Download Speaking at a press conference following the European

Speaking at a press conference following the European Central Bank (ECB) governing
council meeting on Jan. 14, president of eurozone’s central bank, Jean-Claude Trichet
said that no country should expect special treatment, or special help, in the current
economic crisis. He then added that “Belonging to the euro, you are helped, because you
have easy financing of your current account deficit and you have a credible currency. So
the problem is not help, the problem is to do the job, to take the appropriate decisions.
That is what is at stake.”
The financial crisis sweeping across of Europe has raised fears that severe economic
problems on eurozone’s periphery, in countries like Greece, Ireland and Portugal, could
adversely affect the euro and therefore the eurozone as a whole. The economic imbroglio
in Greece, to which Trichet was directly speaking to, has put this fear into focus of
investors, governments and eurozone leadership.
To understand the current crisis, and the potential side-effects for the eurozone, Stratfor
looks at the underlying consequences that euro adoption has had on member states of the
eurozone.
History of the Euro
The creation of the euro draws its roots in the collapse of the Bretton Woods system in
1971-72. Bretton Woods was a global economic system created out of the ruin of the
Second World War which established the U.S. as the world’s central banker due to its
preeminent position as the global post-War hegemon. World currencies were pegged to
the dollar, while the U.S. dollar was pegged to gold (for credibility sake). The idea was to
establish a competent global monetary system that would encourage trade, which itself
was seen as crucial for post-War global economic integration and therefore the
preservation of world peace. Managing exchange rate was a way to prevented countries
from using devaluation of currency to undercut exports, “beggar-thy-neighbor” policies
that profligated in the aftermath of the Great Depression.
Bretton Woods system of fixed exchanges failed under the stress of the U.S. economic
imbalances, primarily the result of large defense outlays in the 1960s and early 1970s.
The U.S. dollar had become overvalued and the U.S. government could no longer uphold
its commitment to convert dollars for gold at $35 an ounce. After a couple attempts to
devalue the peg, the U.S. ultimately abandoned it. Without an anchor to gold, the U.S.
dollar's exchange rate was free to float on the open market -- and, conversely, world
currencies were left to float as well.
For the fledgling EU (then called the European Economic Community), this created a
problem because large currency fluctuations -- which make it difficult to properly price
foreign goods -- would impede trade between member states. The fear was that volatile
exchange rates could put in danger 20 years of post-war economic progress and seed
potential future conflicts. Europe therefore created its first attempt at currency
coordination in 1971, albeit still pegged to the dollar, and later established the European
Monetary System (EMS) in 1979, which un-pegged Europe from the dollar by setting up
a peg against a basket of European currencies of which the German Deutschmark was the
unofficial anchor by being the currency of the most powerful European economy.
In the early 1990s impetus developed to b
The peg to the currency basket dominated by the Deutschmark actually gave German
Bundesbank inordinate policy power throughout the 1980s. An impetus therefore
developed to move towards a coherent monetary union, one that would include a single
currency and a single bank.
Impetus for EMU:
1.
2.
3.
4.
German unification
Need to somewhat temper power of the German Bundesbank
Sovereignty would be preserved, but under strict rules of monetary policy
Some (Italy) saw future EC curbs on national fiscal policy as great way to get
their budget problems under control
5. Commission argued that savings on transaction costs would amount 0.3 to 0.4
percent of GDP
There were also problems:
1. Labor cannot move
2. There were no automatic stabilizers in the euro area as a whole
Trouble with the Euro:
Even before it was put in… the exchange rate system almost failed in the early 1990s
because of German economic policy. Germany maintained high interest rates
German were in manufacturing… Purging of the Thatcher, manufacturing…
Germans liked interest rates to keep a high capital formation, to overhaul their industry
and in order to build up a high capital information for investments in Eurasia.
Ultimately, the problem was fixed by expanding the band to 15 percent around - When Austria, Sweden, Finland -- All three countries:
Open ended co-sign. Cosigning with kids. Germany is the parent.
VISA with a $500 credit limit. It doesn’t force them to spend more. ``
Euro leads to:
Easier access to spending
They
The system also experienced its first shock when high German interest rates in 1992 -put in place to encourage investment in East Germany -- started to flood the system with
funds from US. Mark rose in value, which created problems for the band of exchange
rates. Italian lira was particularly in trouble and the Germans had to spend to prop it up.
dominated by the German Deutschmark by default