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Will the Euro collapse?
Topic Started: Dec 9 2011, 12:17 AM (2,719 Views)
Woody
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Grade A Leprechaun
A question on the flaws of the euro and policy response could come up in my exam on Monday, so I thought I should add to the debate here and show the answer that I have prepared.

Quote:
 
The euro is a common currency introduced by the European Union in January 1999. Today it is used by Ireland, Spain, Portugal, France, Germany and Italy among others. This common currency can be used anywhere in the euro area. A monetary union, such as that in the eurozone, offers microeconomic efficiency gains and facilitates the development of a deep, liquid market. All eurozone member government's have delegated the operation of monetary policy to the European Central Bank (ECB). This may been seen as more effectively insulated from political pressures than national monetary authorities.

Within the eurozone, all member states have the same monetary policy controlled in Brussels by the ECB. A 'one size fits all' monetary policy may ben seen as a source of instability for member states with business cycles that are not highly correlated with the core of the eurozone. Say the ECB sets an interest rate according to eurozone averages but one or two states within the eurozone area are growing muach faster or much slower than this average. This interest rate level may not be suitable for every member of the eurozone. For example, if one region is showing signs of inflation eg Germany, then the ECB may set higher interest rates. These higher interest rates are going to hurt states in a recession eg Greece.
There are other flaws in the euro.
1)lack of fiscal union
2)dissimilar structures in different economies (eh Boston vs Berlin debate)
3)inadequate coordination of banking regulation
There has been a number of attempts to compensate for these deficiencies, fro example, cohesion funds. There was a belief that the single currency would help bring a systematic structure throughout the different economies over time. This was never going to happen over a reasonable time scale. How could Greece develop a similar economic structure to that of Germany. The ECB has recently cut interest rates in an attempt to increase liquidity and the flow of credit.

Since the introduction of the euro, there has been no common fiscal policy throughout the eurozone. While countries benefitted greatly from the low interest rates that ensued after the introduction of the euro, fiscal discipline was neglected resulting in huge government debt. Fears of a sovereign debt crisis developed among fiscally conservative investors concerning some European states. In countries where sovereign debts have increased sharply due to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members. Bond yields were increasing as credibilty of some government's ability to repay their debts came into question as debts mounted. Bondholders sold the debt in the secondary bond markets, pushing down prices and pushing the yields up.
The only attempt at convergence was limited to the Growth and Stability Pact. The Growth and Stability Pact's goal is to maintain the stability of the Economic and Monetary Union and aimed at preserving fiscal discipline by limiting annual budget deficits to 3% and a national debt to GDP ratio of lower than 60%. The Growth and Stability Pact was introduced as a result of the 'free rider problem' which was the fear that some countries would be fiscally irresponsible. A 'no bailout' clause was inserted in European treaties and as part of this, the ECB was prohibited from lending directly to countries. The ECB is leading from the front in seeking to stabilise European public and private financial sectors. It crossed the Rubicon and took the dramatic step of buying Italian and Spanish government bonds. This action risked blurring the distinction between monetary policy and fiscal policy on whcih the ECB's credibility as an inflation fighter depends. This was done in an attempt to keep interest rates down and was needed due to lack of credibility.

The eurozone has no federal government like in the US. Europeans don't have a means of redistributing revenue to the countries of the eurozone that are in need. The European Financial Stability Facility (EFSF) and the European Financial Stability Mechanism (EFSM), together with the International Monetary Fund (IMF) would bailout EU states in trouble. However, the EFSF and EFSM were intended only as a temporary measure in part due to the lack of a legal basis in the EU treaties. The EFSF is a special purpose vehicle which was agreed by the 16 countries that share the euro to provide aid to eurozone countries in financial difficulty. It is authorised to borrow up to €400bn and is incorporated in Luxembourg. It is eurozone specific. The EFSM is a fund set up by the EU Commission, back by all EU members, aimed at preserving financial stability in the EU and is authorised to borrow up to €60bn and can support all EU member states. The eurozone governments allowed the EFSF to acquire sovereign debt at a discount on the secondary market which would help to finance the recapitalisation of banks and to extend preemptive credit lines to countries under pressure in debt markets. EFSF bonds require a triple A credit rating, whcih depends on Germany and France retaining their triple A status.

Austerity measures were introduced to prove to the markets that they can spend less. These austerity measures also apply to countries that have not been bailed out. Governments need to stop borrowing and begin to cut budget deficits. As the Troika are imposing these, it is a form of fiscal integration.

There is little doubt that the euro is flawed, but there was no way to say that it was predestined to fail. Property bubbles and crashed along with fiscal irresponsibility along with the failure of banking regulation, were not foreseen nor were they inevitable. Once the problems began, the financial markets punished the offending countries. Punishment may have been deserved, that of the international markets, may have been more severe than it normally would have been fo 3 reasons:
1) global savings are tight
2) US is taking most of the little savings there is
3)the ratings agencies are trying to mend their reputations by being tougher than ever on sovereign borrowers

In order to save the euro, there has been proposals for greater economic governance within Europe, fro example, eurobonds. If eurobonds were introduced it would represent a much greater integration in the eurozone and would mean all countries would be responsible for all debt within Europe.
The euro could also survive in some 2 tier form, though it is doubtful that France could stand shoulder to shoulder with Germany using the same currency. There would be constant pressure on the euro which would only end if France joined the second tier, in which case, Germany would be the only country left with the full euro, which would then become the DeutcheMark.

Although the euro was never important on economic grounds, its collapse may lead to the unravelling of the EU. But its survival may lead to much closer integration
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Plonker
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Oracle of Truth.
Stryke
Dec 9 2011, 08:54 PM
On a side note the 'outrage' from Europe over the recent veto by the UK is brilliant. One EMP went as far as to say "Europe will be better off without Britain". Really? Better off if you ditch the 2nd largest contributor to the EU budget? I'd love to see the magical accounting that would erase that budgetary blackhole.
The UK is the 4th biggest contributer.

http://news.bbc.co.uk/2/hi/europe/8036097.stm

:monty:
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RubberToe
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Chewbacca Lookalike
Arent Italy on the verge of collapse as well?
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Stryke
Star of Brokeback Mountain
Gooner #1
Jun 18 2012, 02:12 AM
Stryke
Dec 9 2011, 08:54 PM
On a side note the 'outrage' from Europe over the recent veto by the UK is brilliant. One EMP went as far as to say "Europe will be better off without Britain". Really? Better off if you ditch the 2nd largest contributor to the EU budget? I'd love to see the magical accounting that would erase that budgetary blackhole.
The UK is the 4th biggest contributer.

http://news.bbc.co.uk/2/hi/europe/8036097.stm

:monty:
On that very same article click on the "net contribution" tab. You'll find that the UK is the 2nd biggest net contributor despite the rebate. :monty:

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Plonker
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Oracle of Truth.
You didn't say anything about net cotributer in your first post tho :p
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footyfan000
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Changing my tune since 2008.
The Euro was always going to be flawed. Here's the way I think about it: the currencies of the world can be thought of as a system or a large machine. They are made up of lots of little parts which are the currencies which form it. The Euro would be one part, the pound another, the dollar another etc. The larger the part, the greater the risk if anything goes wrong. With smaller parts, a machine can function better if one part fails. Sure, there is an effect on the overall performance of other parts of the machine and of the machine as a whole, but the machine is better able to cope with failures of small parts than large ones.

As the Euro counts as a collection of smaller parts in this analogy it is catastrophic when it goes wrong. Instead of parts being independent, the failure of one part suddenly brings greater risks to the other parts. It was a doomed idea from the start and I can't see how it would ever work.

In other news, good to see Germany learning from history by insisting on unmanageable terms for a country who does something wrong which results in people of that country giving more and more power to extreme parties. You'd have thought they'd learnt from the Treaty of Versailles (WWI) but apparently not, looking at Greece :lol:
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Jeffers
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Ginger Prince
It was a poor idea in the first place, Germany were always going to end up holding it up with how superior there economy could be compared with Spain/Greece/Ireland.

Even the Dollar is struggling in the US because of the many different economies state to state.

























Edited by Dimitar, Sep 5 2012, 08:40 PM.
"I don't play against a particular team. I play against the idea of losing." - Cantona
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Plonker
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Oracle of Truth.
It was a noble idea actually. To unite all the economies to make Europe more competitive. In a multipolar world, European countries can only compete with giants like the US, India or China if they work together. Alone, only Germany and maybe France stand a chance. The rest is pretty much forked.

I have never heard the theory of the US Dollar struggling because of the different economies within the country.

Inflation, trade deficit, and some other factors are the reasons why the Dollar is struggling.

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footyfan000
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Changing my tune since 2008.
Gooner #1
Jun 18 2012, 10:35 PM
It was a noble idea actually. To unite all the economies to make Europe more competitive. In a multipolar world, European countries can only compete with giants like the US, India or China if they work together. Alone, only Germany and maybe France stand a chance. The rest is pretty much forked.

I have never heard the theory of the US Dollar struggling because of the different economies within the country.

Inflation, trade deficit, and some other factors are the reasons why the Dollar is struggling.

Sure, there are differences in American politics, ideology and economy across the country. At a central government level though, there tends to be more common ground between the states than many of the countries across Europe. It is a nobel idea to make one common currency to make things work in Europe but the fact of the matter is that it simply won't work. Ever. There is limited power to control inflation for individual countries in the Eurozone as the Bank of England does in the UK. It is less of a problem in the US because there is a central government and not just a central bank. The European Union does not count as a central government as it cannot enforce all that much in the grand scheme of things.

For the Euro to work, we would need to forego much of our national identities across Europe and accept a United Countries of Europe imo as a central, binding government for everybody. There are so many countries to deal with and such varying beliefs and infrastructure that the US approach simply would not work.

I'm not saying I'm definitely right btw, it is just my opinion and I'm open to listening to what others have to say. I just feel that evidence seems to support Euroskepticism in light of the potential for the Eurozone to collapse if Greece defaults and if Spain follows suit. Italy won't be far behind, Portugal is on dodgy ground and there are others ready to sink into the pit. If they drag Germany down too much then the whole thing collapses. The UK is isolated from complete disaster in that we don't have the same currency, but as world currencies are intrinsically linked in a global market we would obviously feel severe effects.
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Stryke
Star of Brokeback Mountain
As a very brief parting comment about a centralised economy working in the US...

One major difference here is that the differences between US states is insignificant compared to the differences between European countries. The vast majority of the states were created BY the existing US government rather than being absorbed or joining afterwards. In most cases there was little to no existing culture (the American Indians don't count in this instance because their contribution to the current US government/economy is negligible), organised economy or political system. The vast majority as themselves as American in one form or another because they either came to the newer states from the original ones or voluntarily came from the 'old world', etc. The various parts of the US economy largely sprang from similar roots.

In contrast Europe is a collection of states (along with their respective cultures, political infrastructures and economies) that have developed largely independently along very different paths that are now being pushed together. That is rarely going to work as well.
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