Euro-Definition, History, & Facts - Research Paper Example

Euro INTRODUCTION This paper aims to look at the single European currency, the euro, tracing its origins and the vision behind its implementation. Now, years after its adoption, this paper discusses the effects of the euro on the member states of the euro area and ultimately to international business and trade. It likewise looks into and discusses the empirical data of such effects. Of the European Union member states outside the euro area, this paper studies the position of the United Kingdom on the adoption of the euro. Part I discusses the need to launch the euro, highlighting its origins from the Marjolin Memorandum to the creation of the Economic and Monetary Union (EMU). It also discusses the expectations that the euro area has placed on the adoption of a single currency. Part II presents the effects of the euro in international business and trade as the second largest currency in the world economy. It also looks into the use of the euro outside the euro area and the Iranian Oil Bourse. Part III presents differing views on the effects of the euro on the economies of the member states in the euro area. It also presents the effects of the euro on the different stock markets of the member states. Empirical data on the effects of the euro are discussed in Part IV, presenting data from 2002 to June of 2006. Part V focuses on the effects of the EMU to Germany, and the transformation it requires from Germany. It presents the assessment of the issue of "balance of fitness" between the EMU and Germany. Parts VI and VII looks into the stand of the United Kingdom (UK) on the adoption of the euro. It discusses the criteria set by UK which the euro has to pass before its adoption. Also discussed are the possible effects should the UK adopt the euro, presenting the differing sides of the issue. THE NEED TO LAUNCH THE EURO The European single currency may trace its origins back to a the vision of an even more united Europe enjoying economic prosperity, where the people, services, capital and goods move freely across member countries. This was first translated into words in the Treaty of Rome on 1957. The Marjolin Memorandum, a European Commission document, issued in 1962, was the first Memorandum to open possibilities toward Community level "economic and monetary union". The idea of a distinct monetary identity once again surfaced in the Barre Plan submitted by the European Commission in 1969. Taking this vision a step further, the Single European Act (1986) and the Treaty on European Union (1992) introduced the Economic and Monetary Union (EMU), the third phase of which begun with the setting of the exchange rates of the different currencies (European Central Bank, 2004). Also, the proponents of the Single European Act introduced the Single Market which is seen to promote greater economic integration among member states. However, it is seen that this can only be fully achieved with a single currency. A single currency is expected to ensure price transparency, eradicate exchange rate risks, reduce transaction costs and ultimately increase the economic development of the euro area. (European Central Bank, 2006) Also, having been beset with poor economic growth since the 1970's, the launch of the euro as the single currency of the EMU member states was expected to address the causes of the problems of high inflation, high interest rates, and unsustainable public finances which are characteristics of exceedingly regulated and fragmented markets. The EMU was expected to pave the way for greater macroeconomic stability and improved economic efficiency in the euro area. (European Commission DG-EFA, 2004). On 01 January 1999, the common currency is adopted by Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland, with Greece subsequently joining on 01 January 2001Two years hence, on 01 January 2002, euro notes and coins were introduced. Of all the European Union member states, only Denmark, Sweden, and the United Kingdom opted not to adopt the euro as their currency. (European Central Bank, 2006) EFFECTS OF EURO ON INTERNATIONAL BUSINESS AND TRADE The euro is now the 2nd biggest currency area in the world. The euro is now being extensively used even outside the borders of the euro area. The increasing use of the euro as an international currency is attributed to three factors: the euro area accounts for approximately 16% of the world GDP, the strong economic foundation of the euro area, and the unification of European financial markets (European Commission DG-ECFIN, 2001) Three years after its implementation, the European Commission Directorate-General for Economic and Financial Affairs published a paper on the developments of the euro area in the world economy. In 2001, the newly introduced euro had to immediately deal with global economic slowdown and shocks (the increase in oil prices, the September 11th). With this global backdrop coupled with domestic factors, GDP in the euro area exhibited a slowdown as well, eventually leading to virtually no growth during the final quarter. The paper stated that from 1999-2001, the euro marked a drop of 20% against the dollars. On the other hand, the lower unit labor cost placed the euro area producers were able to in a favourable position to compete against third countries' suppliers (European Commission DG-ECFIN, 2001). In 2004, the European Commission Directorate-General for Economic and Financial Affairs published a Special Report on the European Economy, specifically of the state of the EMU after five years. The Report also evaluated the position of the euro in the international economy and presented the following findings: The increasing influence and international acceptance of the euro shows itself more in international debt markets and international bank liabilities d foreign exchange transactions, the euro accounting to 30% of international debt markets, slimming the gap between the euro and the US dollar (40%) by the end of June 2003; 25% of international bank liabilities (US dollar 53%) as of end of 2002; and 19% of foreign exchange transactions, with the US dollar at 44% as of April 2004. The euro effect in the third countries is also apparent in invoice and settlement of external trade transactions (European Commission DG_ECFIN, 2004). Evidence of euro acceptance has also manifested in the official sector even outside the euro area. Most notable is the increase of the euro foreign exchange reserves held by central banks of countries even outside the euro area. This trend has started since the third stage of the EMU. By end-2003, the euro foreign exchange reserves around the world are recorded at 19.7% with the US dollar at 63.8%. Further, the territories of Kosovo and Montenegro use the euro as an official currency. In new member states and candidates countries to the EMU, chiefly in Central Europe and western Balkans, the euro is being used as a "de facto parallel currency in their exchange rate regimes". It has been noted that the euro would most likely also be used as an intervention currency by countries that already use it as an "anchor currency" in their exchange rate regimes (European Commission DG_ECFIN, 2004). A survey on the use of the euro outside the euro area was likewise conducted by the European Commission Directorate-General for Economic and Financial Affairs in 2004. The survey yielded the result that the use of euro cash as payment remains largely confined to tourist areas. With regard to the exchangeability or the conversion to euro of local currencies abroad, a wider acceptance and availability of the euro at banks and exchange offices was noted. In terms of exchanging euro cash into the local currency, a positive response was achieved. On the other hand, the official use of the euro by countries abroad has likewise increased. The central banks of Australia, China, Indonesia, and Syria have increased their foreign currency reserves in euro, and the Philippines have started to issue euro-denominated bonds. Lastly, there was an observed increase in the general awareness of the euro in countries outside the euro area. This has been contributed to the rise in the euro exchange rate (European Commission DG-ECFIN, 2004). Another significant effect of the euro in international trade is the "proposed Iranian Oil Bourse" which will be based on a "euro-based oil trading system", thus payments for oil will be done in euro, and not in US dollars. It was also predicted that this payment scheme would be eagerly adopted by China and Japan, to lower their dollar reserves. Also, in view of the depreciation of the dollars, Russia and Arab oil-exporting countries are also likely to support the Iraninan Oil Bourse (Bowey and Associates, 2006). Over the past years, has seen an increase in the usage of the euro and in the political and economic weight of the euro area in the global economy. An important reflection of the euro in international business and trade is that the euro area as whole is now being considered in international macro-economic issues. The IMF and the OECD in fact now conducts assessments of the over-all macroeconomic stance of the entire euro area. The G7 Financial Ministers likewise looks into the overall euro area position, and not in the individual positions of its member states (European Commission DG-ECFIN, 2002). EFFECTS OF EURO ON EURO AREA The euro is projected to effect the lowering of inflation and interest rates in participating member areas towards macroeconomic stability. Further, the adoption of the euro is expected to reduce costs by the removal of exchange rate risks and conversion fees, the creation of healthy competition in the euro area by allowing easier price comparison given the price parity, and fostering a more conducive trading and investment environment for local business in the euro area, which eventually translates to savings (European Central Bank, 2006). The Departamento de Economia Financiera, Universidade Complutense de Madrid conducted a study on how and to what extent has the euro effected the integration of European stock markets. It aims to "verify whether the euro introduction affects the integration of the European stock markets, and to investigate whether the integration of the European stock markets has increased after the introduction of the euro" (Melle, n.d.) The study generated the following conclusions: 1. Having been strongly linked even prior to its introduction, the euro did not increase the degree of integration of the stock markets. However, the main stock exchanges (German, French, Italian, Dutch and Spanish) show an increase in correlation after the introduction of the euro. This is attributed to the "increased possibilities of international diversification of portfolios". Also, the more efficient markets provided benchmarks on which other exchanges based theirs; 2. The German stock exchange had been a leader market in the European stock exchanges; and 3. The euro has fostered and hastened the integration of EU equity markets and reduced the dependence on the dollar of national stock markets (Melle, n.d.) Since the adoption of a single currency, though the integration of the stock markets into a central European stock market has yet to be completed, deeper financial integrations have developed in the euro area (Melle, n.d.). However, in its 28 April 2006 edition of Country Briefing entitled "Europe economy: Euro blues", The Economist paints a dissenting picture. It claims that though the euro has provided the member states a monetary anchor, it has failed in resulting to greater convergence between member states in terms of economic performance. It highlighted the discrepancy between the growth of Ireland (average of 6% since 1999) and Germany (barely 1%), and Spain and Portugal, with Spain's almost twice as that of Portugal's growth. It also stressed the different if not opposite reactions of member states to similar situations. For instance, though Ireland and Italy had above-average inflations, the exports of both countries displayed different growths, with Ireland's flourishing and Italy's stand still. It has concluded that the euro "has promoted stability in currency but contributed less to economic expansion, creation of jobs, and significant economic reform" (The Economist, 2006) EMPIRICAL EVIDENCES FOUND TO DATE On July 2005, the HSBS Global Research published a paper by Prior-Wandesforde and Hacche on Macro European Economics entitled the "European Meltdown" which claims in general that "EMU is helping create persistent growth difference and economic imbalances which show no sign of easing and are unsustainable over the long term. Without reform, the political commitment to EMU will be tested to the limit". It pointed out that the problems raised of a single currency are results of different structural inflation rates of the member states, with most of the member states failing to adjust to these structural differences (Prior-Wandesforde and Hacche, 2005). The European Commission DG, ECFIN presented the following key indicators for the euro area as of 01 June 2006: 1. Output - In terms of industrial confidence, from a -12 rating in 2002, a steady increase has been registered to a rating of 2 in May 2006. Industrial production has likewise registered a steady increase from -0/7 in 2002 to 0.4 as of March 2006. 2. Private Consumption - This indicator registered fluctuating ratings with 0.6 in 2002, 1.1 in 2003, 2.6 in 2004, 0.8 in 2005 and 0.7 as of May 2006. 3. Investment - Capacity utilisation in the manufacturing sector remains relatively unchanged from 81.2 in 2002 to 82.0 in 2003. Gross fixed capital formation rose from -2.0 in 2002 to 0.3 as of the first Quarter of 2006. The change of stocks as of percentage of GDP is 0.5 percent as of the first Quarter of 2006. 4. Labour market - Unemployment rate failed to leave the 8% mark from 8.2% in 2002 to 8% as of April 2006. On the other hand, employment rate remained relatively unchanged from 0.7 in 2002 to 0.8 as of April 2006. There was also a decrease in the shortage of labour in the euro area from 2002 (3.8) to May 2006 (2.4). 5. International transactions - The assessment of export order goods in manufacturing greatly changed from -22 in 2002 to -2 as of May 2006. The estimate of trade balance in the euro area reflected a -4.7 deficit in 2002 to a 0.3 surplus as of March 2006. 6. Prices - The euro area annual HICP inflation reflects a relatively steady rate (2.3 in 2002, 2.1 in 2003, 2.2 in 2004, 2.2 in 2005 and 2.5 as of May 2006) while the core inflation rate decreased from 2.5 in 2002 to 1.6 as of April 2006. Producer prices inflation increased from 1.7 in 2002 to 5.1 in 2006. Likewise, import prices inflation increased from 97.9 in 2002 to 111.9 as of February 2006. 7. Monetary and financial indicators - The euro exchange rate steadily increased from 0.95 US dollar per euro in 2002 to 1.28 US dollar per euro as of May 2006 (European Commission DG-ECFIN, 2006). EURO AND GERMANY The German response to EMU has been shaped by its complex "discursive structure" and the behaviour of its policy makers. The third stage of the EMU, with the adoption of the euro as a single currency, coincided with major structural changes in Germany. In particular, EMU brought the following paradoxes to the attention of Germany's policy makers (Dyson, 2000): One challenge is between the "export" of the economic stability espoused by Germany and the newly introduced methodology in setting points of reference or the yardstick for best practice. Another concerns the general public, particularly on how to introduce to them particular reforms and the Europeanization of Germany as embodied in programmatic statements, and how to frame them to the general public. There also seems to be a paradox between the fixed timetable for EMU and strict convergence". The German banking system likewise poses a paradox, specifically on the role of the Bundesbank, with it reigning over the transition to EMU's stage three and it having to strengthen its position by "seeking a new role structure". Lastly, the "managed" capitalism mode being adopted by German seems to pose paradox as against the EMU (Dyson, 2000). The German Ordo-liberals, neo-Keynesians and "Rhineland" capitalists looks into the issue of "goodness of fit" which the EMU raises as it requires "transformation rather than just accommodation". Overall, the following assessment on the "goodness of fit" of the Germany and the EMU has been presented in a paper by Kenneth Dyson, University of Bradford (2000): The German government works under the framework of "managed" capitalism and the transition towards being an EMU member state seems to test the sustainability of this framework in terms of being able to effect the transformations required by the EMU. In the end, it has been said that Germany and the EMU has in fact met the "goodness of fit" criteria especially in their parallel and common ideas on economic stability. (Dyson, 2000) THE EURO AND UK The UK government would enter into membership in the EMU if the following economic tests on convergence, flexibility, investment, financial services, and employment and growth are met: (European Commission DG ECFIN, 2004) a. The first economic test aims to see as to what extent can the convergence of UK economic cycles and business structures with that of the euro be sustained. This also looks into the euro interest rates, monetary transmission mechanisms, and housing markets. b. Taking into account the inevitability of economic changes, the second test looks into the flexibility of the euro system and its adjustment mechanisms in adopting and responding to such economic changes. This also tests the capability of the fiscal policy as an economic stabiliser. c. The third economic test deals with prospects of long-term investments in the UK. If the UK shall adopt the euro as its currency, would this create a more conducive climate for investments How would this affect the cost of capital d. The importance of how EMU membership will affect the UK's wholesale markets and the financial services industry is underscored in the fourth economic test. e. Lastly, the 5th criterion tests the effect of the EMU in the generation and stability of employment in the UK (Currie, 1997) The European Commission (2004, cited HM Treasury, 1997) reports that the first assessment was conducted in 1997 and generated a negative appraisal. On 09 June 2003 (cited HM Treasury, 2003a) the second assessment was conducted. However, this once again resulted to a negative assessment, with only the fourth criterion having been met (Kimber and Jarvis, n.d.) WHAT WOULD BE THE POSSIBLE EFFECTS IF THE UK JOINED THE EURO The case for the UK's adoption of the Euro is being advocated from both sides. By joining the euro, it is argued that the UK will be able to wield greater influence on economic matters in the euro area. On the other hand, it has been argued that whether the UK joins the euro or not, it has and will remain to be an important partner in the euro area. Also, attention is called to the provision of the Maastricht Treaty that prohibits the governments of the member states from influencing the decisions of the ECB (Kimber and Jarvis, n.d.). Presented below are the pro and con arguments on the possible economic effects of and considerations for the adoption of the euro (Kimber and Jarvis, n.d.): 1. Sterling Volatility: Outside the euro, the sterling will be caught between the euro and the dollar. This could result to wild fluctuations. 2. Unemployment: Joining the euro would strengthen links with other member states and thus ensure stability of employment of 12.5% of UK's workforce, which relies on its exports to the European Union. 3. Lower Prices: It is argued that "price transparency" in the euro area would bring prices lower. However, the European Union Competition Policy already aims to bring prices into line. Thus, it is argued that this could be achieved even without adopting the euro. The UK recognizes the potential benefits of adopting the euro and EMU membership. While it is held that the growth of the UK's financial services sector would continue to flourish even without adopting the euro, the adoption of the euro could still bring on a positive effect by strengthening the UK's competitive position. However, the UK underscores the importance of the EMU achieving a sustainable and durable convergence of its markets. The UK believes that this is necessary before higher growth, stability, and more jobs could be achieved (European Commission DG ECFIN, 2004). CONCLUSION It has to be stressed that the effects presented in this paper are not affected by the euro alone, but are likewise due to a variety of factors including global economic and political factors and the inherent history, structures, and issues of each member state. Despite the setbacks and the questions on the success of the euro there seems to be a general consensus that the euro has indeed strengthened the interrelation and convergence of the markets of the euro area member states (Melle, n.d.). With regard to the UK position, though the UK government supports the euro in principle, the highly political and volatile criteria set by the Treasury still has to be met, before a referendum on the matter could be held. (European Commission DG-EFA, 2004) As with all referendum, it has to be emphasized that proper education on the effects of the euro on the UK economy should be given due notice to give the British people an informed say on the issue. REFERENCE LIST CURRIE, David, 1997. The pros and cons of EMU [online]. HM Treasury. Available from: www.hm-treasury.gov.uk/media//0679E/emupc.pdf [Accessed 09 June 2006] DYSON, Kenneth. 2000. Germany and the Euro: Redefining EMU, Handling Paradox, and Managing Uncertainty and Contingency [online]. Department of European Studies, University of Bradford. Available from: www.qub.ac.uk/.../FileStore/EuropeanisationFiles/Filetoupload,5299, en.pdf [Accessed 09 June 2006]. EUROPEAN COMMISSION DIRECTORATE GENERAL FOR ECONOMIC AND FINANCIAL AFFAIRS. 2006. Key Indicators [online]. European Commission. 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Brussels, European Commission (COM [2002] 332 final) Available from: www.eu.int/comm/economy_finance/publications/europapers_en.htm [Accessed 09 June 2006]. J. DOUGLAS BOWEY AND ASSOCIATES. 2006. The Proposed Iranian Oil Bourse [online]. Le Metropole Caf. Available from: eldoradogold.net/pdf/January%202006/proposed_Iranian _oil_bourse_011706.pdf [Accessed 09 June 2006]. KIMBER, Richard and Brian W. Jardin. No date. UK-Euro FAQ [online]. Available from: http://www.psr.keele.ac.uk/docs/efaq.htm [Accessed 08 June 2006] MELLE, M., (no date). The Euro Effect on the Integration of the European Stock Markets [online]. Departamento de Economia Financiera, Universidad Complutense de Madrid, Available from: xiforofinanzas.ua.es/trabajos/1027.pdf [Accessed 09 June 2006]. PRIOR-WANDERSFORDE, Robert and Gwyn Hacche. 2005. European Meltdown Europe fiddles as Rome burns [online]. HSBC Global Research. 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