Single Currency in Europe - Assignment Example

Single Currency in Europe Introduction It was in 1999 that Europe has launched a Single Currency for the region. The single currency of Europe was named as Euro. Prior to the formation of Euro every countries in the European Union was following their individual currencies. After 1999 all these individual currencies were replaced by the Euro. All member countries agreed to fix the exchange rate of their currencies after 1999. (European Single Currency, 2010) The main agenda behind the launch of Euro was to make the European Union equally competent with that of the US. Trade between the European Union countries became less restricted by the launch of Euro. After 1999, Euro became the immediate contender to the Dollar. For coordination of economies within the European Union, Maastricht Agreement was signed between the member countries. Maintaining price stability was the main objective of this agreement. (Crook, 1998) The inflation target that will be taken is not of any single individual European Union member but of the member countries as a whole. (Springerlink, 2008) The launch of a single currency and adoption of a single monetary policy has thrown better challenges and opportunities for European Union. However, it is now 10 years since the launch of Euro and is time to assess whether the currency has been a success in terms of the development of the European Union and the achievement of the objective for which it is constituted. Such an assessment is highly inevitable especially in the present situation of sovereign debt crisis in many countries across the world. This essay makes a critical analysis of Euro as a single currency for the European Union. Initial years Ever since the launch of Euro, it has many stories to tell about the challenges it faced and also the success it had met. One of the main successes that the European Central Bank point out is about the integration of various economies into a single market. Trade barriers between the European Union nations were removed within a short span of time. Difference between exchange rates was one of the major trade barriers existed. But as single currency was introduced, this problem was solved. Not only is the trade between nations but also the whole financial markets developed as a result of this single currency. Investors from one European country were easily able to access the other European markets. (European Central Bank, 2005) Another success story that European Central Bank has to point out is improved resilience against crisis in financial markets. They say that with the introduction of single currency the European Union, countries were insulated from crisis arising mainly out of exchange rate fluctuations and interest rate factors. They opined that events like September 11 attacks, etc did not trigger any crisis in the Euro Zone mainly because of the single currency. However, this point can again be referred in the later part of this essay to assess whether it actually is a success. The success of Euro can further be analysed in this part of the essay. Share of Euro in the global foreign reserves is a determinant of the success of the currency. (Burghardt, 2010) It can be seen that the share of Euro in the global foreign reserves has increased over years. In 1999, the share of Euro in the global foreign reserves is 15%. By the end of 2009 the share of Euro in the global foreign reserves has reached to over 27.4%. (Appendix 1) The share of Euro is increasing while at the same time Dollar’s share has declined from 2008. Still, dollar share around 65% of the global foreign currency. The share of Euro denominated bonds is another determinant of the success of Euro. As of 1998 Euro denominated bonds accounted for 28% of the outstanding amount on the world issues. By the end of 2009 the rate was much higher than that. Similarly, the case of Euro denominated money market instruments also show a same trend. The share of Euro denominated money market instruments was 17% in 1999. Now it is much more than 46%. (Appendix 2) Another determinant of the success of Euro is the number of countries that are using the currency. In that case too, Euro can be said as a big success because as of now more than 50 countries include Euro as a reference currency for operating managed exchange rate. (Burghardt, 2010) Euro has also faced many challenges during these initial years. The first and foremost challenge of Euro is the sustainable economic growth of member countries. There is huge disparity between the size and growth of economy of the member nations. When all the member countries perform differently, bringing them under a single umbrella is a problem. When a member country does not perform well it affects the whole union. The second major challenge is expansion of the Euro area. For making all countries in the region follow the Euro, the economy of all those nations have to be more or less similar. This is called the convergence. Making such a convergence between the member countries was a problem. (European Central Bank, 2005) In fact the major challenge faced by the European Union is convergence. The size and economic indicators of countries was different from one another. Later years The success and challenges of Euro in the initial years were seen above. In the later years, that is, years beginning from 2006 onwards, Euro have been facing serious challenges. These challenges of Euro were the rippling effect of the subprime mortgage crisis in US. Now the new issue that questions the success of Euro that was boasted by European Union is the recent crisis in the Euro Zone. The recent crisis was the deepest in the history of European Union. The countries that are faced by the crisis are Greece, Spain, Ireland and Portugal. Greece has faced the major crisis among these regions. Greek crisis was seen by many experts as a factor that will destabilise the European Union. Due to the sovereign debt crisis in Greece, Euro was under serious pressure. The question aroused whether Euro will survive the Greek Crisis. The Greece crisis wouldn’t have affected the Euro Zone if Greece was not following the Euro. But by the introduction of Euro every economy of the European Union became interlinked. The crisis in Greece has lead to reduction in the value of the Euro. When Greece faced crisis every country in the European Union turned against Greece as they feared that their economy will be affected. The deficit of the country was estimated to be 12.7 % of GDP. But it became 3% beyond the expected limit. Greece would have very easily solved it if it was following its own currency. Pegging its currency against others would have solved the problem. But as they were following Euro they could not peg the currency against other. Thus Greece Crisis is in other words a Euro crisis. Spain is another nation which has faced crisis in the recent times. Unemployment rate of the country has increased tremendously. (Appendix 3) The crisis of Spain also has more or less the same effect on the Euro as is caused by Greece. The GDP of Spain has contracted by around 3.6%. The problem for Spain is the dependability for deciding the monetary policies. As Spain has joined the European Union, it has to depend on European Central Bank for its monetary policies. The problem of Spain could be solved by devaluing its currency and thereby increasing the inflow of funds. Spain cannot do that because it has no control over the value of Euro. Spain has no voice in framing policies for Euro. (Americano.com, 2010) The crisis of Ireland is another test case for Euro. Ireland is one of the serious threats to the future of Euro. There was also threat from Ireland that they will exit the Union. Due to these crises Euro has fallen heavily against the Dollar in the recent months. If these persist Euro will be under serious problems. “Spreads on 10-year Greek bonds have widened to 325 basis points over German Bunds since the IMF entered the frame. The euro fell to $1.3330 against the dollar in early trading Wednesday.” (Pritchard, 2010) Neither could Spain control or adjust its interest rates. Many economists believe that Spain is a test for the effectiveness of Euro. Conclusion One major flaw in the formation of Euro was that, the decision was more political than monetary. The sole objective was to compete against US and other big powers. Economic consideration was not in the forefront while forming the Euro. European Union pretended itself to be a genuine super power and so they wanted to have a single national currency. (Belien, 2010) At the time of formation of Euro the Nobel Prize winner Milton Friedman opined that he is very negative on the decision to form the Euro. In the initial years it was seen that Euro was a great success. In terms of the growth in the currency and instruments based on that, it can be seen that Euro was a success. But when it came to the crisis faced by member countries, Euro Zone was in a Dilemma. What went wrong was the political agenda behind formation of Euro. As member countries face problems the future of Euro is under big pressure. Thus it can be concluded that Euro was not a success in full terms. The EU needs to address the problems of non uniformity in the economic conditions of the member countries. If that problem is solved Euro can continue as one of the strongest currencies even in the future. Works cited European Single Currency, 2010. What is the European Single Currency? [Online] Available at: http://www.europeansinglecurrency.com/what_is_the_euro.htm [Accessed 16 April 2010] Clive Crook, 1998. A Single Currency for Europe: Monetary and Real impact. [Online] Available at: http://www.cepr.org/pubs/bulletin/049/crookbox.htm [Accessed 16 April 2010] Springerlink, 2008. The Euro’s Start-up phase is a success. Intereconomics, [Online]. 1-2, Available at: http://www.springerlink.com/content/r5218866kv055037/ [Accessed 17 April 2010] European Central Bank, 2005. The Euro: Success and Challenges. [Online] Available at: http://www.ecb.int/press/key/date/2005/html/sp050114.en.html [Accessed 17 April 2010] Gunter Burghardt, 2010. Success and Challenges for th Euro. [Online] Available at: http://www.piie.com/publications/chapters_preview/3748/02iie3748.pdf [Accessed 18 April 2010] Americano.com, 2010. The Euro Effect on Spain’s Economy. [Online] Available at: http://theamericano.com/2010/03/03/the-euro-effect-on-spain’s-economy/ [Accessed 18 April 2010] Ambrose Evans Pritchard, 2010. Portugal downgrade knocks euro as Merkel imposes IMF solution for Greece. [Online] Available at: http://www.telegraph.co.uk/finance/financetopics/financialcrisis/7514987/Portugal-downgrade-knocks-euro-as-Merkel-imposes-IMF-solution-for-Greece.html [Accessed 18 April 2010] Paul Belien, 2010. Will the Euro Survive the Greek Crisis? [Online] Available at: http://www.brusselsjournal.com/node/4294 [Accessed 18 April 2010] Imf, 2009. International Reserves. [Online] Available at: http://www.imf.org/external/pubs/ft/ar/2009/eng/pdf/a1.pdf [Accessed 21 April 2010] Thierry Warin, 2010. The Euro at 10: Success and Challenges. [Online] Available at: http://www.cirano.qc.ca/pdf/publication/2009RB-05.pdf [Accessed 21 April 2010] Appendix (1) Share of national currencies in total identified official holdings of foreign exchange (in %) (2) Share of money market instruments/debt instruments (3) Unemployment and Employment in the Euro area over years Read More