Is It True That If the Euro Fails, the EU Fails - Essay Example

IF THE EURO FAILS, THE EU FAILS’. DO YOU AGREE? By and Introduction The recent economic upheavals that face the Euro nations especially Italy and Greece have had a marked effect on the performance of the Euro which is now leading to a debate that argues whether the European Union will survive this huddle. Taking into consideration all the events that have occurred in the last 21 months within the Euro zone I am inclined to agree that a fall of the Euro will inevitably lead to a fall of the European Union. In the stated period, there have been 14 summits, six Euro zone nations collapsing while an unprecedented four bailout packages offered to affected countries in the hope of reviving them. However, after all these attempts and talks, the union is still faced by the largest economic crisis threatening it very existence (Mail Online 2011). After all these failures we have seen numerous agencies come forward laying blame on each other, in line with what different governments have been doing to each other in the same period. This blame game and wrangles have made it relatively difficult to now bridge the differences and as such the painfully constructed bailout plans fall short since not everyone is willing to finance the plans. As a consequence, we have seen numerous such plans fall painfully short and into irrelevance within days. The issue has been more political than economical and as such we are tempted to start imagining what a new Europe will be like once the crisis has come to pass and what it would mean for the rest of the world (Archer2011). Thus far various European leaders such as Angela Merkel and Nicolas Sarkozy have come forward claiming that if the Euro does fail then there is no way that the union can survive. Basically, the Euro is the glue that binds the European Union. Sarkozy has out rightly said if talks aimed at managing the fall of the currency do fail, then there can be no peace in Europe. This may seem like a threat of war from the French prime minister but critically analyzing the progress the union has made in the last few years it is evident that most of the differences have been resolved since the union introduced the currency. The use of one currency does create a sense of belonging and equality among all member states, and as such if this is taken away, I do not see any way the member states can be equated (CNN 2011). In this paper I will be analyzing the prominence of the Euro in the world market and especially the European Union and its associated effects if it at all falls. I do assume that there is no way that the Union will survive once the Euro falls. My analysis and arguments are based upon the structure of the European Union and the stance taken by the various European nations given the problems that face the Euro. The role of the Euro in holding the union together cannot be ignored and as such it is important that the leaders and economists do all they can to ensure that the Euro does not fall if they really do want to see the organization survive this crisis. The Euro and its role in the Euro zone- why is it so important? The Euro is the official currency of the Euro zone with 17 out of the 27 member nations adopting it as their official currency. Furthermore it is also adopted as the official currency by five other nations that are not official members of the EU. The scope of the Euro has grown over the years to the extent of overtaking the Sterling Pound as the 2nd highest reserve currency in the world after the US dollar. It is also the most acceptable currency in world having overtaken the US dollar. Until the problems started surfacing, the Euro was looking certain to overtake the US dollar as the world leading reserve currency. Most of the world economies had come to accept the Euro as the currency of choice and as such freely leveraged it against most of their financial commitments both locally and internationally. This kind of scope means that so many economies will be greatly affected if the Euro does fail (Archer2011). The Euro officially came into use on 1st January 1999 and has since grown to have the highest combined value of circulating bank notes and coins just over 890 billion Euros ahead of the US dollar. The Euro’s success and exponential growth has generally been due to the stability of the currency. Such stability had been assured by the low and consistent rates that had been witnessed in most of Europe. Even at times of economic upheavals in some nations, the stability in most of the nations that use the currency did help to steady the ship at the end of the day. This generally led most non-member nations to want to join the union in order to enjoy the same macroeconomic stability devoid of inflationary pressures (El-Agraa and Ardy 2011). The high macroeconomic stability associated with the Euro has made most of the financial securities such as bonds that are denominated in Euros to be highly liquid. In addition, they do have lower interest rates in comparison to what they were when they were denominated in individual national currencies. While common knowledge dictates that increased liquidity is likely to lower nominal interest rates on bonds, denominating the securities in a currency with relatively lower levels of inflation arguably plays a greater role. The lower rate of risk that debts will be eroded in future by higher levels of inflation presented by the lower levels of inflation and stable debts presently do allow for the debts to be issued at relatively lower interests rates. It is such conditions presented by the Euro that saw an increased level of trade and investments in the euro zone. Trade increased by about 5 percent due the period that the Euro was in use. The effect was spread in other world markets increasing total trade in the world by nearly 15 percent. Despite other sources claiming the effect of the Euro on trade being negligible, there is some evidence on the ground to prove otherwise. Physical investment had increased by 5 percent as of the year 2005 in the Euro zone. Foreign direct investment within and without the euro zone had also increased as high as 20 percent due to the convenience of using the same currency across borders thus saving the time and costs associated with exchanging currencies (El-Agraa and Ardy 2011). The introduction of the euro into the market reduced the risk associated with fluctuation of exchange rates. This generally improves the terms and time of trade for exporters and importers of goods in and without the euro zone. The stability of the exchange rates throughout Europe created an overall reduction the market risk exposures to non-financial firms in the Euro zone and outside it. This generally increased the activities of the non financial firms which in turn led to growth and development in the Euro zone. The growth of these firms within Europe and without increased their productive capacity and as a consequence the number of people they employed. This thus led to solving of the labour problems that were plaguing the Euro zone i the early 2000s. Joblessness was a major problem affecting Europe by the turn of the century and the governments could no longer help solve the problem and as a consequence it would need the input of the private sector if the problem were to be solved (Korres, G. 2011). The use if a similar currency within the euro zone had the hopes of financially integrating the economies of all the member nations. It seems that the tact did work since the introduction of the Euro did improve the financial integration aim speeding it up immensely. The Euro did reshape the financial system with most changes witnessed in the securities markets within Europe. Integration was also possible in the in the wholesale banking system with challenges witnessed in the corporate and retail sectors mainly due to challenges of real and policy formulation within the Euro zone. The policy problems were mainly down to the barriers posed by the political arm of the union and thus not entirely down to the currency. A look at the effect of the Euro after the financial integration, it is evident the prices of bonds, banking assets and equity reduced substantially within the Euro zone. Borrowing within and without the euro zone did increase due to the financial integration. Globally, there is evidence that there is some form of financial integration that took place and it increased the volume of trade and investments (McCormick 2011). The introduction of the euro had the effect of reducing interest rate within the member countries. This was much greater in the nations that initially had weaker currencies. This had the effect of substantially increasing the value of firms within the weaker economies. Such countries include Ireland, Greece, Spain, Portugal and Italy. Surprisingly, these are some of the countries that have been most affected by the financial crisis that is threatening to end the union. The reported low interest rates in the countries that most benefited from the integration made it possible for banks within to borrow large amounts from abroad at rates as low as 3 percent. These amounts borrowed at times exceeded levels of budget deficits set in the euro zone and as such managed only to increase public deficits in those countries and as such the amounts held by the private sector and especially the consumers. The governments were forced to dig deep in order to reduce the amount of public debts but it may seem that they could not do much to avert the impending financial meltdown. Another issue of interest on the role of the Euro in the Euro zone has been the convergence of prices in the region. There has however been a debate raging on whether the Euro actually did bring any form of price convergence within the Euro zone in the time that it has been in use. The differences in opinion may be down to the fact that the convergence may not have been linear thus fluctuating from one period to another. What is however in agreement theoretically is that price convergence should be there if the region was open to trade. The differences in prices should be reduced due to an influx of cheaper products in countries that have more expensive. What applies here is the law of one price which argues that the price of the same commodity should be the same everywhere given that there are no barriers to trade or tariffs charged to move the goods across borders. This therefore helped to bring about economic growth in low cost countries and also bring about economic equality for residents of the Euro zone (McCormick 2011). Finally, the Euro did help increase the amount of tourism into the Euro zone by just over 5 percent. In addition, domestic tourism increased by just over 20 percent. The use of a common currency within the Euro zone saved interested tourists both international and domestic the hustle of having to visit exchange bureaus every time they needed to cross borders. Having to exchange currencies proved to be very costly and also time consuming and as a consequence the most tourists opt to visit fewer destinations than they would otherwise prefer given the financial and logistical challenges they would face. Furthermore, the movement across borders may require offering undue fees to officers posted on the borders in order to gain access. This would generally reduce the amount of money that would be in their possession. As consequence they will not be able to visit as many sites as they would wish. The European Union structure and its reliance on the Euro The European Union was formed to help integrate the European continent in attempt to ensure that it grew and developed evenly. The European Union is at the Economic and Monetary union level. This form of integration involves sharing similar fiscal and budgetary policy 9 Elafif 2011). The nations within this form of integration do share a common currency and as such have a common central bank that manages the currency on behalf of all the nations. In this form of integration, the currency in question is an integral part of the union. As a consequence, a fall in the currency will have some substantial effect on the very existence of the union (Korres, G. 2011). The European Union depends entirely on the existence of the Euro if it is to survive the crisis. The structure of the union is built around the strength of the Euro in the World and local markets. The European Central bank controls the flow of funds to every arm of the union and if the flow is cut, then the constituent arms of the union will either stall or fail. The restriction of the budget to the various governments will eventually force the local governments to seek different options to help manage their financial needs. The dependence on outside sources will weaken the power wielded by the central bank of Europe. This will eventually lead to a collapse of the bank and the Union as a whole. Thus far the Bosnian central bank has come forward stating that, "In case of a non-desirable scenario, regarding the model of Bosnias monetary policy, we would seek a possibility to index the local currency to another stable foreign currency." Such kind of thinking is bound to be infectious and it would be of no surprise if other nations do follow suit (EUbusiness 2011). Beyond all the economic factors that affect the European Union as pertains to the stability of the Euro, is the political will or the powers that be within the organization. There have been numerous talks and summits to help sought out the issues that are plaguing the European Union. The leaders of the member nations have come forth in support of keeping the organization intact even as it faces its toughest test yet. For this reason the Union has thus far tried it best to bail out ailing nations such as Italy and Greece but all seems not to be enough. For this reason, we have heard numerous European leaders claiming to pull out in the event that the euro does fail. This shows just how much they all think the Euro is important to the organization. The political arm of the union has substantial say on where the European Union will be heading if and when the Euro does fail (CSIS 2011). In my opinion, most of the political leaders, especially those of the smaller nations have given up on the Union assuming that the Euro does fail. The effects of leaders such as Merkel are admirable as she attempts to ensure that the Euro does not fail. To her, “If the euro fails, Europe fails. And if Europe fails, we all fail.” For this reason, she has dedicated her energy and resources in trying to convince all other leaders to join her fight to keep the boat a float. She recognizes the role that Euro holds within the set up and why it is important to ensure it does not fail. In his speech at the European Union summit in Brussels, Nicolas Sarkozy stated that, "Never has Europe been so necessary and never has it been in so much danger ... Never has the risk of Europes explosion been so great." It is such statements that one realizes just how important it is that the euro does not fail. Mr. Sarkozy also states that if talks there won’t be any second chance for the organization if the talks to help stabilize the Euro fail (Hurriyet Daily News 2011). What would happen if the Euro falls? If and when the Euro does collapse, there is expected to be general chaos within and without the Euro zone. The state of confusion would mean that most member nations would be in economic turmoil. They would thus be forced to engage in individual problem solving since the group problem solving would have failed. This will eventually force the governments to pull out from the organization with the aim of addressing their own problems. The mentality that policies designed at national level will lead to the notion that other nation’s problems are the reason that the individual nation is facing its own. This may eventually lead to a blame game that could eventually lead to a war between the European nations. This can be affirmed by claims by both Sarkozy and Merkel while giving their take on the economic crisis that faces the European Union. According to Sarkozy, "End of euro would mean end of Europe, end of peace." This I do tend to agree with (Express.co.uk 2011). As witnessed recently, the fall in the euro will prompt individual nations to increase their interest rates while at the same time trying to recover what they are owed by both private and public borrowers. While unable to recover their funds, most of these financial institutions will be forced to shut down business which is bound to cause contagion to other world banks. The shutting down of banks in European nations would stop the flow of money from lenders to borrowers which could eventually force foreign investors to pull out of the troubled nations. This could lead to estranged relations between the nations. With every nation trying to protect its own people and investments, they would advice them to pull out at every opportunity thus making the countries suspicious of each other. This will eventually force various nations to pull out of the union mainly due to mistrust. With the falling of the Euro, most of the investors will most probably panic thus disposing off their investments and general trade will be reduced as the most traders will be unwilling to trade using the Euro. Given the shortage in currencies to carry out trade the commodity prices will most likely sky rocket leading to unprecedented levels of inflation in the Euro zone and markets that heavily rely on the euro to trade. This may lead to the crushing of the markets and the financial institutions will likely be forced to increase the borrowing rates or even completely refuse borrowers funds. The high rates of interests were reflected on the government bonds, have continued to increase thus locking out majority of borrowers from accessing the funds they require. Panic and contagion will have effect of destabilizing most governments (Global Post 2011). The failing of the Euro will reduce the ground that the Euro zone nations had gained against the other competing nations such as the United States of America. The individual nations will be forced to revert back to use their original currencies. This will prove to be a very costly venture and as such the nations will be forced to exchange their Euro reserves for other currencies such as the US dollar with the European Central bank. Such actions will force the bank to completely shut down. These will handicap the organization since there will be no funds to help finance any activities of the Union. At the end of the day, the union will be forced to close office (Fox Business 2011). Conclusion Critical analysis of all factors relating to the Euro and the place it holds within the union reveal some interesting information. While most may assume that the Euro can easily be done away with but still leave the organization intact, I do dispute this opinion. I do hold that the European Union will fall if the Euro falls due to economic and political reasons. Crashing of the European financial markets and political wrangles will have an adverse effect on the organization thus it is very much unlikely to survive the euro fail. 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