Euro Effects on Global Financial Systems

The Euro is a currency that was founded in 1957 and is used in some countries that are members of the European Union (EU). It is the official currency and is used by sixteen out of twenty-seven countries that form the European Union. The EU is a union that deals with political and economic matters mostly in Europe. The European Currency Unit is a reference currency consisting of the currencies of all the countries that are members of the European Union. The Euro exists in both coins and banknotes. Just like other currencies, the Euro is transferable in non-physical forms. The currency has had major effects on both participating and non-participating markets. This paper will seek to analyze the effects of the Euro on global finance systems.

The European Union is a union that is located in Europe composed of twenty-seven members. The union addresses political and economic issues affecting member states. The union was formed on November 1, 1993, and it has undergone major developments since then. The union has developed a single market where goods, people, services, and capital can move freely across the borders of member countries. However, all these must be from the member countries. The countries that participate in the European Union include Austria, Bulgaria, and Belgium. Cyprus, Denmark, Czech Republic, Finland, Germany, Estonia, France, Hungary, Greece, Italy, Ireland, Latvia, Lithuania, Malta, Luxembourg, Poland, Netherlands, Romania, Portugal, Slovakia, Spain, Slovenia, Sweden, and United Kingdom. The unions have had many effects on all these countries.

Since the founding of the European Union in 1957, one of its primary goals was to bring about a common market. This required “closer economic and monetary co-ordination of the internal market” (Commission, n.d, par5). The radical changes on the European frontier in the late 1980s and early 1990s, primarily the fall of the Soviet Union and the reunification of Germany, helped lead to one of the most significant achievements in economic history. Based on that single market that the EU long strived for, the euro has brought much-needed economic integration to the European economy. This has been a major move towards the establishment of a common market.

When the United States ended the fixed link between the dollar and the price of gold in 1971 it also ended the system of fixed exchange rates (Commission, n.d, par.8). Countries of the European Union took action to prevent exchange fluctuations of up to 2.25% between European currencies (Commission, n.d, par.3). The result was the creation of the European monetary system (EMS) in March 1979 (Commision, n.d, par.9).

The EMS established a reference currency called the European Currency Unit (ECU). The ECU made up a collection of all the member country currencies. The EMS also ensured an exchange rate mechanism, where each currency exchange rate was linked to the ECU. (Commision , n.d, para.4) Lastly the EMS created a credit mechanism (Commision, n.d, par.4). Each member country contributed 20% of currency and gold reserves into the EMS joint fund (Commision, n.d, par.5). All these currencies are the ones that were later combined to form the current Euro.

The strength and support for the EMS began to decline. The reunification of Germany and the departure of the Italian Lira and pound sterling from the EMS in 1992 contributed significantly. The European Union governments decided to establish a “full monetary union and to introduce a single currency” (Commision, n.d, par.6). In June 1989 a three-stage plan to achieve economic and monetary union was created by the European Council. It became part of the Maastricht Treaty on European Union and was adopted in December 1991 (Commision, n.d, par.6).

The first stage toward economic and monetary union began in July 1989 when restrictions were lifted on moving capitals between member countries. (Bank, n.d, par.2) The second stage established the European Monetary Institute (EMI) and the European Central Bank (ECB) (Bank, n.d, par.4). The EMI goals were to “strengthen central bank cooperation and monetary policy co-ordination” and prepare for the establishment of the European system of Central Banks (ESCB). The ESCB‘s goal were to prepare for the single monetary and currency (stage three). Stage two also consisted of the establishment of the ECB in June 1998 and the Council of the European Union choosing 11 countries to be part of the initial stage three. The third and final stage saw the birth of the euro (Commision, n.d, par.11), which consisted of fixing the exchange rate between the 11 chosen countries (Bank, n.d, par.5).

Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain were the initial countries chosen to begin using the euro on January 1, 1999. Known as the convergence criteria (Commission, n.d, par.13 ), there were set requirements for countries to meet before they could go to stage three. First the countries rate of inflation must not exceed the average rate of inflation of the three member countries with the lowest interest rates by more than 1.5% (Commision). Second, the long-term interest rate must not vary by more than 2% than that of the three member countries with the lowest inflation. Third, national budget deficits must not exceed 3% of GDP (Commision, n.d, par.11). The fourth requirement states that public debt must not be more than 60% of GDP (Commision, n.d, par.10). Lastly, exchange rates must have remained within authorized margin of fluctuation for the past two years (Commision, n.d, par.12).

Euro notes and coins were issued to the 12 countries on January 1, 2002. Old national currency was withdrawn from circulation a couple of month later (Commision, n.d, par.5). With the exception of the United Kingdom and Denmark, all EU countries will adopt the euro once they meet the convergence criteria. Taking an opt-out clause, the United Kingdom and Denmark are exempt from participating in the euro currency (Commission, n.d, par.7 ). Among possible political and social reason, the United Kingdom was experiencing a considerable larger economic growth rate than that of the euro zone, a structural unemployment that sat at 5.5% and a states share in economy 4.9% lower than that of the euro zone (Teachers, 2006, par.4). Denmark had an unemployment rate at 4.6% and comparable “healthy public finances” (Teachers, 2006, par.6) to that of the United Kingdom which contributed to not joining.

On January 4, 1999 the exchange rate was 1.1789 of the U.S. dollar (Triacom, 2009, par.3). It also was 0.712381 of the British pound, and 7.44983 of the Danish krone. When euro notes and coins were issued to the 12 countries on January 1, 2002., old national currencies were withdrawn from circulation a couple of month later (Commision). By then the exchange rate for the euro on January 4, 2002 was 0.894598 of the U.S. dollar, 0.618885 of the British pound, 7.43903 of the Danish krone. On March 24, 2010 the euro exchange rate was 1.3338 of the U.S. dollar, 0.894599 of the British pound, and 7.4404 of the Danish krone.

Real GDP Growth Rate

Euro Area GDP Growth Rate

16 countries are now using the euro. Greece joined the euro in January 2001. Slovenia joined the euro in 2007, Malta and Cyprus in 2008, and Slovakia in 2009 (Bank E. C.). With just a decade in circulation the euro is only surpassed by the dollar (Frankel, 2002, p.3). As the current account deficit and external debt loom on the dollar along with the ECB’s ability to keeps inflation relatively low (Nesvisky, n.d, par.2) the euro could possible surpass the dollar as the major international currency (Nesvisky, n.d, par.3). In conjunction, rising prices in commodities such as oil have “increased foreign reserves in oil-exporting countries.” Since these reserves come “primarily from U.S. current account deficits (Nesvisky, n.d, par.5) a slight “shift out of dollar assets” could cause notable dollar depreciation (Nesvisky, n.d, par.6). Emerging market countries are accumulating large foreign reserves assets three times more than in 1998, much in euro assets (Nesvisky, n.d, par.6).

As with any financial system, the euro is not without its troubles. Greece is experiencing an increasing public deficit which many believe could have a significant effect on the future of the euro currency and has already triggered a euro crisis. Grease’s deficit is up to 12.7 percent of GDP (Bryant, 2010, par.6), well above the 3 percent limit under EU rules. One of the concerns is that Greece may not be able to implement its EU approved austerity plan and may default on its debt (Gelinas, 2010, par.9). This would discourage bondholders from lending to other weak euro zone countries (Gelinas, 2010, par.10). Critics say that Greece could “abandon the euro, go back to the drachmas, export goods and services using a cheap currency to spur economic growth” (Gelinas, 2010, par.9). This would encourage other countries during tuff economic times to leave the euro.

France and Germany, the strongest of the euro zone nations (Gelinas, 2010, par.11) may bail out Greece, breaking the euro zone’s no bailout clause (Gelinas, 2010, par.12). Though this would help the bondholders and creditors that Greece owes debt to it likely wouldn’t fix the Greek economy. It would only mask the economic issues of “a bloated public sector and too much debt” (Gelinas, 2010, par.12). According to Chartered Financial Analyst Nicole Gelinas, if Greece decided to bail itself out while keeping the euro, the outcome could be positive. Though this would cause the euro value to fall investors would see that stipulations under the euro zone are solid. Also, a weak euro benefits not only Greece but other European nations as lower rates bring in tourism. Europe also sells its goods and services cheaper, increasing export (Gelinas, 2010, par.13).

In the long term, Greece’s problems could be a blessing in disguise. If Greece can set the example and recover from its severe debts while keeping the euro, other struggling euro zone countries will follow. Portugal and Spain’s rising deficits are also causing more strain on the euro zone (Gelinas, 2010, par.9). A prevailing Greece would encourage these and other countries that recovery is possible while remaining under the euro (Gelinas, 2010, par.8). The euro prevailing over this current crisis also shows investors that the currency is indeed dependable and ‘made’’ to-will last through tuff financial times. As a result, there are very high chances that more European countries will start using the currency and gain the advantages of using it.

The Euro is a currency that founded in 1957 and is used by sixteen countries out the twenty seven that make the European Union. It exists in form of notes and coins and is transferable through non-physical means. The European Union is located in Europe and addresses political and economic issues affecting member states. It was formed in 1993 and has been very useful to the member states. The union was formed with intention by the different countries to form a common market. The European monetary system was formed when the United States stopped exchange links between the dollar and the price of gold in 1971. EMS then established a reference currency called the European Currency Unit. An economic and monetary union began to be formed when restrictions were lifted on moving capitals between member countries and the European Monetary Institute and the European Central Bank were formed. The eventual end was the invention of the Euro. Initially, only eleven countries were chosen. On January 1, 2002, the Euro notes and coins were issued to twelve countries and the currencies belonging to these countries were withdrawn. Currently, sixteen countries are using it. The currency has many past and present effects. Countries like Greece, France, and Germany have benefited a lot in using the currency.

Reference

Bank, E. C. (n.d.). Economic and Monetary Union (EMU). 2010. Web.

Bank, E. C. (n.d.). Map of euro area 1999-2009. Web.

Bryant, L. (2010). Greece’s Problems Spark Euro Zone Woes. Web.

Commision, T. E. (n.d.). Economic and monetary union (EMU) and the euro. 2010. Web.

Commission, E. (n.d.). Economic and Financial Affairs. 2010. Web.

Frankel, J. (2002). Will the Dollar Eventually Lose Its Place as Leading International Reserve Currency? Web.

Gelinas, N. (2010). Forbes.com. Web.

Nesvisky, M. (n.d.). “In a 2005 survey of central banks, most respondents said they intended further diversification away from the dollar, and several have recently made public announcements along these lines.”. Web.

Teachers, E. A. (2006). European Association of Teachers. Web.

Triacom, (2009). U.S. dollar: Historical exchange rates. Web.