During the global financial crisis of 2008-2009, it was widely believed among a large majority of people ranging from laymen to hedge fund managers that the Euro was a haven of safety where people could park their savings and investments without any fear of degradation of the currency and thus shield them from the depreciation of their money. This was a time when the fall of the US Dollar was considered imminent (along with the end of American hegemony in the world economy). Oh, how the times have changed!
It is now evident that the kind of crisis that has occurred in Greece and is feared to occur in Portugal, Spain and even Italy was inevitable.
The reason why this kind of crisis was bound to happen is that the Euro has been adopted in a situation where the countries that have adopted it have done so in a semi autonomous economic fashion where the European Central Bank (ECB) holds the power to issue and regulate the currency but the member nations themselves hold the authority to regulate their own sovereign finances which are merely monitored at the Euro Zone level but not regulated by questionable and ineffective laws. The second reason is a mere extension of the first. The Euro has been adopted by an economic "Super State" (the Euro Zone) while the politics of the member states is still an internal matter of the member countries. Thus, while there is an economic union there isn't a political one.
The introduction of the Euro with a low common rate of inflation (the law of averages is at work here) caused sharp declines in the rates of interest in many of the member countries which until the adoption of the single currency, had high borrowing rates. This resulted in these countries succumbing to the temptation of increasing government borrowing at the now lower interest rates resulting into ever rising rates of debt to GDP ratios. The debt to GDP ratio is as high as 115% in Greece and Italy.
Until recently before the crisis most debt issued by Euro Zone countries was treated as equal resulting in maintenance of the low interest rates of high debt countries. This continued until a default seemed clear in the near term for countries like Greece which might now have to go for a massive debt restructuring (read: refinancing) with help from other rich Euro Zone countries (read: Germany) and the International Monetary Fund (IMF).
Even after the crisis has surfaced, Greece does not have the adequate tools to fight it as it is locked into the Euro. If Greece still had its own currency - the drachma, it would be able to fight this situation by devaluing its currency and thus help boosting exports and reducing imports. This is one of the biggest if not the biggest drawback of a single currency. Greece also loses the ability to control interest rates and use monetary policy effectively.
Economic blocs around the world have a unified mechanism for increasing inter-regional as well as intra-regional trade but do not have a single currency precisely because of the reason mentioned above. The North American Free Trade Agreement (NAFTA), the East African Community (EAC), the Association of South East Asian Nations (ASEAN) are examples of economic blocs with members agreeing on trade mechanisms but maintaining separate currencies.
Despite all these problems the Euro still looks resolute enough to survive this on going crisis but from the looks of things the Euro Zone may lose some of its members with only countries fiscally strong enough remaining in the zone with perhaps a resurgent and strong Euro. Looking back one can say that countries which were fiscally weak and having high debt-GDP ratios were allowed to join the union which ultimately lead to this crisis.
Even if the union manages to frame some sort of policy to control fiscal irregularities amongst members in the future, the problems of having a single currency will still remain.
Mitul Choksi
30th May 2010
11 PM Indian Standard Time
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