International Financial Institution and Markets - Research Paper Example

International Financial and markets The report seeks to deal with the factors such as whether it is advantageous for the UK to enter into a currency union with the Euro zone. The report seeks to identify various factors which are considered as of advantage as well as of disadvantage for the UK to enter into such an agreement of currency union. It also deals with whether the Euro could substitute the US dollar as the major currency in the global market. Contents Abstract 2 The report seeks to deal with the factors such as whether it is advantageous for the UK to enter into a currency union with the Euro zone. The report seeks to identify various factors which are considered as of advantage as well as of disadvantage for the UK to enter into such an agreement of currency union. It also deals with whether the Euro could substitute the US dollar as the major currency in the global market. 2 Introduction 4 Discussion 4 a. Arguments for and against the Euro 4 b. Euro becoming a global currency that rivals the US dollar 8 Conclusion 9 References 11 Appendices 13 Introduction Euro is considered to be a currency that is widely used by the European Union Institutions and it is said to be the official currency for euro zone. Euro zone comprises 18 member states out of the 28 member states that is said to constitute the European Union such as Spain, Slovenia, Netherlands, Malta, Portugal, Luxembourg, Greece, Germany, France, Finland, Estonia to name a few. There are also other five European countries that use the currency Euro and as a consequence is said to be used by 334 million Europeans currently. Moreover it is considered that 210 million people across the universe including 182 million from Africa use currencies that are said to be pegged to the currency euro. Euro is considered to be the second largest reserve currency in the globe after the US dollar. It is also considered as the second most traded currency in the universe after the US dollar. Euro is considered to be a single currency arrangement which came into force between members of European Union in the year 1999. The implication of a single currency is that there are no different national monetary policies. In this regard, the Central Bank of Europe was set up which used to conduct wide monetary policy and also sets the interest rates in Europe. This resulted into a loss of different national monetary policies, exchange rates, and interest rates. In this regard, the intention of Germany to introduce an economic policy to fight against unemployment is considered as very difficult as this role can only be played by the European Central Bank. Discussion a. Arguments for and against the Euro There are numerous advantages to sector of financial services with regard to Britain joining the Euro. In the absence of floating exchange rate, the relative labour costs can be considered to still have the potential to adjust to the changes that are there in the rate of wages. In this regard, the attainment of a degree of flexibility by the labour markets is considered very useful which makes such a situation feasible. It is considered that opponents to the European Monetary Union (EMU) offer only those alternatives that are considered to be textbook system alternatives (Bodie, Kane, and Marcus, 2008, p. 51). In the practical life, it is considered that floating exchange rate systems do not offer well aligned and stable exchange rates. UK can experience a significant increase in its economic well being through decreased exchange rate uncertainties and lower transaction costs for exchange rates with respect to both tourists and businesses. In this regard, it can be said that that the elimination of exchange rates between European countries can lead to elimination of unforeseen exchange rate devaluations and revaluations. The European Monetary Union would become stronger and can also be considered as quite resilient as compared to the mechanism of exchange rate. It is also considered that the currency would not be susceptible to speculative attacks which were very much prominent during the 1990s. The constant focus of European Central Bank on economic issues across the community would lead to reduced volatility in interest rate policies as compared to the Bank of England and also other central banks. The credibility of the monetary policy of a European wide central bank is considered to have the potential of rendering the Euro as a strong currency and this could lead to lower interest rates as compared to that of UK (Bruce, Bruce, Cheol and Cheol, 2011, p. 75). In this regard, growth and investment are considered to be as obvious benefits. Sustained low inflation is considered to be a prospect which is the main responsibility of the independent European Central Bank. It is also considered to have the potential of reducing long term interest rates and this could lead to sustained competitiveness and economic growth. The existence of a highly flexible labour market in UK is considered to be very effective under a regime of single currency. It is also considered that European Monetary Union might restrain such fiscal policies which are considered as independent but it might not remove such an opportunity in its entirety. It is also largely held that a 20% proportion of transactions of UK are said to be dominated by the US dollar. In this regard, it can be assumed that demise of sterling may not lead to totally unfamiliar circumstances. The existence of a common currency is said to remove significant number of potential barriers with respect to free competition across the national borders. It is also widely held that price transparency is promoted by the existence of a single currency. Consumers have the potential in this regard to access the prices of similar products within the union. The integration of national financial markets by the large Euro zone could lead to efficient allocation of capital in Europe (Bruetsch, 2009, p. 83). The development of a single currency would lead to an increase in intra European trade flows which have the potential to provide numerous benefits to the UK. It would also lead to higher capital investment which can also render many benefits to the UK. The UK is considered to receive major amounts of foreign direct investments in the recent times and this factor could be considerably threatened by its non participation in currency union. The possibility of a single currency has the potential of rendering the European Union as a powerful player in the global economy. The UK in this regard could benefit in a significant manner by its full scale participation in currency union. The new Euro is considered to be one of the strongest currencies in the world along with Japanese Yen and US dollar (Chinn and Frankel, 2008, pp. 49-53). It is also considered as the most important reserve currency after the dollar of the United States. Britain can considerably lose economic and political influence in the future economic integration of Europe if it chooses to stay outside of the new system. There are numerous instances that showed collapse in currency unions. In this regard, there is no guarantee to the fact that EMU have a high probability of success. The possibility of the European Central Bank pursuing a deflationary monetary policy with regard to Europe might be at odds with the requirements of domestic UK economy. Such a situation is considered to have the potential to render the Euro in a situation of economic stagnation and could also lead to higher structural unemployment (Cuthbertson and Nitzsche, 2008, p. 57). It is also considered that the monetary union might not be sustainable because countries which find themselves in a situation of difficulty might have a tendency to cancel their membership. In this regard, such countries might consider following an inflationary monetary policy and could re establish an independent currency. The departure of Ireland from the area of sterling currency is representative of the fact that leaving a union of currency might be beneficial rather than joining a currency union. Theory suggests that unions of currency may offer economic benefits only under fortunate circumstances (Kohn, 2004, p. 67). The absence of exchange rate mechanism might render the adjustment of imbalances between countries very difficult which are said to have risen from the differential shocks to economies of various countries. History is representative of the fact that well chosen devaluations can help the economy of a country out of numerous difficulties and that UK should stand by this option. Under situations of recession, it is very difficult for a country to stimulate its economy by currency devaluation and increasing exports. The entry of UK in currency union implies permanent transfer of autonomy with regard to domestic monetary policies to the European Central Bank. This would result in the UK having no control over short term interest rates and also exchange rates. The residents of UK are considered to hold high number of variable rate mortgages in the housing market of UK and as such the country is considered to be more sensitive to interest rate fluctuations as compared to that of other EU countries. The UK needs to have more flexibility with regard to its housing markets and labour markets in order to be able to join a currency union with less or no monetary flexibility (Madura, 2008, p. 59). The rented sector of the UK is also considered to be too small to be considered as a suitable substitute for owner occupation. The sustainability of a currency union is considered as more difficult as compared to beginning one. The tax revenues of the EC are considered to be only 1.5% of GDP and as such are considered as insufficient to begin an efficient system of re-distributive taxation. It would require huge costs for banks and businesses to adjust to new European currency. It is also considered as very difficult to adjust to economic divergence by migration of capital or labour and there is also no commitment to relieve such costs by the EC. There are also no evidences in recent times which show the formation of an unchanged rate of exchange regime since last 4 to 5 years. b. Euro becoming a global currency that rivals the US dollar The USA is considered to be affected by numerous international deficit and debt problems which have turned the country from the biggest creditor to the biggest debtor of the world. The current account deficit of the US is considered to have reached $ 550 billion which is considered as 5% of Gross Domestic Product. Moreover the Euro zone is considered to have reached a population, GDP, and size which can be considered to be rivalling those of the US (Van Horne, 2001, p. 63). In this regard, it is said that the Euro is considered to have the potential to rival the dollar or even surpass the dollar. However, the economic size is considered to be an important factor that has a considerable influence on the international status of a currency but it is not considered as the sole factor (Madura, 2012, p. 93). It is very important to define an international currency in order to determine whether the Euro has the potential to rival the US dollar. An international currency is considered as that currency which is used in an extensive manner outside the country of its issuance as a medium of exchange, unit of account, and store of value. It is claimed by some persons that Euro has made considerable progress with regard to dollar when it is considered to function as a store of value. It is not supposed to pose a serious challenge to the US dollar with regard to unit of account and medium of exchange (Maude, 2006, p. 67). Other important elements in this regard besides economic size are considered to be the sophistication and maturity of domestic financial markets, network externalities, and confidence in the value of currency. Open, deep, and broad financial markets are considered as necessary to satisfy the needs which are considered to be of global nature of both central banks and private investors (Posen, 2008, pp. 75-79). It is largely held that the lack of fiscal harmonization in the countries belonging to Euro zone may lead to dominance of US dollar in the transactions which are considered to be of international nature. But with regard to confidence in people in the value of a currency, the USA’s image as a large scale debtor country can be considered as negative for the dollar. It has the potential of rendering the dollar as unattractive (Rajan, 2003, p. 83). Moreover, the transaction costs in this regard are considered to significantly affect a currency’s attractiveness as a medium for international trade or foreign exchange transactions. It is also considered that dollar enjoys a natural advantage with respect to incumbency. The transaction costs of Euro are considered as high as compared to that of the dollar. Hence it can be said that unless the Euro becomes cost effective, it is very unlikely that it will be used as an international currency. The political leadership of the USA in affairs of security related matters can also be considered as a source of dominance of the US dollar over the Euro (Taillard, 2012, p. 65). The EU is considered not to offer efficient security benefits as compared to that of the USA and this limits the attractiveness of the Euro outside to that of Europe. Conclusion The factors that are responsible for currency fluctuations around the world are considered to be numerous such as the supply and demand for one currency against the other, inflation outlook, economic performance, capital flows, technical support, resistance levels, and differentials in interest rates. The huge fluctuations in a nation’s currency can largely determine the economic future of that nation. The impact of gyrations of currency on an economy is considered to be far reaching. The development of the floating rate of exchange was considered as a major achievement with regard to the monetary approach that determines exchange rates. The factors such as capital flows, forward premium, and volatility of capital flows are considered important with the development and liberalization of foreign exchange markets with regard to determination of exchange rates. There are numerous advantages to sector of financial services with regard to Britain joining the Euro. In the absence of floating exchange rate, the relative labour costs can be considered to still have the potential to adjust to the changes that are there in the rate of wages. In this regard, the attainment of a degree of flexibility by the labour markets is considered very useful which makes such a situation feasible. References Bodie, Z., Kane, A. and Marcus, A.J., 2008. Investments, 7th ed. London: McGraw-Hill. Bruce G. R., Bruce R., Cheol E. and Cheol S. Eun., 2011. International financial management, Global edition, 6th Edition. New York: McGraw-Hill Education. Bruetsch, M., 2009. From Capital Market Efficiency to Behavioral Finance. Berlin: GRIN Verlag. Chinn, M. and Frankel J., 2008. Why the Euro Will Rival the Dollar. International Finance, Vol. 11(1), pp. 49-53. Cuthbertson, K. and Nitzsche, D., 2008. Investments, 2nd ed. London: Wiley. Kohn, M., 2004. Financial institutions and markets, 2nd edn. London: Oxford University Press. Madura, J., 2008. Financial Institutions and Markets. London: Cengage Learning. Madura, J., 2012. Financial institutions and markets, 10th edn. London: Cengage Learning. Maude D., 2006. Global Private Banking and Wealth Management. London: John Wiley & Sons. Posen, A., 2008. Why the Euro will Not Rival the Dollar. International Finance, Vol. 1(1), pp. 75-79. Rajan, R., 2003. Sustaining Competitiveness in the New Global Economy: The Experience of Singapore. Massachusetts: Edward Elgar Publishing. Taillard, M., 2012. 101 Things Everyone Needs to Know about the Global Economy: The Guide to Understanding International Finance, World Markets, and How They Can Affect Your Financial Future. London: Adams Media. Tradingeconomics. 2014. United Kingdom GDP Growth Rate. Available at: http://www.tradingeconomics.com/united-kingdom/gdp-growth. [Accessed on: 22 March. 2014.] Van Horne J.C., 2001. Financial Market Rates and Flows, 6th edition, London: Prentice Hall. Yahoo Finance. 2014. Basic Chart. Available at: http://finance.yahoo.com/q/bc?s=EURUSD=X&t=5y&l=on&z=l&q=l&c=. [Accessed on: 22 March. 2014.] Appendices Appendix 1 (Source: Yahoo Finance, 2014) Appendix 2 (Source: Tradingeconomics, 2014) Read More