for the internal market to develop and flourish further. But the goal of achieving the EMU including a single currency was not enshrined until the 1992 Maastricht Treaty (Treaty on European Union), which set out the ground rules for its introduction. These state what the objectives of EMU are, who is responsible for what, and what conditions Member States must meet in order to adopt the euro. These conditions are known as the 'convergence criteria' (or 'Maastricht criteria') and include low and stable inflation, exchange rate stability and sound public finances (European Commission, 2011).

With the launch of the euro monetary policy became the responsibility of the independent European Central Bank (ECB), which was created for that purpose, and the national central banks of the Member States having adopted the euro. Together they compose the Eurosystem. Fiscal policy (public revenue and expenditure) remains in the hands of individual national authorities – although they undertake to adhere to commonly agreed rules on public finances known as the Stability and Growth Pact. Member States also retain overall responsibility for their structural policies (i.e. labour markets, pension and capital markets), but agree to co-ordinate them in order to achieve the common economic goals (European Commission, 2011).

Apart from making travelling easier within the EU, a single currency makes economic and political sense. The framework under which the euro is managed underpins its stability, contributes to low inflation and encourages sound public finances. A single currency is also a logical complement to the single market and contributes to making it more efficient. Using a common currency increases price transparency, eliminates currency exchange costs, facilitates international trade and gives the EU a more powerful voice in the world. The size and strength of the euro area also better protect it from external economic shocks, such as unexpected oil price rises or turbulence in the currency markets. Last but not least, the euro gives the EU’s citizens a tangible symbol of their European identity.

 

Against the background of the current debt crisis important measures to improve the economic governance in the EU and the euro area in particular have been taken. EU Member States have strengthened the Stability and Growth Pact, introduced a new mechanism to prevent or correct macroeconomic imbalances and are increasingly coordinating structural policies. These are crucial steps to strengthen the "E" - the economic leg - of the EMU and to ensure the success of the euro in the long run (European Commission, 2011).

 

Economeka Analysis the Current state , Structure, the Flaws and the Inevitable

Current State

To break the ice I must indicate that I have full faith that the Euro will not break up. A look at the price insurance against wild swings in the currency will confirm my assertions.

According to a Bloomberg report the options market is signaling the threat of a breakup in the 17-nation euro bloc is disappearing as the price of insurance against wild swings in the region’s single currency fall to a five-year low (Masaki Kondo, 2013).

Butterfly options that protect against both gains and declines slid to the lowest since March 2008 on Feb. 4. Implied volatility on three-month options on the euro-dollar exchange rates has risen about half as much as a broader gauge of currency volatility this year. The currencies of nations with top credit ratings have dropped against the euro over the past six months as concern eased that Europe’s currency union would unravel. The bonds of Greece, Portugal, Ireland, Spain and Italy -- the region’s most indebted-economies-- have been the best performers among sovereign debt in that period, indexes tracked by Bloomberg and the European Federation of Financial Analyst Societies show (Masaki Kondo, 2013).

Stress in European funding markets has eased since July, according to the Bloomberg Financial Conditions Monitor, the same month European Central Bank President Mario Draghi pledged to do whatever it takes to preserve the monetary union (Masaki Kondo, 2013).

The shared currency has appreciated 4 percent over the past three months and 7.1 percent over the past six, according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-nation currencies. It has climbed more than 10 percent on a trade-weighted basis since Draghi’s pledge in July.

 

Draghi spurred gains in the euro last month when he spoke of “positive contagion” in financial markets and a return to economic growth later this year. The ECB cut its benchmark rate to a record low of 0.75 percent in July.

 

“Concerns of a break-up of the single currency and general global economic concerns have eased,” Alan Wilde, head of fixed-income and currencies in London at Baring Asset Management, which oversees $53 billion, said in a telephone interview on Feb. 14. “Some of these tail risks have dissipated as actions have been taken and markets have gained more confidence.” (Masaki Kondo, 2013)

The Flaws

The flaws of the Euro stem mainly from the lack of fiscal and structural consolidation. Public revenue and expenditure still remain in the hands of individual countries. Structural policies on labor, pensions and capital markets also remain the hands of individual countries. While such autonomy has been necessary at a domestic level it has generally gone against the best interest of the Euro region as a whole.

If the Euro is to succeed and which I have no doubt in my mind that it will, there will be need for greater fiscal and structural consolidation. Now when I say this I don’t mean it the way most economists would say it, rather more boldly I mean fiscal and structural policy decision making authority at a broader level will have to be given to the European Central Bank. “The European Central Bank must become a fully-fledged central bank,” Former Italian Prime Minister Silvio Berlusconi said. “That means it should guarantee the sovereign debt of all countries that use the euro as a currency.”

There will be many who would oppose such an assertion but it is the only way to streamline policy across the Euro region. To some nations it will mean surrendering a portion of their sovereignty of which I will admit will have to be the case.

The current status quo makes it ineffective for the much needed structural reforms to take place. Talks of austerity are not received very well by the masses of peripheral nations in debt. A closer look at Greece which has suffered from years of poor fiscal and structural management will show the issues at hand. For example Greece's structural problems go back a long way. We are talking about chronic deficits, declining competitiveness and poor public sector performance. Foreign investment has been static for a decade. The tax code is opaque and regulations for business are notoriously complex. The country has been on the EU's naughty step for a long time, certainly since 2004 when Athens sensationally announced its previous government "misreported" expenditures. It "discovered" Greece had exceeded the 3% deficit threshold for the Eurozone.

 

The Inevitable

In my personal opinion I consider it inevitable that fiscal and structural consolidation will take place even if it means at a slow pace, it will happen eventually. Given the ECB’s evident support to keep the Euro together it is a safe bet that the Euro will stay together.

The derivation from such an assertion requires fiscal and structural consolidation. 2 things are probable,1 is inevitable. Break up of Euro & 1 Government for the Euro Region. The latter is inevitable.

Bibliography

European Commission. (2011, February 20). Economic and Financial Affairs - The Euro. Retrieved February 20, 2013, from European Commision: http://ec.europa.eu/economy_finance/euro/index_en.htm

Masaki Kondo, L. C. (2013, February 19). Euro Breakup Risk Falls to 5-Year Low in Butterfly: Currencies. Retrieved February 20, 2013, from Bloomberg: http://www.bloomberg.com/news/2013-02-19/euro-breakup-risk-falls-to-5-year-low-in-butterfly-currencies.html