What is the Euro
The euro is the single currency of the European Monetary Union, which was adopted by 11 Member States from 1 January 1999. The 11 Member States are Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. Greece became the 12th Member State to adopt the Euro on 1 January 2001. The name “euro” was chosen by the European Heads of State or Government at the European Council meeting in Madrid in December 1995.
What is Economic and Monetary Union? Economic and Monetary Union (EMU) is a single currency area within the European Union single market in which people, goods, services and capital move without restrictions. It creates the framework for economic growth and stability and is underpinned by an independent central bank and legal obligations on the participating Member States to pursue sound economic policies and to coordinate these policies very closely.
As trade between the EU Member States reaches 60% of their total trade, EMU is the natural complement of the single market. This market will work more efficiently and deliver its benefits more fully with the removal of high transaction costs brought about by currency conversions and the uncertainties linked to exchange rate instability. The rules, institutions and objectives of EMU are set down in the Maastricht Treaty. What determines the external value of the euro?
The external value of a currency is determined on the foreign exchange markets and is shaped by a variety of factors whose importance will vary from time to time, including inflation in its domestic economy, monetary and fiscal policies pursued by the public authorities and the state of its balance of payments. The exchange rate developments of the euro will be closely monitored by the Economy and Finance Ministers Council. The Council may, in exceptional circumstances, for example in the case of a clear misalignment, formulate general orientations for exchange rate policy in relation to non-EC currencies such as the US dollar.
What monetary and financial precepts do participating states have to follow? The Treaty has clearly indicated the monetary and financial precepts on which Economic and Monetary Union (EMU) is based. The primary objective of monetary policy is maintaining price stability, while also supporting the Community’s general economic policies. The management of monetary policy must be in accordance with the principles of an open market economy with free competition.
As regards fiscal policies, countries participating in the euro area are required to sustain well managed public finances, as defined in the Maastricht Treaty. Moreover, in order to ensure a lasting budgetary convergence, a ‘Stability and growth Pact’ has been adopted, in which all Member States acknowledge the need for sound fiscal policy to ensure the proper functioning of EMU. Participants in the euro area will adopt medium-term programmes aimed at a budgetary position close to balance or in surplus; an excessive deficit, if not corrected in time, will ultimately lead to financial sanctions.
Those states that have not adopted the euro will also be subjected to convergence programmes, but not to sanctions. Apart from the general guidelines mentioned above, those countries adopting the euro will, like all Member States, have to follow the general framework for economic policy co-ordination and the procedures established by the Treaty. So how does it work? Europe’s monetary union works a bit like all states in the United States sharing the US dollar and having the same key interest rate. For the eurozone, the interest rate is set by the European Central Bank (ECB).
Even though the eurozone’s citizens are still using their old coins and bank notes, the exchange rates between member currencies are already fixed – so that the euro represents a fixed percentage of one Deutschmark or franc. Banks and many companies are already using the euro for internal book keeping and electronic money transactions. And foreign exchange dealers now trade the euro, rather than francs or lira, against other currencies. Consumers will receive their first euro banknotes and coins in January 2002. There are 100 cents to one euro.
Why is the euro in trouble? When the euro was launched, it bought $1. 17. In the following 22 months, it lost about 30% of its value against the US dollar, trading as low as $0. 82. After hitting that low in October 2000, the euro recovered for a while, even getting close to parity with the dollar. However, it has since slipped once again close to its historic low. EU officials still argue that the euro is “markedly” undervalued and say the economic fundamentals should soon push up the single currency again. Why did the euro get so weak?
During the first two years of the euro’s life, the US economy strongly outperformed most eurozone economies. This, and the fact that productivity growth in the US was much higher, persuaded eurozone companies to make large investments in the United States. To invest in US companies, they had to sell euros and buy dollars, which drove down the euro’s value on the market. Another factor were stock market investment flows. Higher productivity of US firms resulted in higher company earnings. Coupled with high interest rates, this made the United States a preferred destination for European stock market investors.
Once again, the euro was sold in favour of dollar investments. At the beginning of the year, the picture changed. The US economy slowed down sharply, while eurozone kept posting strong growth. US stock markets, meanwhile, were in deep trouble. Both factors boosted the euro – but not enough to push it to its launch value. As a matter of fact, as signs of a slowdown of the eurozone emerged, investors fled yet again into the dollar, even though the economic prospects of the US economy are still markedly worse than those of the 12 countries using the euro.
Why does everybody criticise the European Central Bank? It’s a question of market confidence. Currency traders are still unhappy with how the ECB conducts its monetary policy. The ECB is controlled by a board made up of all 11 central bank governors, who still may represent the interests of their countries rather than of the eurozone as a whole. There is a feeling that a sense of direction is lacking, and that not only EU politicians but even central bank officials are not always singing from the same hymn sheet.
Unlike the US Federal Reserve, the ECB has not yet mastered the fine art of keeping the markets guessing about what it is up to, while providing some clarity about the direction of monetary policy at the same time. As a new currency, the euro must prove itself attractive to international investors. The uncertainty means that many investors prefer to buy dollars rather than euros in a time of crisis. A fine example was the run-up to the ECB’s decision in May to cut interest rates. Until a day before the rate cut, ECB officials had warned of inflationary pressures.
On the day of the rate cut, the bank argued that inflation was not a threat anymore. The next day official figures showed inflation figures surging in three key eurozone economies. So that’s it for the euro, then? Not so fast. Have a look at the broader picture: Currency swings can be very violent and take a long time to ride out. If you look at how the mighty Deutschmark, now part of the puny euro, has done over the past 15 years, you will see that it dropped even faster against the US dollar between 1995 and 1997 then it did as part of the euro during the past two years.
And compared to 1985 – when the dollar was at its strongest, the euro is still in pretty good shape. However, investor and market confidence is not an exact science that can be expressed in numbers. The euro’s fall is an embarrassment for politicians who predicted a single currency strong enough to challenge the dollar. And it has left many of the European Union’s voters seriously disenchanted with the euro. The latest example is the clear no in the Danish referendum on whether to join the single currency. Most companies, all trade unions and all the big parties in Denmark were in favour of the euro.
The euro’s weakness – and worries about national sovereignty – persuaded many people to vote against joining. Does monetary union bring any advantages at all? Yes, it does. First of all, firms that export a lot to other countries within the eurozone don’t have to bear the costs of exchanging profits into their home currency anymore. Multinationals also save a lot of money if all their subsidiaries trade in the same currency. Smaller firms suddenly are finding customers in regions they thought they could never be bothered to export to.
The disappearance of these transaction costs is bound to boost economic growth, and will make goods cheaper for consumers. And even the weak euro has been a boon for the eurozone, as its exports to the United States and the UK have become more competitive. Once euro coins and bank notes are available, consumers and tourists in the eurozone will feel the benefit as well. Travelling in the eurozone will become cheaper, and competition could drive down prices – at least in border areas. And what do the euro’s critics say? Some say that monetary union on such a large scale does not make economic sense.
They argue that an interest rate suitable for Italy or France may actually do harm for the economies of Ireland or Finland. They argue that the economic cycles of countries that want to join the euro should be in step with that of the eurozone. Low eurozone interest rates, for example, could overheat the already strong economy of a new member state – or high euro rates could damage an already struggling country. However, the same holds true for the United States – or even the UK, where Midlands firms are complaining about rates that benefit the south-east.
But the euro critics say that economic cycles there are much more in tune with each other than those of various European states. The biggest criticism, though, is not one of economics, but politics. Joining the euro means pooling a country’s control over its monetary policy with that of other states. Could small states be outvoted by big economies? Will large countries outmanoeuvred by the small nations ganging up against them? Will economic and monetary union not ultimately force all members to harmonise taxes and other policies, thus eroding political sovereignty?
And what happens during a serious economic crunch? Competitive devaluation – as Brazil’s government did during its economic crisis in 1999 – would not be an option anymore. Personal Views In my personal opinion, joining the Euro would be a bad thing for the United Kingdom. Throughout this project I have weighed up the good and bad points, the pro’s and con’s, of the United Kingdom joining the Euro, and although there are advantages to joining the European single currency, I still believe that there is no need for this change, and that the UK economy will prosper without joining the Euro.
Over the years we have learned to use the strength of the pound to our advantage, and have successfully used interest rates as leverage in business deals and suchlike. Such an upheaval in our economy must have a huge advantage or it is not worth doing, and in my eyes, the chaos of this historic change would out-weigh the advantages it would bring us.
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