The Euro in the 21st Century (The International Political Economy of New Regionalisms)

The Euro in the 21st century

The International Political Economy of New Regionalisms Series The International Political Economy of New Regionalisms series presents innovative analyses of a range of novel regional relations and institutions. Going beyond established, formal, interstate economic organizations, this essential series provides informed interdisciplinary and international research and debate about myriad heterogeneous intermediate level interactions. Reflective of its cosmopolitan and creative orientation, this series is developed by an international editorial team of established and emerging scholars in both the South and North. It reinforces ongoing networks of analysts in both academia and think-tanks as well as international agencies concerned with micro-, meso- and macro-level regionalisms. Editorial Board Timothy M. Shaw, Institute of International Relations at The University of the West Indies, St Augustine, Trinidad and Tobago Isidro Morales, Tecnológico de Monterrey, Escuela de Graduados en Administracion (EGAP), Mexico Maria Nzomo, Institute of Diplomacy and International Studies, University of Nairobi Nicola Phillips, University of Manchester, UK Johan Saravanamuttu, Institute of Southeast Asian Studies, Singapore Fredrik Söderbaum, School of Global Studies, University of Gothenburg, Sweden and UNU-CRIS, Belgium Recent titles in the series (continued at the back of the book) Crafting an African Security Architecture Addressing Regional Peace and Conflict in the 21st Century Edited by Hany Besada Comparative Regional Integration Europe and Beyond Edited by Finn Laursen The Rise of China and the Capitalist World Order Edited by Li Xing

The Euro in the 21st Century Economic Crisis and Financial Uproar

María Lorca-Susino University of Miami, USA

© María Lorca-Susino 2010 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the publisher. María Lorca-Susino has asserted her right under the Copyright, Designs and Patents Act, 1988, to be identified as the author of this work. Published by Ashgate Publishing Limited Ashgate Publishing Company Wey Court East Suite 420 Union Road 101 Cherry Street Farnham Burlington Surrey, GU9 7PT VT 05401-4405 England USA www.ashgate.com British Library Cataloguing in Publication Data Lorca-Susino, María. The euro in the 21st century : economic crisis and financial uproar. -- (The international political economy of new regionalisms series) 1. Euro. 2. Euro area. 3. European Union countries-Economic integration. 4. European Union countries-Economic conditions--21st century. 5. Financial crises-European Union countries. 6. Board of Governors of the Federal Reserve System (U.S.) 7. European Central Bank. 8. International Monetary Fund. I. Title II. Series 332.4'94-dc22 Library of Congress Cataloging-in-Publication Data Lorca-Susino, María. The euro in the 21st century : economic crisis and financial uproar / by María Lorca-Susino. p. cm. -- (The international political economy of new regionalisms series) Includes indexes. ISBN 978-1-4094-0418-7 (hbk) ISBN 978-1-4094-0419-4 (ebk) 1. Euro. 2. Euro area. 3. European Union countries--Economic conditions--21st century. 4. Europe--Economic integration. I. Title. HG925.L67 2010 337.1'42--dc22

 ISBN 978 1 4094 0418 7 (hbk) ISBN 978 1 4094 0419 4 (ebk) I

2010026844

Contents List of Graphs   List of Tables   Foreword   Acknowledgements   List of Abbreviations   PART I

HISTORICAL AND THEORETICAL INTRODUCTION TO THE EURO

1 Historical and Theoretical Considerations   PART II 2

vii xi xiii xvii xix

3

THE EURO AS A COMMON, INTERNATIONAL, AND GLOBAL CURRENCY: AN EMPIRICAL STUDY

The Euro as a Common Currency  

27

3 Statistical Analysis of the Euro as a Stabilizer for the Eurozone  

49

4

81

The Euro as an International and Global Currency  

PART III

THE EURO AND THE EUROZONE: BEFORE, DURING, AND AFTER THE FIRST ECONOMIC CRISIS OF THE 21st CENTURY

5

The New Monetary Order of the 21st Century  

111

6

The Eurozone and its First Economic Crisis  

143

7

The Future of the Eurozone and the EU at a Crossroads: Coordination or Breakup  

183

8

The Euro in the Twenty-First Century: The Need for a “Euro Index”  

211

The Euro in the 21st Century

vi

PART IV 9

CONCLUSION

The Eurozone in the 21st Century  

249

Bibliography  

275

Index  

309

List of Graphs 2.1 European Commission Euro Area Business Climate Indicator   2.2 US Conference Board, US Leading Index of 10 Ten Economic Indicators   2.3 GDP based on purchasing power parity (PPP) per capita in selected AEC countries   2.4 Inflation in selected AEC countries   2.5 GDP based on purchasing power parity (PPP) in Mercosur full member countries   2.6 Inflation in Mercosur full member countries   2.7 Current account balances in Mercosur full member countries   2.8 Alternative measures of political and economic integration—six countries compared   2.9 Economic freedom—six countries compared   2.10 Some problematic factors for political integration—six countries compared   3.1 US Dollar Index (USDX)   3.2 US Dollar Index with 20-month simple moving average and de-trended   3.3 Deutsche mark composite   3.4 Deutsche mark composite and US Dollar Index   3.5 Evolution of the euro   3.6 Euro and US Dollar Index   3.7 Deutsche mark composite and euro   3.8 French franc and euro   3.9 Spanish peseta and euro   3.10 Italian lira and euro   3.11 UK pound and euro   3.12 Euro and UK pound since 1981   3.13 Dow Jones Industrial Average (DJIA)   3.14 DJIA with 30-month moving average and de-trended   3.15 Deutscher Aktien IndeX 30 (DAX)   3.16 DAX with 30-month moving average and de-trended   3.17 DJIA and US Dollar Index   3.18 DAX and euro   3.19 DAX and euro   3.20 DJIA and DAX with covariance   3.21 DJIA, DAX, and Eurotop 100  

32 33 37 37 40 41 41 42 43 45 56 57 57 58 59 59 60 60 61 61 62 63 64 64 65 66 66 66 67 67 68

viii

The Euro in the 21st Century

3.22 Crude Oil and CRB Indexes   69 3.23 CRB and Crude Oil Indexes with covariance   69 3.24 CRB Index and US Dollar Index   70 3.25 Crude Oil and US Dollar Indexes   70 3.26 Crude Oil and US Dollar Indexes with covariance   71 3.27 Crude Oil Index and euro   72 3.28 US 2-year Treasury Note and Eurodollar (3 months)   73 3.29 US 10-year Treasury Note and Bund   74 3.30 Eurodollar (1 month) and Eurodollar (3 months)   74 3.31 EURIBOR (3 months) and Eurodollar (3 months)   75 3.32 EURIBOR (3 months) and LIBOR (1 month)   76 3.33 EURIBOR (3 months) and euro   77 3.34 Euro and Bund   77 4.1 Export activity between Eurozone’s Member States   84 4.2 Total bond issuing activity in Eurozone   86 4.3 Evolution of Eurozone bond issuing—central and local governments 87 4.4 Sovereign bond spread with German yield   89 4.5 Evolution of Eurozone bond issuing—corporate and financials   90 4.6 GDP comparisons—US, EU, and Eurozone   94 4.7 Comparison of growth in trade exports to the world   95 4.8 Size of the capital market, 2007   97 4.9 Bond, equities, and bank assets compared (as % of GDP), 2007   98 4.10 Financial asset comparison—US and Eurozone   99 4.11 Hourly compensation costs in manufacturing   100 4.12 Labor productivity growth indexes compared   101 4.13 Capacity utilization comparison   102 4.14 Comparison of US and Eurozone GDPs   104 4.15 Consumer Confidence Indicators—Eurozone and US compared   105 4.16 Global capital flows   106 5.1 Euro and UK pound, 1981 to 2010   123 5.2 Euro and UK pound, April 2008 to August 2009   125 5.3 Currency reserves worldwide   129 5.4 Special drawing rights, percentage change   130 5.5 Time series data on international reserves and foreign currency liquidity—selected countries   134 5.6 Bank of Russia foreign exchange reserves by currency   136 5.7 Banco Central do Brasil—reserve currency composition   137 5.8 Chinese yuan and Hong Kong dollar   140 5.9 Euro and the euro/Hong Kong dollar composite   140 5.10 Euro/yuan and euro   140 6.1 Comparative analysis of government debt levels, 2010   145 6.2 Euroarea government debt as % of GDP   146 6.3 Government debt in Eastern EU countries   147 6.4 General government financial balances—selected countries   149

List of Graphs

ix

6.5 Eurozone government deficits   150 6.6 Deficits and surpluses in Eastern EU countries   151 6.7 Sovereign bond spread with German yield   152 6.8 The Markit iTraxx Europe Index   154 6.9 EU current account   155 6.10 Current account balances   155 6.11 Economic Sentiment Indicator (ESI)   157 6.12 Recent Spanish economic history   165 6.13 Euro and Crude Oil Index   168 6.14 Spanish peseta and Crude Oil Index   169 6.15 Spanish peseta and DJIA   170 6.16 Credit default swaps   171 6.17 Spanish Tourism Index   173 6.18 Average labor costs per worker in Spain   174 6.19 Spain’s trade balances, 1997–2008   176 6.20 Academic excellence—comparison of Spain with selected countries 177 6.21 Labor productivity index—selected countries   178 6.22 General government debt as % of GDP—Euroarea and Spain   179 6.23 Spain’s total government revenues and expenditures   180 7.1 Trade balances for Germany and the Eurozone   194 8.1 US Dollar Index   214 8.2 Trade-weighted US Dollar Index   216 8.3 US Dollar Index and trade-weighted US Dollar Index   217 8.4 Random walk   219 8.5 White noise   219 8.6 DJIA, DAX, and Eurotop 100   222 8.7 Australian dollar and DJIA   223 8.8 New Zealand dollar and DJIA   223 8.9 Singapore euro and US Dollar Index   224 8.10 US Dollar Index movement—June 2004 to March 2010   225 8.11 A periodic trajectory 228 8.12 Critical point, convergence, and attractor   228 8.13 Sandpile   229 8.14 Critical point in thermodynamics   230 8.15 Fractals: year, month, week, day   231 8.16 Cross-rates used for the Australian Index   234 8.17 Cross-rates for the Australian Index at the critical point   235 8.18 Australian Index and its cross-rates   236 8.19 Cross-rates used for the New Zealand Index   237 8.20 Cross-rates for the New Zealand Index at the critical point   238 8.21 New Zealand Index and its cross-rates   239 8.22 Cross-rates used for the Euro Index   240 8.23 Euro Index and its cross-rates   241 8.24 Self-made US Dollar Index and its cross-rates at the critical point  243



The Euro in the 21st Century

8.25 Indexes compared   9.1 Job openings and labor turnover survey   9.2 Comparison of US and EU productivity   9.3 Comparison of US and EU capacity utilization   9.4 US Small Business Optimism Index   9.5 European Commission Euro Area Business Climate Indicator   9.6 Comparison of Consumer Confidence Indicators—US Conference Board and European Commission Consumer Indicator for the Eurozone   9.7 Gross household saving rate—share of gross savings as % of gross disposable income  

244 252 252 253 254 255 257 258

List of Tables 1.1 Monetary system date overview   1.2 Summary of monetary evolution from the Bretton Woods System to the European Monetary System   2.1 List of existing and de facto monetary unions   2.2 List of planned monetary unions   2.3 Recognized regional economic communities (RECs)   3.1 Summary of indexes   3.2 Summary of currencies analyzed   3.3 Summary of stock exchange, Crude Oil, and CRB Indexes   3.4 Summary of money market indexes   3.5 Summary of statistical study   3.6 Custom-made covariance formula   3.7 Custom-made de-trended formula   3.8 20-month simple moving average   4.1 Functions of an international currency   4.2 Some currencies pegged to the US dollar, the euro, the UK pound, and other currencies   4.3 Credit rating of countries by Moody’s, Standard and Poor’s and Fitch, as at March 7, 2010   4.4 Currency Composition of Official Foreign Exchange Reserves (COFER) (in US$ millions)   4.5 Leading exporters and importers in world merchandise trade, 2008 (in € billions)   4.6 Financial assets, US and Eurozone compared (in US$ trillions, using 2008 exchange rates for all years)   5.1 Currency distribution of reported foreign exchange market turnover: percentage share of average daily turnover, April 2007   5.2 Daily global foreign exchange turnover, 1989 to 2008 (US$ billions)   5.3 Daily average foreign exchange turnover, net of double-counting, by instrument (US$ millions)   5.4 Daily foreign exchange turnover and transactions costs, net of double-counting, by instrument, counterparty and currency, April 2004   5.5 Daily foreign exchange turnover and transactions costs, net of double-counting, by instrument, counterparty and currency, April 2007  

7 9 34 35 36 50 51 51 52 52 53 54 55 83 85 88 91 96 97 115 115 117 118 120

xii

The Euro in the 21st Century

5.6 Comparative analysis: the UK pound, annual turnover and transaction costs   5.7 Daily averages of trading transactions in the UK pound (in US$ millions), 2001 and 2007 compared   5.8 Special drawing rights allocations to IMF members since 1970   5.9 Calculated quota share of SDRs   5.10 Participants and credit amounts in IMF’s NAB and CAB arrangements   5.11 Foreign exchange turnover, net of local and cross-border interdealer double-counting, by instrument, counterparty and currency (in US$ millions)   5.12 Estimated reserves of foreign exchange and gold (as at December 31, 2008)   5.13 Emerging and developing economies (in US$ millions)   6.1 Some European corporate defaults in 2009   6.2 Macroeconomic data in time of crisis   6.3 Structural and cohesion funds received by Spain since 1986   6.4 Credit default risks as measured by credit default swaps prices (cost in US$ for a US$10,000 debt for 5 years)   7.1 Estimated global exposure to Greece’s default   7.2 Cost–benefit analysis of introducing the Economic Monetary System (EMS) in Germany   7.3 The Lisbon Agenda – Employment Rate Objectives   8.1 Case studies   8.2 Summary of ideas and fields used   8.3 Composition of self-made indexes  

121 122 126 128 132 133 133 135 153 166 166 172 187 192 201 221 226 233

Foreword Joaquín Almunia

This insightful and timely monograph by María Lorca-Susino is likely to meet the needs of a diverse readership: academics, policy-makers, and analysts of finance, economics, and European affairs. This broad appeal should not come as a surprise if one considers the topics chosen by the author and her courage in dealing with their complex and sensitive repercussions. The introduction of the euro and the creation of the Eurozone are among the greatest achievements of Europe’s process of integration. However important these achievements have been for financial and monetary policy and for the internal market, their significance is not limited to these domains. I have long held the author’s view that the euro has strong political, social, and cultural implications, which will become increasingly clear in the years to come. The present study also offers a timely analysis of recent events, as evidenced by its sections devoted to the economic and financial crisis that started in 2008 and that is—at the time of this writing—still with us. We can be proud of our common currency and of what it has done for the European Union over the past ten years. The euro has brought stability, trade and investments to the countries that have adopted it. The euro has also brought large benefits to the other countries of the EU, principally because it has shown what Europe can do when it stands united behind an ambitious project. Finally, the euro has become an international currency and a pillar in the global monetary system; as such, it has projected a strong image of Europe in the world and has become a symbol of our unity and determination. Since the end of 2008, the euro has helped the EU weather the economic and financial storm. The crisis hit just as the Eurozone was establishing itself as a model for the world to study and emulate and has since tested EU countries’ ability to play as a team both within the Union and on the world scene. I am convinced that the EU will once again manage to turn the formidable challenges of these months and years into fresh opportunities for the European project. The need for stronger and smarter supervision of the financial sector is one of the main lessons Europe has learned in these testing times. Over the past few years, supervision has remained largely national, while financial services have grown increasingly global. As a consequence, the case for a set of reforms that would adapt our regulatory frameworks to reality has become compelling. While dayto-day supervision will remain a national responsibility, common supervisory

xiv

The Euro in the 21st Century

authorities will allow everyone to play according to the same rules; they will reconcile differences between national authorities; and they will make sure that EU law is applied correctly and uniformly. In this context, I would like to comment on the belief held by some that there is an inherent tension between regulatory and market forces. I regard this view as misguided for two main reasons: first, because a clear and coherent legal framework is essential in all areas of business and, second, because markets are not natural phenomena that occur beyond our control; they are human constructs and social institutions; they exist to serve society. In essence, a market is established, defined, and governed by a set of agreed conventions and formal rules set by society; there is no principled contradiction between regulation and the market. The application of EU competition rules is a good example. Competition policy ensures that markets are open, fair, and efficient; it creates a level playing field for all businesses and it ultimately brings benefits to enterprises and consumers alike. As to the broader policy implications, the current crisis has taught us that Europe needs to couple stability-oriented macroeconomic policies with structural reforms if we are to meet our goals for growth and social justice. Recent analyses carried out by the European Commission identify the creation of favorable conditions for entrepreneurship and innovation as priority areas. Swift and incisive policy initiatives can create a better environment for business in Europe, where companies can become more competitive and thrive. This will help Europe’s entrepreneurs to profit from the recovery in world trade driven by growing demand from emerging economies; perhaps one of the best routes that can take us out of the recession and put us back on track. I believe that economic policies are means to higher ends. To cite from “Europe 2020”—the overall strategy the EU has adopted as a beacon for all its policies in this second decade of the century—our efforts must be directed towards the creation of a smart, sustainable and inclusive economy delivering high levels of employment, productivity and social cohesion. I am happy to note that Dr. Lorca-Susino adopts a similarly broad outlook, explicitly linking the risks associated with soaring national debts to economic hardship on the ground and their likely consequences on the standards of living of our fellow European citizens. This is the most important reason why we need to take concerted action at European and national level; ensuring good economic policies is a matter for everyone’s concern. The European Commission will not tire in encouraging structural reforms across the EU. We will also continue to support policies that deepen and broaden macroeconomic surveillance. I am fully aware that the comprehensive and ambitious agenda we advocate requires a fair amount of political will, determination, and coordination among national authorities. Works such as The Euro in the Twenty-First Century are very useful in this respect, because they offer policy-makers a sound and impartial basis for their

Foreword

xv

debates, negotiations and deliberations. European citizens demand that budget cuts, austerity plans, and more flexibility go hand-in-hand with more and better opportunities, and enhanced social cohesion. It is the task of Europe’s leaders to heed this call and revive the success of the euro’s first roaring decade.  

Joaquín Almunia July 2010

This page has been left blank intentionally

Acknowledgements I would like to acknowledge the help and support received from Dr. Joaquín Roy and Dr. Michael B. Connolly. Also, I would like to thank the academic ideas received from every single paper published by the European Union Center at the University of Miami under the Jean Monnet/Robert Schuman Paper Series and the European Union Miami Analysis (EUMA) Special Series. Finally, special thanks go to Dr. Bruce Bagley, Dr. Manuel Santos, and the University of Miami.

To my Family

This page has been left blank intentionally

List of Abbreviations ACP Countries African, Caribbean, and Pacific Countries BDL Bank Deutscher Länder BRIC Countries Brazil, Russia, India, and China CAD Canadian dollar CAP Common Agricultural Policy CDS credit default swaps CHF Swiss franc CME Chicago Mercantile Exchange CO Crude Oil index COFER Composition of Official Foreign Exchange Reserves CPE central planned economy CPI Consumer Price Index CRB Commodity Research Bureau DAX German Deutscher Aktien IndeX 30 Dem German mark or deutsche mark DJIA Dow Jones Industrial Average D-mark German mark or deutsche mark EC European Community ECB European Central Bank ECOFIN Economic and Finance Council ECOWAS Economic Community of West African States ECSC European Coal and Steel Community ecu European currency unit EEC European Economic Community EFTA European Free Trade Association EMI European Monetary Institute EMS European Monetary System EMU Economic and Monetary Union ERM Exchange Rate Mechanism (ERMII after introduction of the euro, if distinction needed) ESCB European System of Central Banks EU European Union Euratom European Atomic Energy Community EURIBOR Euro Interbank Offered Rate € euro FDI foreign direct investments The Fed US Federal Reserve Bank

xx

The Euro in the 21st Century

Fed Funds Federal Funds Rate FRG Federal Republic of Germany GBP UK pound GDP gross domestic product GDR German Democratic Republic (formerly East Germany) GNP gross national product HICP Harmonized Index of Consumer Prices IGC intergovernmental conference IMF International Monetary Fund ITL Italian lira JER Joint Employment Report JPY Japanese yen LIBOR London Interbank Offering Rate LMU Latin Monetary Union NBER National Bureau of Economic Research NCB National Central Banks NYBT New York Board of Trade NYSE New York Stock Exchange OAPEC Organization of Arab Petroleum Exporting Countries OCA optimum currency area OECD Organization for Economic Cooperation and Development OEEC Organization for European Economic Cooperation OPEC Organization of Petroleum Exporting Countries PIIGS Countries Portugal, Italy, Ireland, Greece, Spain SDR special drawing right SEA Single European Act SEK Swedish krona SGP Stability and Growth Pact TFEU Treaty on the Functioning of the European Union technology, media, and communications TMT UK United Kingdom US United States of America UEMOA African Economic and Monetary Union USDX US Dollar Index USSR Union of Soviet Socialist Republics WAMZ West African Monetary Zone WWI World War I WWII World War II

PART I HISTORICAL AND THEORETICAL INTRODUCTION TO THE EURO

This page has been left blank intentionally

Chapter 1

Historical and Theoretical Considerations This chapter uses a new regionalism approach to examine how the introduction of the euro has affected the so-called “new world order” in the twenty-first century and how the current economic crisis and financial uproar is affecting both the new order and the tenets of the new approach. The introduction of the euro created the Eurozone, a new region considered a supranational or world region with an important role in the current global transformation. The euro has demonstrated that although it was introduced as an economic tool for integration, it has a political, social, and cultural dimension. Thus, the euro has become a multidimensional form of integration because the actors behind integration are not only states, but also a large number of institutions and organizations with the political desire to strengthen regional coherence and identity. The Eurozone should be considered the core region because it is economically and politically dynamic and structured and the rest of the European Union (EU) and non-EU members relate to it. Particularly, this chapter explains how, under new regionalism, the Eurozone and the euro have helped increase not only economic, but also political, social, and even cultural homogeneity respecting diversity. Further, this book reflects that the current economic crisis and financial uproar has affected the new regionalism trend that began in the 1980s with the political and economic integration efforts in the EU and the Eurozone. The current economic events are affecting the integration process in the EU and the Eurozone in two dangerous but interesting ways. On the one hand, the economic crisis has negatively affected to different degrees the economies of some countries such as Portugal, Italy, Ireland, Greece, and Spain. In particular, Greece, Spain, and Portugal are in financial and economic positions that are halting the integration program, particularly financial and economic integration. On the other hand, these economic difficulties are pushing certain countries to look inward in a sort of defensive mechanism. Such is the case of Belgium, the UK, and in Spain, where national nationalism is suddenly being revamped and is now becoming more skewed than ever as the economic situation is getting worse. As a consequence, countries that were in line to adopt the euro are rethinking their view on becoming part of the Eurozone. Mainly, the impossibility of using monetary policy as a method of adjustment in the event of deep monetary problems, added to the lack of coordination among Eurozone Member States on how to tackle the current crisis, has also made certain countries wanting to join the EU and the Eurozone change their prospects. Furthermore, the current crisis has affected other integration projects such as Mercosur and the African integration. However, Asian countries



The Euro in the 21st Century

seem to be immune and January 1, 2010 has become a milestone date because it was the beginning of the China-ASEAN Free Trade Area. This agreement, which has an economic purpose in mind, is a “breeze of fresh air” for models for regional unity because “today, the free trade area is of greater significance amid the ongoing global financial crisis and rising trade protectionism when developing countries are more vulnerable because of their fragile economies.” (People’s Daily Online 2010) Finally, this chapter introduces an overview of the rest of the book’s contents and presents the book’s research design and methodological approach, because this book uses a number of time series and statistical approaches to strengthen its findings in order to provide the conclusion with a solid theoretical and statistical foundation. Also, Chapter 1 explains what have been the technical and theoretical difficulties found along the way. This chapter explains that the EU and the Eurozone suffer from an important lack of time series availability and variety. The fact that it is complicated, at best, to find the same time series for a number of countries in the same time frame and period of time makes any quantitative analysis complex. The Twentieth Century: Regionalism and the New World Economic Order The twentieth century witnessed dramatic changes in the state and nature of government and governance. This century endured two major world wars, a cold war, a major economic recession, and a number of minor ones. However, all these events seem to have taught that conflict and confrontation result in nothing but social misery and economic pauperism. Thus, although the first half of the century witnessed two world wars, the second half of the century put to work the lesson that cooperation is more productive than destruction. In particular, the end of the Cold War and the first stages of globalization made a number of geographically closed countries realize the benefits of cooperating and coordinating economic strategies to find synergies in a non-zero-sum game. The devastation of World War II and the economic situation in which most of world’s nations were immersed required the arrangement of the economic system, beginning with the urgency for fixing dangerous imbalances in the currency system in order to control currency fluctuations and allow commerce to flourish. After World War II, the world had to be completely reconstructed. The regionalist approach provided the right set of tools because, according to Wallis, regionalism was characterized for being all about government, structures, coordination, and power. For instance, regionalism was oriented towards empowering any one government with the mandate to “construct” and defend the nation while the world was going through one of the most turbulent periods of history. Regionalism was concerned about developing the public sector to create a backbone of government, which consequently was necessary to establish structures. The devastation of the two wars had left nations and governments

Historical and Theoretical Considerations



with almost no structure, and it was necessary to spend resources on the creation and organization of much-needed government and country structures for the efficient functioning of nations. Furthermore, regionalism was closed because it was concerned with defining boundaries and jurisdictions that ranged from the delimitation of national borders to the design of economic, political, and social policies that needed to be implemented. As a consequence, it was clear that countries were looking to coordinate how to best implement those policies, and as Allan Wallis (n.d., 4) explains, “coordination typically implied hierarchy; for example, a regional authority with powers to determine the allocation of resources to units of government within its boundaries.” Finally, all these four factors required accountability, which is a way of analyzing if the established goals have been accomplished and implementing corrective measures if they have not. A number of economic and monetary systems were put in place, and although none worked out completely satisfactorily, they were all stepping-stones rather than stumbling blocks and contributed to the need for cooperation at the economic and monetary level in order to strengthen synergies to enhance governance, government, and the living standard of the population. Thus, attempts at the monetary level unveiled the advantages of monetary and economic integration. The first stepping-stone that led to regionalism was the creation of the Bretton Woods System (July 1944–August 1971). During Bretton Woods, European currencies were under control because countries participating in the system signed an agreement in which national authorities were to submit their exchange rates to international disciplines. This system bolstered coordination and planted the seed for further cooperation and the beginning of regionalism. Under the Bretton Woods System, the US dollar was the numeration of the system, or the standard to which every other currency was pegged; this meant that other currencies were to peg their currencies to the US dollar and maintain market exchange rates within ± 1 percent of parity. At the same time, in order to bolster faith in the dollar, the US agreed to link the dollar to gold at the rate of $35 per ounce of gold. When the US economy began to weaken, loss of confidence in the dollar prompted other countries to redeem their dollar reserves for gold, further weakening US exposure. F.W. Engdahl (2004, 140) explains that “at the end of 1967, international holders of dollars went to the New York Federal reserve Gold Discount Window and demanded their rightful gold in exchange.” De Gaulle’s economic adviser, Jacques Rueff, went to London in January 1967 with a proposal for raising the price of gold, which would in turn mean the devaluation of the US and UK currencies. Washington refused to change the $35 per ounce official valuation of gold. Because the US was neither going to exchange dollars for gold nor change the gold valuation, France, the country that had most requested to redeem dollars for gold and was one of the largest holders of gold, withdrew from the system. Nonetheless, Engdahl (2004, 142) explains: France itself was the target of the most serious political destabilization of the postwar period. Beginning with the leftist students at the University of Strasbourg,



The Euro in the 21st Century soon all of France was brought to a chaotic halt as students rioted and struck across France. Coordinated with the political unrest (which, interestingly, the French Communist Party attempted to calm down), U.S. and British investment houses started a panic run on the French franc, which gained momentum as it was touted loudly in Anglo-American financial media. The May 1968 student riots in France were the response of the vested London and New York financial interests to the one G-10 nation which continued to defy their mandate. Taking advantage of the new French law allowing full currency convertibility, these financial houses began to cash in francs for gold, draining French gold reserves by almost 30% by the end of 1968, and bringing a full-blown crisis in the franc.

Under the Bretton Woods System, Germany’s industry became the most efficient and competitive sector in Europe, and its economy became the leader among those of other European nations. The secret of this success rested in Germany’s industrial ability to take advantage of increases in demand within its borders and within most European countries by maintaining strong productivity growth while keeping labor costs from rising and achieving sound export competitiveness. As Germany’s export surplus began to grow, becoming a national symbol of monetary and economic performance, economic imbalances began to surface for other European countries. In fact, most European “firms constructed their growth strategy mostly on extracting productivity growth without much investment but by using existing capacity” (Halevi 2005, 4). Germany, instead, would use those surpluses to modernize its industries, which helped to develop new products and improve productivity. The Bretton Woods System worked well as long as the US economy remained strong and countries agreed to hold dollars on the basis of their value in gold. Unfortunately, in the 1960s, due to the decline in the US’s balance of payments position, the system began to collapse. As a result, there was an oversupply of dollars held by foreign banks, and countries were less willing to hold dollars. These countries soon began to redeem their dollars for gold, resulting in a fall in gold reserves and an increase in the gold price. In August 1971, President Nixon announced that the US would no longer exchange dollars for gold, and the US dollar was removed from the Bretton Woods gold standard. After the collapse of Bretton Woods, currencies opted for a system of floating rates. However, this system soon proved not to be beneficial. In an attempt to restore order to the exchange market, ten leading nations made up of the European Economic Community (EEC) Member States, as well as the UK, Ireland, and Denmark, met at the Smithsonian on December 16 and 17, 1971. This partnership marked the first step in regionalism. Two days of negotiations resulted in a new system of exchange-rate parity that was called the “Smithsonian Agreement.” As Daniels and VanHoose (2004, 12) explain, “Although this new system was still a dollar-standard exchange-rate system, the dollar was still not convertible to gold.” Unfortunately, the Smithsonian Agreement collapsed within 15 months and a de

Historical and Theoretical Considerations



facto system of floating rates emerged. The reason for this collapse is explained by Mundell (2003, 12) as follows: The US monetary policy was expansionary in the 1972 presidential election year and the balance of payments deficit built up large dollar balances in Europe and Japan. In February 1973 the U.S. raised the official price of gold to $42.22 an ounce (where it remains to this day). This devaluation only served to whet the appetites of speculators and the crisis intensified. The market price of gold soared and exchange markets became turbulent.

After the collapse of this agreement, European countries realized that they really needed to seek currency stability and independence from the US dollar. This time they signed the Basle Agreement, on April 10, 1972, which had been designed as an intervention system of the central banks. This intervention system, commonly known as the “currency snake,” limited fluctuations between currencies and the US dollar to a maximum of 2.25 percent and fluctuations between any two currencies participating in the snake to a maximum of 4.5 percent. Unfortunately, this system failed mainly because economic events, led by US dollar fluctuations, made it impossible for the majority of currencies in the snake to remain within the fluctuation bands. Members participating in the snake were constantly leaving and entering. For example, the UK and Ireland left the snake in June 1972; Italy left in February 1973; and France left in January 1974, rejoined in July 1975, and left again in March 1976 (Schwartz 1983). By March 1973, only Germany and the Benelux countries remained in the snake system, underscoring once more the cohesion of the FRG economy and the strength of the D-mark. Furthermore, these events demonstrated that those countries that were not inclined to pursue price stability to avoid inflation were doomed. The lesson learned was that in order to have currency stability, countries must follow a uniform monetary policy. Consequently, Germany’s Helmut Schmidt and France’s Valéry Giscard d’Estaing did not give up on the dream of engineering a united Europe. To ensure currency stability, they originated the European Monetary System (EMS). Table 1.1 summarizes the dates of the various arrangements discussed above. Table 1.1

Monetary system date overview

System

Years

The Bretton Woods System The Smithsonian Agreement The Snake in the Tunnel The European Monetary System The Economic and Monetary Union

July 1947–August 1971 December 1971–1972 April 1972–March 1973 March 1979–December 1998 January 1999 to present



The Euro in the 21st Century

The Twenty-First Century: New Regionalism and the Current Economic Crisis and Financial Uproar At the time of writing (January 2010) the EU and the Eurozone are facing a difficult period. It seems that suddenly the integration process—widening and deepening— has come to an abrupt halt. On the one hand, there are no more countries “waiting in line” to join the EU, which gives a sense of emptiness. On the other hand, it seems as if the Lisbon Treaty impasse has stalled the deepening process, because there has been scant progress in integrating the EU in areas such as security, defense, immigration, and social policies. In addition, the four freedoms are still not fully implemented, and economic integration has not been accomplished. This situation has been worsened with the economic crisis and financial uproar that has made certain actors wonder about the EU project, particularly because economic and monetary integration successes have been the fuel necessary for the EU and the Eurozone to continue moving forward. The Lisbon Treaty impasse was the result of an implacable economic situation in Ireland that let society reject it, and in the UK, the vision of the euro changes with the economic difficulties of the country. Currently, the UK is facing one of worst recessions in history, and the actual position is that 75 percent of the population would reject adopting the euro (Tax Payers Alliance 2009). Finally, the current economic situation in Greece and the necessity for implementing harsh budgetary reforms are causing social upheavals and many complain about the prudence of remaining within the Eurozone and the EU. David Marsh (1993) explains that the European Monetary System (EMS), introduced on March 13, 1979, became the ultimate plan designed to obtain monetary cooperation among members of the European Union in order to finally provide the currency stability necessary for the introduction of a common currency. In order to achieve this goal, Member States had to work towards synchronizing their economies in many areas, which increased their feeling of belonging to a group. Because European countries trade more with each other than with the rest of the world, it made sense for them to transcend currency fluctuations and transaction costs in order to allow trade to flourish even more. As a consequence, the EMS came into effect in 1979 with the blessing of the Federal Republic of Germany (FRG), which wanted to ensure its export grounds and surpluses by putting European currencies under the control of the Exchange Rate Mechanism (ERM) (see Table 1.2). The EMS became a successful mechanism and was operative until December 31, 1998 when Member States fixed their currencies to the euro. The introduction of the EMS in 1979 launched many economies further into an expansionary economic cycle that boosted productivity, exports, employment, internal demand, and investment in both equipment and construction. This has been considered the new regionalism approach in action. Despite many setbacks, neither the political nor the economic project of a united Europe were abandoned, and the first stage of the Economic and Monetary Union’s (EMU) adoption of the euro was eventually introduced on July 1, 1990.

Historical and Theoretical Considerations



With the introduction of the EMU, the D-mark became the anchor currency and the Bundesbank became the de facto central bank for the other countries because it was doing the best job of keeping inflation low. The problem arose due to the strength of the German economy and the low-inflation policies of the Bundesbank, which ultimately forced other countries to follow its lead. Countries were able to follow the Bundesbank but, by the mid-1980s, were driven to use changes in interest rates to maintain their currencies within the bands. However, at the beginning of the 1990s, the EMS was strained by the differing economic policies and conditions of its members, particularly those of the newly reunified Germany, and a revision of the EMS requirements was necessary. The Brussels Compromise, in August 1993, awarded the EMS with a new fluctuation band of ± 15 percent. Table 1.2

Summary of monetary evolution from the Bretton Woods System to the European Monetary System

End of Bretton Woods in 1971

April 10, 1972

March 25, 1979

Treaty of Maastricht

The end of fixed exchange rate and the beginning of Floating Currency System.

Basel Agreement The Snake – to maintain currency fluctuation between the-/+2.25% bands.

European Monetary System (EMS) Currency fluctuation of +/-2.25% (6% for Italy).

Maintains the EMS system of currency fluctuation for those currencies willing to adopt the euro in January 1, 2000.

Despite all the ups and downs, the EMS worked well. Most importantly, the EMS ended with the imposition of rigid bands, which never helped to stabilize the currency, but rather attracted currency speculators. However, the EMS did help stabilize the currency to the point that—in the mid-1980s, when Jacques Delors became President of the European Commission—the momentum was perfect for the creation of the common currency. With the introduction of the euro, regionalism and its proposals made a step forward to a new regionalism approach. The new regionalism approach better explained the necessity to promote even freer trade and economic integration, because it was proven that regionalism had positive political effects. New regionalism has been called a “halfway house between the nation-state and a world not ready to become one” (McMahon and Baker 2006, 3). Allan Wallis stated that the interest in a newer version of regionalism was the result of the globalization of the economy that at the end of the Cold War allowed for “international trade agreements, like NAFTA, and the development of a European Community all demonstrate reduced economic competitiveness on a country-by-country basis, and increased competitiveness on a region-by-region basis.” This new approach was strengthened with the creation

10

The Euro in the 21st Century

of the European Community and all the integration efforts it conveyed. The new regionalism approach explained that trade and broader economic integration has created a European Union in which another war between Germany and France is literally impossible. Argentina and Brazil have used Mercosur to end their historic rivalry … Central goals of APEC include anchoring the United States as a stabilizing force in Asian and forging institutional links between such previous antagonists as Japan, China and the rest of East Asia (Bergsten 1997, 1).

In fact, new regionalism is, according to Fredrik Söderbaum (2003, 1), “characterized by its multidimensionality, complexity, fluidity and non-conformity, and by the fact that it involves a variety of state and non-state actors, who often come together in rather informal multi-actor coalition.” According to Allan Wallis, the new regionalism approach is characterized by five key elements that perfectly well explain the foundation of the EU and the Eurozone. First of all, the European project is fundamentally concerned with governance, because the main role of institutions such as the European Central Bank or the European Commission is to set the goals of what must be accomplished, establish the rules, and implement the regulation necessary to achieve these goals. Furthermore, these goals are achieved through the implementation of a process. In fact, in order for countries to join the EU, it is necessary that certain objectives are met, which requires the implementation of a process rather than mere structures. Also, recommendations on certain structural reforms—for example, labor market reforms—advise the introduction of a number of processes intended to improve employment rates. Second, new regionalism is concerned with open boundaries, a concept implied in some of the policies that have been pooled from each nation, as well as the concept embedded in the four freedoms so characteristic of the EU. Third, new regionalism entails collaboration, a trait found in most of the Treaties and Directives, the Lisbon Agenda, or even in the newly introduced Europa 2020. Collaboration means canceling all coercive measures, which annuls the need to implement the necessary structural reforms because they can be implemented as collaborative rather than as punitive measures. This goes hand in hand with the fourth characteristic of new regionalism: that Member States operate on a basis of trust and not accountability. This means that Member States are trusted to implement the recommendations and not held accountable if they do not. For instance, the current economic and financial crisis has been deepened by the fact that some EU Member States had not been meeting the necessary requirements and were not held accountable for not doing so for years. The integration process is currently at a crossroads, however, because it has hardly been tested. The Lisbon Treaty impasse and the current economic crisis are testing the foundations of the Union to the point that support for the project is being negatively affected. In fact, different actors are beginning to raise doubts and concerns concerning the integration process. First, it is questioned as to

Historical and Theoretical Considerations

11

whether globalization is still positive for the economic development of a nation. Second, there is close scrutiny as to whether the EU is still the best actor to defend nations’ battered economic interests. Certain countries are in the middle of a harsh economic recession, and certain actors are wondering if being part of the EU and the Eurozone is still in their best interests. Under these circumstances and feelings, it might be that the EU—borrowing but adjusting Barry Buzan’s idea—is no longer regarded by important powerful actors as a “regional economic complex,” understood as a group of states whose economic needs and concerns are so highly interlinked that it is almost impossible to differentiate the economic needs and concerns of any one of the nations in isolation. This is what the Eurozone and the EU is expected to have become, because the four freedoms, the introduction of the euro, and the objective of becoming a solid economic bloc should have forced economies to become one. The current economic crisis and the impasse of the Treaty of Lisbon have significantly weakened the project. Therefore, a thorough analysis of the European feelings recorded in the Eurobarometers demonstrate that under the current economic crisis and financial uproar, Europeans are falling out of love with the EU and the Eurozone and are in fact seeking to go back to the nation-state as a provider and defender of interests. In fact, Eurobarometer 71 (Eurobarometer 2009b) has reported significant shifts in public opinion about the EU and its institutions. A detailed analysis of these studies demonstrated that European public opinion on the role of the EU, globalization, integration, and enlargement has suffered a setback, which could eventually become negative for the support of the project. Eurobarometer’s analysis demonstrates that Europeans are drifting away from the global vision of the EU and turning to their national governments for coverage and even protectionism with renewed nationalistic feelings. This trend indicates that, under the current economic crisis, Europeans would rather trust their national government to help them cope than they would institutions of the EU. Eurobarometer 72 (2009c) reports that there has been a dramatic shift in opinions concerning the institution that Europeans believe could better handle the current economic crisis. Suddenly, Europeans are forming a growing consensus that national governments are better fitted to solve the current economic crisis than the institutions of the EU. In detail, whereas Eurobarometer 71 states that only 12 percent felt that their national government had the right tools to tackle the crisis while 21 percent defended the EU in this role, in Eurobarometer 72 (2009c), national governments had the support of 19 percent of Europeans while only 22 percent believed that the EU was better fitted to take effective action to deal with the current situation. This concludes that there is an increased inclination among Europeans towards the national governments. However, the EU is still the preferred actor. Nonetheless, this conclusion is strengthened by the fact that before 2008—when the current economic situation became a global issue—public opinion held that the EU was the best actor to take care of a harsh economic situation (Eurobarometer 2009c). This agrees with the public opinion that stated before the crisis that the EU had “sufficient power and tools to defend

12

The Euro in the 21st Century

its economic interests in the global economy” (Eurobarometer 2009c). However, under the current circumstances, this confidence has decreased significantly. Special Eurobarometer 307 explains that 43 percent of Europeans believe that the national level is the level exercising the most impact on their daily lives whereas 9 percent believe it is the European level and 38 percent believe that it is the regional or local level. Also, 50 percent of Europeans believe that the regional or local authorities are the institutions to trust, against 47 percent who believe the EU is the best actor (Eurobarometer 2009). Concerning the future of the EU, in June 2007, 58 percent of Europeans felt fairly optimistic, whereas only 11 percent felt very optimistic (Eurobarometer 2007b). Finally, the current crisis has negatively affected the opinions of Europeans towards globalization, with 43 percent of Europeans believing that globalization presented a threat to employment and companies in their respective countries in November 2008, and only 39 percent believing it was a good opportunity (Eurobarometer 2008). As a consequence, Europeans have changed their opinion of the integration process as well as of the enlargement and the euro. Concerning the current speed of the ongoing integration process and the construction of Europe, the results evidence a desire to reduce the speed of building Europe (Eurobarometer 2005), which coincides with the fact that 55 percent of Europeans believe that “things are going in the wrong direction” in their country, with 39 percent having misgivings about the EU level (Eurobarometer 2008d). As a consequence, the images of the Eurozone and the euro have suffered a deterioration, and “more than two-thirds of non-member states citizens thought that their country should not rush into joining the euro area: 36 percent would like to have the euro introduced after a certain time and one-third as late as possible” (Eurobarometer 2008c, 3). Furthermore, the current economic crisis has affected European opinion on the euro’s introduction. In September 2007, 45 percent of the population favored the introduction of the euro, with 35 percent rather or very much against it. Two years later, the polls showed that in September 2009, 44 percent of the population favors it and 37 percent are against it. (Eurobarometer 2008c) Although this is not a dramatic change, it may indicate a trend. The impact of globalization on national economies and the current economic crisis force governments to put in place bailout plans, and yet economic and political nationalism have still emerged. These nationalistic feelings are strengthened because Europeans feel their economic security and standard of living are seriously threatened because there has been a “substantial loss of jobs in manufacturing; in recent years this has been particularly associated with companies moving their manufacturing plants to Eastern Europe, India, China, and the Far East” (European Movement 2006). Thus, according to Raymond J. Ahearn (2006), “since the summer of 2005, a number of EU member states have erected barriers to prevent cross-border mergers and acquisitions that undermine the effort to deepen the single market.” The latest Eurobarometer shows that 61 percent of Europeans believed in the middle of 2009 that the worst was still to come (Eurobarometer 2009c). This state of mind explains the recent revival of

Historical and Theoretical Considerations

13

protectionism and nationalistic feelings. This situation is attacking the essence of the idea behind the single market and the basic foundation of the integration process. Curiously enough, this trend is coming from some Member States’ “governments (and or politicians) fearful of losing national prestige and jobs as a result of merger activity” (Ahearn 2006, 4). For instance, the UK’s Conservatives have clearly stated that if they win the upcoming election (in May 2010) they would never adopt the euro and that they will not be in favor of any more transfer of sovereignty to the EU without a proper national referendum. Chapters in this Book What follows is a brief introduction to the individual chapters. The purpose of Chapter 2, “The Euro as a Common Currency,” is threefold. First of all, this chapter summarizes the main tenets of the Optimal Currency Area (OCA) and explains the theoretical evolution of this theory since it was first presented by Robert Mundell, in 1961, in the paper titled “A Theory of Optimal Currency Areas,” until it was finally used as the theoretical framework for the creation of the euro in 1999. Secondly, this chapter succinctly overviews the most important attempts to introduce a monetary and economic union; thus, it reviews the various efforts taken since the Latin Monetary Union of 1865, up to the Delors Reports and the introduction of the Economic and Monetary Union. This chapter stresses the fact that all these failed attempts must be considered stepping-stones that had led to the perfection of a long-time dream: the introduction of a successful common currency. Finally, Chapter 2 analyzes integration attempts in Africa and in the Southern zone and compares these attempts with the EU and the Eurozone to identify a number of reasons why these two blocs are not making progress with their integration efforts. Today, the creation of the European Economic and Monetary Union (EMU) has proven to be a good shelter from the current economic storm, and the euro has become an anchor of regional stability and integration. As a consequence, the Eurozone has become an example to follow, and the common currency has come to be regarded as the solution that will end economic crises and prevent further ones. In light of these outcomes, the current chapter explains how African and Latin American countries are all reconsidering the importance of regional monetary integration. This chapter reviews the fact that many of these countries have already integrated into a number of trading blocs. This chapter also analyzes the fact that although the African effort is slowing down yet achieving results, the Latin American attempts have unfortunately proven to be crisis-prone as well as both economically and politically unstable. As a result, they have not been able to fully reach their trading potential, let alone achieve monetary integration. In light of these circumstances—and taking the Eurozone as a benchmark—this chapter addresses the economic and monetary sacrifices as well as the difficulties that all those countries willing to form a solid single market, and eventually a monetary union, must face and endure.

14

The Euro in the 21st Century

Chapter 3, “Statistical Analysis of the Euro as a Stabilizer for the Eurozone,” analyzes whether the euro has truly become a common currency. In order to conclude affirmatively that the euro is a common currency and a stabilizing factor for the Eurozone, this chapter focuses on a thorough, innovative, quantitative analysis of the fitness of the euro as a stabilizing factor, using a vast variety of indexes in three markets: the foreign exchange market, the stock market, and the money market. First, the euro is studied in the foreign exchange market with the purpose of comparing and explaining the evolution of the euro vis-à-vis other currencies. Second, the evolution of the euro is analyzed to explain how the common currency is affecting the stock market cycles on both sides of the Atlantic, demonstrating that the introduction of the euro has helped synchronize stock indexes and provide European investors with wider investing opportunities. Furthermore, this chapter presents an interesting study that shows that the euro has helped keep inflation under control, which is one of the “musts” of the common currency. This study is presented with an innovative graphical analysis of the relationship between the evolution of crude oil, commodity prices, and the euro. Third, this chapter analyzes the euro and its impact on the money market indexes. This study is important because the European Central Bank uses the money market as an escape valve to fight inflation and to maintain price stability, and this will affect the money supply and the value of the euro vis-à-vis other world currencies. This section revises the US money market to provide a basis for understanding the money market in the Eurozone. This chapter becomes particularly innovative as it introduces three statistical studies. The first one is the covariance used to measure the extent that two random variables vary together, defined as Cov(x,y) = E{[x – E(x)][y-E(y)]}. The importance of this statistical method is that the result obtained will indicate the relationship, or lack thereof, between two random variables. For instance, when the result of the covariance is negative, it indicates that the two random variables have varied in opposite directions, meaning there is no linear relationship between the two. Also, the larger the magnitude of the product, the stronger the strength of the relationship. The covariance presented in the chapter is a custom-made formula that has been altered and programmed as a built-in effect in the Omega ProSUit 2000i computer program. This covariance has a length of 30 months (or periods) and has been programmed to move within a –0.35 to +0.35 range. The second statistical tool used is the “de-trend.” When a time series is de-trended, the secular trend is removed from the macro data: therefore, the cyclical and growth components of that time series is disentangled. De-trending a time series is a controversial aspect of the business cycle study because it implies transforming data, and some scholars believe this is a manipulation of pure data. However, detrending has been demonstrated to be particularly useful when studying certain time series exhibiting high volatility. Finally, a number of series has been studied using a 20-month simple moving average. A simple moving average is a statistical technique used to analyze a set of data points by creating an average of one subset of the full data set at a time with each number in the subset given an equal statistical weight. In this chapter, a 20-month simple moving average is used, which means

Historical and Theoretical Considerations

15

a 20-month simple moving average of closing price is the mean of the previous 20 months’ closing prices. If those prices are: PM, PM-1, PM-2, PM-3 … PM-19, then the formula is SMA = {(PM + PM-1 + PM-2 + … + PM-19) / (20)}. Finally, each time a new data (month or period) is added to the time series, the entire moving average is recalculated to account for the new value added while dropping out the old one. The purpose of Chapter 4, “The Euro as an International and Global Currency,” is twofold: to analyze if the euro has become (a) an international and (b) a global currency. This chapter shows that the creation of the European Monetary Union and the introduction of the euro brought about an intense debate concerning whether or not the euro would manage to challenge the status of the US dollar and the hegemonic power of the United States consolidated since World War II. For this challenge, the euro had to first consolidate its position as a common currency, then gain recognition as an international currency, and finally become a global, or dominant, currency. As the euro gained international financial recognition, it became a stabilizing tool capable of furthering the political integration process of the EU. The euro has provided the economies of Europe with a degree of collective macroeconomic stability, flexibility, and economic transparency that individual Member States could never have achieved on their own. Therefore, the effect of the euro has been not only economically but also politically significant, because its inception as an international currency has provided enough weight to garner, for Europe, some of the political influences heretofore enjoyed solely by the US due to the hegemony of the dollar since World War II. This chapter studies whether or not it can be claimed that the euro has become an international and global currency. The results show that the euro has developed a solid market that has consequently eroded some of the advantages that historically supported the hegemony of the US dollar as a global, or dominant, currency. Hence, the euro can be considered an international currency; nevertheless, the US dollar remains the sole global currency. There are two correlated reasons that explain the reign of the US dollar. On the one hand, there is an inertia in the use of the US dollar due to years of currency preeminence. On the other hand, this preeminence has given the greenback an edge over the euro in terms of the size, credit quality, and liquidity of the dollar financial market over the euro financial market. The preeminence of the US dollar has helped the US exercise political hegemony, which has resulted in the “Pax Americana.” The euro has, nonetheless, transformed the Eurozone into a solid and internationally respected economic bloc with a wide area of influence and with an ever-increasing voice in the political and economic arena. However, these achievements have oftentimes been the target of fear and confusion as expressed by public opinion and representing the perspective of the euro-skeptics. Nevertheless, the reality is that the Eurozone has become viably competitive with the US for the first time in history. Chapter 5 explains that the current economic crisis and financial uproar that began in September 2008, globalization, and the necessity of achieving economies

16

The Euro in the 21st Century

of scale and synergies to keep high competitiveness levels are all pushing to reform the current international monetary order. The current global monetary system is anchored in the US dollar at a point of time when the world has reached sophisticated economic and monetary synergies due to globalization forces. From a monetary point of view, the need for a new global monetary system is based on the fear that if the US government continues running the deficit to counter the worst recession since the Great Depression, the value of the US dollar will decline, negatively affecting the value of held assets in this currency, especially when almost 75 percent of today world’s currency reserves are held in US dollars. Consequently, it is believed that the current US dollar-based global monetary system must be revised and that a more inclusive system should emerge. This chapter explores two alternatives. First, some advocate the need for having an international reserve currency other than the US dollar, disconnected from any particular country, and find in the IMF’s Special Drawing Rights the right tool. Second, some proclaim the benefits of having a single, global, common currency and monetary system managed by a global central bank within a global monetary union. This chapter, therefore, explains that Robert Mundell, the father of the euro, has been advancing the idea of a global common currency for some time now, claiming that a reduction in the number of currencies in circulation will reduce transaction costs, increase price transparency, and force economic synergies. He has named this global currency the “intor.” It is not supposed to be a single currency; rather, countries and areas would keep their own currencies, which would circulate along with the intor. Further, Mundell has lately been advocating the need to have a fixed dollar–euro rate to avoid big swings in the exchange rate. He believes that implementing this fixed rate would be an easy and convenient way of increasing world trade because the US and the Eurozone make up almost 50 percent of the world economy. The introduction of a global common currency will have a direct impact on the foreign exchange market and its two participants—the customer and the market maker—because it would eliminate transaction costs for the customer and reduce benefits for the market maker. These transaction costs and benefits are measured by the spread between the bid price and the ask price in the foreign exchange market. This section presents the foreign exchange turnover by instruments—spot, forwards, swaps—in 2001, 2004, and 2007 to establish the importance that the FX market has gained over the last ten years. Second, it calculates the transaction costs for consumers and benefits for the market makers of the euro–sterling cross-rate in 2004 and 2007 to assess how the euro–sterling cross rate will affect the foreign exchange market if it were to join the euro and disappear. Finally, it analyzes the counterparties involved in this market, to shed light on which economic agent would be most affected if the pound were to cease to exist. Thus, this chapter analyzes the impact in terms of transaction costs of the UK pound by calculating the bid–ask spread and interprets it as a transaction cost that consumers face when exchanging pounds and euros and a benefit that market makers receive in these

Historical and Theoretical Considerations

17

transactions. This study concludes that the pound is a financial instrument of great economic revenues, a “cash cow” for the market makers, and of great economic cost for consumers. The second approach to reinventing the international monetary system rests on the fact that the current global economic crisis has revived the role of the International Monetary Fund (IMF) and the purpose of the dormant Special Drawing Rights (SDR). The idea is for the SDR to substitute for the US dollar as the world reserve currency. However, the structure of the SDR and the IMF means that rich-country governments will end up dominating this new world economic order and limiting the access to the funds that emerging countries truly need. Nonetheless, many envision the IMF as a global central bank and the SDR as a common currency. Finally, this chapter elaborates on the fact that Brazil, Russia, India, and China are not only becoming increasingly important in the foreign exchange market, but also important advocates of a new monetary order, because they are major holders of foreign reserves. Chapter 6, moreover, presents an overview of the economic and monetary performance of Eurozone Member States, and it explains their current situation. It highlights that before the introduction of the euro, Portugal, Italy, Ireland, Greece, and Spain (also known as “PIIGS countries”) were in constant financial and economic turmoil, a situation that disappeared due to the economic prosperity of the past years and the economic and monetary sobriety that adopting the euro imposed on them. Nevertheless, PIIGS countries, also known as the “Garlic Belt,” have barely met the economic and monetary requirements imposed by Maastricht. As economic hardship intensified, these Eurozone Member States began to feel how their already feeble monetary and economic stability was becoming increasingly difficult to maintain and even more impossible to disguise. In fact, for the past years, PIIGS countries are not only suffering from excessive deficits and debts, but are also overwhelmed with other economic unbalances such as unmanageable and excessive current account deficits, which the current economic crisis is exacerbating due to, among other reasons, their extremely uncompetitive trade position. As a consequence, they are beginning to blame the euro. The problem that these countries are facing stems from the fact that monetary union amplifies fiscal imbalances, since opting for competitive currency devaluation is no longer an option and the only other alternative comes from forcing bond yield differentials down. This chapter shows that in 2005 there were almost no yield differentials between the German Bund and the yields of those countries with excessive current-account deficits. In 2009, however, yield spreads have become a worrisome reality, which has, in turn, increased government default risks measured by a sudden increase in the demand for credit default swaps (CDS). Hence, the current economic turmoil has in fact demonstrated that in a monetary union, currency risk is substituted by default risk, since the sovereign debt of each Member State is issued under the control of each Member State Ministry of Finance due to the fact that there is no European Ministry of Finance. The Treaty of Maastricht forces Member States to obey a common monetary policy, but when

18

The Euro in the 21st Century

it comes to the fiscal requirements, each Member State is free to implement its own fiscal measures. Therefore, fiscal policy has become the “escape valve” to help offset monetary pressure. Most of the countries in dire straits are not complying with fiscal requirements, and it is argued that these countries should have been compelled by EU authorities with respect to the limits. However, there have been times when countries such as Germany and France were not respecting these limits either and were not punished. The problem is that Germany and France have an economic and fiscal structure completely different from Greece, Portugal, and Spain. Under the current economic turmoil, these scenarios have become a difficult liability to ignore and, in fact, Greece has become the focus of attention because its economic circumstances have almost caused the disintegration of the Union. This chapter touches on the problem in Greece to analyze the importance of the Stability and Growth Pact as a stabilizing factor. However, this chapter goes on to show how this fiscal instability is now present on the bond and equity markets, which in turn are negatively affecting the financial strength of not only those countries involved, but of the entire union. This chapter pays attention to understanding the state of the current account of many of the countries involved in this financial uproar because this account helps shed light on the current situation. This chapter concludes by thoroughly analyzing the economic, political, and social situation of Spain, another country that has brought grave concern to the stability of the EU due to its high public debt, current account deficit, and unemployment. Chapter 7 explains that, despite the euro’s runaway success during its first decade of existence, Eurozone governments must assume responsibility and strengthen efforts to coordinate and reform the economic, monetary, and social policies needed to maintain the solid performance of the EMU and the euro. This chapter shows that the Eurozone and the EU are at a crossroads where economic and fiscal reforms, and most importantly structural reforms, must be implemented to avoid a painful outcome. This crisis in Greece—the result of a continuous lack of transparency and hiding the real state of affairs—makes one wonder what has happened to the political class. In some countries, “long behind and forgotten” seem to be the principles put forward, curiously enough by classical Greeks such as Socrates, Plato, Aristotle, or Eratosthenes, whose works and philosophical views have much to do with theorizing on the idea of the perfect state or government. This chapter explains that, despite a number of asymmetric shocks preparing us for “thinking the unthinkable,” everything should be done to help the euro and the Eurozone survive. After detailing the dramatic events visited upon the Eurozone by Greek economic mismanagement, this chapter shows that the cost of participating in the euro has increased because this economic crisis has demonstrated that a common monetary policy might be inappropriate for certain countries. It warns that the cost of leaving the euro club is beginning to be imaginable, particularly if countries experiencing economic hardship default on their national debt, experience the collapse of their national banking system, or suffer civil unrest. However, withdrawal from the Eurozone is a complicated matter from both a legal standpoint—since it is not contemplated in any of the

Historical and Theoretical Considerations

19

treaties—and from an economic standpoint, since reintroducing a national currency would be difficult and painful. Despite the fact that withdrawing from the Eurozone is not a stipulated option, this chapter thoroughly examines the potential breakup of the Eurozone, if the economies of Eurozone Member States are not set back on track and a solution is not put into place. This chapter elaborates on the two possible scenarios to save the project. On the one hand is the prospect that Eurozone Member States do nothing to help defaulting countries. Another possibility is that Member States decide to help by offering bilateral funds to save a country in difficulties. This chapter also elaborates on the role of the IMF, because the actual legal framework has the “no-bailout” rule that prevents Member States from saving a country, which gives no other option to a country short of money than to turn to the IMF as a lender of last resort. Knowing the role of Germany is critical in understanding the behavior of the Eurozone Member States in the current crisis, because Germany is reluctant to help countries neither able nor willing to put their finances in order. However, this chapter explains that Germany does not want to see the disappearance of the Eurozone or of the euro, but is ready to let go of those countries that are not up to the test. Although Germany was ready to introduce the euro as a way to put certain countries on a leash—because these countries were using competitive currency devaluation to gain competitiveness against Germany—nowadays, Germany’s industries are so consolidated that if certain PIIGS countries were to reintroduce their national currencies, it would hardly affect Germany’s economy. Furthermore, the pursuit of competitiveness— via currency devaluation—must be analyzed in conjunction with the idiosyncrasy of the financial market and its impact on the economy. Introducing either the old or a new currency is extremely complicated. The immediate fate of the reintroduced currency is that it would be attacked by the market, which would automatically send the markets plunging; as a consequence, these countries would suffer from “euroization.” Going back to a new devalued currency is going to have a tremendous impact nowadays, not only when converting sovereign debt but, most importantly, when converting private debt held outside the country. The reason for this reluctance to lend financial help to certain defaulting countries is based on the fact that certain countries have not been willing to implement the type of structural reforms necessary to make themselves competitive. The EU and the Eurozone are not just suffering a financial crisis, but this financial crisis has its roots in a complete lack of necessary structural reforms. The proper functioning of the EMU depends not only on Member States adopting and complying with monetary and fiscal policy requirements, but on a number of structural reforms, especially in the labor market, required to foster economic growth and a stable euro. Before 1960 unemployment was not considered an economic issue that demanded worldwide attention; hence, research concerning unemployment was not taken into consideration, due to the fact that the unemployment rate within the European Community stood at less than 3 percent of the labor force. However, for the past twenty years the unemployment rate has increased dramatically in various countries. As a result of the economic and political impact of a significant

20

The Euro in the 21st Century

increase in unemployment, its causes and its consequences have become one of the most debated topics in recent years. The European Union Member States had many problems to solve when drafting the Treaty of Rome (1958). Since then, many of those same problems were considered priorities, giving scant attention to labor market performance, let alone the idea of full employment, until the Treaty of Amsterdam (1997). Unemployment was simply not considered a Community concern at the time, although, in 1990, unemployment was to become the EU’s most intractable economic problem (Van Oudenaren 1999). When the Maastricht Treaty was signed, in 1997, it was agreed for the first time that all efforts to fight unemployment were to be joined. This chapter discusses how the solution to this situation is not an easy one because failing to solve the Greek tragedy is failing to contain a problem that might arise in other PIIGS countries sooner rather than later. This chapter demonstrates that to respect their international debt obligations, highly indebted countries must run a trade surplus, which under current economic circumstances can only be achieved by forcing painful economic, monetary, and social transformations. In order to have a trade surplus, a country must improve its trade balances, which requires, at the minimum, a domestic demand contraction that must be offset by an increase in export levels, to avoid recession. Increasing exports levels is, in turn, contingent upon ameliorating trade productivity and competitiveness standards, which are highly related to human capital. The Eurozone cannot further delay any recommendations to push forward the structural reforms necessary to strengthen resilience and boost productivity that will, in turn, increase economic dynamism grounded on better performance. In fact, these highly indebted countries are continuously losing their positions on the European Innovation Scoreboard. Chapter 8 tries to demonstrate that the euro has become a solid common currency because it has become a stabilizing factor in a number of areas of the economy. Most significantly, the euro has helped keep inflation under control and has synchronized financial markets and eased the cost of accessing certain markets for investors. The purpose of this chapter is twofold. First, this chapter takes the euro as a common currency a step forward and proposes the creation of a innovative Euro Index similar to the US Dollar Index. Second, this chapter tries to demonstrate whether this index could be considered a strong leading index. The US Dollar Index (USDX) measures the value of the greenback relative to a basket of six major currencies—euro, Japanese yen, UK pound, Canadian dollar, Swedish krona, and Swiss franc—and each currency has a weight that reflects its trading relationship with the US. Similarly, because the euro is used to trade with major world countries and currencies, the Eurozone should have an index to measure its value relative to the majority of its most significant trading partners. In the case of the Eurozone, the index should measure the value of the euro relatively, not only to the US dollar, the Japanese yen, the UK pound, the Canadian dollar, the Swedish krona, and the Swiss franc, but should also take into account the increasing trading significance of Brazil, Russia, India, and China (BRIC). The importance of a Euro Index rests on the fact that it would present the euro as a common project

Historical and Theoretical Considerations

21

that will enhance and force further economic, financial, and political integration. The fact that the performance of the Euro Index could be compared and analyzed with the performance of the USDX improves market transparency, which in turn favors investors and consumer choices. This index will, consequently, become an economic and monetary indicator for the Eurozone, which will build on the prestige of the euro club enhancing not only the analysis of the Eurozone’s economic performance, but also predictions of future performance. This chapter therefore presents, on the one hand, four self-made foreign exchange indexes, the Euro Index, US Dollar index, the New Zealand Index, and the Australian Index, and, on the other hand, an innovative multidisciplinary approach used to interpret patterns in these indexes. The aim is to use this pioneering model to predict with some degree of certitude the pattern that a particular index will follow. This approach feeds from a series of theories and models put forward by scholars as diverse as Per Bak, George Cantor, and Henry Poincaré, among others, and contradicts the tenets of certain models and theories such as the Efficient Market Hypothesis, which posits (a) that the market follows a random walk that makes it impossible predict the next move and prevents investors from making profits, as well as (b) the behaviorist approach, which believes that markets are moved by the collective action of investors. These four self-made indexes are composed putting together various currency cross-rates. The reason for the creation of the New Zealand and Australian Indexes is that these indexes are used as a benchmark against which to compare the pattern used in the Euro Index. Furthermore, a self-made US dollar index using the same mathematical approach has also been created to be able to compare the Euro Index with it under the same premises. Curiously enough, the study shows that the New Zealand and the Australian Indexes could be classified as strong leading indexes whereas the Euro Index could be classified as a weak index because it lacks a strong convergence among its underlying cross-rates. Thus, an important tenet of this innovative approach is that although these are all indexes, the idea expressed in this study is that in order for these currency indexes to be leading there must be a strong convergence among their underlying cross-rates. This convergence can be traced using a mathematical approach because these cross-rates are a chaotic dynamical system that tends to converge and arrive at a critical point called the “attractor.” Convergence takes place when the covariance tends to zero. Therefore, this study explains that the self-made euro index follows these graphical and mathematical rules, but its cross-rates do not all converge. This chapter will graph and thoroughly explain each of the self-made indexes. The creation of the self-made Euro Index would be an important contribution to both understand and shed light on the euro as a common, international and global currency. The purpose of Chapter 9 is threefold. First, this chapter summarizes the book’s main findings. Second, it takes into account the limitations of this work. Third, it sets a number of recommendations. Chapter 9 summarizes the book’s main empirical findings: that the euro has become a successful common and international currency that has transformed the Eurozone into an economic,

22

The Euro in the 21st Century

monetary, and political model to imitate. However, this study highlights that the current economic crisis and financial uproar is taking a toll on the project because some countries are suffering harsh financial difficulties that, on the one hand, are dividing countries on how they handle this situation and, on the other, are making others reconsider their aspiration to join the EU. As a consequence, this financial crisis—just after the project is recovering from the Lisbon Treaty impasse—is bringing the integration process to a halt. Nonetheless, this book draws on the implications of these findings for theoretical and methodological debates on international economics and regionalism. This chapter discusses the book’s implications for current debates on the prospects of the Eurozone’s survival, arguing that recent economic developments highlight the bloc’s enduring economic and political rationale and raising questions about its longer-term coherence and sustainability. Current economic hardships are testing the economic maturity of Eurozone Member States, some of which are going through challenging times and are putting an extra burden on the other Member States. As a consequence, since the introduction of the euro, some have been arguing for the Eurozone’s demise while others have praised it as a way of weathering an economic storm. Ultimately, the future of the Eurozone depends on the ability of Member States to resolve current economic and monetary tensions between supranational strategic incentives as well as individual Member States’ political and economic constraints on cooperation. In fact, this chapter concludes that the breakup of the Eurozone—which was considered to be unlikely—has suddenly become no longer trivial. Despite the fact that leaving the Eurozone is such a complicated option, some countries may consider themselves to be better off leaving the EU altogether. A breakup of the Eurozone will lead to the collapse of economic, monetary, social, and political structures not only of the Eurozone but also of the EU as a bloc. Hence, this chapter emphasizes the necessity of a strong political class fully committed to the EU project and prepared to implement a painful set of necessary reforms for its sake. This greatly needed political class must emphasize the importance of maintaining the necessary reforms that will sustain the euro, because such efforts have been proven to work. This chapter, therefore, concludes that there is a lack of what can be called “euroization” that must be rectified in order for the euro to truly act as an integrating force, and it highlights that the Eurozone and the EU are missing the vision of true statesmen for the future of the project that certainly is in need of a new productive model. This chapter also exposes the limitations found along the way. The main limitation has been the difficulty of finding unified macroeconomic data to be able to analyze and strongly assert conclusions. The main problem found in this field was that not all countries submit the same information, and oftentimes when they do, time frames do not coincide, which renders a cross-time analysis of particular series in a number of countries exceedingly difficult. This book therefore exposes the fact that the Eurozone and the EU should definitely improve data collection, and it would even be valuable if a there could be an institution—such as the National Bureau of Economic Research—in charge of analysis and reporting on

Historical and Theoretical Considerations

23

business cycle issues. For the EU and the Eurozone to group their data indicators into “leading,” “coincident,” and “laggard” would be of great help to the academic community. Finally, this chapter presents two recommendations that would help improve and secure the EU and the Eurozone project. The first is that the EU should avoid creating more institutions and strive to make the ones that already exist respected and obeyed. Amid the current economic crisis and financial uproar, many officials have proposed the creation of more institutions to introduce more rules and regulations that must be respected as a “vaccine” to “cure” the current “illness.” They fail to realize that the current “disease” is not because there was a lack of measures, but because these were not obeyed. The second recommendation is that the EU should understand that if, in case of financial difficulties, countries cannot exit, the EU and Eurozone must implement the right type of measure to ensure the correct observance of the requirements necessary to make the system work. Otherwise, if they are not going to execute this surveillance role, there should be the possibility for a “misbehaved” country to leave the Eurozone or the EU altogether to avoid jeopardizing the project. Nonetheless, the actual Treaty of Lisbon has been already breached, not only because the no-bailout rule is broken but, most importantly, because there are a number of countries that have been for some time not respecting the requirements, thus completely breaking the Treaty.

This page has been left blank intentionally

PART II THE EURO AS A COMMON, INTERNATIONAL, AND GLOBAL CURRENCY: AN EMPIRICAL STUDY

This page has been left blank intentionally

Chapter 2

The Euro as a Common Currency The adoption of the gold standard remained in effect until 1971when President Nixon eliminated the fixed gold price, and the Bretton Woods System disappeared. The demise of this system was followed by a period of monetary instability, which in the case of European countries led to the introduction of the euro as a common currency. The introduction of the euro has, therefore, been considered the most dramatic change in the monetary system since the adoption of the gold standard in the latter part of the nineteenth century. Before the euro was nominally introduced on January 1, 1999 and physically introduced on January 1, 2002, each country had its own currency representing the sovereignty of each nation and its people. When the time came to reach an agreement on a common European currency many disputes ensued regarding what its format and essence would be. The original idea for a common European currency came from the Nobel Prize winner, Robert Mundell, and his theory on Optimal Currency Areas. Back in 1970, Robert Mundell presented his work at the “Conference on Optimum Currency Areas” in Madrid. At this conference he presented a paper entitled “A Plan for a European Currency” (Mundell 1973a) in which he illustrated the gains that European countries would obtain by adopting a common currency, which he proposed to name the “Europa.” Following the conference, Lorenzo Bini-Smaghi, a senior staff member of the European Monetary Institute (EMI) asked Mundell if he had been the originator of the idea to name the currency “Europa.” Mundell explained that he thought that the popular usage would most likely end up being abbreviated as ¨euro” instead. In 1970 Bini-Smaghi invited Mundell to the European Monetary Commission and asked him how long it would take to create the European currency, to which Mundell (2002b, 10) replied, “it is more difficult than you think. Even if there were no political impediments, it would take at least three weeks.” It took three decades. Today, the creation of the European Economic and Monetary Union (EMU) has proven to be a good shelter for the weathering of the current economic storm, and the euro has become an anchor of regional stability and integration. As a consequence, the Eurozone has become an example to follow, and the common currency has come to be regarded as the solution that will end economic crises and prevent further ones. In light of these outcomes, this chapter explains how African and Latin American countries are all reconsidering the importance of regional monetary integration. This chapter reviews the fact that many of these countries have already integrated into a number of trading blocs: it also analyzes the fact that while the African effort is slowing down yet achieving results, Latin American attempts have unfortunately

28

The Euro in the 21st Century

proven to be crisis-prone as well as both economically and politically unstable. As a result, they have not been able to fully reach their trading potential let alone achieve monetary integration. In light of these circumstances, and taking the Eurozone as a benchmark, this chapter addresses the economic and monetary sacrifices and the difficulties that all those countries willing to form a solid single market, and eventually a monetary union, must face and endure. The Optimal Currency Area: Theory and Debate Mundell’s depiction of the adoption of the euro as “the most dramatic change in the international monetary system since President Nixon took the dollar off gold in 1971” (Bergsten 2005b, 2) places the creation of the EMU and introduction of the euro among the major economic, political, and historical events of the twentieth century. In fact, the only other case of successful monetary unions that can be compared to the introduction of the euro is that of the greenback after the Civil War of 1861–65. Nonetheless, the idea of a common currency aimed at solving the various economic disadvantages associated with different monies is not new. Both the US and the UK proposed the importance and convenience of having a world currency when planning the new post-war economic order at the 1944 Bretton Woods summit. Under President Roosevelt and the then Secretary of the Treasury, Henry Morgenthau Jr., the US presented the White Plan—named after the Treasury’s economist, Dr. Harry D. White—which included the provision of a dollar-based new world currency called the “unitas.” The UK, guided by John M. Keynes, also proposed a pound-based currency called the “bancor.” Both currencies were only meant to play the role of an accounting unit. Later on, in 1969 the IMF introduced a new international reserve asset, the Special Drawing Right (SDR), to support the Bretton Woods fixed exchange rate system. Unfortunately, in 1973 the Bretton Woods System collapsed and the major currencies shifted to a floating exchange rate regime. The SDR was introduced because “gold and the US dollar proved inadequate for supporting the expansion of world trade and financial development that was taking place” (IMF 2008, 1). Therefore, the international community decided to create a new international reserve asset under the auspices of the IMF. At the time of the signing of the Maastricht Treaty, the monetary union was still a much-debated issue; scholars, economists, and politicians alike were struggling with the pros and cons of such a union. The decision to give up one’s national currency and adopt a common one is based on a determination of the costs and benefits that relinquishing national monies to adopt a common currency would have for a group of countries. Still, today, some countries either do not understand or do not choose to accept the notion that a world engaged in global trade should just as well share a common currency. As the originator of the idea to adopt a common currency in Europe, Robert Mundell’s work as focused on its feasibility and desirability has been classified

The Euro as a Common Currency

29

by Ronald McKinnon (2004) into two categories: “Mundell I” and “Mundell II.” This classification is based on the evolution of Mundell’s thoughts on this issue. In 1961, Mundell employed a Keynesian perspective in a paper entitled “A Theory of Optimal Currency Areas.” Later, in 1970 in Madrid, during a conference on optimum currency areas, he presented two major papers, “Uncommon Arguments for Common Currencies” and “A Plan for a European Currency.” According to McKinnon, the 1961 paper can be labeled “Mundell I,” and the Madrid papers, influenced by the new monetary economic vision of the 1980s, represent “Mundell II.” “Mundell I” expressed some skepticism about the benefits of a common currency area and believed in “making currency areas smaller and more homogeneous— rather than larger and more heterogeneous—while emphasizing the advantages of exchange rate flexibility” (McKinnon 2004, 691). The theory of Optimum Currency Areas (OCAs) of 1961 studies how countries with a monetary union and common currency adjust when affected by asymmetric economic shocks. Mundell claimed that adjustments are based on whether wages are rigid, labor mobility is limited, income transfers are difficult, and differences exist in the labor market and growth rates. According to him, countries with a monetary union and a common currency would not be able to properly absorb asymmetric shocks unless, among other circumstances, labor mobility is a reality. “Mundell II” emphasized the benefits of a common currency in overcoming economic shocks because “the common currency assures an automatic and equal sharing of the risk of the fluctuation” (Mundell 2003, 119). This idea, which triumphed under the Maastricht Treaty, was explained in Mundell’s (1973b) article “Uncommon Arguments for Common Currencies.” Following his view, the European Commission’s (1990) document, entitled “One Market, One Money,” sets forth a defense arguing for the benefits of a common currency in terms of microeconomic and macroeconomic stability, and the opportunity to improve equality among countries and regions of the Eurozone. The Path to the Economic Monetary Union (EMU): From the Latin Union to the Euro The path to the EMU and the euro has not been an easy one. The nineteenth and twentieth centuries witnessed a number of major attempts to achieve European monetary integration. A monetary union is not simply achieved when a number of countries adopt a common single currency; it also requires an effective exchange rate between Member States as well as the adherence of all countries to a common monetary policy. History has demonstrated that trade and commercial relations tend to be higher among countries with geographic proximity, which sparks the need for a monetary and economic union. In the nineteenth century, the first attempt was the Austro-German monetary union (1857–66). The second attempt was the Latin Monetary Union (1865–78) between France, Belgium, Italy, and Switzerland. The third attempt was the creation of the Scandinavian Monetary Union (1875–1917)

30

The Euro in the 21st Century

between Denmark, Norway, and Sweden. Furthermore, the twentieth century witnessed a world divided into two political blocs, which implemented monetary and economic unions. On the one hand, the world witnessed the particular way in which the Union of Soviet Socialist Republics (1922–91) understood and implemented the idea of a monetary and economic union. On the other hand, the European Commission (n.d.), in “The EMU: A Historical Documentation,” explains that only two attempts at monetary integration occurred during the twentieth century. The first attempt occurred at the 1969 Den Haag summit, during which the Werner Report was introduced. This report represented the first commonly agreed plan of action to create an economic and monetary union in October 1970. The second attempt was the creation, in 1979, of the European Monetary System (EMS) and the introduction of the European Currency Unit (ecu) as common currency. The main purpose of this second initiative was to set up a zone of monetary stability and to increase efforts to achieve closer economic convergence between Member States. Thus, the history of Europe reveals that, over the years, there have been many efforts aiming for the achievement of an economic and monetary union and the establishment of a common currency. Fortunately, after all these failed attempts came the successful creation of the EMU and the euro. Nevertheless, every single failed attempt has, without a doubt, left an imprint, which has also led to a final and successful attempt. In April 1989, Jacques Delors outlined what became known as the Delors Report—a thorough, three-stage plan—to introduce the EMU via a process that culminated with the final introduction of a common currency, the euro, on January 1, 1999 in 11 of the 15 member states. On that date, the euro currency became a reality, and the single monetary policy as a major underpinning was introduced under the authority of the European Central Bank (ECB). Although the conversion rate for the euro was put in place on January 1, 1999, actual euro notes and coins were not introduced until January 2002; this was an intentional delay meant to provide a three-year transition period for the 11 countries adopting the euro. Thus, 11 national currencies legally ceased to exist on December 31, 1998. On January 1, 1999, 11 out of 15 EU countries freely chose to adopt the euro and the Eurozone was born. Greece, which was unable to meet the convergence criteria to join in 1999, finally qualified in 2000 and was admitted to the Eurozone on January 1, 2001. Denmark, Sweden, and the UK did not adopt the euro; these three countries are part of the EMU but are still not part of the Eurozone. Of the ten   Denmark has an “opt-out” clause from the Maastricht Treaty. The country held two referendums and both rejected the adoption of the euro. The latest public referendum took place in 2000.  Sweden has to join the euro as stipulated by the 1994 Act of Accession agreement. However, at first, Sweden did not meet the economic conditions to join the Eurozone; and later, in 2003, a public referendum resulted in a rejection of euro membership.   The UK has an opt-out from Eurozone membership under the Maastricht Treaty. The UK meets the economic conditions for joining the Eurozone; however, its government has not yet put the question to public referendum.

The Euro as a Common Currency

31

new countries that joined the EU in 2004, Slovenia qualified in 2006 to adopt the euro in January 2007, and Cyprus and Malta adopted the euro on January 1, 2008. Slovakia eventually joined on January 1, 2009. As a result, in 2009 the Eurozone had a total of 16 Member States. The creation of the Eurozone is a unique endeavor that stands as a model to imitate because of the integration force of the EMU as well as the successful role of the euro. In fact, the economic stability achieved after the introduction of the euro has been an incentive attractive enough to propel Member States toward the pursuit of further integration at the political and social level. The euro has amply demonstrated the many benefits of a common currency. Some authors believe that economic and monetary integration entail political integration, while others believe political integration entails economic and monetary integration. The majority of scholars, however, agree that a political union could only be achieved once an economic and monetary union is set, and that political union is necessary to strengthen the other two. In fact, De Grauwe (2006, 728) believes that although the EMU is a remarkable achievement, “the absence of a political union is an important flaw in the governance of the Eurozone.” Nonetheless, there is a continuing effort to complete political integration in the EU, given its past success at economic and monetary integration. There is an important difference between the previous unsuccessful monetary unions and the EMU. While the previous monetary unions rested on the value of gold or silver, or metallism, the EMU rests on the euro, or chartalism, as fiat money. Metallism or bimetallism is a monetary system in which the value of the currency unit is expressed in amounts of gold or silver, and where the “exchange rate” is fixed by law. This system is very stable mainly because gold and silver are scarce resources and because, as a result, governments can only print as much money as can be backed up by the stock of gold or silver stored. Fiat money, on the other hand, is issued by a central national bank, and its value and stability depends on the good credit of the issuing authority. This good credit, in turn, is based on the political and economic stability of the country. However, fiat monies are less stable because of the temptation of the inflationary tax or seigniorage when the Treasury is unable to finance the deficit. In the EMU, stability has mainly been achieved through the introduction of the following two pillars: an economic union and a monetary union. Economic union is achieved by complying with the Stability and Growth Pact (SGP), which is based on the implementation of specific fiscal requirements among EMU Member States with the goal of maintaining fiscal stability. Monetary union is based on the existence of the euro as a common currency and the implementation of a common monetary policy supervised by a central bank in this case, the European Central Bank (ECB). The introduction of a common interest rate by the ECB, and the requirements of the SGP have encouraged further integration because they have fostered the synchronization and harmonization of economic behavior or the business cycle. This leads Rose (2000, 2) to believe that “business cycles are systematically more highly correlated between members of

32

The Euro in the 21st Century

currency unions than between countries with sovereign currencies.” In fact, since the introduction of the euro the business cycles of the Eurozone and of the US seem to have reached a high degree of synchronization, as is represented in Graphs 2.1 and 2.2 below.

Graph 2.1

European Commission Euro Area Business Climate Indicator

Source: Bloomberg Finance LP

Other Monetary Unions: Success or Failure? As a result of the synchronization between the business cycles of the Eurozone and the US, the euro is viewed as a successful common currency capable of promoting convergence among economies of different sizes and natures. Since its inception, it has been closely watched by other areas willing to follow in the footsteps of the EMU and the euro. This is particularly the case for many Asian countries. Haruhiko Kuroda (2008, 1) has stated that “the euro has played an essential role in fostering harmony among diverse economies. This experience is extremely useful for Asia, as the region moves ever more resolutely towards its own style of regionalism.” This also applies to African countries, which are finalizing the idea of clustering into groups to create monetary and/or economic unions; and to Latin America which is rethinking its own integration process. The success of the euro rests on the fact that the Eurozone is a full monetary union. Full unions, such as the Eurozone, are characterized by having a monetary authority embodied in a single joint institution, normally a central bank. In the Eurozone, the ECB, together with the central bank of each Member State, creates the European System of Central Banks (ESCB). As Mundell (2002b, 126) puts it, with the EMU and the adoption of the euro, “each country sacrificed its policy sovereignty in the field of its own money in exchange for its share of policy sovereignty in the direction of the ECB.” He also explains that the implications of

N ov -0 M 0 ar -0 1 Ju l-0 N 1 ov -0 M 1 ar -0 2 Ju l-0 N 2 ov -0 M 2 ar -0 3 Ju l-0 N 3 ov -0 M 3 ar -0 4 Ju l-0 N 4 ov -0 M 4 ar -0 5 Ju l-0 N 5 ov -0 M 5 ar -0 6 Ju l-0 N 6 ov -0 M 6 ar -0 7 Ju l-0 N 7 ov -0 M 7 ar -0 8 Ju l-0 N 8 ov -0 M 8 ar -0 9 Ju l-0 N 9 ov -0 9

110

105

100

95

90

85

80

Graph 2.2 US Conference Board, US Leading Index of 10 Ten Economic Indicators

Source: Bloomberg Finance LP

The Euro in the 21st Century

34

the creation of the euro and the replacement of national currencies are extremely important for the countries involved in this initiative because “the right to produce a national currency has, for centuries—even millennia—been looked on as a principal dimension of political independence and a badge of legal sovereignty” (Mundell 2002b, 127). There is also what is called a “pseudo,” “incomplete” or “intermediate” currency union. Pseudo, intermediate, or incomplete unions are, according to De Grauwe (2007, 121), those formed by “countries in the world [that] peg their currencies to another one, in particular to the dollar … to form an ‘incomplete’ monetary union with the country to which they peg.” For Mundell (2002a, 135), “in a pseudo currency area, monetary policy may be allocated to domestic objectives.” There are many examples of incomplete unions that become fragile. This fragility is due to what De Grauwe (2007, 121) calls a problem of “credibility.” According to Eichengreen (2002, 21), the intermediate union “forces governments to choose between credibly and unconditionally subordinating monetary policy to the exchange rate.” In fact, the success of the Eurozone as a full union lies in the fact that “the ECB and the European System of Central Banks … were given the mandate to maintain price stability and to safeguard the credibility of the euro” (Trichet 2008c, 5). Table 2.1

List of existing and de facto monetary unions

Existing monetary unions 1. 2. 3. 4. 5.

The euro in the Eurozone The East Caribbean dollar in Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, Saint Kitts and Nevis, Saint Lucia, Saint Vincent, and the Grenadines The CFA franc (BEAC) used by Cameroon, the Central African Republic, Chad, the Republic of Congo, Equatorial Guinea, and Gabon (Hadjimichael and Galy, 1997 CFA franc (BCEAO) used by Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Senegal, and Togo The East African shilling used in the East African Community (EAC) by the Republics of Kenya, Uganda, Burundi, Rwanda, and the United Republic of Tanzania

De facto monetary unions 1. 2.

The euro is legal tender in Andorra, Kosovo, and Montenegro The Hong Kong dollar is used in Macau (Bank of Hong Kong)

3.

The Russian ruble is used in Russia and the Georgian Autonomous republics of Abkhazia and South Ossetia (McMullen 2008) The Swiss franc is used in Liechtenstein The US dollar is used in Palau, Micronesia, the Marshall Islands, Panama, Ecuador, El Salvador, Timor-Lester, the British Virgin Islands, and the Turks and Caicos Islands

4. 5.

The Euro as a Common Currency

Table 2.2

35

List of planned monetary unions

Name

Currency

Date

West African Monetary Zone, as part of Eco the Economic Community of West African States (ECOWAS)

December 2009, revised to January 2015

Gulf Cooperation Council (GCC)

Khaleeji

2010, revised to 2013–2020

Caribbean Single Market and Economy (CSME) as part of the CARICOM

Unknown

Due between 2010 and 2015

Southern African Development Community

Unknown

2016

De Grauwe (2007, 121) explains that the collapse of systems like Bretton Woods in 1973, the Economic Monetary System in 1993, and the unions among South-East Asian currencies in 1997–98 and Latin American currencies in the 1990s, were all the result of “the fragility of a fixed exchange rate system [that] has everything to do with credibility.” In contrast, the strength of the Eurozone rests precisely on the credibility of the requirements set when the EMU was being implemented and the ECB was established. However, if these requirements are no longer met nor respected by Member States, the Eurozone might soon suffer from a lack of credibility that will negatively affect the project. Table 2.1 lists the number of existing monetary unions which include the Eurozone and some others that exist with a certain degree of difficulty. Furthermore, Table 2.1 list the de facto monetary unions which are areas where a particular currency has been adopted as legal tender although that particular country does not belong to the economic and monetary union where that currency is the common currency. Table 2.2 lists the number of planned monetary unions. A thorough analysis of Table 2.2 shows that some of the expected currencies have not been introduced. For instance, the ecu as a common currency has not been introduced in 2009 and the date has been revised for January 2015. Similarly, the khaleeji was scheduled for 2010 but now has been postponed until sometime between 2013 and 2020. The African Attempt: An Integration Conundrum African countries, with the exception of Morocco, have grouped into an intergovernmental organization, the African Union (AU), established on July 9, 2002 as a result of a dispute with the Sahrawi Arab Democratic Republic. It was conceived by the Libyan leader Muammar Gaddafi who proposed a “United States of Africa: with a structure that loosely resembles that of the EU” (BBC News n.d.). The main objective of the AU is to foster the political and socioeconomic integration of the continent in order to strengthen peace, security and human rights; a set of goals that much resemble the founding goals of the EU. The AU also seems to share a very similar institutional structure with the EU. For example,

36

Table 2.3

The Euro in the 21st Century

Recognized regional economic communities (RECs)

The Arab Maghreb Union (UMA) The Common Market for Eastern and Southern Africa (COMESA) The Community of Sahel-Sahara States (CEN-SAD) The East African Community (EAC) The Economic Community of Central African States (ECCAS) The Economic Community of West African States (ECOWAS) The Intergovernmental Authority on Development (IGAD) The Southern Africa Development Community (SADC)

the AU has an Assembly which functions as its decision-making organ, a PanAfrican Parliament with 265 members elected by their national parliaments, other institutions such as the Economic, Social, and Cultural Council (ECOSOCC) which is a civil society that functions as a consultative body, and a number of financial institutions such as the African Central Bank, the African Investment Bank, and the African Monetary Fund. However, the AU has taken a unique approach to achieve economic and monetary integration. While the EU is an economic and monetary union of 27 Member States, the AU’s integration efforts rest on eight regional economic communities (RECs) summarized in Table 2.3. The 1980 Lagos Plan of Action for the Development of Africa and the 1991 Abuja Treaty which established the African Economic Community (AEC) proposed that the economic and monetary integration of the African continent should depend on the integration of these eight sub-regions. Thus, these eight regional economic communities form the pillars of the AEC. The AEC seeks the creation of an economic and monetary union, as in the case of the EU, by implementing free trade areas, customs unions, a single market, a central bank, and a common currency. The Abuja Treaty, signed in 1991 and initiated in 1994, established that by 2028 the AEC should have integrated and established a continent-wide economic and monetary union with full circulation of a common currency. However, this desire lacks any solid economic structure upon which the creation of a common currency can rest. The EU established a set of standards that countries had to respect in order to guarantee some degree of economic and fiscal uniformity among its members. A brief economic analysis of these countries shows that they all share the same low GDP per capita (Graph 2.3) except for Equatorial Guinea and Gabon. When it comes to inflation, Graph 2.4 shows that some countries are suffering from an exceptionally high inflation rate—a threat to any common currency. In fact, this graph shows that almost all of the countries experience rates that are well above 100 percent, and even Ghana and Guinea, which curiously enough are the two countries with the highest GDP per capita, bear rates of close to 500 percent. This proves that these countries are lacking all kinds of economic, monetary, and fiscal structure.

The Euro as a Common Currency

Graph 2.3

37

GDP based on purchasing power parity (PPP) per capita in selected AEC countries

Source: Global Finance magazine

Graph 2.4

Inflation in selected AEC countries

Source: Global Finance magazine

One of the RECs which follow in the footsteps of the EU model is the Economic Community of West African States (ECOWAS), a regional group of 15 African countries founded on May 28, 1975, with the signing of the Treaty of Lagos. It aims   Member States of the ECOWAS are Benin, Burkina Faso, Cape Verde, Cote d’Ivoire, The Gambia, Ghana, Guinea, Guinea Bissau, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leona, and Togo.

38

The Euro in the 21st Century

at promoting economic integration among its members. Curiously enough, the ECOWAS Member States are divided into two different economic and monetary unions: the West African Economic and Monetary Union (UEMOA) and the West African Monetary Zone (WAMZ). First, UEMOA is a customs and monetary union with the CFA (Communauté Financière d’Afrique) franc as a common currency whose exchange rate is tied to the euro, is guaranteed by the French Treasury and is issued by the BCEAO (Banque Centrale des Etats de l’Afrique de l’Ouest). On January 10, 1994, Benin, Burkina Faso, Cote d’Ivoire, Mali, Niger, Senegal, and Togo signed a treaty in Dakar in which they agreed on a number of objectives oriented towards increasing competitiveness, macroeconomic convergence, and the creation of a common market. The IMF 2003 report on the area explains that the bloc has increased its external competitiveness as well as the pace and range of its economic integration. However, the strong economic expansion of the area after the devaluation in 1994 of the CFA franc has tapered off despite prudent monetary policy pursued by the regional central bank. Furthermore, the CFA franc is also used in a number of countries in central Africa such as Cameroon, the Central African Republic, Chad, the Republic of the Congo, Equatorial Guinea, and Gabon. The CFA franc of central Africa is issued by the Bank of the Central African States (BEAC, after the original French name of Banque des Etats de L’Afrique Centrale). Both the West and Central African CFA franc have the same value. It is important to highlight that some of the countries included in the ECOWAS have left the UEMOA because to be part of the union was jeopardizing the project: other countries such as Guinea, Mauritania, and Mali left and, after devaluating, rejoined years later. Second, on December 1, 2000 Gambia, Ghana, Nigeria, and Sierra Leona joined forces to create the West African Monetary Zone (WAMZ) with the goal of introducing the “eco” as a common currency by 2015 (Obayuwana 2009) and as a rival to the CFA franc. However, by 2020 both currencies, the CFA franc and the eco, are expected to merge, preceded by the launching of a monetary union, with the establishment of a regional central union for the area. These various measures and groupings are summarized in Figure 2.1. Latin American Attempts: Objectives, Successes, and Shortcomings Many attempts aiming at integration using a political approach have been made among Latin American countries; however, as the case of the EU demonstrates, only those attempts using trade and economics as the main approach toward integration stand a chance. Currently, in Latin America, Mercosur and the Andean Community of Nations (CAN) are the most important and successful trading agreements withstanding. In fact, in Cusco, Peru, in December 2004 during the Third American Summit, these two trading blocs signed a cooperation agreement and published a joint letter of intention (Preamble to the Foundation Act of the South American Union) in which they stated that their aim was to work together

The Euro as a Common Currency

Figure 2.1

39

Progress of ECOWAS

towards the integration of all of South America in what was called the South American Community of Nations. The Constitutive pact explains that Their determination to develop a politically, socially, economically, environmentally and infrastructurally integrated South American area that will contribute toward strengthening the unique South American identity and, from a subregional standpoint and in coordination with other regional integration experiences, that of Latin America and the Caribbean and will give it a greater weight and representativeness in international forums (Comunidad Andina 2004).

Furthermore, the Preamble called for the creation of a regional parliament, a common market, a constitution drafted with the EU as a model, and even a common currency. None of this has happened; thus this project has stalled, with the creation of the single market to eliminate tariffs expected by 2018: the gradual implementation of the four freedoms is still under review. However, member states created the South American Bank which was launched with a capital of US$7bn to finance economic development projects, a task that has nothing to do with the mandates of the ECB. The reason why this project is at a standstill is explained by the fact that the integration process of Mercosur and CAN are also at an impasse since these two underlying trading blocs have not followed their pre-established integrating path. However, if the South American Community of Nations were

40

The Euro in the 21st Century

to become operative, it will bring together 387,948 million people and create a trading area of 6,846,154 square miles. Many similarities can be drawn when analyzing the efforts of these blocs on opposite sides of the Atlantic. Furthermore, as the creation of the EU and the Eurozone have proven to be extremely beneficial for the area, Mercosur and CAN will surely be equally beneficial for Latin America. Mercosur and CAN have achieved some level of accomplishment but have followed an erratic path due to economic setbacks and a lack of commitment. If these blocs want to succeed, it seems that they should follow in the footsteps of Europe as the EU has proven to be the only integration attempt that has worked. The EU is a fully developed common market and the Eurozone is a successful economic and monetary union under the supervision of the newly agreed Treaty of Lisbon and a set of institutions that overviews the integration process. The success of the EU and the creation of the Eurozone can be briefly explained as based on three foundations that are highly intertwined. First, according to Ana I. Eiras and Brett D. Schaefer (2001) the integration process rests on the existence, among Member States, of strong economic and political stability which establishes the grounds for mutual trust and a common willingness to give up the same level of political and economic sovereignty to develop a common project. Secondly, the EU rests on the creation of institutions whose legally binding resolutions are respected and complied with by all Member States which, in turn, fosters political integration. Finally, economic and monetary integration is achieved by a strict adherence to a list of requirements. In the case of Mercosur and CAN these three premises are absent in varying degrees.

Graph 2.5

GDP based on purchasing power parity (PPP) in Mercosur full member countries

Source: Bloomberg Finance LP

The Euro as a Common Currency

Graph 2.6

41

Inflation in Mercosur full member countries

Source: Bloomberg Finance LP

From an economic point of view, Mercosur member states do not share many economic characteristics. First of all, as Graph 2.5 demonstrates, the GDP per capita in all four countries is quite uneven, with Brazil having the highest level and Uruguay and Paraguay representing one fourth of Brazil’s. By the same token, inflation, which is one of the main requirements for a sound economy with a solid common market, is extremely high in all four member states. Graph 2.6 shows that inflation has been increasing since the year 2000. Finally, as Graph 2.7 demonstrates, the state of their current account balances shows a very mixed picture. The current account in the balance of payments of a country measures that country’s economic health by indicating whether it has a surplus or a deficit. Curiously enough, Argentina has been running surpluses which

Graph 2.7

Current account balances in Mercosur full member countries

Source: Bloomberg Finance LP

42

The Euro in the 21st Century

significantly increased in 2009. These surpluses were aided by a trade surplus that was characterized by a slump in imports in the second quarter of 2009 (Popper 2009). On the other hand, Brazil is enduring a significant deficit (particularly in 2009) due to, according to Gerald Jeffris and Tom Murphy (2010), “a fall in the profit and dividend remittances and the fact that the country’s imports fell more than exports.”

Graph 2.8

Alternative measures of political and economic integration— six countries compared

Sources: Fraser Institute, “Freedom of the World: 2008 Annual Report,” at (accessed November 2, 2009); The Economist Intelligence Unit, “The Economist Intelligence Unit’s Index of Democracy 2008,” at (accessed November 4, 2009); World Economic Forum, “Competitiveness Reports 2008–2009,” at (accessed November 23, 2009)

The history of Mercosur shows that Brazil and Argentina suffer from a political instability that prevents these countries from having a stable economy. This simple premise has developed a “hidden” lack of political and economic trust which has consequently developed a strong unwillingness to give up national sovereignty. Graph 2.8 compares a number of measures that indicate the level of economic and political stability in Argentina and Brazil in relation to Germany, France, the UK, and the US Consequently, the Democracy Index elaborated by the Economist Intelligence Unit (2008) graded Brazil and Argentina as “flawed democracies” due to the fact that certain freedoms have been eroded; the other countries in this graph are considered full democracies. Furthermore, the World Economic Forum (2008–09) presents a “Global Competitiveness Index” that measures the level of institutional development, macroeconomic stability, and policy instability in the

The Euro as a Common Currency

Graph 2.9

43

Economic freedom—six countries compared

Source: Fraser Institute, “Freedom of the World: 2008 Annual Report,” at (accessed November 2, 2009)

area. The index shows that in terms of institutions, both Brazil and Argentina have a poor score since Argentina ranks 128 and Brazil 91 out of 134 countries, while European countries and the US are in the top 25, proving that these countries have achieved a high level of integration in terms of institutions. Consequently, the score for macroeconomic stability is very poor in Brazil and Argentina and the level of policy instability is very high, particularly in Argentina. This demonstrates that low economic policies and political instability prevent these two countries from achieving a worldwide noteworthy position despite their potential. Finally, political instability will take a toll on the economic freedom of Argentina and Brazil; Graph 2.9 shows that both countries already have the very low levels of economic freedom. In the case of the European countries, the level of economic freedom increased after 1980 when efforts to fully develop the EU and create the Eurozone became an objective agreed upon by Member States. In the case of Argentina and Brazil, after the Treaty of Asunción was signed in 1991 and Mercosur was launched, economic freedom increased. It remains almost identical for both countries, yet it remains below the European level. The Brazilian maxi-devaluation of 1999 and the 2001 Argentine default on the larger part of its public debt brought about economic mistrust between these two countries, bringing the Mercosur integration process to a standstill. When economic difficulties hit one country, the other country, rather than helping in a common effort to make it through, sought shelter outside the bloc. In the case of Brazil in 1999, Argentina tried to insulate itself by adopting the US dollar as a national currency, a policy that further impeded Brazil’s recovery. By the same token, when Argentina defaulted on its almost $132bn public debt (Voice of America 2001) it affected Brazil, whose currency lost almost 30 percent of its

44

The Euro in the 21st Century

value against the US dollar (Businessweek 2001). Furthermore, Mercosur lacks the existence of a country that can act as an economic anchor, since the two major countries—Brazil and Argentina—are in almost constant economic disarray; this is a situation that each country tries to solve using country-specific measures, which proves that Mercosur members lack common political and economic policies. Finally, in contrast to the EU project which only initially required the economic assistance of the US, Argentina and Brazil continue to be economically and politically dependent on nations like the US, Germany, Japan, and, recently, China. This fact hinders internal development. Furthermore, although the Additional Protocol on the Institutional Structure of Mercosur (Ouro Preto Protocol) was signed on December 17, 1994 to boost the creation of institutions that help with the legal personality of the organization and to set a mechanism in place to make decisions and force agreements, Mercosur lacks the institutional infrastructure necessary to organize the integration process and enforce legally binding regulations agreed upon by Member States. The problem lies in the fact that achieving political integration through the deepening of institutions would be very difficult since both Argentina and Brazil experience difficulties in maintaining stable institutions at home. Therefore, setting institutions at a supranational level becomes rather difficult. Nonetheless, Bouzas and Soltz explain that in Mercosur: In contrast to the detailed, rules-based approach of the North American Free Trade Agreement (that includes a total of 245 articles crammed in over 1,200 pages), the Treaty of Asunción and the Ouro Preto Protocol laid a broad and flexible framework to foster regional integration. They also differ from the Treaty of Rome in the detail of the commitments undertaken by the signatories, the nature of governing organs, the role given to an “autonomous” legal order and the procedures adopted for decision-making.

The Treaty of Asunción (ToA) created the Common Market Council (CMC) in charge of working towards a common market. The purpose was to bring together the ministers responsible for economic affairs and foreign relations. Furthermore, the Common Market Group (CMG) included each Member State’s ministers responsible for foreign relations, economic affairs, and central banks, with the mandate to cooperate in order to boost economic integration. In 1994, the Ouro Preto Protocol (OPP) created the Trade Commission (MTC), the Joint Parliamentary Commission (JPC), and the Economic and Social Consultative Forum (ESCF). Of all these institutions, only the Trade Commission was designed as a decision-making organ with powers to dictate “directives” oriented toward the enforcement of common trade policies. The rest of the institutions are counseling and advisory organs. This structure and organization is far from the institutional rigor found in the creation of the EU and the Eurozone. Graph 2.10 shows the level of corruption, inefficiency, and even the possibility of government instability (or coups d’état) for Argentina and Brazil compared

Graph 2.10 Some problematic factors for political integration—six countries compared Source: World Economic Forum, “The Global Competitiveness Report 2009–2010,” at (accessed December 2009)

46

The Euro in the 21st Century

to those in the EU and the US. Curiously, Germany has the lowest levels while France, the UK, and the US rank higher in terms of the level of government inefficiencies. From an economic integration point of view, much is still to be done in Mercosur, which is still considered to be just a customs union while the EU is a single market with a de facto free movement of people, services, goods, and capital, whose members have agreed to comply with common policies on trade, such as agriculture and fishing, and on regional development. Furthermore, Mercosur, created in 1991, has still, in 2009, been unable to fully reach a solid customs union, let alone the next stage of economic integration: the single market. In the European case, the EU was born in 1951 with the European Coal and Steel Community; in 1957 with the Treaty of Rome it became the European Economic Community (EEC), and in 1968 internal tariff barriers were abolished. However, the integration project stood still until 1986 when the Single European Act was signed, establishing, by 1993, the single European market which allowed for the freedom of movement of goods, labor, and capital. By 1999, 13 of its Member States went on to the last step of economic integration. In the EU there continues to be a debate concerning the final steps toward complete political integration in light of past successes in economic and monetary integration. Some authors believe that economic and monetary integration entail political integration, while others believe that political integration entails economic and monetary integration. The majority of scholars agree that a political union could only be achieved once an economic and monetary union is set, and that political union is necessary to strengthen the other two. In fact, De Grauwe (2006, 728) believes that although the EMU is a remarkable achievement, “the absence of a political union is an important flaw in the governance of the Eurozone.” This is consistent with the latest findings on integration that conclude that “political integration is not rapidly followed by economic integration. Instead, we estimate that it takes at least one generation (between 33 and 40 years or more) to remove the impact of political borders on trade” (Nitsch and Wolf 1). Thus, founding nations of Mercosur, CAN, or the South America Community of Nations must work towards improving their national political institutions to strengthen economic development and mutual trust among nation states as the only sure recipe for achieving solid integration. Final Words The creation of the EU and the introduction of the euro as a common currency have demonstrated that economic and monetary cooperation is possible among countries. The essential point is not only that cooperation is possible but also that it is more importantly desirable to improve economic development, political stability, and social well-being in a country and a group of countries. The fact that the European countries that had been involved in two devastating wars were capable of cooperating under the umbrella of the EU and the euro has become a

The Euro as a Common Currency

47

model to imitate. This chapter explains that to introduce the euro has not been an easy task, although the idea had been around for many years and with different formats. Finally, after a number of failed attempts, the euro has been introduced in a number of Member States. This chapter demonstrates that the introduction of the euro has been such a total success that the euro as a national currency has been adopted by other countries that are not even part of the Eurozone. This is important because the significance of a national currency is also measured by the number of countries that unilaterally, or via a specific agreement, adopt that currency as a national one. This chapter also explains that there are a number of countries that have followed the evolution of these European countries in their quest to create a union and introduce a common currency. The fact that, after the creation of the EU and the introduction of the euro, countries have improved economically, politically, and socially has been an incentive for a number of countries and regions. The countries of Latin America comprise the first important region that has been trying for quite some time to create a union: there have been many attempts but almost all have also failed. Mercosur is the most important attempt as it has the presence of the two economic giants of the area: Brazil and Argentina. However, evidence demonstrates that the incentive to continue the common effort of all four countries is at an impasse. Brazil seems to be aware that its economic development is on the way with or without the cooperation of Argentina, Paraguay, and Uruguay. In fact, Brazil has become (together with China, India, and Russia) one of the most important developing countries. As a consequence, Brazil has raised the living standard of its citizens and has become an important economic global actor, thus allowing it to focus on developing other areas. For instance, Brazil is for the first time looking into improving its national security and defense: in 2008 it put together for the first time in history a national defense strategy framework and raised national defense spending by 50 percent. On the other hand, at the time of writing in early 2010, Argentina is in a middle of a political crisis that is affecting the economy, as the political fight between the President and the Central Bank of Argentina is disturbing the economic state of affairs. Another problem for integration in this region is that there is a complete lack of trust among countries which prevents any efforts at integration. Mercosur, after all these years, cannot be considered a fully developed customs union. Furthermore, this chapter has explained the integrating attempts of some of the African countries which are already trying to introduce a common currency. However, there are many setbacks and obstacles to be overcome. Although having a single market and an economic and monetary union is extremely appealing, as it truly increases economic expansion and social progress, this is no easy task to achieve. The example of the EU and the Eurozone demonstrates that it takes clear institution organization, political commitment, and social sacrifices to have a successful story. The study of the integration efforts of these two blocs has revealed that both the African and the Latin America blocs lack, to a different degree, these three main characteristics. Dangerously, the current economic crisis and financial uproar is negatively affecting the progress that these regions had achieved throughout the years.

This page has been left blank intentionally

Chapter 3

Statistical Analysis of the Euro as a Stabilizer for the Eurozone Since the mere idea of the euro was envisioned the prediction was that the euro was never going to become a reality. During the first stage of its introduction, the naysayers predicted that the euro was destined to have a very short life and become another very expensive failed attempt to “unify” Europe. As the euro began to turn into a reality, the debate switched to discussing whether the euro would ever become a successful common currency strong enough to transform the Eurozone into an optimum currency area. The argument was that most of the individual countries adopting the euro were not prepared to maximize the economic efficiency derived from sharing a common currency due to their different economic, monetary, political, and social backgrounds. Skidelsky (2001, 9) states that “monetary union is a political project pursued by economic means.” However, the success of this project rests on how the common currency affects the economies of the Member States after its adoption. A monetary union can, indeed, only be considered optimal if the introduction of a single currency helps the “(1) maintenance of full employment; (2) the maintenance of balanced international payments; [and] (3) [the] maintenance of a stable internal average price level” (McKinnon 1963, 717). This shows that there is a strong correlation between employment and stability in price levels, which, as Friedman states, are two of the most important benchmarks that will determine the success of the union. In fact, Friedman (1976, 3) explains that “the effects of a change in aggregate nominal demand on employment and price levels may not be independent of the source of the change, and conversely the effect of monetary, fiscal or other forces on aggregate nominal demand may depend on how employment and price levels react.” Ten years after its introduction, many still doubt that the euro is a common currency. This chapter demonstrates that today the euro is a de facto solid common currency and that the Eurozone is, in fact, an optimum common currency area. According to theory, a successful common currency must be able to help reduce the asymmetric shocks produced by a negative externality. This chapter examines how the euro has been able to cope with an increase in the price of oil and commodities, with the fluctuation in the stock market and the currency market across the Eurozone, and with the evolution of the labor market and consumer prices. The main focus of this study is to examine whether the euro has been an economic, monetary, fiscal, and social stabilizer for the Eurozone. In order to do this, the underpinnings of the euro are analyzed in this chapter. Moreover, the requirements and benchmarks that have to be achieved, maintained, and respected are tested

The Euro in the 21st Century

50

against the data found in two major statistical data sources: the European Central Bank’s Statistics Data Warehouse (), and E-signal. This chapter focuses on a thorough quantitative analysis of the fitness of the euro as a stabilizer using a vast variety of indexes. For this purpose, this chapter studies the evolution of 18 indexes (Table 3.1) analyzed by means of 34 graphs. Table 3.1

Summary of indexes

US Dollar Index (USDX) German deutsch mark (D-mark or Dem) Euro French franc (FRF) Spanish peseta (ESP) Italian lira (ITAL) UK pound (GBP) Dow Jones Industrial Average (DJIA) Eurotop 100 German Deutscher Aktien IndeX (DAX) Crude Oil (CO) Commodities Research Bureau (CRB) US 2-year Treasury Note Eurodollar (3 months) US 10-year Treasury Note German Bund LIBOR (1 month) EURIBOR (3 months)

The foreign exchange market is the first market studied to analyze whether the euro has become a successful common currency. In order to do this, the foreign exchange indexes and currencies are analyzed as listed in Table 3.2. The currencies used for this study—the German mark, the Spanish peseta, Italian lira, and French franc—no longer exist as national currencies; however, Future Source is a data vendor that still carries their daily values (<www.futuresource.com>). The stock market is the second area analyzed to study how the introduction of the euro has affected some major stock indexes and also to study the impact of the euro on investors’ investment opportunities (see Table 3.3). This section also includes an innovative study to analyze the relationship between the euro and the price of oil and commodities. There is an important relationship between them as the prices of oil and certain commodities do have a direct effect on the price of certain necessities, thus affecting price stability and inflation.

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

Table 3.2

Summary of currencies analyzed

Graph

Index

3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 3.11 3.12

US Dollar Index (USDX) US Dollar Index with 20-month simple moving average and de-trended Deutsch mark composite D-mark and US Dollar Index Evolution of the euro Euro and US Dollar Index Deutsche mark composite and euro French franc (FRF) and euro Spanish peseta (ESP) and euro Italian lira (ITL) and euro Euro and UK pound (GBP) Euro and UK pound since 1981

Table 3.3

51

Summary of stock exchange, Crude Oil, and CRB Indexes

Graph

Index

3.13 3.14 3.15 3.16 3.17 3.18 3.19 3.20 3.21 3.22 3.23 3.24 3.25 3.26 3.27

Dow Jones Industrial Average (DJIA) DJIA with 20-month moving average and de-trended Deutscher Aktien IndeX (DAX) DAX with 30-month moving average and de-trended DJIA and US Dollar Index DAX and euro DAX and DJIA DJIA and DAX with covariance DJIA, DAX, and Eurotop 100 Crude Oil and CRB Indexes Crude Oil and CRB Indexes with covariance CRB Index and US Dollar Index Crude Oil and US Dollar Indexes Crude Oil and US Dollar Indexes with covariance Crude Oil Index and euro

As a direct consequence of the evolution of the price index and inflation, the European Central Bank (ECB) decides on the “price of money” and adjusts the money markets accordingly. For this reason, the third market analyzed is the evolution of the money market and its relationship with the euro (Table 3.4).

The Euro in the 21st Century

52

Table 3.4

Summary of money market indexes

Graph

Index

3.28 3.29 3.30 3.31 3.32 3.33 3.34

US 2-year Treasury Note and Eurodollar (3 months) US 10-year Treasury Note 10-years and Bund Eurodollar (1 month) and Eurodollar (3 months) EURIBOR (1 month) and Eurodollar (3 months) EURIBOR (3 months) and LIBOR (1 month) EURIBOR (3 months) and euro Euro and Bund

Technical Matters and Computer Program Technicalities This chapter presents a total of 34 graphs to investigate three markets: the foreign exchange market, the stock exchange and commodities market, and the money market. These graphs have been created using two different advanced graphing programs, and permission to reproduce has been granted. First, Graphs 3.2, 3.14, 3.16, 3.20, 3.21, 3.23, and 3.26, have been plotted with the consent of the Omega Research Pro-Suit 2000i program. This is a professional program which only plots data in Metastock form. In order to convert Excel data into Metastock readable data, a professional data converter program, the Downloader, was used. Second, the rest of the graphs presented in this chapter have been plotted using Future Source. Furthermore, these graphs plot a wide variety of custom-made indexes, strengthened by the statistical reliability of a number of significant statistical methods such as the covariance, de-trend, and simple and exponential moving averages. Table 3.5 provides a summary of which graphs have been analyzed. Table 3.5

Summary of statistical study

Graph

Index

Covariance

3.2 3.14 3.16 3.20 3.23 3.26

US Dollar Index (USDX) DJIA DAX DJIA and DAX CRB and Crude Oil Indexes Crude Oil and USDX

√ √ √ √ √

De-trend

Moving Average

√ √ √

√ √ √

The first statistical analysis used in this work is the covariance. The covariance was first introduced and used by Jean Le Rond d’Alembert, a French mathematician who put together the d’Alembert Criterion which basically is used to measure the level of convergence of series of positive terms. This criterion specifies that if the positive terms series tend to less than one, these series are converging, and if

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

Table 3.6

53

Custom-made covariance formula

Inputs: IndependentVal(Close of Data1), DependentVal(Close of Data2), Length(30); Plot1(Correlation(DependentVal, IndependentVal, Length), “Covariance”); Plot2(0, “Zero Line”,BLACK); Plot3(.35, “COV POS”,BLUE); Plot4(–.35, “COV NEG”,RED); {Alert Criteria} If Plot1 < .35 Then Alert(“There is a strong positive correlation in the last”+NumToStr(length,0)+” bars”) Else If Plot1 > –.35 Then Alert(“There is a strong inverse correlation in the last”+NumToStr(length,0)+“bars”); Condition2 = PLOT1 > –.35; Condition3 = PLOT1 < .35; if CONDITION2 then setPlotColor(1,green); if condition2 then setplotwidth(1,6); if CONDITION3 then setPlotColor(1,red); if CONDITION3 then setPlotwidth(1,6);

these series tend to more than one the series are diverging. Convergence is used to measure to what extent two random variables vary together and it is defined as Cov(x,y) = E{[ x – E(x) ][ y – E(y) ]}. The importance of this statistical method is that the result obtained will indicate the relationship, or lack thereof, between two random variables. When the result of the covariance is negative, it indicates that the two random variables have varied in opposite directions, meaning that there is no linear relationship between the two. On the other hand, positive covariance implies that both variables enjoy a linear relationship and are moving in the same direction. Finally, the larger the magnitude of the product the stronger the strength of the relationship.

54

Table 3.7

The Euro in the 21st Century

Custom-made de-trended formula

Inputs: Price(Close), Length(N) N = 20; PLOT1(0,“CERO”,“Cero Line”); PLOT2(CLOSE–XAverage(Price, Length), “DETREND”); {Alert Criteria} CONDITION1= PLOT2 < 0; CONDITION2 = PLOT2 >0; if CONDITION1 THEN setPlotColor(2,red); if condition1 THEN setplotwidth(2,6); if CONDITION2 THEN setPlotColor(2,green); if CONDITION2 THEN setPlotwidth(2,6); {Alert Criteria} condition2= plot1 > +0 and plot1 < plot1[12] and plot1 < plot1[14] and plot1 < plot1[16] and high = highest (high,16) and high–low > high[1]–low[1] or plot1 = lowest(plot1,16); condition3= plot1 < –0 and plot1 > plot1[12] and plot1 > plot1[14] and plot1 > plot1[16] and low = lowest (low,16) and high–low > high[1]–low [1] or plot1 = highest(plot1,16); {Alert Criteria} if (CONDITION2 ) then setPlotColor(1,red); if (CONDITION2 ) then setPlotwidth(1,5); if (CONDITION3 ) then setPlotColor(1,green); if (CONDITION3 ) then setPlotwidth(1,5); if condition2 or condition3 then alert;

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

55

For this chapter, the covariance used is a custom-made formula that has been altered and programmed as a built-in effect in the Omega ProSuit 2000i computer program. This covariance has a length of 30 months (or periods) and has been programmed to move within a –0.35 to +0.35 range. The formula used is explained in Table 3.6. Also, three of the figures analyzed in this chapter have been “de-trended.” When a time series is de-trended the secular trend is removed from the macro data, hence the cyclical and growth components of that time series are disentangled. Detrending a time series is a controversial aspect of the business cycle study because it implies transforming data and some scholars believe this is a manipulation of pure data. Nonetheless, Nobel Prize winner Simon Kuznets used this system most of his academic life and demonstrated that, for certain time series with high volatility, a de-trend is recommended. He used the de-trend for the first time in his work titled Secular Movements in Production and Price. In this chapter the formula used to de-trend the time series is explained in Table 3.7. Moreover, a number of indexes have been analyzed using a 20-month simple moving average. A simple moving average is a statistical technique used to analyze a set of data points by creating an average of one subset of the full data set at a time with each number in the subset given an equal statistical weight. In this chapter, a 20-month simple moving average is used which means a 20-month simple moving average of closing price is the mean of the previous 20 months’ closing prices. If those prices are: PM, PM-1, PM-2, PM-3, …, PM-19, then the formula is SMA = {(PM + PM-1 + PM-2 + … + PM-19) / (20)}. Finally, each time a new data (month or period) is added to the time series, the entire moving average is recalculated to account for the new value added while dropping out the old one. Further, this 20-month moving average has been programmed and its exact formula is explained in Table 3.8. Table 3.8

20-month simple moving average

Inputs: Price(Close), Length(N); N = 20 Months; Plot1 = Current Value; Plot1[1] = Prior Value; Plot2[2] = Two Values Ago; Plot1(AverageFC(Price, Length), “SimpAvg1”); {Alert Criteria} IF Price < Plot1 AND Plot1 < Plot1[1] AND Plot1[1] > Plot1[2] Then Alert(“The Moving Average has just changed direction and is now uptrend”) Else If Price > Plot1 AND Plot1 > Plot1[1] AND Plot1[1] < Plot1[2] Then Alert(“The Moving Average has just changed direction and is now downtrend”);

56

The Euro in the 21st Century

The Euro and the Foreign Exchange Market Graph 3.1 plots the US Dollar Index (USDX) from 1986 until December 2008. The USDX measures the performance of the US dollar against a basket of currencies composed of the euro (EUR), Japanese yen (JPY), UK pound (GBP), Canadian dollar (CAD), Swiss franc (CHF), and Swedish krona (SEK). This index started in March 1973, soon after the demise of the Bretton Woods System, and it is listed in the New York Board of Trade (NYBT).

Graph 3.1

US Dollar Index (USDX)

In 1995 the index value, worth around 80 (point A), began an appreciation period that lasted until 2002 when it reached a significant all-time high around 120 points (point B). Since 2002 the index has been steadily losing value, reaching at the beginning of 2008 an all-time low at around 72 points (point C). However, since 2008, the USDX has been gaining ground and has been testing new highs at around 90 (point D) but falling during most of 2009. It seems that the DJIA is recuperating again in 2010. Graph 3.2 plots the USDX with a 20-month simple moving average and the detrend of the index. The 20-month moving average crosses the USDX every time a change of tendency is taking place. This change of tendency is further represented by the “de-trend” of the index. When the index is changing tendency and is going up, the de-trend is in green. When the index changes tendency and is losing value, the de-trend is in red.

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

Graph 3.2

57

US Dollar Index with 20-month simple moving average and de-trended

Graph 3.3 plots the evolution of the US dollar against the deutsch mark (D-mark) from October 2009 to March 2010. The D-mark is no longer trading as a currency since it was absorbed by the euro. However, there are several foreign exchange data vendors who still maintain the daily trading value of European currencies such as the D-mark, French franc, Spanish peseta, and Italian lira. Technically speaking, the value of the US dollar divided by the value of the D-mark is known as the Dem—the name of the German currency in the foreign exchange market when it was traded against the US dollar. Graph 3.3 shows the evolution of the Dem from October 2009 to March 2010. Had the Dem not ceased to exist, its value

Graph 3.3

Deutsche mark composite

58

The Euro in the 21st Century

over the past years would have been the one represented in Graph 3.3. In fact, its value as of March 9, 2010 would have been $1.4354/Dem. Graph 3.4 plots a positive relationship between the USDX and the Dem from October 2008 to March 2010. As the value of the USDX goes up, the value of the currencies that form the index goes down. Simultaneously, the evolution of the Dem shows that as the value of the US dollar goes up the value of the Dem goes down. Hence, when the USDX and the Dem exchange rates are plotted together, robust positive correlation is the result. The rationale behind this correlation is the following. An increase in value of the USDX represents the decrease in value of the currencies that form the index. For instance, from August to March 2010 the value of the USDX increased and the value of the currencies included in the index decreased. Simultaneously, the evolution of the Dem shows that from April to December 2009, the value of the US dollar decreased and the value of the Dem increased. Hence, there is an inverse relationship between the value of the USDX and Dem exchange rate; however, graphically they both move in tandem.

Graph 3.4

Deutsche mark composite and US Dollar Index

Graph 3.5 plots the evolution of the euro (€/$). Although the €/$ was first introduced on January 1, 1999, this graph represents a composite of the ecu/$ from 1979 to January 1, 1999 and the €/$ ever since. This graph shows how on January 1, 1999 the changeover from ecu/$ to €/$ took place above parity. On January 1, 2002, the common currency was physically introduced at a exchange rate under parity. However, since 2002 to mid-2008 the euro has been increasing in value, reaching an all-time high of around €1.5/$ during the third quarter of 2008 (point A).

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

Graph 3.5

59

Evolution of the euro

Graph 3.6 plots the evolution of the €/$ and the USDX since 1980. In this case, there is an inverse relationship between the USDX and the €/$. This perfect inverse relationship generates a curious mirror image effect. Hence, as the €/$ goes up the value of the USDX is going down. For instance, from 2002 to the middle of 2008 the value of the euro has been increasing against the US dollar and, at the same time, there is a decrease in the value of the USDX.

Graph 3.6

Euro and US Dollar Index

60

The Euro in the 21st Century

Graph 3.7

Deutsche mark composite and euro

Graph 3.8

French franc and euro

Graph 3.7 plots the evolution of the €/$ and the Dem/$. Again, there is a perfect negative relationship between both currencies, generating (again) a mirror image effect. As the euro appreciates in value against the US dollar, the Dem is also gaining value against the US dollar. The reason for this relationship is that the Dem is part of the euro and if the euro increases in value, the Dem must also increase in value.

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

Graph 3.9

61

Spanish peseta and euro

Graph 3.10 Italian lira and euro The same can be inferred from Graph 3.8, which plots the relationship between the euro and the French franc (FRF). Although the FRF ceased to exist as a national currency with the introduction of the euro, the value of this currency has been continued by Future Source. If the FRF were to be reintroduced as a national currency in France, Graph 3.8 shows the evolution of its value from June 2003 until March 12, 2010. In fact, its value as of March 12, 2010, would have been $4.0106FRF. Since the FRF is part of the euro, there is a positive correlation in value; hence, as the value of the euro has been increasing against the US dollar, the value of the FRF has increased as well. Therefore, this relationship generates a mirror image effect. Graph 3.9 plots the €/$ and the $/Spanish peseta (ESP) and the same rationale applies. (Readers should note that the graph has been mislabeled by the data supplier: the data relates to the Spanish peseta, which in fact is identical to the Andorran

62

The Euro in the 21st Century

peseta.) There is a positive correlation in value since as the euro appreciates against the US dollar the ESP does too. Graph 3.9 shows this relationship which generates a mirror image effect. Finally, Graph 3.10 plots the evolution of the Italian lira (ITL) from June 2003 until March 9, 2010. Once again, there is a mirror image effect between the evolution of the euro and the ITL. Graph 3.11 plots the evolution of the UK pound against the euro since January 2003. The GBP is not part of the euro and there is a vast debate on whether the GBP should, or should not, join the euro. Since mid-2008 the drop in value of the GBP against the euro has, once more, stirred the debate. When the euro was introduced in 1999, the value that the pound would have had against the euro was one of the reasons used to excuse the pound for not adopting the euro. On January 1, 1999 the value of the pound was very high against the euro, and joining would have meant a dramatic loss of purchasing power for those holding pounds. However, ever since January 1, 1999 the pound has been losing value against the euro. In fact, as of January 1, 2009 the value of the pound was close to parity with the euro. Curiously enough, it is now (early 2010), when the pound has almost reached parity with the euro, when the changeover would be monetarily beneficial for both parties.

Graph 3.11 UK pound and euro A detailed analysis of the evolution of the GBP and the euro can be found in Graph 3.12, which shows how since 2000 the pound has been moving with the euro but always with a higher value. Now, nonetheless, the fall of the pound is greater than the fall of the euro. Point A is very important because it marks the moment when the GBP had to leave the monetary snake, suffering a dramatic lost of value. Right after exiting the snake, the pound dropped to an all-time low level marked by point B; after that, it began to float freely against all currencies. Point C highlights the introduction of the euro and shows how the pound has been moving in tandem with the common currency. Finally, point D marks the second most important drop in the value of the GBP since 1992, a drop that has made the GBP to come closer to parity with the common currency.

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

63

Graph 3.12 Euro and UK pound since 1981 In summary, Graphs 3.1 to 3.12 have brought out four interesting points. First, this chapter presents a number of European currencies that do not exist anymore; however, their trading values are still been published by Future Source. Second, a number of figures have proved that the euro is basically the continuation of the Dem, and that there is a perfect inverse relationship between the euro and the Dem against the USDX. Thirdly, Graphs 3.6 to 3.10 have shown that the euro, as well as all the currencies that form it, have been moving together, providing the euro with strength and stability. Finally, it can be concluded from the analysis that the euro has stabilized the value of the UK pound, bringing it in 2009 to a level which made, for the first time in history, jumping onboard the “euro boat” interesting for the UK. The Euro and the Stock and Commodities Markets This section focuses on how the euro has become a stabilizing factor for the Eurozone. In order to do so, it analyzes how the euro has helped smooth the business cycle by studying the correlations between the euro and both the Dow Jones Industrial Average (DJIA) and the German Deutscher Aktien IndeX 30 (DAX). Moreover, this section will demonstrate that the euro has helped contain inflation in the Eurozone.

64

The Euro in the 21st Century

Graph 3.13 Dow Jones Industrial Average (DJIA) Graph 3.13 follows the evolution of the DJIA from 1989 to March 3, 2010. Since 1896 the DJIA has measured the daily performance of 30 of the largest “blue-chip” corporations in the US, making the DJIA the best-known measure of the performance of the stock market in the US. The DJIA is traded in the New York Stock Exchange (NYSE) in US dollars. In Graph 3.13, point A indicates that in mid-2007 the DJIA reached an all-time high at around 1,400 points after which it began to lose value to reach levels of around 7,500 points—levels tested in 2002 and 2004 (point B). However, since 2009 the DJIA has been rallying, which means that investors are back investing on the stock market.

Graph 3.14 DJIA with 30-month moving average and de-trended

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

65

Graph 3.14 studies the DJIA when measured with an optimized 30-month moving average and the de-trend of the index. It shows that when the moving average crosses the index a change of tendency follows. This change of tendency is supported by the de-trend because every time the moving average crosses the DJIA, a change of tendency follows and the de-trend simultaneously changes. This graph demonstrates the validity of a 30-month moving average to forecast a change in tendency when plotted with the DJIA.

Graph 3.15 Deutscher Aktien IndeX 30 (DAX) Graph 3.15 graphs the evolution of the Deutscher Aktien IndeX 30 (DAX) from 1993 to March 10, 2010. The DAX is a market index representing the 30 major German companies trading on the Frankfurt Stock Exchange and is one of the most important stock indexes of the Eurozone. The value of the DAX was quoted in D-mark until December 31, 1999; since January 1, 2000 it has been expressed in euros. Graph 3.15 highlights that the DAX reached an all-time high of around 8,000 points in mid-2007 (point A); that is, right after the introduction of the euro. The DAX, however, has suffered an important loss of value when it sank to around 2,000 points at the beginning of 2003 (point B). Since then, the DAX has gained value, reaching a new high at around 8,000 points during 2007 (point C) just in time to begin a new decline (point D). The DAX can be considered a leading economic indicator for the Eurozone since, as point C shows, the DAX began to decline in the last quarter of 2007. However, the German government did not declare that Germany had entered a recessionary period until November 12, 2008; that is, almost one year after the DAX began to decline.

66

The Euro in the 21st Century

Graph 3.16 DAX with 30-month moving average and de-trended

Graph 3.17 DJIA and US Dollar Index

Graph 3.18 DAX and euro

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

67

Graph 3.19 DAX and euro Graph 3.16 plots the DAX against the optimized 30-month moving average. When the moving average crosses the DAX there is a change in tendency that is reflected in the “de-trend.” The values of the DJIA and USDX since 1992 are plotted in Graph 3.17, which shows that there is no clear relationship between the two; that is, from this graph it cannot be inferred that as the value of the USDX declines the value of the DJIA systematically increases or decreases. The relationship between the DAX and the euro is depicted in Graph 3.18. If Graph 3.17 showed no clear relationship between the DJIA and the USDX, Graph 3.18 plots a better relationship between the DAX and the euro. This shows that the strength of the ecu and the euro has helped the performance of the German index which, in turn, is a measure of stability.

Graph 3.20 DJIA and DAX with covariance

68

The Euro in the 21st Century

Graph 3.21 DJIA, DAX, and Eurotop 100 Graph 3.19 depicts a clear positive relationship between both the DAX and the DJIA. This positive relationship between the two is further analyzed in Graph 3.20 by using an alternative way of presenting the traditional covariance. This graph plots a positive covariance between both indexes which hints that the euro has helped harmonize and stabilize the business cycle on both sides of the Atlantic. However, data on the DAX traded in euros has only been available since 1998, offering a very short time series of only ten years. Moreover, since the covariance is based on 30 months, the result of the covariance is limited although robust. Graph 3.20 plots a positive covariance between both indexes which again hints that the euro has helped harmonize and stabilize the business cycle on both sides of the Atlantic. However, data on the DAX traded in euros has only been available since 1998, offering a very short time series of only ten years and again, since the covariance is based on 30 months, the result of the covariance is limited although robust. Finally, Graph 3.21 plots the evolution of the DJIA, the DAX, and the Eurotop 100 indexes showing that all of them are moving in unison although the euro and the US dollar are moving in opposite directions. The next group of graphs helps us to conclude that the euro has harmonized and stabilized prices in the Eurozone. Graph 3.22 plots the evolution of the Crude Oil (CO) and the CRB Indexes. In the US, the curve of the CO Index is the price— in US dollars—of the light sweet crude oil future contract traded on the NYSE which represents the cost of imported crude oil. The CRB Index curve is a worldrenowned index comprised of 28 commodities that serves as the most widely recognized measure of global commodities prices which, in turn, are “responsible” for consumer prices, and, ultimately, inflation rates. Hence, the price of the CO and CRB are two key indexes for measuring and forecasting inflation rates worldwide. Graph 3.22 shows that since 2007 both

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

69

Graph 3.22 Crude Oil and CRB Indexes indexes have suffered an increase in price reaching all times highs during the summer months of 2008. Fortunately, since mid-2008 both indexes are experiencing a decrease in their prices which has helped alleviate not only inflation pressure worldwide but also economic prospects. In fact, Graph 3.23 shows that there is a strong covariance between these two indexes: as the price of oil increases so does the price of commodities.

Graph 3.23 CRB and Crude Oil Indexes with covariance

70

The Euro in the 21st Century

Graph 3.24 CRB Index and US Dollar Index This second set of graphs has demonstrated that there has been a systematic increase in the overall prices of both commodities since 2003. Both commodities are quoted in US dollars, and Graphs 3.24 to 3.27 demonstrate that the increase in the prices of crude oil and commodities have had a direct impact on the economies of the US and the Eurozone. Graph 3.24 plots the relationship between the US Dollar Index and the CRB Index. Curiously, as the CRB Index increases in value the value of the USDX is decreasing. This inverse relationship explains that the US has been suffering from the increase in price of these two important resources; in fact, the US has

Graph 3.25 Crude Oil and US Dollar Indexes

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

71

been paying the rising prices with a weak dollar, which has negatively affected its economy. Graph 3.24 shows that from June 2003 to June 2008 the USDX was losing value while the CRB Index was increasing. After June 2008, however, the CRB Index began a steep decline and the USDX timidly began to gain ground. This inverse relationship between the CRB and the US dollar has been a devastating factor for the economy of the US in 2009. The same can be appreciated in Graph 3.25, which demonstrates that in June 2008, when the price of oil reached record highs, the USDX was exhibiting record lows. At this point, a gallon of gasoline reached an all-time high in the US, affecting considerably not only productivity and industrial growth as it became extremely expensive to pay the bill, but also having a negative effect on inflation as prices of goods and services had to be adjusted to account for the increase in the price of crude oil.

Graph 3.26 Crude Oil and US Dollar Indexes with covariance For instance, the relationship between the USDX and the price of crude oil (CO) is depicted in Graph 3.26, which plots the covariance between the two indexes and shows that there is a negative covariance between them; that is, as the price of CO was increasing, the value of the USDX was decreasing. In fact, the negative covariance is more significant—it reaches more than –0.60 of correlation—from January 2008 to November 2009 when the price of oil was going up dramatically and the value of the USDX was going down. Finally, as Graph 3.23 demonstrated that there is a strong covariance between crude oil and the CRB, it is safe to imply and conclude that if there is a strong negative covariance between the USDX and the price of crude oil, there is a strong negative relationship between the USDX and the CRB as well. Fortunately the Eurozone has not suffered this toll and Graph 3.27 plots that as the price of CO has been increasing since June 2003 so has the value of the

72

The Euro in the 21st Century

Graph 3.27 Crude Oil Index and euro common currency. This means that the Eurozone has had an advantage when paying its oil bills because, although the Eurozone Member States had to pay the price of crude oil in US dollars, the value of the euro against the US dollar has been very favorable for these countries. This has been an advantage for all Eurozone Member States, particularly between 2003 (when the price of crude oil increased from around US$50) and mid-2008 (when the price reached historic highs of around US$150). In fact, from March to August 2008 the price of oil fluctuated between US$120 and US$150 and the value of the euro reached historic highs at around €1.50/$. As of March 2010, the price of crude oil was US$81.52 while the euro was quoted at US$1.36. This section has therefore shown that the euro has been a major stabilizing factor for two reasons. First, the euro has harmonized the business cycle by bringing together stock indexes prices which are considered leading economic indicators. Second, the strong euro has helped pay the high prices of crude oil and commodities in the Eurozone which, in turn, has helped keep inflation under control. The Euro and the Money Market This section analyzes Graphs 3.28 to 3.34 to study the relationship between the euro and the money market (MM). The MM is a subsector of the fixed-income market and consists of very short-term debt securities that usually are highly marketable.

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

73

The purpose of this section is twofold. On the one hand, it tries to demonstrate if there is a synchronization of the monetary cycles in the US, the UK and the Eurozone since the introduction of the euro. On the other hand, it analyzes the effect of the euro in the money market in the Eurozone. The aim of this section is to study the behavior of the European Central Bank in its mission to use monetary policy to control prices and its impact, if any, in the euro. Analyzing, therefore, the MM is important because the ECB uses the MM as escape valve to fight inflation and to maintain price stability. In theory, it is expected that whatever decision the ECB takes to fight inflation and maintain stability will, in turn, affect the value of the euro.

Graph 3.28 US 2-year Treasury Note and Eurodollar (3 months) Graph 3.28 plots both the US 2-year Treasury Note (T-Note) and the Eurodollar. The Eurodollar is the name given to all the dollar-denominated deposits at foreign banks, or foreign branches, of American banks. Despite the tag “euro,” these deposits are not in euros. Most Eurodollar deposits are for large sums with less than six months’ maturity. Based on these deposits, the Eurodollar futures contracts are futures contracts traded at the Chicago Mercantile Exchange (CME) in Chicago. The US 2-year T-Note is a US government debt financing instrument issued by the US Department of the Treasury. Graph 3.28 shows that both indexes move in unison and that there is a close correlation between the T-Note and the Eurodollar deposits. The reason for this is that as the price of the T-Note is increasing the discount yield paid to hold this security is decreasing; as a consequence, demand for the T-Note is decreasing, which seems to affect directly the demand for Eurodollar future contracts. Graph 3.29 explains the relationship between the US T-Note (10-years) and the German Bund. The US 10-years T-Note has become the security most frequently used when analyzing the performance of the US government bond market and one of the most used instruments to convey the market’s take on longterm macroeconomic expectations in the US. The German Bund is the name of Germany’s federal bond issued by the German government to finance spending. It is, therefore, a government-backed instrument of the highest quality, as is the T-Note. Graph 3.29 plots the positive relationship that has always existed between

74

The Euro in the 21st Century

Graph 3.29 US 10-year Treasury Note and Bund both securities as they share the same trend; this similarity in trend can be explained because both the Federal Reserve and the Bundesbank were implementing the same type of monetary policy; there is therefore a synchronization of the business cycles. However, since the introduction of the euro in 1999, there has been an impressive perfect match between the two. Therefore, it is fair to assert that from 1999 to 2010 there has been harmonization in the debt market on both sides of the Atlantic. Only from 2004 to 2008 has there not been a perfect match, although the trend has been the same. Therefore, it is safe to assert that since the introduction of the euro these two treasury securities have witnessed an increase in their synchronization.

Graph 3.30 Eurodollar (1 month) and Eurodollar (3 months)

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

75

Graph 3.31 EURIBOR (3 months) and Eurodollar (3 months) Graph 3.30 plots the 1-month Eurodollar and the Eurodollar 3-months, demonstrating a close relationship between the two and proving a close relationship between the US and the European business cycles. However, Graph 3.31 plots a lack of relationship between the EURIBOR 3months and the Eurodollar. EURIBOR stands for the Euro Interbank Offered Rate, and it is the average interest rate at which term deposits are offered between prime banks in the Eurozone money market. The EURIBOR is used as the reference rate for euro-denominated short-term interest rates. The relationship, or lack thereof, between these two indexes is represented in Graph 3.31. This is a very significant graph as it conveys important information on the performance of the European Central Bank (ECB) and the US’s Federal Reserve. The Eurodollar began a clear downtrend in June 2004 demonstrating that monetary authorities in the US were already changing the monetary policy. However, the EURIBOR did not begin to decrease until 2006. This means that it took the ECB approximately one year to reduce rates. Further, this graph shows how the Eurodollar was stable for almost a year (from June 2006 to June 2007) before it saw an increase again in the third quarter of 2007. The Eurodollar has been erratic since then. However, the Eurozone is lacking this transition period as the EURIBOR has been in a downward trend since the end of 2005 to December 2008, and since 2008 it has been suffering an erratic path. All this shows that while the American index is a leading economic indicator, the EURIBOR is not. There is also an interesting relationship between the EURIBOR 3-months and the London Interbank Offered Rate (LIBOR). The LIBOR is the interest rate at which banks borrow funds from other banks in the London interbank market. This rate, which is quoted in dollar-denominated loans, has become the premier short-term interest rate quoted in the European money markets, and it serves as a reference rate for a wide range of transactions. Hence, the LIBOR has become one

76

The Euro in the 21st Century

of the most important interest rate benchmarks because it is the rate at which most preferred borrowers can borrow money and the one used to make adjustments to adjustable rate mortgages. Graph 3.32 plots the relationship between the LIBOR and the EURIBOR. Curiously, this graph very much resembles Graph 3.31; in fact, analyzing Graphs 3.31 and 3.32 helps us to conclude that the LIBOR and the Eurodollar enjoy a high correlation. The LIBOR began to decrease at the beginning of 2004 just when the Eurodollar was decreasing as well: the LIBOR enjoyed a period of stability from June 2006 to July 2007 as well as the Eurodollar, but has been erratic ever since. This brings the conclusion that the Fed and the Bank of England do have the same cycle; however, the ECB follows them with a year’s delay. This is interesting as it demonstrates that the ECB is faithful to its commitment to price stability.

Graph 3.32 EURIBOR (3 months) and LIBOR (1 month) Graphs 3.28 to 3.32 have demonstrated that there is a harmonization of the monetary policies and money markets of the US, the UK, and the Eurozone, which indicates that there has been an improvement in the synchronization of the business cycles. However, while the US and UK have an identical business cycle trend, the Eurozone follows behind, indicating that the Eurozone business cycle has merged but is not yet fully synchronized. Graphs 3.33 and 3.34 shed light on the relationship between the euro and the EURIBOR and the Bund. The theory goes that as the EURIBOR increases, the euro should see an increase in value. Similarly, if the EURIBOR and the euro increase, the German Bund should see an decrease in its price. Graph 3.33 shows how in 2006 the ECB began to decrease the EURIBOR, affecting the price of money. Against all expectations, as the EURIBOR was declining, the value of the euro was increasing. These two economic circumstances can be identified with a boost in inflation in major Eurozone Member States in the past two years. However, the graph also points out that as interest rates began to be raised in summer 2008, the value of the euro began to decline. Moreover, Graph 3.34 plots the relationship between the German Bund and the euro since June 2004. This graph is somewhat controversial as it contradicts

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

77

Graph 3.33 EURIBOR (3 months) and euro economic and monetary theory. According to the theory, there should be a direct relationship between the German Bund and the euro. As the yield paid by the Bund increases, the demand for the euro should increase accordingly. However, Graph 3.34 demonstrates that there is “carry-trade” with the euro.

Graph 3.34 Euro and Bund Final Words From a qualitative standpoint, this chapter demonstrates that the euro has become a solid common currency, and a monetary and economic stabilizer. From a quantitative standpoint the euro has in fact become a stabilizing factor for the Eurozone and the EU as a bloc. As a consequence, the euro has become a successful common currency for the Eurozone. This statement is corroborated by the analysis of the euro in three important markets. The first section—“The Euro and the Foreign

78

The Euro in the 21st Century

Exchange Market”—quantitatively confirms that the euro has become a solid common currency by examining the relationship between the US Dollar Index (USDX) and the D-mark to explain the creation of the euro. Further, the evolution of the Spanish peseta, the Italian lira, and the French franc showed that, if those currencies were today in circulation they would be following the euro cycle. These quantitative results prove that the euro has become a de facto common currency for Eurozone Member States. Also, this section explains the relationship between the UK pound and the euro and emphasizes that since early 2008 both currencies have been moving in tandem (and there has been a synergy in both currency cycles hinting at a possible long-time desired merger between the pound and the euro). The second section—“The Euro and Stock and Commodities Markets”—provides a thorough view of the behavior of the euro in compliance with the monetary policy requirements imposed by the Maastricht Treaty. To do this, this section first presents how the stock markets have reacted to the introduction of the euro. It further shows that there is a lack of relationship between the valuation of the Dow Jones Industrial Average (DJIA) and the German DAX, and between the USDX and the euro. However, the data proves that since the introduction of the euro, the DJIA, the DAX, and the Eurotop 100 have been increasingly correlated. Moreover, this section presents data that supports the idea that the euro has helped maintain prices under control since 2007 when the value of both the CRB and the CO reached all-time record highs; in fact, these high prices were balanced out by the euro reaching record highs. Since 2007, the appreciation of the euro has helped offset the rise in commodity prices, especially oil. Therefore, the euro has so far helped maintain prices and inflation under control. The final section—“The Euro and the Money Market”—specifically presents a detailed analysis of the euro money markets, which are influenced by the ECB’s setting of interest rates to control prices and inflation. This section presents the relationship between the euro and the EURIBOR, compared with the behavior of the USDX, the US T-Note, and the LIBOR. The statistical results demonstrate that the LIBOR and the US T-Note money market cycle moved in unison until the euro was introduced. With the introduction of the euro, the LIBOR, particularly during 2009, has been converging with the EURIBOR. This proves that the euro has also acted as a stabilizer for the money market but that the business cycle in the Eurozone lags behind. As in most scholarly works, this study has its own specific limitations. One such limitation concerns the quality and variety of the economic and monetary time series available to study the economy of the Eurozone and its Member States. The quality of the data found was at times weak for two reasons. First of all, the Eurozone was formally created on January 1, 1999; hence, most time series just cover the Eurozone from 1995. This means that most economic and monetary time series just provide 14 years of information. The length of these series is in some cases not enough to apply a variety of relevant statistical methods which require a larger number of periods in order to eliminate “statistical noise.”

Statistical Analysis of the Euro as a Stabilizer for the Eurozone

79

There is, moreover, a very limited variety of time series available to study economic, monetary, fiscal, and social issues in the Eurozone. This study has, in fact, been limited at times by the difficulty in comparing a number of time series that would have helped infer a stronger conclusion. Had some of these indexes been available for the Eurozone, they would have warned of the situation that has unfolded in certain countries which have been greatly affected by the demise of their construction/real estate markets. This study has therefore been limited by the availability of the data and not by the tools necessary to analyze and interpret the data. In fact, the value-added of this work rests on the use of sophisticated computer programs used to transform the numerical data and to apply innovative statistical methods to infer conclusions. This study has demonstrated that the use of optimized statistics methods, such as moving averages, covariances, and detrending, to study a series of graphs and indexes could be of great help to “predict” the trend of some time series. Although these statistical methods have helped find repetitive patterns in this particular time series, there is no guarantee that these repetitive patterns could be found in every single one. In conclusion, had all the data necessary been available for the Eurozone, stronger statistical conclusions could have been reached on whether the euro has been a monetary, economic, fiscal, and social stabilizer for the Eurozone. Accurate and lengthy time series are powerful academic tools that arm any scholar with a competitive advantage to produce significant results. In fact, the superiority and importance of the US’s reports is based on the strength and accuracy of the data used. The US has a structured system of well-defined time series organized by leading, coincident, and lagging economic indicators. Researchers using these tools are able, without a doubt, to come up with powerful conclusions about the state of the US economy and even to elaborate on its future. The Eurozone that is “under construction” must understand the importance of having an organized and reliable set of harmonized data in order to facilitate robust and accurate research.

This page has been left blank intentionally

Chapter 4

The Euro as an International and Global Currency The creation of the European Monetary Union (EMU) and the introduction of the euro brought about an intense debate concerning whether or not the euro would manage to challenge the status of the US dollar and the hegemonic power of the United States as consolidated since World War II. For this challenge, the euro had to first consolidate its position as a common currency, then gain recognition as an international currency and, finally, become a global, or dominant, currency. As the euro gained international financial recognition, it became a stabilizing tool capable of furthering the political integration process of the European Union (EU). The euro has provided the economies of Europe with a degree of collective macroeconomic stability, flexibility, and economic transparency that individual Member States could never have achieved on their own. Therefore, the effect of the euro has not only been economically but also politically significant since its inception as an international currency with enough weight to garner, for Europe, some of the political influences heretofore enjoyed solely by the US due to the hegemony of the dollar since World War II. This chapter examines whether or not it can be claimed that the euro has become an international and global currency. The results show that the euro has developed a solid market that has consequently eroded some of the advantages that historically supported the hegemony of the US dollar as a global, or dominant, currency. Hence, the euro can be considered an international currency; nevertheless, the US dollar remains the sole global currency. There are two correlated reasons that explain the reign of the US dollar. On the one hand, there is the inertia in the use of the US dollar due to years of currency preeminence. On the other hand, this preeminence has given the greenback an edge over the euro in terms of the size, credit quality, and liquidity of the dollar financial market over the euro financial market. The preeminence of the US dollar has helped the US become a political hegemony, which has resulted in the “Pax Americana.” The euro has, nonetheless, transformed the Eurozone into a solid and internationally respected economic bloc with a wide area of influence and with an ever-increasing voice in the political and economic arena. However, these achievements have oftentimes been the target of fear and confusion expressed by public opinion and representing the perspective of the euroskeptics. Nevertheless, the reality is that the Eurozone has become viably competitive with the US for the first time in history. This chapter will briefly review the history of the euro and how it has become an international and global currency.

82

The Euro in the 21st Century

The Euro and its Evolution: From Common Currency to International Currency The euro was nominally introduced on January 1, 1999 and despite its success as a common currency, the full impact of the euro is yet to be seen at the time of writing (early 2010). Nonetheless, with the available data, it is not too bold to affirm that the euro has contributed to integration on many levels. Indeed, ever since the introduction of the euro, Eurozone Member States have experienced an increase in trade. The euro has not only reduced both direct and indirect trading costs but has also removed the exchange risk and the cost of currency hedge. The euro has allowed for price transparency, and reduced price discrimination. Finally, the euro has reduced competitive devaluations, which have helped bolster foreign direct investments. The euro has therefore brought countries together; as Trichet (2006, 4) indicates, “we are not witnessing the creation of a ‘fortress Europe,’ but that the European Integration is perfectly complementary with the global integration.” The euro is, above all, money. In economic theory, money refers to the circulating currencies with legal tender status conferred by a national state and government. In order for a currency to be considered “money” by a nation’s government it has to serve as a unit of account, a store of value, and a medium of exchange. Furthermore, a limited number of national currencies can be considered to be an international currency, or currency that plays an active role in both international trade and financial transactions. Mundell (1999, 4) explains that a currency is international “when it is used outside the domain in which it is legal tender.” National governments do not decide which currency will become international; rather, it is decided, indirectly, by the market which examines the size of the economy and financial system and analyzes the currency’s value as well as the level of political stability of the country. Hence, not all national currencies can become international. Francesc Granell (2007, 205) explains that “the size of the market, the exchange restrictions and the aforementioned inertia/tradition” are key in determining if a currency can be used as an international currency. However, most governments work hard to transform their national currency into an international one as it helps a country strengthen its international political position. Benjamin Cohen (2007, 104) explains that there are four benefits to becoming an international currency: a potential for seigniorage (the implicit transfer of resources, equivalent to subsidized or interest-free loans, that go to the issuer of money that is used and held abroad): (2) an increased flexibility in macroeconomic policy afforded by the privilege of being able to rely on one’s own currency to help finance foreign deficits; (3) a gain in status and prestige that accompanies market dominance, a form of “soft” power; and (4) a gain in influence derived from the monetary dependence of others, a form of “hard” power.

The Euro as an International and Global Currency

Table 4.1

83

Functions of an international currency

Function Unit of account Store of value Medium of exchange

SECTOR Private Invoice Financial assets Vehicle/substitution

Official Exchange rate peg Reserves Intervention

Table 4.1 outlines the three major functions that all currencies must fulfill in order to become an international currency (Pollard 2001, 18). Trichet (2006, 2) explains that soon after its introduction, the euro not only succeeded in becoming an international currency but also demonstrated that “one single currency is more efficient than multiple currencies in performing the roles of a medium of exchange and unit of account.” On August 1, 2007, Diana Farrell (2008, 2) reported that “there were $840 billion worth of euro notes sloshing around the world, compared to $814 billion US dollars.” Jean-Claude Trichet explains that the European Central Bank (ECB) estimated that “the stock held outside the Eurozone must be worth at least €55bn, and that it is almost certainly too low an estimate given the net outflow accounted for by tourists.” This chapter analyzes the function of the euro as a unit of account and as a store of value. The Euro as a Unit of Account: Invoice Currency and Currency Peg A currency will be considered an international currency if it can operate as a unit of account at both the private and the official level. In the private sector, the euro must be used to price international trade and debt contracts; that is, it must be used as an invoice currency. In theory, when trade takes place between two industrial economies, the invoice will have the currency of the exporter. Trade between industrial and developing countries will be invoiced in the currency of the industrial country. Trade between two developing countries is usually priced in the currency of a third country. The data shows that before the euro was introduced, the US dollar was the designated third country leading currency. The preeminence of the US dollar continues to this day; however, its potency has diminished with the introduction of the euro. Jeffrey A. Frankel (2008) asserts that countries in the Eurozone have experienced a significant increase in their bilateral trade with other Eurozone member states. He notes that this general trend has also been corroborated by the findings of other scholars. In fact, Frankel (2008, 3) explicates Flam and Nordström (2006) found an effect of 26 percent in the change from 1995–98 to 2002–05. Berger and Nitsch (2005) and De Nardis and Vicarelly (2003) reported similarly positive results. More recently, Chintrakarn (2008)

The Euro in the 21st Century

84

finds that two countries sharing the euro have experienced a boost in bilateral trade between 9 and 14 percent. Overall, the central tendency of these estimates seems to be an effect in the first few years on the order of 10–15 percent.

Graph 4.1 shows the evolution of export activity between Eurozone Member States. It clearly demonstrates that trade among Eurozone Member States has increased, especially after 2001.

Graph 4.1

Export activity between Eurozone’s Member States

Source: Bloomberg Finance LP

In the official sector, the euro is considered to be a unit of account dependent on the number of countries that choose it as a currency peg. Under the Bretton Woods System most currencies were pegged to the US dollar. When the Bretton Woods System collapsed, some of the currencies allowed their value to float, but most chose to peg their exchange rates to the US dollar. Although, there was a general preference for the US dollar, some European currencies began to develop areas of interest. This was the case with the French franc that was used as a currency peg for most of France’s old African colonies. This was also the case for the UK pound, which was used as the currency peg for most of its old colonies, mainly those located in the Caribbean. The Euro as a Store of Value: Financial Assets and Reserve Currency Currencies act as a store of value when they guarantee the purchasing power of money over time. Granell (2007, 206) clarifies that: the future trends in this international function of the euro as a “store of value” would depend on the “euro intrinsic” qualities demonstrated to the markets, and

The Euro as an International and Global Currency

Table 4.2

Some currencies pegged to the US dollar, the euro, the UK pound, and other currencies

Pegged to the:

Currency

Pegged rate

US dollar

Bahamian dollar Belize dollar Bermudian dollar Cayman Island dollar Cuban convertible peso East Caribbean dollar Eritrean nakfa Lebanese pound Maldivian rufiyaa Panamanian balboa Qatar riyal Venezuela bolivar Bulgarian lev Bosnia/Herzegovina convertible mark CFA franc Comorian franc (Comoro) Danish krone Estonian kroon Latvian lat Lithuanian litas Gibraltar pound Guernsey pound Jersey pound Manx pound (Isle of Man) Cook Island dollar Kiribati dollar (Kiribati) Lesotho loti Swazi lilangeru (Swaziland) Nepalese rupee Tuvaluan dollar (Tuvalu) Abkhazian apsea (Abkhazia) Belarusian ruble

Par 1 US$ to 2 BZ$ Par 1 KYD to 1.2 US$ 1 Cuban peso to 1.08 US$ 1 US$ to XCD 5.40 1 US$ to 16.5 nakfa 1 US$ to 1,507.5 pound 1 US$ to 12.8 rufiyaa Par 1 US$ to 3.75 riyals 1 US$ to 4,299 bolivars 1 € to 1.95 leva 1 € to 1.95 marks (BAM) 1 € to 665.95 CFA francs 1 € to 491.96 KMF francs 1 € to 7.46 kroner 1 € to 15.64 krooni 1 € to 0.702 lats 1 € to 3,452 litas

Euro

UK pound

Others

85

Par Par Par Variant New Zealand dollar at par Australian dollar at par South African rand at par South African rand at par Indian rupee to 1.6 NR Australian dollar at par Russian rouble to 0.10 apsea Basket of currencies (which include the euro, the Russian ruble, and the US dollar)

the political will of the national authorities of the third countries to diversify the euro to avoid overdependence on the US dollar if the United States continues to run enormous external imbalances.

In the private sector, the purchasing power of the euro is measured by the demand of products denominated in euros in the bond market, money market, and foreign exchange market for currency diversification.

86

The Euro in the 21st Century

For instance, since the introduction of the euro in 1999 the bond market has witnessed two developments. On the one hand, there has been an increased trend in total euro-denominated bond issuance, and, on the other hand, there has been an increase in the number of bonds issued by the Eurozone Member States. According to Cappiello et al. (2006) this demonstrates that after the introduction of the euro, the bond market has witnessed a dramatic increase in integration, proving that the single currency has been an integrating factor. First of all, the total euro-denominated bond issuance has been growing consistently since 1999. Graph 4.2 demonstrates that the total volume of bonds issued in euros has tripled between 1999 to 2009. However, it is important to analyze the evolution of debt issuing by governments as well as by corporations and financial institutions. While the issuing evolution of both types of bonds are important to measure how the euro has become an instrument to store value, the increase in debt issued by corporations and financial institutions demonstrates that the euro has broadened access to the capital market.

Graph 4.2

Total bond issuing activity in Eurozone

Source: Bond Market Notes, European Commission’s Directorate of Economic and Financial Affairs
Graph 4.3 shows the trend of local and central government issuance activity since 1999. A comparison analysis between the issuing activity in 1999 and August 2009 demonstrates that there has been a significant increase. Although this increase could be considered low, it proves that governments have been attempting to subdue their expenditures in order to comply with the requirements of the Stability and Growth Pact (SGP). In fact, in 2003 and 2004 the issuing activity peaked, which is coincident with the breach of the requirements of the SGP by most of the Eurozone Member   Total issuing activity is a compilation of bonds issued by agencies, central governments, local governments, supranationals, asset-backed security and financial institutions, and corporates.

The Euro as an International and Global Currency

Graph 4.3

87

Evolution of Eurozone bond issuing—central and local governments

Source: Bond Market Notes, European Commission’s Economic and Financial Affairs, at (accessed October 4, 2008)

States. It was subdued between 2005 and 2007 but it has spiked again in 2008 and 2009 due to the economic crisis that is affecting most Eurozone Member States. It is important to mention that the Eurozone provides countries with a framework of financial credibility that Member States would not enjoy had they been operating financially on their own. In fact, before the euro was introduced, sovereign debt issued by Portugal, Italy, Ireland, Greece, and Spain was pejoratively called PIIGS due to the very poor governmental fiscal management that negatively affected the quality of their sovereign debt, while German Bunds were considered the gold standard of European sovereign debt issuance. The introduction of the euro forced PIIGS countries to put their fiscal houses in order. However, after a short period of fiscal restructuring, certain countries ceased being fiscally responsible. As a consequence, in 2006, Italy witnessed the downgrading of its “sovereign debt to the same level as Botswana’s” by two credit rating agencies (Munchau 2006, 1). In addition, Portugal and Greece have also witnessed a downgrade in their sovereigns’ rates. On June 2005, Portugal was downgraded from AA to AA– and Greece was downgraded, on November 2004, from A+ to A (Standard & Poor’s 2007), and on January 15, 2009 from A to A– (APF 2009). In September 2008, Spain had to suspend an auction of 15-year sovereign bonds worth around 3,000 million euros due to a lack of demand. Ever since then, Spain’s situation has become increasingly worrisome to such a degree that, on January 13, 2009, it was reported on the Financial Times’ front page that “Standard & Poor’s, the rating agency, said Spain’s top-notch triple A credit ratings could be downgraded because of its high private sector debt after it entered what is likely to

88

The Euro in the 21st Century

be a deep recession” (Oakley and Mallet 2009, 1). In fact, it was downgraded just days later, on January 19, 2009, from triple A to AA–. Italy, with a debt-to-gross domestic product of 104 percent, and Ireland, which announced that it will not control government spending in order to face the economic recession, have also been warned of a possible downgrade in their debt credit rating. These warnings might, nonetheless, be extended to “other European countries as governments take on record debt levels, which could jeopardize the sustainability of their public finances” (Oakley and Mallet 2009, 1). Table 4.3 specifies the grading rating of sovereign debt for Eurozone Member States by three rating agencies: Moody’s, Standard & Poor’s, and Fitch. While the Eurozone as a whole enjoys a solid credit rating, it is still below that of the US, which has the highest rating according to both rating agencies. An analysis of all three institutions shows that their ratings concur although they use different rating symbols. Table 4.3 Country Austria Belgium Cyprus Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain

Credit rating of countries by Moody’s, Standard & Poor’s and Fitch, as at March 7, 2010 Moody’s Aaa Aa1 Aa3 Aaa Aaa Aaa A2 Aa1 Aa2 Aaa A1 Aaa Aa2 A1 Aa2 Aaa

S&P AAA AA+ A+ AAA AAA AAA BBB+ AA A+ AAA A AAA A+ A+ AA AA+

Fitch AAA AA+ AA– AAA AAA AAA BBB– AA– AA– AAA A+ AAA AA A+ AA AAA

Source: Bloomberg Finance LP

The reason for these record high and dangerous government debt levels— represented in Table 4.3—lies in the fact that in order to fight economic difficulties, governments are expected to increase debt levels by issuing government bonds. In 2009, €1.000bn worth in government bonds was issued, double what was issued in 2008. Finally, what has really set off all the alarms is that “the gap in bond yields

The Euro as an International and Global Currency

89

between the benchmark German bunds and the sovereign debt of Spain, Greece, Ireland, Italy and Portugal has risen fourfold since July to levels not seen since the launch of the euro in January 1999” (Oakley and Mallet 2009, 1). Had these countries been outside the Eurozone, the outcome would have been very dangerous for their economic viability and credibility. Unfortunately, this demonstrates that these countries have not transformed their economic and fiscal discipline to close the gap with Germany and the Nordic countries that sustain impeccable economic and financial behavior. Gros and Micossi (2008, 1) have explained that the reason why the public bond markets in the US and Japan are more successful than the public bond markets of individual EU Member States is that if needed, the government could always force the (national) central bank to print the money necessary to meet its obligations. But this is not the case in the eurozone, since no government can force the European Central Bank to print money. For international investors, there is no euro area government bond in which they could invest to diversify their risk away from the dollar.

Gros and Micossi (2008, 1) have further reported that one of the most significant disadvantages is that the eurozone’s “separate markets for sovereign debt paper of unequal quality issued by European governments cannot compete with the US market … until the Eurozone develops a unified market for bonds denominated in euros.” Jean-Claude Trichet (2008b, 2), the President of the European Central Bank, opposes the idea of a joint bond market expressing, during his testimony at the economic committee of the European parliament, that “[w]e consider it good that each particular state, each particular treasury has its own refinancing and has its own way of being on the market.” In particular, given the current lack of compliance of Member States with the requirements stated in the SGP, it is almost impossible to have a unified bond market.

Graph 4.4

Sovereign bond spread with German yield

Source: Bloomberg Finance LP

90

Graph 4.5

The Euro in the 21st Century

Evolution of Eurozone bond issuing—corporate and financials

Source: Bond Market Notes, European Commission’s Directorate of Economic and Financial Affairs, at (accessed October 4, 2008)

The result of the fragmentation of bond markets is that the government debts of Portugal, Italy, Ireland, Greece, and Spain have been witnessing a rise in bond spreads which is worrying Joaquín Almunia—the EU Economic and Monetary Affairs Commissioner. This rise in bond spreads, represented in Graph 4.4, is due to the fact that the economic situation of these countries has been down-graded by the market; that is, market and investors do not trust these economies as much as they trust other economies. In order to invest in the country—through the purchasing of government bonds—PIIGS’ governments are forced to offer a higher return as an incentive. This, in turn, makes debt financing more expensive for governments. This gap in the spreads between PIIGS countries and the German debt is also noticeable when analyzing credit default swaps (CDS) for these countries Finally, Graph 4.5 illustrates the issuing activity of corporations and financial institutions in euros from 1999 to August 2009 and demonstrates an impressive increase in issuance activity. This proves, on the one hand, that the euro has facilitated corporations’ and financial institutions’ access to the capital markets; on the other hand, it corroborates that governments enjoyed a “crowding-out” effect discouraging corporations and financial institutions from issuing bonds. With the introduction of the euro and the obligation of governments to reduce their debt, corporate and financial institutions were given the opportunity to increase their debt issuance to raise capital. In the official sector, the performance of the euro as a store of value is analyzed according to its use as a reserve currency since a country will hold reserve currency to finance imports, repay foreign debt, and to intervene in currency markets in order to manage the exchange rate. According to the Currency Composition of Official Foreign Exchange Reserves (COFER), the allocated reserves claim in US dollars increased to almost

Table 4.4

Currency Composition of Official Foreign Exchange Reserves (COFER) (in US$ millions) 1995

1999

2000

2002

2007

2008

2009 (QIII)

Total foreign exchange holdings

1,389,801

1,782,136

1,936,516

2,408,435

6,410,917

6,645,124

7,515,981

Allocated reserves US$ US$ percentage Euros (ecus) Euro percentage Industrial countries’ total foreign exchange holdings Allocated reserves US$ US$ percentage Euros (ecus) Euro percentage Emerging and developing economies

1,034,175 610,337 43.92 88,288 6.35 917,735

1,379,705 979,783 54.98 246,950 13.86 1,108,128

1,518,244 1,079,916 55.77 277,963 14.35 1,203,298

1,795,915 1,204,673 50.02 427,327 17.74 1,419,044

4,119,190 2,641,190 40.64 1,082,276 16.82 2,394,712

4,210,701 2,699,701 40.62 1,116,116 16.79 2,450,974

4,434,829 2,734,072 36.37 1,230,570 16.37 2,670,896

752,519 407,735 44.42 88,116 9.60 472,066

997,111 701,693

1,093,947 768,827

1,254,861 844,294

2,119,372 1,408,823

174,242.

193,979

281,546

499,098

673,819

732,984

989,065

4,016,205

2,157,582 1,462,623 59.6 488,826 19.9 4,194,149

2,338,278 1,529,388 57.26 572,349 21.42 4,845,085

Allocated reserves US$ US$ percentage Euros (ecus) Euro percentage

281,656 202,602 42.91 172 0.036

382,594 278,090

424,296 311,089

541,054 360,379

1,999,817 1,232,822

72,708

83,713

145,781

583,177

2,053,120 1,237,191 29.49 627,290 14.95

2,096,556 1,204,684 24.86 658,221 13.58

Source: International Monetary Fund, “Currency Composition of Official Foreign Exchange Reserves (COFER),” at (accessed October 2, 2009)

92

The Euro in the 21st Century

55 percent with the introduction of the euro in 1999 while in 1995 allocation stood at 43 percent. In 2008, the claim in US dollars has decreased and remains stable at 40 percent (Table 4.4). The data presented in Table 4.4 demonstrates that, from 1995 to 2008, total foreign exchange holdings in both the US dollar and the euro have changed significantly. In industrialized countries, the percentage of the allocation of US dollars has varied slightly from 1995 to 2008 as it has moved from 43 percent to 36 percent. The euro allocation has increased significantly from 6 percent in 1995 to 16 percent in 2008. However, the analysis of the composition in emerging economies does provide an interesting picture. While in 1995 the US dollar represented 44 percent of the currency composition and the ecu/euro just 0.03 percent, in 2008 the US dollar represented only 29 percent while the euro reached almost 15 percent. This trend is consistent with Anne Y. Kester’s findings (2007, 3), reporting that the “US dollar [is] gradually declining in use as reserve currency [and] more developing countries than industrial economies [are] switching into euros.” In fact, despite the current crisis, the level of US dollar holdings has not suffered a dramatic decline nor has the level of the euro increased significantly. This points to the accuracy of Lindsey’s (2005, 247) claim that ever since the US dollar surpassed the UK pound, “people all over the world [have looked] to the dollar as a reliable store of wealth,” since the US dollar has demonstrated its status as a “secure and portable asset that will hold its value over time.” Nonetheless, it must be stressed that, as Guillermo de la Dehesa (2009, 12) posits, the real composition of foreign currency reserves is not easy to calculate. He concludes that “fifty percent of total reserves are disclosed, 24 percent are not disclosed and another 26 percent are held by sovereign wealth funds (SWF) and are only estimated because they are not exactly known.” In fact, the latest report from the IMF on currency composition shows that in 1995 the total foreign exchange holdings that were unallocated represented 25 percent while in 2008 that amount represented 36 percent. In 2005, Menzie Chinn and Jeff Frankel (2005, 14) presented a study that concluded that the euro would take over the dominance of the US dollar as a reserve currency if the Eurozone economy were to become larger than the US economy and if macroeconomic instability were to “undermine … confidence in the value of the dollar, in the form of inflation and depreciation.” In fact, the difficulty of America’s financial situation and the dollar’s depreciation against the euro for the past two years suggest that the greenback could lose its status as a reliable reserve currency. Table 3.4 demonstrates that the US dollar continues to be the preferred reserve currency and that the euro is the second preferred currency. The table indicates that the euro has been continually gaining ground; its increase from 6 percent in 1995 to almost 17 percent in 2008 represents a total growth of 11 percent, indicating a percentage increase that is expected to rise as China and Middle Eastern countries continue to reduce their currency pegging to the US dollar and increase their pegs to the euro along with a basket of multiple currencies.

The Euro as an International and Global Currency

93

For almost a century the dollar has been the sole dominant and de facto international currency available. However, the introduction of the euro has changed this monopoly although, as Pedro Gomis-Porqueras and Joaquín Roy (2007, 230) explain, the international role of the euro rests “on the ability of policy makers to implement consistent and sustainable economic policies that can promote economic growth;” nevertheless, the euro has to first and foremost become “a symbol of common identity, shared values and the success of European integration in bringing the people and nations of Europe together” (230). The Euro as a Global Currency Since the introduction of the euro, the debate has centered on the question of whether or not it would become an effective de facto common currency; when this was achieved, the debate shifted to a discussion of whether or not the euro would become a solid international currency. Now the debate is concerned with whether or not the euro will dethrone the US dollar as a global currency. Economic theory agrees on five key factors which measure whether a currency can become a global currency. According to Bergsten (2005a, 279) those factors are: • • • • •

the size of its underlying economy and global trade the economy’s independence from external constraints avoidance of exchange controls the breadth, depth, and liquidity of the economy’s capital markets the economy’s strength, stability, and external position.

There have only been three currencies that have managed to become global currencies: the Dutch guilder, the pound sterling, and the US dollar. Basically, for a currency to become global, the country must have a strong financial, economic, and military position together with a strong record in the international trade of goods, services, and capital, transforming the country into a lender of last resort. Since World War II, the US has been the only country that fits this particular profile; and, since the introduction of the euro, the debate has centered on whether or not the Eurozone could pose a challenge to the US. Particularly, the debate has been fuelled by the precariousness of the US’s financial situation alongside the depreciation of the dollar against the euro over the last three years, as well as the exorbitant trade and budget deficit of the US. These factors have suggested that the US dollar may lose its status as a global currency, as it did temporarily in the 1930s. However, an analysis of the behavior of the euro against a number of these criteria demonstrates that although the US dollar remains an international global currency, the euro has become increasingly more attractive. Although, despite the impact of the economic disarray since mid-2007, the Eurozone is recognized as an economic and financial power, it lacks the possibility of becoming a military

*UDSK*URVV'RPHVWLF3URGXFW 333RIFRXQWU\*'3ELOORI86 

ϭϴ͕ϬϬϬ ϭϲ͕ϬϬϬ ϭϰ͕ϬϬϬ ϭϮ͕ϬϬϬ ϭϬ͕ϬϬϬ ϴ͕ϬϬϬ ϲ͕ϬϬϬ ϰ͕ϬϬϬ Ϯ͕ϬϬϬ

hŶŝƚĞĚ^ƚĂƚĞƐ

Graph 4.6

GDP comparisons—US, EU, and Eurozone

Source: Bloomberg Finance LP

ƵƌŽĂƌĞĂ

ƵƌŽƉĞĂŶhŶŝŽŶ

ϮϬϭϬ

ϮϬϬϵ

ϮϬϬϴ

ϮϬϬϳ

ϮϬϬϲ

ϮϬϬϱ

ϮϬϬϰ

ϮϬϬϯ

ϮϬϬϮ

ϮϬϬϭ

ϮϬϬϬ

ϭϵϵϵ

ϭϵϵϴ

ϭϵϵϳ

ϭϵϵϲ

ϭϵϵϱ

ϭϵϵϰ

ϭϵϵϯ

ϭϵϵϮ

ϭϵϵϭ

ϭϵϵϬ

ϭϵϴϵ

ϭϵϴϴ

ϭϵϴϳ

Ϭ

The Euro as an International and Global Currency

95

'ƌĂƉŚϰ͘ϳdŽƚĂůDĞƌĐŚĂŶĚŝƐĞdƌĂĚĞdžƉŽƌƚƐƚŽƚŚĞtŽƌůĚ ;DŝůůŽĨh^ΨͲh^ĚŽůůĂƌĂƚĐƵƌƌĞŶƚƉƌŝĐĞƐͿ

ϰϱϬϬϬϬϬ ϰϬϬϬϬϬϬ ϯϱϬϬϬϬϬ ϯϬϬϬϬϬϬ ϮϱϬϬϬϬϬ ϮϬϬϬϬϬϬ ϭϱϬϬϬϬϬ ϭϬϬϬϬϬϬ ϱϬϬϬϬϬ Ϭ ϮϬϬϰ

ϮϬϬϱ

ƵƌŽnjŽŶĞ

Graph 4.7

ϮϬϬϲ

hŶŝƚĞĚ<ŝŶŐĚŽŵ

ϮϬϬϳ

ϮϬϬϴ

hŶŝƚĞĚ^ƚĂƚĞƐ

Comparison of growth in trade exports to the world

Source: Bloomberg Finance LP

power. This important factor will hinder the euro from becoming a global currency and will keep the Eurozone from becoming a lender of last resort. The Euro and the Facts that Make a Global Currency In order to measure whether a currency will become global, it is important to analyze the size of the underlying economy as measured by the GDP and the level of global trade. These two measures will indicate the significance of a country and its currency in the global economic arena. Before the EU was created, the US was the largest economy in the world; however, the EU now takes its place. Graph 4.6 shows GDP evolution in the US, the EU, and the Eurozone from 1987 to the expected level at the end of 2010 (IMF 2008a). Since 1987, the EU has been enjoying a higher GDP, a slight margin over that of the US; however, the GDP of the Eurozone has always been lower than the that of the US. When it comes to trade, it is important to analyze the evolution of exports as well as how the value of the euro against the US dollar has impacted the trade

The Euro in the 21st Century

96

balance. Despite the increase in the value of the euro and the tight contractionary monetary policy implemented by the ECB until 2008, the Eurozone has witnessed unprecedented export volumes. Graph 4.7 illustrates the trend in exports, which, curiously enough, is in total disagreement with the economic fundamentals that predict that there should be an inverse relationship between currency value and exports. In other words, as the value of a currency increases vis-à-vis another currency, exports decrease and imports increase. In fact, Table 4.5 demonstrates that, despite the high value of the euro against other major currencies, in 2008 Germany was the leading exporter in world merchandise trade while the US ranked third after China. Despite the high value of the euro, Germany was ranked as the number one exporter. Even so, President Table 4.5 Rank 1 2 3 4 5 6 7 8 9 10 11 12

Leading exporters and importers in world merchandise trade, 2008 (in € billions)

Exporters Germany China US Japan Netherlands France Italy Belgium Russian Federation UK Canada Korea, Rep. of South

Value 1461.9 1428.3 1287.4 782.0 633.0 605.4 538.0 475.6 471.6 458.6 456.5 422.0

Rank 1 2 3 4 5 6 7 8 9 10 11 12

Importers US Germany China Japan France UK Netherlands Italy Belgium Korea, Rep. of South Canada Spain

Value 2169.5 1203.8 1132.5 762.6 705.6 632.0 573.2 554.9 469.5 435.3 418.3 401.4

Source: US Department of Transportation, Bureau of Transportation Statistics; based on data from the World Trade Organization, “Table 1.5: Leading Exporters and Importers in World Merchandise Trade, 2000,” International Trade Statistics 2001, available at , as of June 11, 2002

Sarkozy expressed concerns about the damage that the strong euro was inflicting on French exports and asked the ECB to take measures to stop the euro from appreciating (Reuters 2008). Another factor that needs to be analyzed is the breadth and depth of the currency’s underlying economy. The depth of an economy is measured by the ratio of the financial assets to GDP; the breadth of an economy is measured by the behavior of the capital market. The breadth of the capital market—where debt or equity securities are traded— shows that global capital markets have experienced a constant growth rate since

The Euro as an International and Global Currency

Graph 4.8

97

Size of the capital market, 2007

Source: McKinsey Global Institute, “Global Capital Markets: Entering a New Era,” at (accessed November 1, 2009)

1990 due to a combination of factors: a generally stable worldwide political and economic situation; the globalization of the financial markets and the innovation of financial products and services; new information and communications technology; and market liberalization. All these have boosted capital flow and investment levels. Graph 4.8 gives a snapshot of the figures for 2007. Concerning financial depth—the ratio of financial assets to GDP—the McKinsey Global Institute (2009) shows that, from 1980 to 2008, there has been an increase in the value of global financial assets. While in 1980 the total global value of financial assets was US$ 12 trillion, in 2006 the value was US$167 trillion. In 2007 (McKinsey Global Institute 2008) the value skyrocketed to US$196 trillion and in 2008 the value plummeted to US$178 trillion. A comparison between the US and the Eurozone shows that in 2008, the financial depth of the US was 345 percent of GDP and in the Eurozone it was 314 percent of GDP. Table 4.6 shows that, on the one Table 4.6

1990 2006 2007 2008

Financial assets, US and Eurozone compared (in US$ trillions, using 2008 exchange rates for all years) US

Eurozone

15 56 60.4 54.9

10 38 43.6 42

Source: McKinsey Global Institute, “Global Capital Markets: Entering a New Era,” at (accessed November 1, 2009)

'ƌĂƉŚϰ͘ϵŽŶĚ͕ƋƵŝƚŝĞƐΘĂŶŬƐƐĞƚƐ;ŝŶйŽĨ'WͿ ;ϮϬϬϳͿ ϲϬϬ ϱϬϬ ϰϬϬ ϯϬϬ ϮϬϬ ϭϬϬ Ϭ h

Graph 4.9

ƵƌŽnjŽŶĞ

h^

Bond, equities, and bank assets compared (as % of GDP), 2007

Source: McKinsey Global Institute, “Global Capital Markets: Entering a New Era,” at (accessed November 1, 2009)

The Euro as an International and Global Currency

99

Graph 4.10 Financial asset comparison—US and Eurozone Source: McKinsey Global Institute webpage, (accessed October 30, 2009) Note: Debt security includes both private and government debt securities.

hand, in 1990 the value of total financial assets in the US stood at US$15 trillion and at US$10 trillion in the Eurozone; on the other hand, in 2008 total financial assets for the US stood at US$60.4 trillion and at US$43.6 trillion for the Eurozone. Graph 4.9 shows that the total amount of bond, equities and bank assets as a percentage of GDP in the Eurozone far surpassed those of the US in 2007. Graph 4.10 compares the distribution of financial assets by instrument in 2006 and in 2008 in percentage terms. In 2008 the US clearly surpassed the Eurozone in equity security assets; both economic blocs were very close in debt securities; and the Eurozone exceeded the US in lending. Trichet explains that since the introduction of the euro, there have been clear signs of integration in the Eurozone’s financial assets. The bond market and bond yields were, right after the introduction of the euro, no longer the results of national factors but the result of factors common to the Eurozone. This integration process helped offer investors a wider variety of Eurozone tools. According to Trichet (2008c, 2), “euro area residents have almost 60 percent of their total bond portfolios in euro area crossborder bond holdings.” However, measuring integration is more difficult in the equity market than in the bond market because, as Trichet (2008c, 3) explains, “stock returns are less directly comparable across countries than returns in the money and government bond markets.” Graph 4.10 compares the financial asset composition between 2006 and 2008 in the US and the Eurozone. Finally, when it comes to the economy’s strength, stability, and external position, the US and the Eurozone should be analyzed based on competitiveness levels measured by labor costs and labor productivity, capacity of utilization, and real GDP per capital. All these economic indicators convey information on capital flows as well as the state of a country’s economy, the latter of which is to be measured by the Consumer Confidence Leading Indicator published by the Conference Board in the US and by the European Commission in the EU.

&ŝŐƵƌĞϰ͘ϭϭ͘,ŽƵƌůLJĐŽŵƉĞŶƐĂƚŝŽŶĐŽƐƚŝŶh͘^͘ĚŽůůĂƌŝŶŵĂŶƵĨĂĐƚƵƌŝŶŐ ϱϬ ϰϬ ϯϬ ϮϬ ϭϬ Ϭ ϭϵϵϴ

ϮϬϬϬ

ϮϬϬϮ

ůůĞŵƉůŽLJĞĞƐh^

ϮϬϬϰ

ϮϬϬϱ

ϮϬϬϲ

ϮϬϬϳ

ůůŵƉůŽLJĞĞƐƵƌŽĂƌĞĂ

Graph 4.11 Hourly compensation costs in manufacturing Source: Bureau of Labor Statistics, US Department of Labor, Washington DC, at (accessed November 12, 2009)

ϭϯϬ ϭϮϬ ϭϭϬ ϭϬϬ ϵϬ ϴϬ ϳϬ ϭϵϵϱ

ϭϵϵϲ

ϭϵϵϳ

ϭϵϵϴ

ϭϵϵϵ

hŶŝƚĞĚ<ŝŶŐĚŽŵ

ϮϬϬϬ

ϮϬϬϭ

hŶŝƚĞĚ^ƚĂƚĞƐƵƌŽnjŽŶĞ

ϮϬϬϮ ƵƌŽnjŽŶĞ

Graph 4.12 Labor productivity growth indexes compared Source: Bloomberg Finance LP

ϮϬϬϯ

ϮϬϬϰ

ϮϬϬϱ

ϮϬϬϲ

ϮϬϬϳ

ϮϬϬϴ

Source: Bloomberg Finance LP

Graph 4.13 Capacity utilization comparison

ƵƌŽnjŽŶĞ

^ĞƉƚĞŵďĞƌϮϬϬϵ

DĂƌĐŚϮϬϬϵ

^ĞƉƚĞŵďĞƌϮϬϬϴ

DĂƌĐŚϮϬϬϴ

^ĞƉƚĞŵďĞƌϮϬϬϳ

DĂƌĐŚϮϬϬϳ

^ĞƉƚĞŵďĞƌϮϬϬϲ

DĂƌĐŚϮϬϬϲ

^ĞƉƚĞŵďĞƌϮϬϬϱ

DĂƌĐŚϮϬϬϱ

^ĞƉƚĞŵďĞƌϮϬϬϰ

DĂƌĐŚϮϬϬϰ

^ĞƉƚĞŵďĞƌϮϬϬϯ

DĂƌĐŚϮϬϬϯ

^ĞƉƚĞŵďĞƌϮϬϬϮ

DĂƌĐŚϮϬϬϮ

^ĞƉƚĞŵďĞƌϮϬϬϭ

DĂƌĐŚϮϬϬϭ

^ĞƉƚĞŵďĞƌϮϬϬϬ

DĂƌĐŚϮϬϬϬ

^ĞƉƚĞŵďĞƌϭϵϵϵ

DĂƌĐŚϭϵϵϵ

ϵϬ

ϴϱ

ϴϬ

ϳϱ

ϳϬ

ϲϱ

The Euro as an International and Global Currency

103

On the competitiveness level, it is necessary to analyze the hourly compensation costs measured in US dollars in the manufacturing sector on both sides of the Atlantic. Graph 4.11 demonstrates that the Eurozone has far higher costs, while Graph 4.12 shows that the productivity level is the highest where compensation costs are the lowest. While Graph 4.11 shows that the hourly compensation has been higher in the Eurozone than in the US since 1999, Graph 4.12 demonstrates that productivity is lowest in the Eurozone. These two graphs illustrate that higher compensation does not necessarily mean higher productivity. Furthermore, the capacity of utilization in Graph 4.13 measures the productive capacity of the US and the Eurozone by comparing the gap between how much output is produced and how much could be produced if factors of production and capacities were fully used; in other words, it measures how efficiently production capacity is being utilized. Capacity of utilization will rise as aggregate demand for goods and services grows, and if demand weakens, capacity of utilization declines as a consequence. On average, 85 percent is considered not only a level where demand will trigger inflation, but also the level below which the economy is believed to be in excess capacity, or producing more than is demanded by society. However, this benchmark varies from country to country. For instance, the Federal Reserve (2009) estimated that the benchmark to measure the country’s capacity of utilization is 80 percent, while for the Eurozone it has been estimated to be 82 percent (Corporate Executive Board 2009). Graph 4.13 shows that from March 1999 to August 2009, the US’s capacity of utilization has been below that of the the Eurozone’s. Also, this graph shows that the capacity utilization in the US has been below the 80 percent benchmark during this period, while the Eurozone has maintained the same level. Hence, the US has been showing signs of excess capacity while the Eurozone is experiencing a high capacity of utilization consistent with the higher inflation rates experienced by the Eurozone. In accordance with the current economic crisis and financial uproar, Graph 4.13 plots how, since 2008, capacity of utilization in the US and the Eurozone has suffered a tremendous decline from levels of 80 percent to 70 percent. Despite the fact that the Eurozone has a higher capacity utilization, Graph 4.14 shows that the US enjoys a higher GDP per capita than the Eurozone. Finally, all these indicators that measure the health of the economy are condensed into the consumer confidence within both countries. Graph 4.15 shows the consumer confidence levels for the US and the Eurozone. The Conference Board provides the data for the US. It is an average index of responses to five questions that measure respondents’ appraisals of current business conditions and projected business conditions for the next six months, current employment expectations and projected employment expectations for the next six months, as well as what the family total income will be in the next six months. The index is benchmarked to 100; thus confidence above 100 implies good expectations for the future of the economy while confidence level below the benchmark means low confidence in the economy. This indicator hints at future economic growth as it estimates consumer spending and savings. Starting in mid-2007 in the US, the

&ŝŐƵƌĞϰ͘ϭϰ'ƌŽƐƐĚŽŵĞƐƚŝĐƉƌŽĚƵĐƚ;WWWƉĞƌĐĂƉŝƚĂ'WͿ ŝŶƵƌƌĞŶƚ/ŶƚĞƌŶĂƚŝŽŶĂůh͘^͘Ψ ϱϬϬϬϬ ϰϱϬϬϬ ϰϬϬϬϬ ϯϱϬϬϬ ϯϬϬϬϬ ϮϱϬϬϬ ϮϬϬϬϬ ϭϱϬϬϬ

ƵƌŽnjŽŶĞ;ϭϯͿ

ϮϬϬϵ

ϮϬϬϴ

ϮϬϬϳ

ϮϬϬϲ

ϮϬϬϱ

ϮϬϬϰ

ϮϬϬϯ

ϮϬϬϮ

ϮϬϬϭ

ϮϬϬϬ

hŶŝƚĞĚ^ƚĂƚĞƐ

Graph 4.14 Comparison of US and Eurozone GDPs Source: Bloomberg Finance LP

ϭϵϵϵ

ϭϵϵϴ

ϭϵϵϳ

ϭϵϵϲ

ϭϵϵϱ

ϭϵϵϰ

ϭϵϵϯ

ϭϵϵϮ

ϭϵϵϭ

ϭϵϵϬ

ϭϵϴϵ

ϭϵϴϴ

ϭϵϴϳ

ϭϬϬϬϬ

RY   E  0 D\   $X J  1 RY   )H E  0 D\   $X J  1 RY   )H E  0 D\   $X J  1 RY   )H E  0 D\   $X J  1 RY   )H E  0 D\   $X J  1 RY   )H E  0 D\   $X J 

 )H

1

















 (XUR]RQH

Graph 4.15 Consumer Confidence Indicators—Eurozone and US compared

Source: Bloomberg Finance LP 86

106

The Euro in the 21st Century

index has suffered a significant decline consistent with the reduction in consumer spending that the country has suffered since then. In the Eurozone, consumer confidence conveys information on consumers’ sentiments in Member States. It measures the state of affairs of personal finance and the job market situation, both of which affect saving and spending patterns and influence the economy. In the Eurozone, the benchmark is zero; hence, a headline above zero indicates positive consumer confidence, while a negative number points to more negative attitudes and perceptions. The Eurozone consumer confidence pattern parallels that of the US as is evidenced by the significant reduction in the index since mid-2007. The movement of money, or capital flow, from 2000 to 2007 depicted in Graph 4.16 shows the movement of money in and out of the US and the Eurozone. A global positive net capital inflow indicates that investors trust the country for purposes of investment, trade, or business production and those governments are receiving money from direct capital flows, from tax receipts into programs and operations, and through trade with other nations and currencies. The state of an economy is going to directly influence the level of capital inflows and outflows.

Graph 4.16 Global capital flows Source: McKinsey Global Institute, “Global Capital Markets: Entering a New Era,” At  (accessed November 1, 2009)

Graph 4.16 shows that the net global capital flow for the US depicts a continued positive trend. That of the Eurozone is positive as well but more irregular. Final Words Chapter 4 has discussed the debate surrounding the status of the euro as an international and global currency and presents an empirical study to corroborate the conclusion. The study concludes that the euro has become an international currency. The euro has become a viable unit of account in the private sector due to its evolution

The Euro as an International and Global Currency

107

when used in international trade and debt contracts; that is, it has become a viable invoice currency. In the official sector, the euro is also considered a unit of account due to the number of countries that have chosen it as a currency peg. While under the Bretton Woods System most currencies were tied to the US dollar, once that system collapsed, some of the currencies allowed their value to float. Although, since the introduction of the euro, most currencies have chosen to peg their exchange rates to the US dollar, the area of influence of the euro has nevertheless been growing considerably. In addition, this study demonstrates that the purchasing power of the euro in the private sector is measured by the demand of products denominated in euros in the bond market, money market, foreign exchange market for currency diversification, and capital markets; hence, the euro can be considered a store of value as it has guaranteed its purchasing power over time. In the official sector, the performance of the euro as a store of value has been discussed according to its performance and evolution as a reserve currency. While the euro can be considered a de facto international currency, the results concerning whether or not the euro has become a global currency are mixed. The analysis explains that the euro has not been able to strip the US dollar of its hegemony as a global currency nor has the euro been able to achieve a solid position as a global currency, as it is still undergoing a number of difficulties. In order to reach a conclusion, this chapter comprehensively reviews existing theories on global currencies in order to conduct an empirical analysis on how the euro performs when taking into account a number of key factors. These factors are: (1) the size of its underlying economy and global trade, (2) the breadth and depth of the economy’s capital markets, and (3) the economy’s strength, stability, and external position. This chapter comprehensively elaborates on the current debate on the role of the US dollar as a global currency. Although the euro is the leading exporting bloc, when it comes to other key factors the Eurozone has mixed reviews. The reason why the euro has been pressed to become a global currency is because the greenback has lately been challenged as global currency on one particular front: the relationship of the euro vis-à-vis the US dollar in BRIC countries, particularly in China. This chapter therefore shows that while the euro can undoubtedly be considered an international currency, empirical evidence demonstrates that the euro cannot be considered a solid global currency despite the precariousness of the US’s financial situation and the depreciation of the dollar against the euro over the past few years. Hence, although the US dollar might have shared its status as an international currency with the euro, it still remains the sole global currency.

This page has been left blank intentionally

PART III THE EURO AND THE EUROZONE: BEFORE, DURING, AND AFTER THE FIRST ECONOMIC CRISIS OF THE 21st CENTURY

This page has been left blank intentionally

Chapter 5

The New Monetary Order of the 21st Century This chapter examines the current economic crisis and financial uproar that began in September 2008, particularly in the context of globalization, and then looks at the necessity of achieving economies of scale and synergies to keep high competitiveness levels while pushing to reform the current international monetary order. The current global monetary system is anchored in the US dollar at a point of time when the world has reached sophisticated economic and monetary synergies due to globalization forces. From a monetary point of view, the need for a new global monetary system is based on the fear that if the US government continues running a deficit to counter the worst recession since the Great Depression, the value of the US dollar will decline, negatively affecting the value of held assets in this currency, specially important when almost 75 percent of today’s world currency reserves are held in US dollars. Consequently, it is believed that the current US dollar-based global monetary system must be revised and a more inclusive system should emerge. This chapter explores two alternatives. On the one hand, some advocate the need to have an international reserve currency other than the US dollar disconnected from any particular country and find in the IMF’s Special Drawing Rights the right tool. On the other hand, some proclaim the benefits of having a single global common currency and monetary system managed by a global central bank within a global monetary union. Robert Mundell, the father of the euro, has been advancing the idea of a global common currency for some time now, claiming that a reduction in the number of currencies in circulation will reduce transaction costs, increase price transparency, and force economic synergies. He has named this global currency the “intor.” It is not supposed to be a single currency; rather, countries and areas would keep their own currencies, which would circulate alongside the intor. Further, Mundell has been lately advocating the need to have a fixed dollar–euro rate to avoid big swings in the exchange rate. He believes that implementing this fixed rate would be easy, as the US and the Eurozone comprise almost 50 percent of the world’s economy. The introduction of a global common currency will have a direct impact on the foreign exchange market and its two participants—the customer and the market maker—as it would eliminate transactions costs for the customer and reduce benefits for the market maker. These transaction costs and benefits are measured by the spread between the bid price and the ask price in the foreign exchange (FX)

112

The Euro in the 21st Century

market. This section presents the foreign exchange turnover by instruments—spot, forwards, swaps—in 2001, 2004, and 2007 to establish the importance that the FX market has gained over the first decade of the twenty-first century. Secondly, it calculates the transaction costs for consumers and benefits for the market makers of the euro–sterling cross-rate in 2004 and 2007 to asses how this will affect the foreign exchange market if it were to join the euro and disappear. Finally, it analyzes the parties involved in this market to shed light on which economic agent will be most affected if the pound were to cease to exist. Thus, this chapter analyzes the impact in terms of transaction costs of the UK pound by calculating the bid–ask spread and interpreting it as a transaction cost that consumers face when exchanging pounds and euros and a benefit that market makers receive in these transactions. This study concludes that the pound is a financial instrument of great economic revenues, a “cash cow,” for the market makers and of great economic cost for consumers. The second approach to reinventing the international monetary system rests on the fact that the current global economic crisis has revived the role of the International Monetary Fund (IMF) and the purpose of the dormant Special Drawing Rights (SDR). The idea is for the SDR to substitute for the US dollar as the world reserve currency. However, the structure of the SDR and the IMF means that rich-country governments will end up dominating this new world economic order and limiting the access by emerging countries that really need the funds. Nonetheless, many envision the IMF as a global central bank and the SDR as a common currency. Finally, this chapter looks at how Brazil, Russia, India, and China (the BRIC countries) are not only becoming increasingly important in the foreign exchange market but also important advocates of a new monetary order as they are major holders of foreign reserves. The relationship between the US and the currency policy of China is also examined. Despite the fact, it is common knowledge that the Chinese monetary authorities are pegging the yuan and the Hong Kong dollar to the US dollar, the US has not renewed its efforts to make Chinese authorities to revalue these currencies. However, the Chinese authorities’ response to this pressure seems to have made the US rethink its tactic as the US rhetoric has changed, and the initial pressure has vanished. A number of political and economic reasons can explain the US’s change. However, history has taught that the Pax Britannica ended and the Pax Americana with the Suez Canal Crisis. At that time, the US used its economic leverage against the UK to advance the American interest in the conflict. This economic leverage came from the fact that the US held most of the sovereign debt issued by the UK: today, China owns most of the US-issued sovereign debt, which give China leverage against the US. A Global Common Currency and the Foreign Exchange Market Since the beginning of time, governments have been in a constant quest to acquire land and integrate neighboring countries or nation states. Up to World War II, this

The New Monetary Order of the 21st Century

113

was done by means of a bellicose approach: after 1945 the approach has largely changed to use of trading, economic, and political strategies. These new strategies have spurred interest in the possibility of introducing a global common currency to solve the various economic disadvantages associated with different monies. Given the level of globalization and the proliferation of trade agreements, having a single world currency might prove very beneficial: unfortunately there are many political, economic, monetary, and social barriers that will have to be overcome. The prospects of a global common currency have long been discussed, but it has not achieved any progress to date. Even the introduction of a single currency for the Eurozone was strongly debated: De Grauwe (2006) explains that at the time of the signing of the Maastricht Treaty, the monetary union was still a muchdebated issue; scholars, economists, and politicians alike were struggling with the pros and cons of such a union. The decision to give up one’s national currency and adopt a common one is made based on a determination of the costs and benefits that relinquishing national monies to adopt a common currency would have for a group of countries. Even today, some countries neither understand nor choose to accept the notion that a world engaged in global trade should share a common currency. The idea of a global common currency is also wielded against currency speculators who not currently posing a serious risk to the market, yet still used as propaganda by those who really do not understand how the new system works and who are anchored in post-cold war economic dogmas. The true problem of the foreign exchange market is the new form of currency devaluation engineered by China and exercised with the Chinese currency in the form of “financial dumping.” Nonetheless, the world is unwilling to group into a global monetary union and there is no global currency. However, the US dollar is viewed both as an international reserve currency and a global currency; thus, it is the closest a currency can be to being considered a “global common currency.” Robert Mundell, the father of the euro, has been for quite some time advocating the idea of a global common currency he has named the “intor.” According to Mundell in his work titled “World Currency” (Mundell n.d.), the benefits of a global currency would be enormous as it would, on the one hand, help with price transparency and, on the other, simplify monetary policies for almost two-thirds of the countries of the world. In fact he stated that My ideal and equilibrium solution would be a world currency (but not a single world currency) in which each country would produce its own unit that exchanges at par with the world unit. We could call it the international dollar or, to avoid the parochial national connotation, the intor, a contraction of “international” and the French word for gold.

Due to the current economic crisis and financial uproar, the idea of a global common currency has been regarded as the way in which to avoid many of the hardships of the current global recession. This is a theory derived from the positive experience of

114

The Euro in the 21st Century

the Eurozone and the euro, which has demonstrated that there are many advantages of having a common currency. For a start, a world currency would reduce the jumble of almost 190 national currencies. It would end national currency crises such as the Argentinian, Mexican, and Russian currency devaluations. Also, countries would not need to stack up reserves of foreign currencies and assets to prevent balance of payment problems. Most important is the fact that, in a globalized world, a global common currency would foster trade, and would simplify foreign exchange fluctuations and transaction costs which are a major deterrent of international business. However, a global common currency would require a globally integrated system of world governance, which has proven to be a major political obstacle. Furthermore, a global common currency would need a common global central bank and a global monetary union, which would mean that governments would no longer be able to use domestic monetary policy to adjust certain economic situations. All of this would only be possible if countries agreed and cooperated to relinquish a certain level of economic, monetary, and political sovereignty which has always been the major obstacle. Furthermore, a global currency would be unviable due to the fact that, despite what can be called the globalization of the world economies, each country has not only its own business cycle, but also its social and political cycle. This means that different countries have different levels of productivity, different political systems, and even different religions. The disappearance of national currencies and the introduction of a global common currency would have an impact on the foreign exchange (FX) market and its participant actors: the customer and the market maker. When the national currencies of the 12 European countries that adopted the euro finally ceased to exist on December 31, 1998, the FX market witnessed an immediate reduction in the number of European currencies being traded and the number of European cross-rates available. Despite this reduction, the FX market has grown to be one of the largest and most liquid financial markets with a daily FX turnover that has increased significantly since 1989 (see Table 5.2 later in this chapter). Singapore, Switzerland, and the UK are the most important financial centers for FX trading. Finally, according to the Bank for International Settlements (BIS), the share of the traditional four largest currencies has been affected by the birth of new national currencies. Table 5.1 presents the market share evolution of the most significant currencies. This table shows that while the percentages of US dollar and yen daily turnover have been decreasing, the euro has maintained its share, but that the New Zealand dollar, and the four BRIC currencies, particularly the Chinese yuan and the Hong Kong dollar, have increased significantly their presence in the FX market. In fact, the BIS (2007, 1) concludes that “the share of emerging market currencies in total turnover has increased to almost 20 percent in April 2007.” The major characteristic of the FX market is that it is under constant transformation. The FX market has, firstly, increased tremendously in volume, and, secondly, has not only experienced the reduction and disappearance of the number currencies traded but has also witnessed the birth of national currencies

The New Monetary Order of the 21st Century

Table 5.1

115

Currency distribution of reported foreign exchange market turnover: percentage share of average daily turnover, April 2007

Currency

2001

2004

2007

US dollar Euro Yen UK pound Swiss franc Hong Kong dollar New Zealand dollar Russian ruble Indian rupee Chinese yuan Brazilian real

90.3 37.6 22.7 13.2 6.1 2.3 0.6 0.4 0.2 0.0 0.4

88.7 36.9 20.2 16.9 6.1 1.9 1.0 0.7 0.3 0.1 0.2

86.3 37 16.5 15 6.8 2.8 1.9 0.8 0.7 0.5 0.4

Source: Bank of International Settlement, “Triennial Central Bank Survey 2007,” December 2007, at

Table 5.2

Daily global foreign exchange turnover, 1989 to 2008* (US$ billions)

Global exchange turnover,¹ daily average in April

1989

1992

1995

1998

2001

2004²

2007

Spot transactions Outright forwards Foreign exchange swaps Estimated gaps in reporting

317 27 190

394 58 324

494 97 546

568 128 734

387 131 656

631 209 954

1,005 362 1,714

56

44

52

60

26

106

129

Total “traditional” turnover

590

820

1,190

1,490

1,200

1,900

3,210

Adjusted for local and cross-border double-counting. Due to incomplete maturity breakdown, components do not always sum to totals. 2 Data for 2004 have been revised. *Bank of International Settlements, Triennial Survey of Foreign Exchange and Derivatives Markets, April 2007. 1

Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007—Final Results,” December 2007, at (accessed December 27, 2009)

116

The Euro in the 21st Century

that will soon help to transform the FX market as we now know it. First of all, the FX market has increased in volume in the past twenty years. The BIS, in the latest Triennial Central Bank Survey published in December 2007, explains that the net daily foreign exchange turnover, or “forex” trading, reached over US$3 trillion. Table 5.2 shows that while in 1989 the daily turnover was US$590 billion, in 2007 the turnover is US$3 trillion; an impressive increase in activity that demonstrates the importance that the FX market has been gaining over the years. Secondly, the introduction of the euro has transformed the FX market as it reduced significantly the number of European cross-rates when 11 national currencies ceased to exist to create the euro in December 31, 1998. Before the euro, there were 15 European national currencies which provided the market with a vast number of cross-rates to choose from. The introduction of the euro reduced the number of tradable European currencies to four—the euro, the UK pound (GBP), the Swedish krona (SEK), and the Danish krone (DKK)—which meant a significant reduction in the cross-rates available among European currencies. Since 1999, ten new countries have joined the EU and five more countries have adopted the euro. This reduction in the number of cross-rates among European currencies has fostered financial integration but affected both sides of the FX market—the customers and market makers. For the FX customer a reduction in the number of foreign exchange crossrates means price transparency and a decrease in transaction costs; for the market maker, it means a reduction of economic benefits. Finally, due to globalization and other factors, certain “developing” countries, particularly Brazil, India, Russia, and China (the BRIC countries), have been improving their political and social systems, which has positively affected their economic development. As a consequence, their national currencies are expected to soon become fully convertible and liquid, and to play a transforming role in the foreign exchange market. If a global common currency were to be introduced, the current number of national currencies and cross-rates will significantly decline. This reduction in the number of cross-rates will have, as in the case of the introduction of the euro, a positive effect for the customer who will see an enhancement of price transparency and, most importantly, a reduction in transaction costs. However, market makers will experience a reduction of their profit and benefits represented by the lost of these transaction costs. In particular, according to Morrison Bonpasse (2005, 92) “the adoption of a single currency will save the world US$400 billion annually in foreign exchange transaction costs, which come from trading US$3.8 trillion every trading day.” Empirical Study: Should the Pound Join the Euro? Since the Maastricht Treaty envisioned the introduction of a common currency, a debate has been created as to whether the UK should give up the pound and adopt   As of January 1, 2009 the EU has 27 Member States and 11 currencies.   Greece, Slovenia, Slovakia, Malta, and Cyprus

Table 5.3

Daily average foreign exchange turnover, net of double-counting, by instrument (US$ millions)

Euro–sterling transactions

Daily average turnover, April 20011

Daily average turnover, April 20042

Daily average turnover, April 20073

Spot Forwards

12,229

$18,328

$29,510

Up to 7 days

1,474 2,345 99 $3,918

3,226 3,648 171 $7,045

3,000 3,082 187 $6,269

Total forex swaps Total US$ millions daily

2,785 5,317 225 $8,327 24,474

10,118 7,136 310 $17,564 $42,937

8,380 6,143 176 $14,699 $50,470

TOTAL US$ MILL YEARLY4

6,216,396

10,905,998

12,819,380

More than a week, less than a year Over one year Total forwards Forex swaps Up to 7 days More than a week, less than a year Over one year

Statistical Annex, Table E-3, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity 2001—Final Results,” Bank for International Settlements (BIS). 2 Statistical Annex, Table E-3, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity 2004—Final Results,” Bank for International Settlements (BIS). 3 Statistical Annex, Table E-3, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity 2007—Final Results,” Bank for International Settlements (BIS). 4 Assuming 254 trading days per year. 1

Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007—Final Results,” December 2007, at (accessed December 27, 2009)

Table 5.4

Daily foreign exchange turnover and transactions costs, net of double-counting, by instrument, counterparty and currency, April 2004

Euro–sterling transactions

Turnover: daily £ Bid-offer spread2 average1 (US$ millions)

US$ bid-offer spread3

Transactions cost OR benefit4 (US$ millions)

Spot Forwards

Up to 7 days More than a week, less than a year Over one year

$18,328   3,226 3,648 171 $7,045   10,118 7,136 310

£0.00020   £0.00028 £0.00400 £0.01750     £0.00028 £0.00400 £0.01750

$0.00035   $0.00049 $0.00694 $0.03035     $0.00049 $0.00694 $0.03035

$6.36   $1.57 $25.30 $5.19 $32.06   $4.91 $49.50 $9.41

Total forex swaps Total US$ millions daily TOTAL US$ MILLIONS ANNUALLY5

$17,564 $42,937 $10,905,998

     

     

$63.81 $102.23 $25,966.09

Up to 7 days More than a week, less than a year Over one year Total forwards Forex swaps

Table E.3, Statistical Annex, Triennial Central Bank Survey April 2004, Bank for International Settlements (BIS). Bid-offer from Treasury Department of Sovereign-Santander Bank. 3 Bid-ask spread assuming dollar–sterling exchange rate of 1,7434. 4 US$ bid-ask spread times net turnover. 5 Assumes 254 trading days per annum. 1 2

Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007—Final Results,” December 2007, at (accessed December 27, 2009)

The New Monetary Order of the 21st Century

119

the euro. Much has been written on the political reasons behind the UK’s refusal to join the Eurozone as well as on the economic costs and benefits of giving up the “quid.” The Bank of International Settlements (BIS) describes itself as the “banker of central banks” and, as such, collects and reports international FX settlement data by currency. The BIS reports average net daily turnover between the euro and the UK pound by instrument: spot, forwards, and swaps. Table 5.3 shows the daily average FX turnover net of double counting by instrument in April of 2001, 2004, and 2007. In April 2001 the daily average turnover between the euro and the UK pound totaled US$24 billion while in April 2004 it was almost US$43 billion and in April 2007 it was US$50 billion. Assuming that there are 254 trading days per year, Table 5.3 demonstrates that the FX turnover has doubled from US$6 trillion in 2001 to US$12 trillion in 2007, making this market one of the most liquid and important financial markets. Secondly, this daily turnover between the euro and the pound has a cost to the consumer who has to face a bid–ask spread; a spread that, in turn, becomes a benefit for the market makers. This cost of money exchange is criticized as being a burden to those consumers who enter the FX market to the point that economists have thoroughly analyzed the impact of these transaction costs in the economy. Robert Mundell identified that reducing the number of currencies in circulation reduces transaction costs and increases price transparency. Tables 5.4 and 5.5 show the product of the daily average transaction turnover of each instrument by the bid–ask spread to estimate the transactions cost, or benefit, between the pound and the euro. Since the data provided by the BIS is the average daily turnover in one month, I have assumed 254 trading days per year to estimate one year’s average turnover. The bid–ask spread was obtained from the trading desk of a leading bank and it does not take into account further commission or management fees that could apply. Table 5.4 shows that in 2004 the average yearly turnover was close to US$11 trillion. In detail, in April 2004, the average daily transaction cost, or benefit, was almost US$102 million and, assuming 254 trading days per year, the result is that in 2004 an estimated US$25 billion are spent annually on financial intermediation between the pound and the euro. These US$25 billion are both a benefit for the foreign exchange market makers and a cost for the consumers. Table 5.5 shows that in 2007 the average yearly turnover was US$12 trillion. In detail, the transaction cost, or benefit, was over US$53 million and, assuming 254 trading days per year, the result is that in 2007 an estimated US$13 billion are spent annually on financial intermediation between the pound and the euro. These US$13 billion are both a benefit for the FX market makers and a cost for the consumers. In summary, if the UK pound were to disappear and join the euro,   The UK pound is commonly called the “quid,” also as the “cable” among foreign exchange traders.   Treasury Department of the Sovereign Bank, Boston, Massachusetts.

Table 5.5

Daily foreign exchange turnover and transactions costs, net of double-counting, by instrument, counterparty and currency, April 2007

Euro–sterling transactions Spot Forwards Up to 7 days More than a week, less than a year Over one year Total forwards Forex swaps Up to 7 days More than a week, less than a year Over one year Total forex swaps Total costs US$ millions DAILY Total US$ millions ANNUALLY5

Turnover: daily average1 (US$ millions) $29,510

£ bid-offer spread2

US$ bid-offer spread3

Transactions cost OR benefit4 (US$ millions)

£0.00020

$0.00029

$8.64

$3,000 $3,082 $187 $6,269

£0.00019 £0.00270 £0.01045

$0.00028 $0.00395 $0.01530

$0.83 $12.19 $2.86 $15.88

$8,380 $6,143 $176 $14,699 $50,478 $12,821,412

£0.00019 £0.00270 £0.01045

$0.00028 $0.00395 $0.01530

$2.33 $24.29 $2.69 $29.31 $53.84 $13,675,32

Table E.3, Statistical Annex, Triennial Central Bank Survey April 2004, Bank for International Settlements (BIS). Bid-offer from Treasury Department of Sovereign-Santander Bank. 3 Bid-ask spread assuming dollar–sterling exchange rate of 1,6443. 4 US$ bid-ask spread times net turnover. 5 Assumes 254 trading days per annum. 1 2

Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007—Final Results,” December 2007, at (accessed December 27, 2009)

The New Monetary Order of the 21st Century

121

market makers would lose an important source of revenue from the euro–sterling cross-rate while wholesale customers would see a reduction in transaction costs which would, in turn, foster trade and international business. Table 5.6 compares the 2004 and 2007 total turnovers and transaction costs/ benefits. It shows that while annual total turnover has significantly increased from 2004 to 2007 by almost US$2 trillion, transaction costs have decreased by US$12 billion. Two reasons can explain this inverse correlation. On the one hand, the bid–ask spread has suffered a reduction and, on the other, the exchange rate has changed from a UK pound/US dollar conversion rate of 1.7434US$ in 2004 to 1.46443US$ in 2007. Table 5.6

Comparative analysis: the UK pound, annual turnover and transaction costs Total turnover (US$ millions)

2004

$10,905,998

Transaction costs OR benefit (US$ millions) $25,966.09

2007 Difference

$12,821,412 + $1,915,414

$13,675.32 – $12,290,77

Finally, the BIS report shows an increase from 2001 to 2007 in the basket of currencies analyzed. While in 2001 the BIS only reported FX turnover of six currencies—US dollar, euro, Japanese yen, UK pound, Swiss franc, Canadian dollar, and Australian dollar—in 2007 the BIS reported on 21 more currencies: the Swedish krona, Brazilian real, Chinese yuan, Czech koruna, Danish krone, Hong Kong dollar, Hungarian forint, Indian rupee, Indonesian rupiah, South Korean won, Mexican peso, Philippine peso, Norwegian krone, New Zealand dollar, Polish zloty, Russian ruble, South African rand, Singapore dollar, New Taiwan dollar, Thai baht, and Turkish lira. Table 5.7 shows that, despite this increase in the number of currencies, the total turnover in the UK pound has increased from 11.83 percent in 2001 to 14.96 percent in 2007, which shows that the pound maintains its status as one of the most traded currencies in the FX market. Moreover, Table 5.7 sheds lights on turnover by counterparty. It shows that the majority of the daily average transactions in all three instruments take place “with reporting dealers” and “financial institutions,” while transactions “with non-financial institutions” represent a slim percentage. This strengthens the theory that the disappearance of the pound will negatively affect market makers who will lose an important source of revenue. The UK and the Eurozone: A Turbulent Relationship The reluctance of the UK to adopt the euro in 1999 was based on social, political and economic grounds. From a social point of view, Eurobarometer 70 (2008a) reported chilling statistics that showed the low national support for the EU and

Table 5.7

Daily averages of trading transactions in the UK pound (in US$ millions), 2001 and 2007 compared 20011

Spot With reporting dealers With other financial institutions UIT non-financial customers Forwards With reporting dealers With other financial institutions UIT non-financial customers Forex swaps With reporting dealers With other financial institutions UIT non-financial customers TOTAL 1 2

20072

Total

Pound

Percentage

Total

Pound

Percentage

$326,648 $184,069 $95,513

$27,900 $16,048 $8,542

8.54%  57.52 30.62

$1,004,889 $426,480 $394,206

$149,912 $62,208 $60,909

 14.9% 41.50 40.63

$47,066 $110,795 $46,939 $34,415

$3,310 $11,317 $5,399 $3,776

11.86 10.2%  47.71 33.37

$184,203 $361,730 $95,875 $158,862

$26,795 $46,274 $10,140 $22,334

17.87 12.8%  21.91 48.26

$29,441 $622,998 $405,713 $168,466

$2,142 $86,273 $53,339 $26,958

18.93 13.8%  61.83 31.25

$106,993 $1,714,370 $796,172 $682,212

$13,800 $264,593 $110,852 $112,807

29.82 15.4%  41.90 42.63

$48,820

$5,975

6.93

$235,986

$40,934

15.47

$1,060,441

$125,490

11.83%

$3,080,989

$460,779

14.96%

Table E.1, Statistical Annex, Triennial Central Bank Survey April 2001, Bank for International Settlements (BIS). Table E.1, Statistical Annex, Triennial Central Bank Survey April 2007, Bank for International Settlements (BIS).

Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007—Final Results,” December 2007, at (accessed December 27, 2009)

The New Monetary Order of the 21st Century

123

the euro, reporting that trust in European institutions was as low as 27 percent and the enthusiasm for euro membership was 28 percent. From a political point of view, governments have not been eager to give up the pound since they view the national currency not only as a badge of sovereignty, but also, as John Stuart Mill noted, as a symbol of liberty and independence. Furthermore, the UK is still today considered a dominant country, as it reigned a sizable part of the world during the Pax Britannica, and, according to Robert Mundell (2003, 4), there is always a … tendency for the dominant country to reject a world currency. The basic fear is that a global currency represents a threat to the position of its own currency. The counterpart of the conjecture is that actual or potential rivals try to pursue international monetary reforms to clip the winds of the dominant power and to redistribute power.

From an economic point of view, Sir Eddie George explained in 2001 during an interview for the BBC, that, given the value of the pound to the deutsch mark, it was very difficult for the pound to join the euro on January 1, 1999. In fact, he stated that “the only way out of the dilemma were if the euro strengthened against the dollar, as then the pound might be able to fall against the euro while also strengthening against the dollar.”

Graph 5.1

Euro and UK pound, 1981 to 2010

  Governor of the Bank of England from 1993 to June 2003.

124

The Euro in the 21st Century

Graph 5.1 plots the pound against the ecu and the euro from 1978 to 2010, and shows several important moments in the history of the UK’s currency. For instance, point A, or the “Black Wednesday” of September 16, 1992, is the moment when the UK government had to withdraw the pound from the European Exchange Rate Mechanism (the snake) because they were unable to keep sterling above its agreed lower limit. After the withdrawal, the pound suffered a brutal devaluation that led the pound to the level labeled as point B. Point C is the moment when the ecu became the euro and 11 European currencies ceased to exist; after the introduction of the euro, the pound suffered another devaluation which sent its value to levels close to that of Point B. Point D, on the other hand, shows the highest price ever reached by the pound since 1978. Graph 5.2 examines in greater detail the 17-month period after April 2008, when a great debate sparked around the level of the pound against the euro and the US dollar. Sir Eddie George explained that the pound would join the euro if three premises were met. First of all, he argued that the euro needed to strengthen against the US dollar, a premise that has been met for the past years during which the euro has reached record highs that have been blamed in certain countries for the lack of GDP growth. Secondly, he stated that the pound would have to fall against the euro; Graph 5.2 shows that since mid-2008 the pound has been losing value against the euro. However, he believed that the pound had to simultaneously strengthen against the US dollar, a premise that has not been met. Graph 5.2 demonstrates that not all these premises have been met, which could explain, from an economic point of view, why the UK pound is not joining the euro. Despite the fact that these required premises have not been met, it is important to highlight that since June 2006 (point A) there has been a synchronization of these two currencies which has strengthened even further since June 2008 (point B). As this book is being written (in early 2010), the UK is facing a general election on May 6, 2010 and the debate on the EU and the adoption of the euro has become a center of debate. It seems that none of the contestant parties have the intention of adopting the euro. The New International Monetary Order of the Twenty-First Century: The SDR and the IMF The US and the UK proposed the importance and convenience of introducing an international reserve currency when planning the new post-war economic order at the 1944 Bretton Woods summit. In 1969 the IMF introduced a new international reserve asset, the Special Drawing Right (SDR) to support the Bretton Woods fixed exchange rate system, claiming that “gold and the US dollar proved inadequate for supporting the expansion of world trade and financial development that was taking place” (IMF 2008b). Unfortunately, in 1973 when the Bretton Woods System collapsed, all currencies shifted to a floating exchange rate regime.

Graph 5.2

Euro and UK pound, April 2008 to August 2009

126

The Euro in the 21st Century

The IMF and the SDRs have regained importance recently for two reasons. First, on March 23, 2009, the President of the People’s Bank of China, Zhou Xiaochuan (2009), stated that there was an urgent need to find “an international reserve currency with a stable value, ruled-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability.” With this statement, China openly manifested its desire to dethrone the US dollar as an intentional reserve currency. Russian President Dmitry Medvedev presented, at the G-8 meeting that took place in Aquila (Italy) in July 2009, a new world currency that bears the words “unity in diversity” and along with this gesture he explained that the need for a supranational currency is a common concern (Telegraph 2009) Second, the IMF has received an injection of funds as the G-20 Summit, held in London in April 2009, aimed at providing the IMF with US$250 billion in general SDR allocation. Moreover, the IMF’s Board of Governors approved in September 1997 a special one-time allocation of SDRs for US$33 billion through the Fourth Amendment which became effective on August 10, 2009 when the US supported the Amendment by joining 133 other members (IMF 2009a). The general SDRs allocation that took place on August 28, 2009 and the special SDRs on September 9, 2009 increased the total amount of SDRs available to US$424 billion. Table 5.8 presents the total allocation of SDRs since 1970. Table 5.8

Special drawing rights allocations to IMF members since 1970

Allocation 1st allocation in 1970–72 2nd allocation in 1979–81 3rd allocation on August 7, 2009 Special allocation on August 10, 2009 Total allocation

Amount in SDRs (billions) 9.3 (in yearly installments) 12.1 (in yearly installments) 161.2 21.5 204.1

The outbreak of the current economic crisis and financial uproar have shown the vulnerability of the existing international monetary system, and a number of countries, particularly the BRIC countries, are not only calling to reform the current international monetary system, but also backing up the idea of introducing a global international reserve currency other than the US dollar (Bretton Woods Project 2009) The idea is to provide central banks with an account at the IMF where US dollars can be substituted by SDRs, thus avoiding the risk of a major dollar crisis and facilitating reserve diversification away from the US dollar. Supporters of this new monetary system defend it by stating that the SDRs meet all the requirements necessary to substitute for the US dollar as a global international reserve currency, and that the IMF (IMF 2008a) would become the global institution in charge of creating and controlling global liquidity.

The New Monetary Order of the 21st Century

127

First of all, the idea is to introduce SDRs as an international reserve asset to reduce certain countries’ tendency to accumulate international reserves to respond against capital account crises. The fact that the world has reached unprecedented levels of globalization and integration and that the US dollar is both an international reserve and global currency, have prompted countries to advocate the creation of an international global reserve currency independent from a particular individual nation that would eventually face a Triffin Dilemma. First identified by economist Robert Triffin, the dilemma is that the country issuing the global currency reserve must be willing to run large trade deficits in order to supply the world with enough of its currency to fulfill world demand for foreign exchange reserves. Can a reserve currency issuer, in this case the US, prefer to choose a particular monetary policy and issue currency in response to the national needs and preferences dictated by the Federal Reserve (“the Fed”) rather than the need of the international payment system and the world economy? The defenders of a new international monetary system argue that “the stability of the international financial system can’t hinge on the currency of one single country, even though that’s the largest economy in the world” (Bloomberg 2009). Thus, they believe that the world cannot rely on a single international currency issued by a single country, particularly in this current globalized world; they argue that no single country should bear this national burden and international responsibility. Defenders believe that this new monetary system would guarantee that the supply of SDRs would be independent of any country’s electoral, political, or/and economic agenda. Secondly, this change would force a shift from the current dollar-centric global monetary system to another currency system which, in turn, is expected to enforce discipline upon reserve issuers, and attenuate demand from reserve-accumulating countries trying to self-insure. For the IMF (2009a), “SDRs allocated to a member will count toward their reserve assets, acting as a low cost liquidity buffer for low-income countries and emerging markets and reducing the need for excessive self-insurance.” At the time of writing (early 2010) the President of the IMF, Dominique Strauss-Kahn, is well aware that the current economic and financial crisis are providing the SDR with a once-in-a-lifetime opportunity to become an global international reserve currency and that this momentum will disappear with any improvement in the economic situation. Finally, the advocates further argue that the IMF will foresee that the SDRs are not only issued according to clear rules but also that they are anchored to a stable benchmark: the “basket of currencies.” This basket consists of the euro, the Japanese yen, the UK pound, and the US dollar. The weight of each currency in the basket is based on the value of the export of the goods and services from the country concerned. The last revision was in November 2005 and the next one will take place in late 2010. The yuan is most likely to be included in the basket in the next revision as it is the currency of the world’s fastest-growing economy, and this is an incentive that is being used to motivate Chinese monetary authorities to strengthen the Chinese currency.

The Euro in the 21st Century

128

The IMF and the SDRs If the IMF and the SDRs—as currently established—were to be chosen as the new international monetary system, this system would suffer from four major weaknesses. First, the amount of SDRs allocated per country is based on each country’s quota share in the IMF. This means that richer and more developed countries—particularly the US and other G-7 countries—will always have easier access to the SDRs than emerging countries. Curiously, while G-7 countries have no real need for SDRs, particularly since they themselves issue reserve currencies, emerging countries that really need the help are underrepresented at the IMF, hindering the effectiveness of introducing the SDRs. Moreover, SDRs are issued by the IMF only when 85 percent of IMF members agree, and are allocated to countries based on the country’s quota at the IMF. This quota is calculated as a “weighted average of GDP (weight of 50 percent), openness (30 percent), economic variability (15 percent), and international reserves (5 percent). For this purpose, GDP is measured as a blend of GDP based on a market exchange rate (weight of 60 percent), and on PPP exchange rates (40 percent)” (IMF 2010). Table 5.9 presents the quota of some of the top 12 countries, showing that the most developed and rich countries are in fact the countries that benefit the most. Table 5.9 Member US China Japan Germany

Calculated quota share of SDRs Percentage 17 7 10 5

Secondly, the IMF, with the support of its member states, must guarantee the level and flexibility of the supply of currency. During the G-20 meeting held in London in April 2009, members of the IMF (2009a) agreed on a plan to increase SDRs allocation to US$1.1 trillion, which is the minimum amount estimated by academics as necessary for the SDR to be able to operate as a international reserve currency. According to the Bretton Woods Project, it is important to highlight that “the IMF essentially creates the SDR allocations out of nothing but the commitment of IMF member states” (2009, 1). Thus, in order for the SDR to supplant the US dollar as an international reserve currency, a much larger allocation of SDRs is necessary in order to match the estimated US$7 trillion global international reserve assets held worldwide at the end of 2008. Graph 5.3 shows the total amount of international reserve holdings of foreign exchange reserve countries alone, as reported by the IMF in 2008. This graph shows not only that the total amount of currency held in reserve has significantly increased from 1999 to 2008, but also that the amount of US dollars held has increased as well, although it is stabilizing. Unfortunately,

)LJXUH&XUUHQF\LQ5HVHUYH:RUOGZLGH   

0LOORI86

       



86'ROODU

Graph 5.3



3RXQG6WHUOLQJ




6ZLVV)UDQF



(XUR



2WKHU

Currency reserves worldwide

Source: IMF, “Currency Composition of Official Foreign Exchange Reserves (COFER) (In millions of US dollars),” at (accessed December 2, 2009)

ϱϬ ϰϱ ϰϬ ϯϱ ϯϬ Ϯϱ ϮϬ ϭϱ ϭϬ ϱ Ϭ h^ĚŽůůĂƌ

DΘ&ƌĞŶĐŚ&ƌĂĐ

:ĂŶƵĂƌLJϭϵϵϭ

Graph 5.4

zĞŶ

ĞĐĞŵďĞƌϮϬϬϵ

Special drawing rights, percentage change

Source: University of British Columbia. Sauder (accessed December 1, 2009)

ƌŝƚŝƐŚWŽƵŶĚ

The New Monetary Order of the 21st Century

131

Graph 5.3 shows that the euro does not seem to have become a tough competitor to the US dollar as the amount of euros held has not increased dramatically. Thirdly, the value of SDRs is based on four major currencies: the US dollar, the euro, the yen, and the pound sterling, leaving out emerging and fast-growing countries, and therefore consolidates the international power of these four currencies and their countries, particularly the US dollar which, in turn, is the currency with the highest weight in the basket of currencies as represented in Graph 5.4. As the SDR is a weighted average of these four major currencies, the value of the SDRs is expected to be more stable than the value of any of the single constituent currencies. However, a problem lies in the fact that the value of the SDRs will be subject to the volatility of the underlying currencies, which indeed has been experienced by those countries since 2006. Finally, the IMF will have to be able to become a reliable lender of last resort to be able to back up not only demand for the SDR as a global reserve currency but also loans demanded from countries in economic distress. However, lending capability is another limitation that the IMF faces, as it gets its money mainly from members’ quotas. When a country joins the IMF it is assigned a quota which determines the financial contribution that this country makes to the IMF. Thus the IMF (2009b) receives money from members to finance lending through two borrowing arrangements: the General Arrangement to Borrow (GAB) which allows the IMF to borrow up to US$27 billion from 11 industrialized countries and the New Arrangements to Borrow (NAB) which, after the G-20 meeting in September 2009, increased up to US$600 billion (IMF 2009c). Thus, the IMF’s lending capabilities rest on the commitment of members to honor theses two bilateral borrowing arrangements. Table 5.10 explains which are the countries participating and which are the quotas committed to the Fund. This table shows that traditional rich countries like the US, the UK, Japan, France, Germany, etc., are the countries contributing the most to the borrowing agreements. Consequently, it has to be concluded that the IMF suffers from a serious flaw that would prevent the SDR from supplanting the US dollar as the leading international reserve currency. Empirical Study: BRIC Countries and their Quest to End the Hegemony of the US Dollar as an International Reserve Currency Brazil, Russia, India, and China (the BRIC countries) have suffered major economic, social, and political transformations in the first decade of the twentyfirst century which have attracted the interest of investors. These countries are experiencing dramatic economic transformations that are, in turn, positively influencing the political and social foundations of these countries. While from a political point of view a country is politically consolidated when a democratic constitution is freely ratified by the citizens, and it is socially matured when the country abides by the terms of the International Bill of Human Rights, a country is economically developed when its currency is traded in the foreign exchange market and exposed to forces of demand and supply; that is,

The Euro in the 21st Century

132

Table 5.10

Participants and credit amounts in IMF’s NAB and CAB arrangements

NAB participants

Credit amounts (SDR millions)

Credit amounts (SDR millions)

Australia Austria Banco Central de Chile

801 408 340

Belgium Canada Denmark Deutsche Bundesbank Finland France Hong Kong Monetary Authority Italy Japan Korea (Rep. of South) Kuwait Luxembourg Malaysia Netherlands Norway Saudi Arabia Singapore Spain Sveriges Riksbank Swiss Nat Bank Thailand UK US Total SDR (millions)

957 1,381 367 3,549 340 2,549 340

Belgium Canada Deutsche Bundesbank France Italy Japan Netherlands Sveriges Riksbank Swiss Nat Bank UK

Total US$ (millions)

53,000

1,753 3,519 340 341 340 340 1,302 379 1,761 340 665 850 1,540 340 2,549 6,640 34,000

Credit amounts (1983–2008) (SDR millions) 595 893 2,380 1,700 1,150 2,125 850 383 1,020 1,700

US

4,250

Total SDR (millions) Total US$ (millions)

17,000 27,000

Source: IMF

free of government intervention. The Brazilian real, the Indian rupee, the new Russian ruble, and the Chinese yuan are, due to political circumstances, neither fully convertible nor liquid, and are all under strict government supervision and intervention. These currencies will, however, sooner rather than later become

The New Monetary Order of the 21st Century

Table 5.11

133

Foreign exchange turnover, net of local and cross-border interdealer double-counting, by instrument, counterparty and currency (in US$ millions)

Total reported transactions, assuming 254 trading days per year

20041 20072 Difference

Brazilian real

Indian rupee

$1,103,376 $2,822,448 $1,719,072 + 155%

$1,540,510 $5,366,766 $3,826,256 + 248%

New Russian ruble $3,100,578 $6,301,740 $3,201,162 + 103%

Chinese yuan

Total

$442,468 $3,716,274 $3,273,806 + 739%

$6,186,932 $18,207,228 $12,020,296 + 194%

Table E1, Statistical Annex, Triennial Central Bank Survey April 2004, Bank for International Settlements (BIS). 2 Table E1, Statistical Annex, Triennial Central Bank Survey April 2007, Bank for International Settlements (BIS). 1

Table 5.12

Estimated reserves of foreign exchange and gold (as at December 31, 2008)

Country

Rank

US$ millions

China Russia India Brazil

1 3 5 7

1,955,000 427,100 254,000 193,800

Source: Central Intelligence Agency, The World Factbook, Country Comparison, at (accessed November 13, 2009)

convertible and liquid, becoming major international players and transforming the FX market of the twenty-first century. Table 5.11 presents the total FX turnovers of these four BRIC currencies which have all increased significantly from 2004 to 2007. For instance, the yuan has increased its turnover by 739 percent, the new Russian ruble by 103 percent. This table shows that these four emerging currencies, which are neither fully convertible nor liquid, have increased their total FX market turnover by almost 200 percent in the past three years, proving that once they become fully tradable currencies, the FX market will be enter a new era. These four countries have not gained an important weight because of the future impact of their national currencies in the FX market, but because their economic transformation has helped them increase tremendously their reserves of foreign

134

The Euro in the 21st Century

Graph 5.5  Time series data on international reserves and foreign currency liquidity—selected countries Source: IMF Time Series Data in International Reserves and Foreign Currency Liquidity. See (accessed November 13, 2009)

currency, mainly in US dollars. Table 5.12 shows that the BRIC countries rank among the top ten countries in terms of foreign reserves accumulated. Furthermore, Graph 5.5 presents the composition of the currency reserves of Brazil, Russia, and India as reported by the IMF from November 2008 to September 2009. Note that the IMF does not report on the reserves held by China but only on the amount held by Hong Kong. This is consistent with the fact that China does not make the exact amount of its foreign reserve holdings public. The important economic relevance of these countries and their increasing presence in the FX market makes it interesting to study how these countries have diversified their foreign currency holdings in terms of the balance between the US dollar and the euro since 1999. However, each central bank is free to report the foreign exchange reserves by currency. The IMF only reports quarterly the total Currency Composition of Official Foreign Exchange Reserves (COFER) in the terms of the US dollar, euro, pound, yen, Swiss francs, and other currencies, but does not include any description of holdings of each currency by the issuing country (IMF 2009d) (see Table 5.13). As countries do not have to report on exact currency composition, the IMF has to present in its reports an entry titled “Unallocated Reserves.” The IMF (2009d) explains that unallocated reserves account for the difference between the total reserves data that countries report to International Financial Statistics (IFS) and to COFER and that it consists of two components: The total reserves of nonreporting countries, i.e., the countries within each grouping, which do not report currency composition data to COFER, and any discrepancy between reporters’ data on total reserves as reported to COFER and to IFS. The Allocated Reserves line equals the reporters’ data on total reserves as reported to COFER.

The New Monetary Order of the 21st Century

135

Table 5.13 shows that this group of reserves has increased significantly from US$291,225 million in 1999 to US$2,141,030 million in 2008; much of this increase can be explained by the “secret” accumulation of foreign reserves by China as this country does not provide official reports of its holdings. There are only estimates that China has US$468 billion in US Treasury and that its FX reserve may have reached US$1.95 trillion. Table 5.13

Emerging and developing economies (in US$ millions)

1999 Total foreign 673,819 exchange holding Claims in:

2000 732,984

2001 818,073

2006 2007 2008 2,818,127 4,016,205 4,194,149

US dollars

278,090

311,089

334,468

834,402

1,232,822 1,2371,91

UK pounds

9,436

10,788

12,367

80,487

116,643

109,740

Euros

72,708

83,713

98,043

411,669

583,177

627,290

Unallocated reserves

291,225

308,688

356,696

1,451,073 2,016,388 2,141,030

Source: International Monetary Fund, “Currency Composition of Official Foreign Exchange Reserves (COFER),” September 30, 2009, at (accessed November 13, 2009)

While the IMF reports overall reserve data, each central bank is free to publish the FX reserves holdings at will. Out of the BRIC countries, only Russia and Brazil publish their foreign reserves holding composition by currency. Since 2007 the Bank of Russia has published the Bank of Russia Annual Report (2008) which includes the FX reserve composition. Graph 5.6 shows that from 2007 to 2008 Russia has changed the composition of its reserves. It has decreased its percentage in US dollar and pounds sterling and has increased its position on euro and yen. In June 2009 the Banco Central do Brasil (2009) began to publish the Relatorio de Gestao das Reservas Internacionais which includes the bank’s holding of foreign reserves from the first semester of 2002 to the second semester of 2008. Graph 5.7 plots the data and shows that Brazil has been increasing its reserves of US dollars and decreasing its allocation in euros. Curiously enough, while Russia is increasing its exposure to the euro, Brazil has increased its reserve holdings in US dollars. Despite the fact that these four countries are an important economic motor, today’s economic debate revolves around China and the Chinese yuan. Since the transfer of sovereignty of Hong Kong to the People’s Republic of China took place on July 1, 1997, China has developed a “one country, two systems” policy which has also meant two currencies: the yuan and the Hong Kong dollar. While the Bank of International Settlement (BIS) reported in 2007 that the Hong Kong

&ŝŐƵƌĞϱ͘ϲ͘ĂŶŬŽĨZƵƐƐŝĂ&ŽƌĞŝŐŶdžĐŚĂŶŐĞZĞƐĞƌǀĞƐďLJƵƌƌĞŶĐLJ ϲϬ ϱϬ ϰϬ ϯϬ ϮϬ ϭϬ Ϭ h^Ψ

ƵƌŽ

zĞŶ ϮϬϬϳ

Graph 5.6

WŽƵŶĚ

ϮϬϬϴ

Bank of Russia foreign exchange reserves by currency

Source: Bank of Russia, “Bank of Russia 2008 Annual Report,” at (accessed December 2, 2009)

*UDSK%DQFR&HQWUDOGR%UDVLO5HVHUYH&XUUHQFHV&RPSRVLWLRQ            











 86GROODU

Graph 5.7

 (XUR













2WKHU

Banco Central do Brasil—reserve currency composition

Source: Banco Central do Brasil. 2009. “Relatorio de Gestao das Reservas Internacionais,” at (acessed December 2, 2009)

138

The Euro in the 21st Century

dollar was the ninth most traded currency in the world, the yuan is subjected to heavy intervention to maintain a certain price level with the US dollar; a level which is considered to be undervalued by the US authorities and which has stirred the current debate. The concern over the currency relationship between the US and China has made a bestseller of a financial novel entitled Currency Wars 2 by Song Hongbing (Buckley 2009). Due to this massive accumulation of US dollars and the depreciation of the US dollar, the Chinese authorities are challenging the role of the greenback as a global currency as the dollar’s declining path is damaging the value of China’s foreign reserve holdings in US dollars. Hence, China wants to end the US dollar’s monopoly as an international reserve currency but does not seem to regard the euro as the next global currency; rather, China is pushing for the Special Drawing Rights (SDRs) (IMF 2009e). Zhou Xiaochuan, the governor of China’s Central Bank, has called for a “super-sovereign reserve currency.” This urge follows economic need because China needs to defend the value of the estimated US$1.2 trillion FX reserves as the US dollar is depreciating. China is immersed in a dollar trap and it is furthermore attracting substantial inflows of foreign capital, thus running a large trade surplus. As a consequence, the country is suffering from excess liquidity, which has granted China an informal creditor status and even that of a new lender of last resort when the IMF and the World Bank are not eager to lend, particularly to certain countries in Latin America. The explanation of China’s dollar trap lies in the fact that China is not letting its currency fluctuate freely in the FX market to arrive at a fair market value and thus the devaluation of the US dollar is negatively affecting the value of China’s US dollar holdings. Nowadays, the debate on whether the Chinese currency is undervalued is a matter of economic survival for certain countries, mainly the US and the EU. In fact, the Obama presidency has been addressing this issue and has been implementing a new hardline stance on China’s currency policy in order to improve the US labor market. It is estimated that, as of April 2010, the Chinese currency is undervalued by as much as 40 percent, which means that it is enjoying a 40 percent margin of competitive advantage for the export of its goods and services. This is having a negative effect on the various economies worldwide that simply cannot compete with this undervalued currency which maintains prices of goods and services extremely low, making “Made in China” products very attractive. This situation with the yuan is not new but it has now become a more pressing issue because of the current economic situation, particularly because it is estimated that this 40 percent devaluation is equivalent to 1.5 million jobs lost in the US’s manufacturing and service sectors. However, there has been a shift in the hardline position first expressed by the government. First and foremost, there has been a delay in the presentation to Congress on April 15, 2010 of a report that would have openly stated that China is manipulating the yuan to benefit its exporters and its economic growth. However, “the US Treasury Department is postponing a contentious report on international exchange rates, a move that allows the Obama administration to

The New Monetary Order of the 21st Century

139

avoid the delicate question of whether to label China a currency ‘manipulator.’” (Politi et al. 2010, 1). There are a number of analyses that try to explain this change in the approach to have China revalue the yuan. On the one hand, it is believed that “Washington has shied away from such a hardline position, with most economists believing it is reluctant to do so for fear that Beijing will withdraw its key role in financing the US budget deficit by curbing its huge purchases of US Treasury bonds” (Duncan 2009). The second explanation that has been used is that the US is seeking China’s support on the nuclear proliferation debate. Nonetheless, there is a debate on what is the real effect on both side of the debate when the yuan is adjusted. For instance, there are some studies that concluded that Between July 2005 and July 2008 the renminbi [or yuan] rose 21 percent against the dollar, to $0.1464 from $0.1208, where it had been pegged since 1997. But the trade deficit, according to the trade statistics compiled by the US Census Bureau, nevertheless, increased to $268 billion from $202 billion over that period (Ikerson 2010, 1).

Another study concluded that “China’s exports fall by about 1.5 percent when its trade-weighted exchange rate, adjusted for inflation, strengthens by 1 percent” (The Economist 2010, 75). Graph 5.8 plots the yuan and the Hong Kong dollar since April 2008. It is interesting to point out that since September 2008 both currencies have traded within bands. This proves that there is a de facto peg to the US dollar. This demonstrates that the Chinese monetary authorities are intervening in the FX market to maintain both currencies within a particular price with respect to the US dollar. This is basically government speculation and financial dumping to maintain an artificially low currency in order to gain currency competitiveness against other currencies. When there is too much international pressure, the Chinese authorities loosen their grip a little. China can have such an interventionist approach because of the fact that the undisclosed amount of US dollars that China has in reserve is sufficient to maintain this artificial exchange rate. Chinese authorities, who should therefore be considered the biggest currency speculators, have triggered the current debate between monetary authorities in the US and in the Eurozone as both economic blocs complain that the yuan is unfairly undervalued. The point is that an undervalued currency distorts the economy, as in the case of China a cheap currency is helping China obtain a trade edge but distorts prices and leads to the wrong investment decisions. Graph 5.8 also shows that the covariance between the Hong Kong dollar and the Chinese yuan, particularly since June 2009, is converging to zero: Lim Cov CHY, HKD → 0 The de facto peg of both Chinese currencies to the US dollar is confirmed when analyzing the cross-rate of the yuan and the Hong Kong dollar with the euro. Graph 5.9 plots the euro/US dollar and the euro/Hong Kong dollar FX cross-rates. On the one hand, this graph shows that from April to November 2008, the euro has

140

The Euro in the 21st Century

Graph 5.8

Chinese yuan and Hong Kong dollar

Graph 5.9

Euro and the euro/Hong Kong dollar composite

Graph 5.10 Euro/yuan and euro lost value with respect to the US dollar and that in 2009 the euro began gaining value again. On the other hand, it shows that the Hong Kong dollar has been losing value against the euro and demonstrates that there is a de facto peg with the US dollar. The same pattern can be analyzed in Graph 5.10 which shows the euro against the yuan and the euro against the dollar.

The New Monetary Order of the 21st Century

141

Final Words This chapter explains that the current economic crisis and financial uproar have stirred a debate on the necessity to have a new monetary order solely focused on the goal of ending the dependency on the US dollar. It has been shown that the greenback is a global and an international currency which has, in turn, become an international reserve currency. These characteristics have led the dollar to be considered a common global currency, a status that no other currency has previously ever achieved. The idea of revising the current international monetary system has been presented by a group of countries which are slowly but surely introducing their national currencies into the FX market and which are among the biggest holders of foreign reserves. This chapter has presented the two alternatives that have been proposed as substitutes for the US dollar. On the one hand, there is the idea of a global common currency along the lines of the euro and the European Monetary Union. The main proposal comes from Robert Mundell who believes that a global common currency will help reduce transaction costs and improve price transparency, thus boosting trade and international business. Although it would be very efficient to have just one global common currency, the different business cycles and the lack of homogeneity in the monetary and fiscal status of different countries makes this proposal unviable. However, this chapter takes the example of the pound to explain that the FX market is truly affected each time a national currency ceases to exist because it joins a monetary union. In fact, the study of the pound demonstrates that if the pound were to join the euro and cease to exist, consumers would save money in transaction costs, which would make trade more expensive and reduce the trading profits of the market makers. The other option rests on the idea of substituting the US dollar as an international reserve currency by the SDR issued by the IMF. This chapter presents both the benefits but most importantly the difficulties that the SDR would face if it became the next international reserve currency. This chapter further analyzes the impact that Brazil, Russia, India, and China are having in the new monetary systems as these economies are considered to be the future of the economic development and progress of this century. Finally, this chapter brings to light the intense debate on China’s monetary policy for the past five years. China is witnessing an economic miracle due to an aggressive export-driven policy aided by a pegging of the yuan to the US dollar at an almost 40 percent devalued value. While this economic practice has been going on for years, it has been the difficulties of the recent economic crisis that have revealed the trigger that has made the US authorities tackle the issue. This chapter demonstrates that in fact China is maintaining a currency peg, and that Chinese authorities are practicing a new system of financial engineering to maintain both the yuan and the Hong Kong dollar artificially low to gain an unfair competitive advantage at the expense of other countries’ economic growth and standard of living.

This page has been left blank intentionally

Chapter 6

The Eurozone and its First Economic Crisis This chapter presents an overview of the economic and monetary performance of Eurozone Member States, and it explains their current situation (as at early 2010). It highlights that before the introduction of the euro, Portugal, Italy, Ireland, Greece, and Spain (also known as PIIGS countries) were in constant financial and economic turmoil, a situation that disappeared due to the economic prosperity of the following years and the economic and monetary sobriety that adopting the euro imposed on them. Nevertheless, after the PIIGS countries, also known as the Garlic Belt countries, adopted the euro they have barely met the economic and monetary requirements imposed by Maastricht. As economic hardship intensified, these Eurozone Member States began to feel how their already feeble monetary and economic stability was becoming increasingly difficult to maintain and even more impossible to disguise. In fact, in the past years, PIIGS countries are not only suffering from excessive deficits and debts, but are also overwhelmed with other economic unbalances such as unmanageable and excessive current account deficits, which the current economic crisis is exacerbating due in part to their extremely uncompetitive trade position; as a consequence, they are beginning to blame the euro. The problems these countries are facing stem from the fact that monetary union amplifies fiscal unbalances, because opting for competitive currency devaluation is no longer an option, and the only other alternative comes from abusing fiscal policy which consequently affects sovereign bond yield differentials. This chapter shows that in 2005 there were almost no yield differentials between the German Bund and the yields of those countries with excessive current account deficits. In the past year, however, yield spreads have become a worrisome reality, which has in turn increased government default risks, measured by a sudden increase in the demand for credit default swaps (CDS). Hence, the current economic turmoil has, in fact, demonstrated that in a monetary union currency risk is substituted by default risk, because the sovereign debt of each Member State is issued under the control of respective Ministries of Finance, due to the fact that there is no European Ministry of Finance. The Treaty of Maastricht forces Member States to obey a common monetary policy, but when it comes to the fiscal requirements each Member State is free to implement fiscal measures; therefore, fiscal policy has become the escape valve to help offset monetary pressure. Most of the   Before the economic meltdown of Ireland, only Portugal, Italy, Greece, and Spain were labeled “PIGS.” After Ireland’s economic problems, the group expanded to adopt Ireland and it became the “PIIGS.”

144

The Euro in the 21st Century

countries in dire straits are not complying with fiscal requirements, and it is argued that these countries should have been compelled by EU authorities to respect to limits. However, there have been times when countries such as Germany and France did not respect these limits either and were not punished. The difference is that Germany and France have an economic and fiscal structure completely different from that of Greece, Portugal, and Spain. Under the current economic turmoil, these scenarios have become a dangerous liability to ignore. In fact, Greece has become the focus of attention because its economic circumstances have almost caused the disintegration of the union. This chapter touches on the economic problem in Greece to analyze the importance of the Stability and Growth Pact (SGP) as a stabilizing factor. This chapter goes on to show how fiscal instability is now present in the bond and equity markets which, in turn, are negatively affecting the financial strength of not only those countries involved but of the entire union. This chapter explains that the problem is not just that certain countries are not complying with the criteria of debt and deficit constrain, but that certain countries should be further examined. Attention is given to understanding the state of the current account of many of the countries involved in this financial uproar as this account helps shed light on the current situation and demonstrates that those countries with week current accounts, high government debt and deficits, and timidity with structural reforms are bound to face great economic calamity. This chapter concludes by thoroughly analyzing the economic, political, and social situation of Spain, which is a country that has caused grave concern as to the stability of the EU due to its high public debt, current account deficit, and unemployment. The Current Economic Crisis and Financial Uproar After two years of economic recession that began in 2008, the Eurozone has started 2010 with a full-blown debt crisis. European public finances are completely unbalanced and becoming unsustainable. The reason is that governments—in order to face the current economic crisis and financial uproar—have dramatically increased spending. The result is that the requirements of the SGP have been breached. This Pact has proven to be decisive because those countries that have not respected it are having serious problems. However, current imbalances are not only due to the lack of commitment with the SGP, but also to overdebt in the corporate sector and disastrous current account positions. The government deficit of OECD countries has increased since 2007 from 4 percent of GDP to 8 percent in 2009, and government debt has risen from 35 percent of GDP to a scary 100 percent of GDP, with an unprecedented increase in Ireland, Greece, Spain, and Portugal (OECD 2009b). Graph 6.1 shows government debt level for certain countries and the overall level for “all countries,” which demonstrates that government debt level is close to 100 percent of 2007 GDP.

*UDSK*RYHUQPHQW'HEW/HYHO 'HFRPSRVLWLRQRIWKHJURVVJRYHUQPHQWGHEW



RI*'3

   

'HEW

&XPP'HILF

$GGLWLRQDO)DFWRUV$IIHFWLQJ'HEW

Graph 6.1  Comparative analysis of government debt levels, 2010 Source: Bloomberg Finance LP

$O -3 OF RX 1 QW ULH V

$

,6 /

,7

%( /

8 6$

35 7 )5 $

$8 7 & $1 + 8 1 * %5

,5 / 32 / 1 /' ' (8

(6 3

& =(

1 6: (

),

;

1 =/ & + ( ' 1 .

/8

$8 6



*UDSK(XURDUHD*RYHUQPHQW'HEWDVRI*'3          

Graph 6.2













Euroarea government debt as % of GDP

Source: Bloomberg Finance LP















*UDSK*RYHUQPHQW'HEWLQ(DVWHUQ(8&RXQWULHV          3RO

&5HS

+XQJ

%XO 

Graph 6.3

5RP 



Government debt in Eastern EU countries

Source: Bloomberg Finance LP

(VWR 

/DW

/LWK

148

The Euro in the 21st Century

The government debt level is particularly important for Eurozone Member States because these countries are forced to meet these requirements. Graph 6.2 shows that never since 1995 have Member States been able to reduce their government debt to 60 percent. Graph 6.3 shows that Eastern European countries, due their political past, are facing a global economic recession and fiscal meltdown for the first time, and each country is suffering different struggles. However, they are not suffering, like the rest of the EU Member States, from high government debt. Similarly, a general study of government deficits shown in Graph 6.4 proves that almost every country of the OECD is suffering from a high government deficit and only Australia, Norway, New Zealand, Korea, Luxembourg, and Finland have a government surplus. The OECD on average, the US, and the Eurozone are all suffering from soaring deficits. This is particular important for the Eurozone Member States as they are required to maintain the deficit within the range established by the Maastricht Criteria. This deficit has increased as the economic difficulties have piled up and governments have been forced to intervene. Thus, in the Eurozone specifically, government deficits have been a constant since 1995, although the levels have been decreasing. Graph 6.5 shows that in 2000 there was almost no overall government deficits for the Eurozone, but since then these deficits have been increasing, and in 2008, the deficit level was not breaking the 3 percent maximum deficit benchmark allowed by Maastricht. Graph 6.6 shows that government deficit levels in Eastern European countries are not complying with the requirements either. Still, in 2008 most of the countries have seen an increase in their government deficits, explained by the need to intervene economically to provide some economic comfort. Those countries that have failed systematically to comply with the requirements are witnessing a worsening of financial, economic, and social stability (Magnus 2010). From an economic and financial perspective, Greece and Spain have seen how rating agencies have downgraded their sovereign debt ratings, and Ireland and Portugal have been warned. In the case of Greece, Standard and Poor’s has rated it to A–/A2, with a stable outlook (Reuters 2010b), and Fitch has rated Greece’s debt to BBB+, the lowest level for 10 years (Slater et al. 2009). Consequently, Greece saw on January 28, 2010 an increase in its 10-year bond yield to 7.25 percent, which puts this yield at the levels paid by Hungary and other emergingmarket countries bailed out by the IMF. The Greek tragedy opened Pandora’s box and exposed the difficult situation of certain countries, all of which share the same economic traits—a legacy of missed budget targets and failures of structural reforms. These have negatively spilled over into other PIIGS countries. Spain is witnessing how Standard and Poor’s has cut Spain’s outlook from AA+ neutral to AA+ negative, which has had a negative impact on the auction of 10-year bonds and will force Spain to increase yields in future issuances in order to offer incentives to future investors (Eurointelligence 2009). Countries with weak fiscal finances that have been exposed are facing an unstable situation as a result of poorly managed national funds, which is worsened by the need to pour billions of

     

 )UDQFH

Graph 6.4

*HUPDQ\

*UHHFH

,UHODQG

,WDO\

1RUZD\

3RUWXJDO

General government financial balances—selected countries

Source: Bloomberg Finance LP

6SDLQ















*UDSK(XURDUHD*RYHUQPHQW'HILFLW

      

Graph 6.5

Eurozone government deficits

Source: Bloomberg Finance LP

































   

3RO

&5HS

+XQJ

%XO

5RP

(VWR

/DW

   



Graph 6.6





Deficits and surpluses in Eastern EU countries

Source: Bloomberg Finance LP



/LWK

       *UHHFH

Graph 6.7

,UODQG

3RUWXJDO

,WDO\

6SDLQ

%HOJLXP

-XO\

0DUFK

Sovereign bond spread with German yield

Source: Bloomberg Finance LP

1HWKHUODQGV

0D\

)UDQFH

6HS

)LQODQG

'HQPDUN

The Eurozone and its First Economic Crisis

153

euros into fiscal stimulus plans and bank bailouts—all of which have devastated government finances. This situation has resulted in a crisis that is widening because governments are not acting firmly on a profound and credible budget consolidation to improve government finances. The first sign of a troubled economy is when both sovereign and corporate bonds are downgraded by rating agencies, signaling that the level of government and corporate indebtedness is becoming a source of concern. In the EU, this concern is measured by the spread between the national sovereign bond yields and the German yield. In fact, Graph 6.7 shows that this yield has increased significantly post-crisis, although the OECD reported that as of September 2009 this spread has decreased, but is still higher than before the crisis. The debt problem pertains not only to the governments, but also to European companies that, according to Standard and Poor’s, will have to roll over approximately half a billion euros (Eurointelligence 2010) of rated corporate debt coming due at the end of 2010—particularly Eastern European companies that have to endure euro- and dollar-denominated debt. As a consequence, the possibility of a high number of European companies defaulting on their debt is a specter haunting investors and government officials because slow economic recovery might take a further toll. Standard & Poor’s has stated that in 2009, the global corporate default amounted to 260 issuers, with a total of 188 corporate defaults in the US, 20 in Europe, 36 in the emerging markets, and 16 in other developed regions (Vazza and Kesh 2009) (see Table 6.1). The reasons behind this increase in defaults can be explained by the worsening of economic fundamentals, together with the unfavorable economic and financial prospects and global deep recessionary conditions. Table 6.1

Some European corporate defaults in 2009

Confidential (Germany) Akerys Holdings SA (France) Nadra Bank (Ukraine) Sensata Technologies BV (Netherlands) NXP BV (Netherlands) Thomson SA (France) CEVA Group PLC (Netherlands) Treofan Holdings GmbH (Germany) Alfa-Bank Ukraine (OJSC Alfa-Bank) (Ukraine) Source: Standard & Poor’s, “Global Corporate Default Update (July 31, 2009–August 6, 2009),” Global Fixed Income Research, at (accessed January 20, 2010)

Therefore, the burden rests not only on governments but also on European companies. The iTraxx Europe Index, plotted in Graph 6.8, is a benchmark index that measures the evolution of the most liquid 125 CDS, referencing European investment grade credits distributed in the financial, TMT, industrial, energy,

                                                                                                                                                                                                   

*UDSK7KH0DUNLWL7UD[[(XURSH,QGH[



















Graph 6.8 The Markit iTraxx Europe Index

Source: Bloomberg Finance LP

*UDSK(8&XUUHQW$FFRXQWLQEQHXUR    4

4

4

4

4

   

&XUUHQW$FFRXQW

Graph 6.9

*RRGV

6HUYLFHV

,QFRPH

&XUUHQW7UDQVIHUV

EU current account

Source: Bloomberg Finance LP          

*HUPDQ\

)UDQFH

1RUZD\

6ZHGHQ

6SDLQ

3RUWXJDO

*UHHFH















Graph 6.10 Current account balances Source: Index Mundi, “Current Account Balance,” at (accessed January 20, 2010)

156

The Euro in the 21st Century

consumer, and auto industries. Graph 6.8 shows that this index bottomed at the end of 2009 and has been increasing ever since until February 8, 2010, when the index reached a record high at 111.8bp. This means that it cost US$111,800 to insure $10 million in corporate bonds. This constant increase proves the unfortunate belief that European corporations’ chances of default are rising. Finally, the EU is suffering from a current account deficit that is curtailing its economic recovery, although at the time of adopting the euro, there were already current account divergences among member states. Graph 6.9 demonstrates that the EU has been carrying a deficit for the past year, even though it has been improving. In detail, out of the four components that form the current account, all of them except service are in deficit. The current account deficit in the EU and in most of the Member States has become unsustainable and a source of unrest. Given the current economic circumstances, governments should take charge and adjust accordingly. Particularly, Graph 6.10 shows that Portugal, Spain, and Greece joined the Eurozone with an already high current account deficit of around 8 percent, 3 percent, and 4 percent of GDP, respectively. This deficit has in fact deteriorated over the years, and it reached in 2009 a worrisome 10.7 percent in Portugal, 4 percent in Spain and 10 percent in Greece of GDP (OECD 2009b). A detailed analysis of the state of the current account in the most significant countries of the EU shows that Germany, Norway, and Sweden are enjoying a surplus whereas PIIGS countries, particularly Spain, are suffering from a dangerous deficit. Consequently, from a social point of view, the confidence of investors has been breached, which means that these Member States will have to pay a bigger premium and will also have to work harder to sell their bonds (Oakley 2010). To solve this confidence crisis, the European Central Bank (ECB) urged these countries to take action to significantly curve deficits downwards, and the Commission is insisting on the urgent need to cut spending and to return to economic growth to reduce the deficit from 11 percent to 3 percent by 2013, all of which can only be achieved with the implementation of a number of structural reforms. Portugal, Ireland, Greece, and Spain are running a deficit closer to 12 percent of GDP, which by far exceeds the requirement-breaching 6.9 percent of the EU. As a consequence, social unrest is increasing in countries with economic problems, particularly in Greece, where a second massive strike took place in February 2010 to protest against spending cuts (Bilefsky and Kitsantonis 2010). In Spain, unions have threatened massive protests in response to the government’s necessary plan to narrow its budget deficit by a total of €50 billion over the next four years to reduce the deficit from 11 percent of GDP to 3 percent of GDP by 2013 (Mallet 2010) and gain some international credibility (Willis 2010a). However, the economic sentiment in the Eurozone, represented in Graph 6.11, is increasing somehow. Graph 6.11 shows the EU Economic Sentiment Indicator (ESI) from January 1990 to the expected ESI for 2011 in the industrial (EU.INDU), service (EU.SERV), construction (EU.CONS), retailing (EU.RETA), and building (EU.BUIL) sectors as well as an overall indicator (EU.ESI). Curiously, since May

        

-

)

0

$

0

-

-

$

6

2



(8,1'8

(86(59

(8&216

Graph 6.11 Economic Sentiment Indicator (ESI) Source: Bloomberg Finance LP

(85(7$

(8%8,/

(8(6,

1

'

-

158

The Euro in the 21st Century

2009, the EU overall indicator is showing an improvement led by amelioration in the service (EU.SERV) and retailing sectors (EU.RETA). The worst performance is found in the building sector (EU.BUIL). The Stability and Growth Pact: A Proven Necessary Fiscal Constraint The Maastricht Treaty (Official Journal of the European Union 1992) establishes in its Article 102.a that Member States and the Community should “conduct their economic policies with a view to contributing to the achievement of the objectives of the Community” (12). In order to guide this achievement, Article 103 highlights that the correct implementation of economic policies is a matter of common concern and sets the procedure to follow, stating that “Member States [are to] coordinate them within the Council, in accordance with the provisions of Article 102a” (12). This article further highlights the importance of avoiding excessive government deficits and points out that “reference values are specified in the Protocol on the excessive deficit procedure annexed to this Treaty” (13). In fact, Article 104.C.3 clearly explains that “if a member state does not fulfill the requirements under one or both of these criteria, the Commission shall prepare a report” (13), stressing the importance of these two requirements for the proper functioning of the common currency. In order that Member States avoid excessive debt and deficits and to force them to maintain fiscal stability, the EU has set in place the Stability and Growth Pact (SGP), which the European Council adopted in December 1996 at the Dublin Summit. The SGP consists of two Council Regulations, 1466/97 and 1467/97, and requires adherence to the fiscal policies that Member States of the EU must comply with to help “contribute to the overall climate of stability and financial prudence underpinning the success of the Economic and Monetary Union (EMU)” (EurActiv 2007, 2). In particular, Council Regulation 14466/97 was signed on July 7, 1997 (Eur-Lex 1997). It is entitled “On the Strengthening of the Surveillance of Budgetary Positions and the Surveillance and Coordination of Economic Policies.” The purpose of this regulation is to set out the rules covering the content, submission, examination, and monitoring of stability programs and convergence programs as part of multilateral surveillance by the Council so as to prevent, at an early stage, the occurrence of excessive general government deficits and to promote the surveillance and coordination of economic policies. Furthermore, Council Regulation 1467/97 was signed on July 7, 1997, and is entitled “On Speeding Up and Clarifying the Implementation of the Excessive Deficit Procedure.” The purpose of this regulation is to set out “the provisions to speed up and clarify the excessive deficit procedure, having as its objective to deter excessive general government deficits and, if they occur, to further their prompt correction” (European Navigator 1997, 2). Opponents of the SGP believe it is procyclical and antigrowth. Bini-Smaghi (2007, 2) explains that “the 3 percent deficit ceiling set by the Maastricht treaty,

The Eurozone and its First Economic Crisis

159

which tends to be reached in cyclical downturns, is likely to push countries to adopt corrective measures in bad times and thus to implement procyclical budgetary policies.” Evidence that the SGP had a procyclical effect, particularly during an economic downturn, led heads of state and government to reform the SGP in order to avoid this procyclical momentum. Hence, during the March 2005 Summit, it was agreed that the SGP should be revised; the rules were relaxed to make it more enforceable. As Commissioner Almunia (2007, 12) explains, The reformed SGP maintains the overall focus on fiscal stability, while addressing a number of problems that were identified over the first five years of its existence. In particular, the new pact puts increased focus on debt sustainability and the need to make greater adjustment efforts in economic good times.

Despite its dissenters, the SGP instituted the most important policies of the Directorate General for Economic and Financial Affairs because it is considered the answer to those with concerns on the continuation of budgetary discipline in the Economic and Monetary Union (EMU). The SGP is characterized by its flexing of a preventative and corrective (or dissuasive) muscle to keep governments from applying less stringent fiscal policies at the expense of the other euro-committed countries. The corrective arm of the SGP is equipped with excessive deficit procedures (EDPs); and, it is this arm’s mission to identify and put an end to situations of excessive deficits. The European Council highlights that the SGP “ought to be respected or penalties will be imposed upon those EU countries not complying with these requirements.” As González-Páramo (2005, 5) explains, “high deficits and growing debt levels are a cause for concern. If unchecked, they are liable to have a detrimental impact on economic growth and welfare. In particular, the need to finance a large stock of public debt pushes up interest rates and discourages private investment.” German Finance Minister Theo Waigel expressed concern that some EU states might be making a one-time effort to qualify for the euro, after which they would revert to their former high levels of borrowing and endanger the stability of the new currency. The SGP was created in order to ensure that countries were engaged in a long-lasting effort. A result of these efforts was the improvement of the fiscal position of some of these countries. However, the benign economic climate that most Eurozone countries enjoyed from 1997 to 2000 that helped improve fiscal balances was a cyclical improvement. Unfortunately, by the end of 2000, a number of economic setbacks experienced by the economies of the Eurozone triggered a low-growth trend that lasted from 2001 to 2005. Under those difficult economic circumstances, most of the countries were neither complying with the SGP nor penalized for their failure to do so, which weakened the Pact’s credibility (Barysch 2003, 2). This is the case behind the decision of ECOFIN (the EU’s Economic and Finance Council), made in November 2003, to put on hold the excessive deficit procedure for France and Germany and to adopt, instead, a set of political conclusions in

160

The Euro in the 21st Century

order to avoid further economic instability. However, the Commission believed that the behavior of the Council put the credibility of the SGP at serious risk. This resulted in a dispute between the Council and the Commission that was eventually settled by the European Court of Justice (ECJ). To add insult to injury, the ECJ did not come to a final conclusion. According to Dutzler and Hable, the ruling was “solomonic,” since “the Court shared the Council’s perception and declared the action inadmissible to the extent that it concerned the failure of the Council to adopt the recommendations. In turn, it followed the Commission’s claim and annulled the Council’s conclusions in its essential elements” (2005, section 3.1). This dispute further hindered the credibility of the SGP, which was considered insufficiently flexible to aid in the recovery of the battered economies of Eurozone Member States. In fact, Romano Prodi once stated, “I know very well that the stability pact is stupid, like all decisions which are rigid” (Keaney 2002). The old Pact forced Member States to implement the proposed corrections in only four months, and the exceptional circumstances under which a deficit of 3 percent was not considered excessive were (1) unusual events such as natural disaster, and (2) a severe economic downturn with a decline in GDP larger than 2 percent. However, the new Pact gives Member States six months to implement the proposed corrections and provides an explicit long list of exceptional circumstances. The new pact specifies that A deficit above 3 percent of GDP is not necessarily considered excessive if it can be shown that the breach is “exceptional and temporary.” In this context, a deficit can be considered exceptional if it results from a “severe economic downturn.” The new pact has made the definition of severe economic downturn less stringent. Now, any negative growth rate, or even a period of positive but very low growth compared with the trend, can be considered exceptional (González-Páramo 2005, 4).

The new modifications to the Pact are still not sufficient to make governments comply with it and the SGP continues to be unevenly respected. There are many concerns on the part of the ECB, the German Bundesbank, the Union of Industrial and Employers’ Confederation of Europe (UNICE), and the International Monetary Fund (IMF), all of which consider the Pact to have been weakened by the modifications made to it. Nevertheless, the Commission is endlessly pushing EU Member States to observe the SGP for the sake of a successful EU and stable euro. Case Study: Spain and the Euro The current economic turmoil is a global phenomenon that is affecting every economy and country. Spain, too, has been profoundly affected and is currently (2010) in dire straits. Spain has faced two great economic opportunities in the past—once with the discovery of the New World and, currently, with its

The Eurozone and its First Economic Crisis

161

admittance into the EU—the transformation of its means of production to take off economically and become a great power. The loss of its colonies impacted the Spanish economy because during the Empire, Spain relied on the riches that arrived from the New World and did not invest in developing its national means of production. Thus, Spain suffered economic, political, and social instability when the flow of wealth from the New World ceased. Spain joined the EU and has received great amount of economic resources that were not used correctly as the country currently is facing a profound economic crisis mainly because it still lacks the correct means of production to be competitive and productive. In addition it no longer has the peseta to adjust; adjustment was based on a competitive devaluation of the currency to gain a competitive level that was lost because Spain was neither productive nor competitive. As a consequence, the euro is blamed. However, joining the EU and adopting the euro have been highly positive for Spain. On the one hand, the EU provided Spain with economic help to improve Spanish infrastructures and means of production; that is, to help make Spain more competitive. On the other hand, this study demonstrates that the euro has not been a negative factor for the Spanish economy; on the contrary, the euro has stabilized the economy and softened the impact of the crisis. Hence, joining the EU and adopting the euro have been as beneficial as the discovery of the New World, and Spain should keep on working to meet the requirements necessary to be part of this selected group of countries. From the Empire to the Euro: The Spanish Peseta as an Adjustment Tool Spain developed a national identity when the Iberian Peninsula became a region of the Roman Empire. After this, the country went through a fitful process until 1492, when the Christian kingdoms in the north of Spain gradually rolled back Muslim rule and the country began its journey to become the Kingdom of Spain. In 1492, Spain not only became a unified country but also, as Columbus reached the Americas, became a global empire. The Spanish Empire helped bring back new knowledge from the New World which, in turn, transformed European understanding of the globe and led to a new way of life. The Spanish Empire was one of the largest in world history. Spain developed trade links with all its colonies, and all kind of goods, ranging from precious metals to new crops, provided Spain with massive amounts of wealth. Spain, however, began to lose the New World, and by 1898, had lost all its colonies. The loss of the Empire revealed that Spain during this time had done nothing other than wait for the riches of the New World to arrive onshore. With no colonies to support Spain with money and no other industry to take over the gap left by the colonies, the country began to suffer an economic meltdown that led to social unrest and a series of political confrontations. The loss of the colonies revealed that Spain was bankrupted despite the flow of money received and that Spanish factors of production lacked competitiveness, because the country knew no alternative ways of economic production other than trade with the colonies.

162

The Euro in the 21st Century

In the twentieth century Spain had difficulties maintaining its finances and developing viable factors of production to make industrial and agricultural production competitive. As a consequence, the Spanish peseta was adjusted when the country was falling far behind. The peseta was first introduced in 1868, when Spain was preparing to join the Latin Monetary Union (1868–1927). Curiously, the peseta disappeared when Spain joined the EMU and adopted the euro. Garcia Delgado and Serrano Sanz (2001) report that the “legal parity of the new currency with the pound sterling and the US dollar was set at 25.22 and 5.18 pesetas respectively.” From the time the peseta was introduced, it suffered many critical moments, which led to a number of competitive devaluations. When the peseta was replaced by the euro, competitive devaluation, as a monetary tool to gain competitiveness, was no longer a solution, which meant that the government had to work towards maintaining the budget under control. The Spanish peseta joined the Bretton Woods Agreements in 1958, pegging the peseta at a value of 60 pesetas to one US dollar and forcing the currency to maintain a fixed but adjustable parity. Spain was part of this club until 1964, when the system began to become unstable and a more flexible parity regime was adopted. During these years, the country and the peseta greatly benefited from participating in the Bretton Woods System. In fact, Jaime Caruana (2004, 1), during the inauguration of the conference titled “Dollars, Debt and Deficits—60 years after Bretton Woods,” explained that in the early years of its participation … Spain received financial and, most importantly, technical assistance from this institution, as part of the process of external openness and liberalisation that allowed its economic take-off in that period. [Spain received] excellent technical guidance in this process, supported by those economic sectors in favour of liberalization.

However, Caruana stated that these needed reforms met notable resistance. Garcia Delgado and Serrano Sanz explain that, in 1967, two years after Spain left the Bretton Woods Agreement, the peseta suffered its first competitive devaluation. The county had an expanding economy because it had opened its borders to international trade and was in a quest to modernize its industrial and agricultural sectors by modernizing factors of production. However, once outside the Bretton Woods club, the country had no pressure to maintain economic and monetary austerity. In fact, as the country was oriented towards economic development and modernization, it implemented a basic expansionary policy, a policy that could not be properly controlled because the country did not yet have the necessary monetary tools to implement a successful monetary policy that would control monetary accumulation. Hence, the country witnessed a worsening of its trade balance because it needed to buy all types of products and raw materials to put its industry back to work to begin a much-needed “catch up.” Consequently, the country began to suffer from high inflation rates and low competitiveness, and it witnessed the worsening of the foreign sector. Spain, therefore, had to devalue

The Eurozone and its First Economic Crisis

163

the peseta for the first time in 1967, establishing a new rate of 70 pesetas to one US dollar (Torrero Manas 2008). By 1976, the world suffered a second oil crisis that not only forced countries to adjust to the new economic conditions but also, most importantly, to transform productive systems. Spain, which was in the middle of a political transition as it was drafting the basis of its new political system, did not adapt to the new market conditions. In fact, the government, in order to control any social tension, gave subsidies to industries, allowing them to maintain artificially high prices. These subsidies further allowed Spanish industry to maintain salaries and prices for products having market values less than their production costs. The result was that Spain witnessed an increase of the public deficit because the prices of goods and services were artificially maintained as government subsidies made up for market losses. This kept nominal wages high but with a decrease in domestic and international sales due to economic conditions and expectations. The country suffered a dramatic decrease of industrial benefits and a sharp rise in unemployment. In order to offset economic imbalances, as Garcia Delgado and Serrano Sanz explain, in July 1977, the government implemented a 24.87 percent devaluation of the peseta against the US dollar to regain competitiveness. Unfortunately, this move did not serve its intended purpose, and the Spanish balance of payments went into a downward spiral, negatively impacting foreign investors, whose much-needed money fled the country. To solve the economic situation, the Moncloa Pact was signed with a political consensus. Torrero Mañas explains that this Pact helped moderate wages and implement structural changes and programs oriented towards the opening up of the financial system and the modernization of the public sector. Spain soon witnessed an improvement in GDP, a reduction of the inflation rate, and better labor conditions. However, the economy of Spain never managed to gain stability, and by the 1980s, despite the reduction in the price of oil, GDP was still low, inflation high, and the labor market was a constant worry, with unemployment levels close to 20 percent of the population. This situation led to the first truly democratic devaluation, which took place in 1982, when the first Socialist government took office. With the support of almost all parties the peseta was devalued. This move was understood as a necessary measure to help the country gain the competitiveness that it needed (Arancibia 1982). In 1986, Spain joined the EU and began an economic expansion, helped by a worldwide economic bonanza and money received from the Structural and Cohesion Funds allocated by the EU to help Spain catch up with the rest of the Member States. The Spanish economy was still not controlled, but with greater political stability, the Spanish government could implement new adjustments that, together with the expansionary phase of the business cycle, helped the Spanish economy to recover and to qualify to join the European Monetary System (EMS) on June 19, 1989. This prosperous economic situation provided Spain with the necessary social and political stability to implement the reforms needed to qualify for the euro, which meant that monetary and fiscal stability

164

The Euro in the 21st Century

had to be respected. With the euro and all the economic support obtained from the EU, Spain flourished economically, becoming, according to the World Bank, in 2008 the tenth-largest economy in the world in terms of nominal GDP. However, the global economic crisis that began to unfold in 2008 has hit Spain disproportionately hard, and the country is again suffering from a budget deficit that, together with low competitiveness, is negatively impacting Spain and is stirring a debate on the future of the euro in Spain. During the 1990s the peseta suffered a number of major devaluations, caused not only by the economic difficulties within the country, but also by the crises of the system and the speculative attacks against the EMS. The first major devaluation took place on September 16, 1992, when the peseta lost 5 percent of its value and then again on November 21, 1992, when it lost 6 percent. In 1992—a special year because Spain hosted in Barcelona the 1992 Olympic Games and in Seville the “Expo” commemorating the 500th anniversary of the discovery of the Americas by Christopher Columbus—although Spain reduced its unemployment rate to 11 percent, the country suffered a difficult budget problem because it had to face all the expenses related with these two major events that presented the “new” Spain to the world. As a consequence, on May 13, 1993, the Spanish economy was shaken with negative macroeconomic data as the Spanish deficit reached 3.77 billion pesetas, or 7 percent of GDP, which by far exceeded the 3 percent required by Maastricht in order to adopt the euro. Inflation was close to 4.5 percent, and unemployment was uncontrolled, with 24 percent of the population seeking a job (Sanchez 1993). Under this circumstance, the Spanish economy entered a severe recessionary period. Although the monetary authorities tried to defend the peseta from speculative attacks by putting into the fight 3.2 billions pesetas, the peseta suffered a third devaluation on May 13, 1993. This time, the peseta lost 8 percent of its value (El País 1993). Finally, the peseta had to face another painful devaluation. This time Pedro Solves— the Spanish Economic Minister—decided, with the approval of Europe, to devalue the currency by 7 percent on March 5, 1995 (Vidal-Folch and Carvajal 1995). This would be the last competitive devaluation of the peseta since its creation 130 years before. Graph 6.12 plots the evolution of the Spanish budget from 1985 to 2000 (Moslares Garcia and Gonzalez Sabate 2002), showing how the budget has been sinking into negative territory, and there is a primary reason for this. Gil-Ruiz Gil-Esparza and Iglesias Quintana (2007) explain that the Spanish public deficit began to increase as soon as the new democratic government began to broaden the welfare system to satisfy the increase in social demands. Furthermore, Graph 6.12 demonstrates the efforts Spain suffered in order to be able to meet the Maastricht Criteria and adopt the euro in 1999. Table 6.2 presents key macroeconomic data that reveal the underlying difficulties of the Spanish economy as well as the percentages by which the peseta was devalued over time. By 1996, the economic scenario of Spain had radically changed, boosted by the expansionary phase of the business cycle, which, according to the National Bureau of Economic Research (1991), began when the US economy reached

      















8QHPSOR\PHQW





,QIODWLRQ5DWH















%XGJHW RU

Graph 6.12 Recent Spanish economic history Source: Eurostat, Country Profile, at (accessed September 15, 2009)

166

Table 6.2

The Euro in the 21st Century

Macroeconomic data in time of crisis

Devaluation dates Budget deficit as percentage of GDP 1967 n.a. July 1977 >1 December 1982 5.5 September 1992 7 November 1992 7 May 1993 6.3 March 7, 1995 6.2

Unemployment Inflation (%) (%)

Devaluation (%)

3 5.71 16.79 20.06 20.06 23.90 22.77

14.28 24.87 7.6 5 6 8 7

3.39 24.54 14.42 5.93 5.93 4.57 4.67

Source: EFE 1995 and ABC 1993

a trough of activity in March 1991. Also, Table 6.3 shows that Spain began to receive money from the Structural and Cohesion Funds in 1986, which, including the entry assigned for 2007–13, will amount to an approximate total of 150,000 million euros received. Table 6.3 Period 1986–88 1989–93 1994–99 2000–06 2007–13

Structural and cohesion funds received by Spain since 1986 € millions (approx.) 1,700 13,000 56,000 45,000 35,000

Despite this influx of money from the EU, Spain also helped its own case because the government decisively implemented a number of painful measures to set the economy back on track, which helped the country comply with the EU’s requirements to adopt the euro on time. Spain reacted positively to these measures, boosting the internationalization of Spanish companies that “spurred on by cultural affinity and a shared language … collectively spent an average of $9.7 billion a year from 1993 to 2000, mostly in Argentina, Brazil and Chile” (The Economist 2009). This expansion helped to reduce the unemployment rate, curb inflation, increase exports, and improve the budget deficit. Despite the fact that the budget deficit in 1996 was 7 percent, the government was able to balance the budget by 2001, even obtaining a surplus in 2003 (Martínez 2003). However, this surplus was reached not only because of a favorable business cycle and a change in economic policy, but also via a modern “disentailment.” In 1996, the Spanish government began to privatize national industries such as Argentaria, Endesa, Repsol, Indra, Tabacalera, and Telefonica; an act that very much resembles the disentailment of Mendizabal and Madoz because the

The Eurozone and its First Economic Crisis

167

purpose was very similar. In 1835, Spain went through an economic revitalization process when Juan Alvaro Mendizabal and Pascual Madoz initiated an ambitious disentailment process—known as the Ecclesiastical Confiscation of Mendizabal— by which they offered in public auction land and nonproductive assets mainly owned by the Catholic Church. This measure pursued two purposes. On the one hand, it sought to help small farmers to enter bids and buy land to create a middle class of farmer-owners that did not exist in Spain before then. On the other hand, the revenue obtained was viewed as a source of much-needed income to improve the difficult economic situation of the time and to finance the Carlist Wars (1834–39). In 1996, this “modern” disentailment first aimed at helping small investors bid for shares in those privatized companies, which created a real sense of participation and inclusion. It further invited foreign investors and widened investment opportunities, stimulating capital markets and promoting liquidity and job creation. Second, the Spanish government raised money to reduce the public deficit. Consequently, the economy recovered, helped by a number of macroeconomic improvements, which strengthened consumer’s confidence, increased private consumption, attracted foreign investments, and finally, helped Spain adopt the euro on time. By the changeover date, Spain was complying with every requirement to adopt the euro. The Euro: The Spanish Debate on the Benefits and Challenges On January 1, 1999, Spain, together with ten other European countries, adopted the euro, and the peseta ceased to exist. With the euro, Spain gave up its monetary policy, losing its autonomy to control the money supply and sealing its course of action to the mandate of the ECB. When Spain adopted the euro, it had its finances in order and complied with a set of rules and regulations benefiting the Spanish economy. However, when the ECB chose to implement an expansionary monetary policy that had to fit all EU countries, Spain began to lose economic direction as it witnessed an unprecedented increase in the money supply. Spain had funds coming from the Structural and Cohesion Funds, and the world economy was booming, improving the internationalization of Spanish firms, as low interest rates encouraged national spending and reduced family savings, and Spain became a recognized worldwide tourist destination, attracting foreign investments. While in Germany, France, and the Northern European countries, this money was invested to modernize, revamp, and strengthen different factors of production to increase the countries’ competitiveness, in Spain this money ended up in the construction sector, creating a “construction bubble.” Ramirez (2008) explains that, at the end of 2007, Spanish real estate properties were overvalued 40 percent. This bubble burst, and not only set the economy off track but also highlighted that, once again, as happened at the end of the Empire, Spain had not used this economic bonanza to develop means of production to reinvent itself.

The Euro in the 21st Century

168

According to the latest macroeconomic forecasts, Spain is facing the deepest recession of the past fifty years as, in March 2010, Spain is suffering from: • • • • • • •

more than 4 million unemployed—close to 20 percent of the population— looking for a job (Rodríguez Braun 2009); a public deficit around 11.4 percent of GDP—14 billion euros—breaking one of the principles of Maastricht (Rodríguez Braun 2009); public debt at 66.3 percent of GDP, which is well over the limit set by Maastricht; a tax burden that has increased to 1.5 percent of GDP (Catan 2009); a loss of GDP of about 4 percent which means that Spanish economic growth is virtually zero (European Commission 2009); a trade deficit of about 35 billion euros, making it the second largest trade deficit in the world after the US (US$32 billion) (Europa Press 2008a); a construction sector in bankruptcy and owing 311.000 million euros to Spanish banks (Ramírez 2008).

Furthermore, Spain is not complying with any of the requirements necessary for the proper functioning of the common currency. In sum, the current economic situation reflects a total lack of economic and financial discipline. Nonetheless, instead of self-critically examining economic behavior and mistakes, Spain is unjustly blaming the euro. In fact, there are a number of studies, scholars, and financiers that are pondering and suggesting that adopting the euro has been a negative factor for Spain and that it might even become a source of social disorder (Calaza 1998). However, the euro has been a stabilizing factor for Spain. As previously mentioned, Spain suffered greatly during the 1973 and 1979 oil crises, as it is an oil-intensive country highly dependent on oil imports. Had Spain not been in the Eurozone when the price of oil began to rise between 2003 and 2008, Spain

Graph 6.13 Euro and Crude Oil Index

The Eurozone and its First Economic Crisis

169

would have suffered the same fate as in 1973 and 1979. Graph 6.13 shows that the increase in the price of oil for every country of the Eurozone was alleviated by the euro’s increasing value. In fact, as the price of oil began to increase in 2003, so did the value of the euro. The last quarter of 2008 witnessed a decrease in the price of oil and the maintenance of a high euro value against the US dollar, two factors that are still helping pay the oil bill. The stabilizing factor of the euro can be analyzed even further. Graph 6.14 presents the hypothetical case that had the peseta been in circulation under the umbrella of the EMS and the euro, the country would not have suffered a major productivity freeze because of the high price of oil. (Readers should note that the graph has been mislabeled by the data supplier: the data relates to the Spanish peseta, which in fact is identical to the Andorran peseta.) Graph 6.14 clearly shows that as the price of oil, represented by the grey line, was spiking in mid-2008, the peseta, represented in black, would have been gaining value against the US dollar, offsetting the impact of this increase in oil.

Graph 6.14 Spanish peseta and Crude Oil Index Further, Graph 6.15 shows that had Spain maintained the peseta under the umbrella of the EMS and the euro, Spanish investors would have benefited from an increase in the value of the peseta with respect to the US dollar, which would have facilitated access to the Dow Jones Industrial Average (DJIA) as its value had been decreasing. In fact, from May 2008 (point A) to March 2009 (point B), the peseta would have increased investment opportunities in the US market as the DJIA was losing value from point C to point D. Even when, in March 2008, the DJIA began to gain ground (point F), the value of the peseta would have still given the Spanish investor a competitive advantage. Therefore, these two examples show that the problem in the Spanish economy is not that Spain has the euro rather than the peseta as a national currency.

170

The Euro in the 21st Century

Graph 6.15 Spanish peseta and DJIA Spain and the Current Economic Situation Spain is not only currently immersed in an economic conundrum and is losing economic prestige, but, most dangerously, it has been identified as the next country that might bring instability to the Eurozone and the EU (Bloomberg 2010, 1). The weak economic situation has led to the downgrade that Spanish sovereign debt suffered at the beginning of January 2009, from AAA to AA+ (Ross-Thomas 2009). Since January 2009, Spain has been having problems allocating its sovereign debt (Evans-Pritchard 2008) in the market, and Graph 6.16 proves that the credit default swaps (CDS) on Spain’s debt have been rising to reach record highs as they have increased from US$18.20 at the beginning of 2008 to more than US$150 in February 2010 (Llamas 2010b). This is extremely negative for the government, which needs to issue at least 225,000 million euros in government debt in 2010 (Llamas 2010b). An increase in the price of CDS signals deterioration in the perception of credit quality. In fact, Graph 6.16 shows the evolution of the Spanish and German credit default swaps. This graph demonstrates that investors believe that the risk of bankruptcy can be higher in Spain than in Germany. At the beginning of 2009 both countries experienced an increase in their CDS, caused mainly by problems with parties at the contract. However, the increase in the gap between German and

  CDSs in the sovereign bond market are financial contracts in which buyers of the sovereign bond also buy a CDS to make sure that at the end of the term they will receive the total reimbursement of the face value of the credit instrument; hence, CDSs protect investors from default because they guarantee that the buyer of the sovereign bond will receive face value should the government fail to adhere to its debt agreements.

Source: Bloomberg Finance LP

Graph 6.16 Credit default swaps ^ƉƌĞĂĚ ^ƉĂŝŶ^ 'ĞƌŵĂŶLJ^

ϭϮͬϬϮͬϮϬϭϬ

ϮϵͬϬϭͬϮϬϭϬ

ϭϱͬϬϭͬϮϬϭϬ

ϬϭͬϬϭͬϮϬϭϬ

ϭϴͬϭϮͬϮϬϬϵ

ϬϰͬϭϮͬϮϬϬϵ

ϮϬͬϭϭͬϮϬϬϵ

ϬϲͬϭϭͬϮϬϬϵ

ϮϯͬϭϬͬϮϬϬϵ

ϬϵͬϭϬͬϮϬϬϵ

ϮϱͬϬϵͬϮϬϬϵ

ϭϭͬϬϵͬϮϬϬϵ

ϮϴͬϬϴͬϮϬϬϵ

ϭϰͬϬϴͬϮϬϬϵ

ϯϭͬϬϳͬϮϬϬϵ

ϭϳͬϬϳͬϮϬϬϵ

ϬϯͬϬϳͬϮϬϬϵ

ϭϵͬϬϲͬϮϬϬϵ

ϬϱͬϬϲͬϮϬϬϵ

ϮϮͬϬϱͬϮϬϬϵ

ϬϴͬϬϱͬϮϬϬϵ

ϮϰͬϬϰͬϮϬϬϵ

ϭϬͬϬϰͬϮϬϬϵ

ϮϳͬϬϯͬϮϬϬϵ

ϬϲͬϬϯͬϮϬϬϵ

ϮϬͬϬϮͬϮϬϬϵ

ϬϲͬϬϮͬϮϬϬϵ

ϮϯͬϬϭͬϮϬϬϵ

ϬϵͬϬϭͬϮϬϬϵ

ϮϲͬϭϮͬϮϬϬϴ

ϭϮͬϭϮͬϮϬϬϴ

ϮϴͬϭϭͬϮϬϬϴ

ϭϰͬϭϭͬϮϬϬϴ

ϯϭͬϭϬͬϮϬϬϴ

ϭϳͬϭϬͬϮϬϬϴ

ϬϯͬϭϬͬϮϬϬϴ

ϭϮͬϬϵͬϮϬϬϴ

ϮϵͬϬϴͬϮϬϬϴ

'ƌĂƉŚϲ͘ϭϲƌĞĚŝƚĞĨĂƵů^ǁĂƉƐ

ϭϴϬ ϭϲϬ ϭϰϬ ϭϮϬ ϭϬϬ ϴϬ ϲϬ ϰϬ ϮϬ Ϭ

172

Table 6.4 Country Japan Ireland Germany Belgium France Mexico Poland Spain UK US Italy Russia Argentina

The Euro in the 21st Century

Credit default risks as measured by credit default swaps prices (cost in US$ for a US$10,000 debt for 5 years) Price of CDS as at March 2009 101.1 361.1 87.6 143.8 91.7 462.4 372.9 145.8 153.8 95 192.5 766.7 3,401.3

Price on December 31, 2008 44.2 171 45.9 79.5 54.1 291.8 244.7 100.7 106.9 67.4 156.9 743.5 3,905

Price on January 1, 2008 8.5 n.a. 6.9 10.6 9.7 70 26.3 18.2 8.9 8 20.3 87.5 460.7

Spanish CDS since 2009 is due to the belief that there could truly be a problem with Spanish sovereign debt. Further, Table 6.4 compares the evolution of CDS prices per country in the past two years (Llamas 2009). While Japan has suffered the greatest increase in its risk of default, almost 129 percent, and Argentina has reduced its risk by 13 percent, Spain has increased its risk by 44 percent. However, the increase in the CDS is just the symptom of a number of malaises that have been eroding the soundness of the country for the past six years. Currently, Spain has two major concerns. First of all, it has a very weak labor market which must be restructured and improved in order to gain much-needed competitiveness. Consequently, Spain is suffering from a trade deficit and a current account situation that is unsustainable. Second, Spain must transform its productive model. While Spain was an empire, the productive model was based on the riches obtained from the New World, but eventually colonies began to gain independence and Spanish rulers did not anticipate that new forms of production had to be developed and promoted at home. Economic collapse followed. Since Spain became democratic in 1976, it has relied on the comparative advantage of the tourist and construction sectors because Spain has been the number one tourist destination and second-home country for Europeans. This was further abused when Spain joined the euro and interest rates were significantly reduced, which together led to a domestic mortgage lending frenzy and an increase in the foreign capital inflow. However, no government has faced the fact that this model will not last forever. Graph 6.17 demonstrates the decline in the Tourism Index, which since 2000 has been in a range between the 100 and 130 levels, but since October 2008 has seen a significant drop to level of 90.

Graph 6.17 Spanish Tourism Index Source: Bloomberg Finance LP



Source: Bloomberg Finance LP

Graph 6.18 Average labor costs per worker in Spain -XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

'HF

6HS

-XQ

0DU

*UDSK$YHUJDUH/DERU&RVWVSHU:RUNHU





















The Eurozone and its First Economic Crisis

175

Consequently, governments have not invested in the necessary resources to develop and branch out of this model of production into a new model, regardless of the currency it is using. The solution is to turn to an export-led model, but this is difficult to implement because most of the European countries are turning to this option, and Spain lacks competitiveness due to low productivity levels, high unit labor costs, and uncompetitive labor market laws, among other factors. Graph 6.18 in fact shows that average labor costs per worker in Spain have been increasing constantly to reach levels that surpass the 100 benchmark during 2008 and 2009, making Spain uncompetitive. Consequently, Spain has a trade deficit—shown in Graph 6.19—because it is importing more than it is exporting. An export-led economy is the root for the strengthening of Spanish cultural and educational fiber because according to the latest PISA report—which measures education level in the OECD countries— Spain ranks 35th out of 57 in reading skills and well below the EU average in math (Aunión 2007). Further, the World Economic Forum ranks Spain number 33 in the global competitiveness report (World Economic Forum 2009). Unfortunately, in Spain the current economic situation has led to a budget reduction of 36 percent for both education and research and development (Rivera 2009), which is a countermeasure that will not help the case. Consequently, Spain must improve and modernize its education and university systems. For instance, according to the OECD, Spain ranks the lowest in three of the most significant measures of academic excellence. Graph 6.20 plots the data presented by the OECD. The government must facilitate investment in the intangible assets of its citizens, which are acquired through a solid education and vocational and professional training programs. Spain must stop producing bureaucrats and start enhancing excellence among its population. It must understand that—as Einstein’s sign hanging in his office at Princeton said—“not everything that counts can be counted, and not everything that can be counted counts” (Einstein n.d.). Graph 6.21 shows that Spanish productivity was in fact the highest among the group of countries studied, but after introducing the euro in 2000, Spanish productivity has become the lowest of them all. This graph further shows that Spanish productivity was even higher than that of the US from 1990 to 2000. Spain must, therefore, come to realize that the economic crisis sweeping the country is not due to the euro and that bringing the peseta back is not going to pull Spain out of this economic situation. Instead, Spain must reinvent itself, implementing tough economic, fiscal, and social measures because Spain is too big a country to be economically rescued. Second, Spain must improve its trade deficit and current account imbalances. Graph 6.22 shows the level of debt to GDP in Spain in comparison with the Euro area. It is clear that Spain is doing much better by far than the average of the Eurozone. However, this scenario has changed since the Spanish-style bailout plan that the government introduced to soften the effect of the economic and financial crisis that has pushed this ratio to 62.5 percent in 2010 (Reuters 2009), despite the fact

*UDSK6SDLQLQWKH:RUOG     

([SRUW6SDLQ

Graph 6.19 Spain’s trade balances, 1997–2008 Source: Bloomberg Finance LP

,PSRUWV6SDLQ

 

 

 

 

 

 

 

 

 

 

 

 



          3RUWXJDO

,UHODQG

6SDLQ

$XVWULD

,QYHVWPHQWLQ.QRZOHGJHDVRI*'3

1HWKHUODQGV

$XVWUDOLD

5HVHUFKHUVSHUWKRXVDQGHPSOR\PHQW

&DQDGD

*URVVGRPHVWLFH[SHQGLWXUHRQ5 'DVRI*'3

Graph 6.20 Academic excellence—comparison of Spain with selected countries Source: Bloomberg Finance LP

'HQPDUN

)LQODQG

8QLWHG 6WDWHV

         



 )UDQFH

*HUPDQ\

 *UHHFH

Graph 6.21 Labor productivity index—selected countries Source: Bloomberg Finance LP

,UHODQG

 ,WDO\

3RUWXJDO

 6SDLQ



*UDSK*HQHUDO*RYHUQPHQW'HEWWR*'3QRPLQDO*'3           









 (XURDUHD







6SDLQ

Graph 6.22 General government debt as % of GDP—Euroarea and Spain Source: Bloomberg Finance LP







*UDSK7RWDO*RYHUQPHQW5HYHQXHV ([SHQGLWXUHV RI*'3

      

7RWDO*RY5HYHQXHV

7RWDO*RY([SHQGLWXUHV

Graph 6.23 Spain’s total government revenues and expenditures Source: Bloomberg Finance LP



























The Eurozone and its First Economic Crisis

181

that the government has announced an austerity plan. Thus, Graph 6.23 shows government revenues and expenditures, and that since 1997 Spain has been having more expenses than revenues. It is particularly worrisome that in 2008 the levels of expenditures considerably surpassed the levels of revenues. As a solution, some are suggesting that Spain should take the easy way out of this situation, leaving the Eurozone instead of fighting to remain in the euro club by implementing Spanish economic discipline and undergoing a dramatic change in the factors and culture of production. Spain is suffering the crisis more than other countries because neither its government nor its people have been willing to undergo a number of painful structural reforms that the OECD (2007) and the EU (La Moncloa 2005) have been advising since 1986. In fact, The Economist (2010b, 57) stated that “some detect a whiff of cowardice. Mr. Zapatero’s determination to avoid general strikes is proof that he will never take a difficult decision.” These reforms are oriented towards strengthening the core of the Spanish economy, which rests not in the hands of a limited number of international corporations, but in the hands of small and medium enterprises that are in need of a number of structural reforms. These reforms would liberalize the labor market; cut red tape; ease the regulatory regime, tax burdens, and transaction costs; and help accessing local and external markets, among other improvements. If the government does not soon implement the necessary measures to reinvent the economy and motivate society to strive in the pursuit of excellence, Spain might be very soon facing a lost decade like Japan. Final Words The current economic crisis and financial uproar is testing the foundation of the EU and the euro project. The EU is now facing a situation that has been in the making since the euro was introduced. This chapter has demonstrated that countries suffering economic, financial, and social unrest have been for some time carrying excessive deficits, debts, high levels of unemployment, and disproportionate current account deficits. Despite the fact that it was commonly voiced that they were not complying with the requirements and that they were economically and fiscally irresponsible, this economic behavior was watched from a distance as if these countries were not Eurozone Member States. The mere essence of the union based on cooperation has failed as the lack of accountability, solidarity, and discipline is now putting the project in a difficult position. These Member States, despite many reports that repeatedly expressed concern with the lack of respect for the established rules, were not penalized with the immediate implementation of any corrective measures. The expansive trend of the economic business cycle fooled both governments and societies who did not want to realize, like the cicada in the fairytale, that summer will end. Had some corrective measure been implemented at all, as it is contemplated in the Maastricht Treaty, and countries forced to put their finances in order, the EU

182

The Euro in the 21st Century

would not be immersed in this current economic and financial situation. Corrective measures have not been forced mainly because it has been argued that imposing penalties, mainly economic, of any sort when countries are already mired in economic problems further hinders economic recovery. However, not enforcing the SGP undermines the main spirit of the Pact, which calls for the enforcement of budgetary discipline among the countries in order to avoid jeopardizing the economic growth of the Eurozone and of the entire European Union of 27 countries. This chapter proves that certain countries have made a one-time effort to comply with requirements to adopt the euro. However, this chapter also proves that those requirements specified in the Pact alone are not enough and that the Treaty of Maastricht should widen the parameters that countries should comply with and respect, such as the current account balance, to adopt the euro. The analysis of Spain proves that not only the country’s weakness is based on the lack of respect for the Pact, but that the economy has been suffering from other maladies such as current account and trade account deficits. Given the complexity of the current global economic world, just a couple of requirements do not guarantee the stability of a country; on the contrary, it is the relationship among many economic indicators that should be analyzed. This chapter concludes by explaining that Greece is not the only country in trouble and that Spain, which is double Greece’s size, has double the economic problems. If saving Greece has been a debatable topic for the political and economic consequences, saving Spain might become a “mission impossible” as the cost of this rescue might truly jeopardize the entire project.

Chapter 7

The Future of the Eurozone and the EU at a Crossroads: Coordination or Breakup This chapter explains that, despite the euro’s runaway success during its first decade of existence, Eurozone governments must assume responsibility and strengthen efforts to coordinate and reform the economic, monetary, and social policies needed to maintain the solid performance of the EMU and the euro. This chapter analyzes the current crossroads confronted by the Eurozone and the EU, an intersection at which economic, fiscal reforms and, most importantly, structural reforms must be implemented in order to avoid a painful outcome. In Greece, this crisis is the result of a continuous lack of transparency. The act of hiding the real state of affairs makes one wonder what has happened to Greece’s political class. In some countries, the principles put forward by classical Greeks such as Socrates, Plato, Aristotle, or Eratosthenes, whose works and philosophical views are often theoretically concerned with the existence of the perfect State or government, seem, curiously enough, to have been long forgotten. This chapter explains that, despite a number of asymmetric shocks that are preparing the basis for “thinking the unthinkable,” everything should be done to help the euro and the Eurozone survive. This chapter analyzes the increased cost of participating in the euro after the dramatic events resulting from the Greek economic mismanagement that have demonstrated the inappropriateness of a common monetary policy for certain countries. It warns that the cost of leaving the euro club is becoming an imaginable alternative, particularly for countries experiencing economic hardship who default on their national debt, experience the collapse of their national banking system, or undergo civil unrest. Nevertheless, withdrawal from the Eurozone is a complicated matter from both a legal standpoint, since it is not contemplated in any of the treaties, as well as from an economic standpoint, since reintroducing a national currency would be a difficult and painful process. Despite the fact that withdrawing from the Eurozone is not a stipulated option, this chapter thoroughly examines the potential break-up of the Eurozone, if the economies of Eurozone Member States are not set back on track and a solution is not put into place. This chapter elaborates on two possible scenarios to save the project. On the one hand, there is the option for the Eurozone Member States to do nothing to help defaulting countries. On the other hand, there is the possibility for Member States to provide aid by offering bilateral funds to save a country in difficulties. This chapter also elaborates an analysis of the role of the International Monetary Fund (IMF) within the actual legal framework with respect to the “nobailout” rule that provides no option to a country experiencing economic hardship

184

The Euro in the 21st Century

other than that of turning to the IMF as a lender of last resort. In order to understand the behavior of the Eurozone Member States in this regard, it becomes extremely important to consider Germany’s role and its reluctance to help countries that have not been able or willing to put their finances in order. However, this chapter explains that while Germany does not want to see the disappearance of the Eurozone nor of the euro, it is ready to let go of those countries that are not up to the test. Although Germany may have initially been intent on introducing the euro as a way of putting certain countries on a leash due to their currency devaluation in an effort to gain competitiveness against Germany, its own industries are now consolidated to such an extent that if certain PIIGs countries were to reintroduce their national currencies, Germany’s economy would hardly be affected. Furthermore, the pursuit of competitiveness—via currency devaluation—must be analyzed in conjunction with the idiosyncrasies of the financial market and its impact on the economy. In the event of a reintroduction of the old currency or the introduction of a new one, the currency would be under immediate attack by a market that will immediately send it plunging, leading, in turn, to an immediate euroization of the countries involved. The impact of a return to a new devalued currency would be tremendous nowadays, not only when converting sovereign debt but, most importantly, when converting private debt held outside the country. The reluctance to provide financial assistance to defaulting countries derives from the fact that certain countries have not been willing to implement the type of structural reforms necessary to make their countries competitive. The EU and the Eurozone are not only suffering a financial crisis, they are also suffering from a complete lack of necessary structural reforms that have led to this crisis. The proper functioning of the EMU depends on the adoption of and compliance with monetary and fiscal policy requirements on behalf of Member States as well as on a number of structural reforms, especially in the labor market, required to foster economic growth and a stable euro. Prior to 1960 unemployment was not considered an economic issue that demanded worldwide attention; hence, research concerning unemployment was not taken into consideration due to the fact that the unemployment rate within the European Community stood at less than three percent of the labor force. However, for the past twenty years the unemployment rate has increased dramatically in various countries. As a result of the economic and political impact of a significant increase in unemployment, its causes and its consequences have become one of the most debated topics in recent years. The EU Member States had many problems to solve when drafting the Treaty of Rome (1958); since then, many of those same issues have come to be considered priorities. Until the Treaty of Amsterdam (1997), scant attention was given to labor market performance, let alone to the idea of full employment. Unemployment was simply not considered a Community concern at the time; although, in 1990, unemployment was to become the EU’s most intractable economic problem (Van Oudenaren 1999). When the Maastricht Treaty was signed in 1997, it was agreed for the first time that all efforts to fight unemployment would be combined.

The Future of the Eurozone and the EU at a Crossroads

185

This chapter explains that solving the Greek tragedy just to contain the crisis will be a short-term solution that will not accomplish any long-term goal, as the same problem will sooner than later arise in other PIIGS countries. This chapter discusses that the EU project should take this crisis as an opportunity to create a restructuring mechanism that will strengthen and reform the economic, political, and social foundations of the project. The “if ain’t broken, don’t fix it” maxim does not apply any more. The union is broken and must be fixed, in fact, this is a great opportunity to learn from past mistakes and act to make the EU emerge from the ashes like an phoenix. This chapter demonstrates that in order to respect their international debt obligations, highly indebted countries must run a trade surplus that under current economic circumstances can only be achieved by forcing strenuous economic, monetary, and social transformations. In order to have a trade surplus a country must improve its trade balances. For a start, this requires a domestic demand contraction that must be offset by an increase in export levels to avoid recession. Increasing export levels is, in turn, contingent upon ameliorating trade productivity and competitiveness standards, which are highly related to human capital. The Eurozone cannot further delay any recommendations to push forward the structural reforms necessary to strengthen resilience and boost productivity that will, in turn, increase economic dynamism grounded on better performance. In fact, these highly indebted countries are continuously losing their positions on the European Innovation Scoreboard. The EU and the Eurozone: Coordination or Breakup For the past three years it has been considered fashionable to explain why the US dollar was about to lose its hegemonic status; yet, overnight, due to the Greek disappointment, it has now become commonplace to predict the demise of the euro, the breakup of the Eurozone and even the full disintegration of the EU. There is no doubt that the Greek crisis, due to government mismanagement and deception on the true situation of the economy, put the entire union and its project at risk. It is important to recognize that both EU and Eurozone authorities are also responsible for these events as is made evident by the fact that, despite so many rules, regulations, meetings and press releases, very few of the requirements clearly stated for the proper functioning of the bloc have been respected by a number of other countries. In addition to this, it is evident that no measures were taken to rectify the situation. As a consequence, the EU faces a major problem with Greece, Spain and Portugal. The situation in Southern European countries has been in the making for quite some time: during the economic bonanza of the past few years and with the allure of the euro as the next global currency, these countries have been abusing the Maastricht Criteria, avoiding painful structural reforms, and building massive account deficits on economies that lack competitiveness and productivity.

186

The Euro in the 21st Century

However, the critical point for Greece arrived when rating agencies, scared by Dubai’s “proposal to delay debt payments [an action which] risked triggering the biggest sovereign default since Argentina in 2001,” decided to review Greece’s situation (Merritt 2009, 1). At this point three events precipitated the current economic crisis and financial uproar in the EU and the Eurozone. First, it came to light that Greece had been hiding valuable information on the true nature of its budget and economic problems. As a consequence, Greece’s rate was downgraded and many investors sold their holdings of Greek government bonds. In addition, the European Central Bank (ECB) was unclear as to whether or not Greek bonds could be used as collateral in liquidity provisions. Finally, financial institutions holding Greek sovereign debt suddenly faced the possibility of sitting on illiquid assets, which prompted them to dump holdings, thus contributing to the worsening of the crisis. The problem resulted in a general mistrust of Greece’s government and of the overall stability of the country. This made it difficult for Greece to raise €20 billion by the end of May 2010. As difficulties have continued to increase, the rate offered to make sovereign debt attractive has also continued to increase; for instance, the yield on the 10-year note, which for Portugal is 4.34 percent, has increased to 6.36 percent for Greece. In the end, this is worsening government debt. However, the actual amount of funding that Greece might soon need is believed to far exceed this amount as Greece’s debt continues to increase. According to the estimates presented by The Economist, in 2009 Greece’s total debt amounted to €269.3 billion. It is believed it will reach €344.2 billion by the end of 2014, which will require the financing of a projected €75 billion (Llamas 2010a.) The estimated total exposure of the international banks, represented in Table 7.1 might shed some light on France’s anxiety concerning Germany’s reluctance to help Greece, in the event that Greece were to default (Llamas 2010a). Ultimately, it is apparent that “Greece is not too big to fail but too inter-connected to be allowed to fail. That is why even the Germans know they have to help them” (Thornhill 2010, 1). The Greek situation has opened up a refreshing debate among the EU Eurozone Member States, which have been shaken from their monotonous routines of meetings and joint communiqués. Greece’s economic situation and the political and economic debate it has sparked is forcing Member States to carefully and seriously reflect on the future of the EU and the Eurozone project. Greece is facing a budget deficit that has the nation at the brink of government bankruptcy. Eurozone Member States must decide what to do next as there is a fear that the crisis might spill over to other vulnerable countries. This situation is forcing Eurozone Member States to consider two options: to help or to not help Greece. If no financial help is provided to Greece, Member States would at least be respecting one of the clauses of the Maastricht Treaty: the “no-bailout rule.” This would send a clear signal to other countries, mainly Portugal, Ireland, and Spain, that the unwillingness to implement strenuous economic, financial, and political reforms for the sake of avoiding social issues is not going to be rewarded, and that countries without discipline do not have a place in the union. Nonetheless, the Greek conundrum has alerted Member States to the possibility of adverse

The Future of the Eurozone and the EU at a Crossroads

Table 7.1

187

Estimated global exposure to Greece’s default

Country France Switzerland Germany US UK Netherlands Other countries Total

€ millions 55,000 47,000 32,000 12,000 9,000 9,000 58,000 222,000

selection of countries that might be interested in joining the Eurozone in order to benefit from a greater degree of protection. On the other hand, this will reduce the moral hazard that results after a country has been accepted, when it has less of an incentive to be careful about risky behavior because, in case of economic or fiscal problems, Member States will be ready to save and cover much of the losses. However, not helping Greece would destabilize the EU banking sector in the EU; a sector that is itself not currently experiencing the best of times as it has serious exposure to other economic issues. In the case of Ireland, banks are in need of as much as €32 billion, a worrisome 20 percent of the country’s GDP, of which about €20 billion is to cover capital shortfall from bad property loans (Mahony 2010). Spain is also about to face a huge problem with its banks, particularly “cajas de ahoros” or savings banks, over exposure to bad property loans. For a start, in the last quarter of 2009, banks had an exposure to bad loans that amounted to an approximate €445,000 million: it is believed that almost half of this amount will not be repaid in the next two years. In addition, the aggregate saving banks losses amounted to €1,500 million (Ramírez 2010). Not helping Greece might open up a Pandora’s box with respect to speculation on vulnerable PIIGS countries as well as on the euro. Thus, although not helping Greece must send a signal that the group does not allow disobedient behaviors, a default of one of the Member States certainly will harm the image of the Eurozone as an economic and political world power. This distress brought heads of state and governments, during the spring European Council that took place on March 26, 2010 in Brussels, to discuss and agree on what measures should be taken to deal with the Greek crisis, even though Greece has not officially asked for any help. They concurred on an emergency system that would guarantee, in case of insolvency, the availability of standby credits for up to a total of €25 billions of voluntary bilateral loans offered by Eurozone Member States. These loans will be computed as debt and not as part of a deficit for members of the Eurozone that participate in the rescue plan. According to the joint statement, each country “will contribute an amount proportional to its gross domestic product and its total population” (Trio Presidency 2010, 1); yet still, “any decision on a bilateral loan will have to be proposed by the European

188

The Euro in the 21st Century

Commission and the European Central Bank (ECB), which will then require the unanimous approval of all 16 eurozone members” (The World Country 2010). The second issue is that the IMF might be called in to provide financial assistance for up to €10,000 million. However, although it has been described as a “joint mechanism,” the role of the IMF in the rescue operation is extremely blurry for two reasons. First, the joint statement by heads of states and governments implies that decisions will be proposed by the Commission and the ECB. This leaves little room for the IMF to decide on any one course of action. Second, if the IMF were to be called in, its financial assistance would be called upon to cover Greece’s budget deficit, which is not one of the three mandates of the IMF. The fund clearly states that the IMF performs three main activities. These are: … monitoring national, global, and regional economic and financial developments and advising member countries on their economic policies (“surveillance”); lending members hard currencies to support policy programs designed to correct balance of payments problems; and offering technical assistance in its areas of expertise, as well as training for government and central bank official. (IMF n.d.)

Therefore, the initiative of inviting the IMF has been quite controversial. The main reason is that this crisis is an internal one that should be dealt with by Member States, not with the assistance of an “outsider.” However, the presence of the IMF would take the burden off Member States because their financial resources and economies are already overstretched. Member States do not have the experience and lack the tools and the impartiality necessary to properly oversee the implementation of any plan. As a consequence, if the rescue mission were to fail, the EU and the Eurozone would automatically lose all credibility. This agreement has not been clear on specifying the most important points; and, like most of the EU agreements in which there was no agreement, it leaves a lot of gray areas and opens the way for many interpretations. The agreement explains that the “IMF is likely to provide the first trance of a coordinated system, with the second and third trances coming from Eurozone members once their parliamentary procedures are over” (Peel 2010, 1). Nonetheless, the first unknown pertains to the question of when the right time would be to provide Greece with financial assistance; that is, should the assistance be offered before or after a default? The second big unknown, which would make a difference, is the rate at which the IMF and Member States will be lending money to Greece. The announcement of the agreement stated that the bilateral loans would be priced at market interest rates. This rate is currently so high that the Greek government might conclude “that default is the financially superior option, especially since 70 per cent of Greek debt is held by foreigners. If they are smart, they will take the EU money and then default” (Munchau 2010, 1). Furthermore, if the rate is lower than what other countries must face, a breach within the EU might result. In fact, Jean-Claude Trichet strongly stated that “there shouldn’t be any subsidy element, no concessionary element” in any eventual loan to Greece (Hugh 2010b)

The Future of the Eurozone and the EU at a Crossroads

189

The problem is that, right now, Greece is paying a high interest rate of around 6.5 percent to get liquidity. If Greece is denied access to the market, in case of bankruptcy, the solvency problem might get even worse. Therefore, this agreement to financially rescue Greece has agreed to nothing nor will it help rescue anything; but, if it is implemented, it will cost a lot of money to already battered economies. The economies of most of the Eurozone Member States are overstretched due to the economic turmoil that has forced governments to inject money into their economies via “stimulus packages” within an economic environment where most of the world economies were suffering from slow growth and a substantial decline in output, which was negatively affecting the labor market and the living standard of millions of people. Governments in the EU have been using “stimulus packages” in an attempt to rectify the precarious situation. The European Commission presented an EU-wide stimulus package proposal, on Wednesday January 14, 2009, worth €200 billion to help resist the impact of the current economic downturn. The President of the Commission, Manuel Barroso, explained that €170 billion will come from national governments and the rest will come from the EU’s finances. This injection of money has increased deficits in most countries above the 3 percent level outlined in the Stability and Growth Pact (SGP). In fact, Girgis (2008, 1) has reported that the EU Monetary Affairs Commissioner, Joaquín Almunia, declared that, “while the deficit rules remain in place, temporarily excessive budget deficits would be allowed. Several decimal levels above the 3 percent maximum outlined by the Growth and Stability pact would be acceptable.” Hutton and Purkiss (2008, 1) have reported that in the UK Prime Minister Gordon Brown has promised a £20 billion package of tax cuts and spending between now and April 2010 to help counter Britain’s first recession since 1991. The Treasury predicts that the budget deficit will soar to 8 percent of GDP in the year starting April 2009 as the recession, in turn, reduces tax revenues. Debt is projected to double to more than £1 trillion by 2012. Other countries that have put forward a stimulus package include Portugal, which will inject €2.18 billion into the economy (Wise 2008, 1), and Germany, which has reported a stimulus package of €83 billion with a compromise reached on a controversial €100 billion bailout for companies in need and a €500 billion package for banks (EurActiv, 2009, 1). Furthermore, France has announced a stimulus package of €26 billion, an amount that pushed France’s budget deficit to 3.9 percent, way above the required 3 percent. In addition, Italy has allocated €80 billion to the stimulus plan (Dinmore 2008, 1). Finally, Spain has announced a modest €11 billion in aid in an attempt to help an economy suffering from the collapse of the construction sector and an increase in unemployment to more than 13 percent, the highest in Europe (Burnett 2008, 1). The IMF that the €200 billion stimulus package put together by the “European Union leaders and equal to 1.5 percent of gross domestic product, would not be enough to revive economies” (Monaghan 2008, 1). However, Monaghan (2008, 1) reported that the President of the ECB, Jean-Claude Trichet, declared that “governments could risk doing more harm than good to their economies if they extend borrowing so much … that [they exceed] their budget deficit.”

190

The Euro in the 21st Century

Germany and its Role in the Future of the EU and the Euro The Greek crisis has once again demonstrated that Germany is the hand that rocks the cradle, as its economic and financial stability give Germany enough leverage to rule the EU and seal the future of the Eurozone. The Eurozone project became a reality only when Germany was confident that the necessary requirements were included to have a solid economic and monetary union. Recently, Germany has been decisive in the drafting of a possible financial aid plan for Greece that will be funded by German taxpayers. Germany is reluctant to lend money to spendthrift countries. Angela Merkel has even said that these countries are in this situation because they have not put their finances in order; consequently, Merkel has said that “they deserve not a cent” (Irvin 2010). Since the beginning of the crisis, Germany has been reluctant to help Greece as Germany has always considered that the problem is the result of lack of government responsibility and too much political complacency. Furthermore, Germany is fully aware that the problem will not be contained by helping Greece. Even if Greece is to be saved by the injection of money into its economy, Spain and Portugal will be next. If saving Greece is a costly and difficult task, saving Spain, which is five times the size of Greece with around €75 billion in sovereign debt, an external current account deficit of over €100 billion, a deficit of about 12 percent, an unemployment rate of 20 percent, and close to a 30 percent loss in international competitiveness in 2009, might just be unfeasible. Germany is not interested in dismantling the Eurozone. It is interested in not having its taxpayers pay for other countries’ lack of financial and economic responsibility. Germany has declared that “delinquent” (Neuger 2010) countries that do not comply with the requirements should somehow be sent back to the ERMII (that is, the post-euro ERM) to put their financial houses in order and reapply later. In fact, the latest poll published by the Financial Times shows that 60 percent of the German people oppose government support of Greece’s budget problem (Atkins and Peel 2010). The political and economic will of Germany has been shaped by the impact of its status as a newly formed empire, its participation in two destructive world wars, its overnight division into two countries, and eventual reunification fifty years later. From an economic point of view, Germany was impacted by the expense of rebuilding itself after the destruction of war and the reparation obligations it owed to the Allies after each World War. Most importantly, it had to fight an episode of inflation and hyperinflation after World War I that almost brought the country to its knees and that, together with the world recession of the 1930s, eventually led to Nazism and World War II. Despite all of the above-mentioned obstacles, Germany has managed to become the most powerful European country and has also been capable of aiding its European neighbors economically. Nonetheless, since the 1950s, Germany has been fighting two evils to maintain Stabilitätspolitik in the country. On the political side lies Nazism, the evil that Germany longs to forget, and on the economic side lies a second episode of hyperinflation, the evil

The Future of the Eurozone and the EU at a Crossroads

191

that Germany hopes to prevent; curiously enough, Nazism was the direct result of hyperinflation. The German inflation and hyperinflation episode (1920–23) is one of the most painful and embarrassing moments of German economic history, which taught the country a great lesson that it will not soon forget. In fact, “it is one of the most notorious and most studied monetary catastrophes in human history” (James 1999, 17). The German inflation and hyperinflation episode was the result of an overly drawn-out war and post-war expenditures. The German government not only had to reconstruct the country but also had to pay the Allies’ reparation obligations specified in the “London Ultimatum” signed in May 1921. The London Ultimatum required that Germany pay a total of 132 billion gold marks in 66 annual installments, that is, 1.7 billion marks a year from 1921 until 1988, placing a substantial burden on the German budget and on Germany’s balance of payment (Zarlenga 1999). In order to make the required payments the German monetary authorities decided to print money, which, in turn, decreased the value of money and increased prices. As more money was needed, more money was printed and the government entered a vicious cycle from which it was unable to extricate itself. In fact, the Reichsbank boasted of the efficiency of its 30 paper factories and 29 plate factories producing 400,000 printing plates to be used by the 7,500 workers in the Reichsbank’s own printing works as well as by 132 other printing firms temporarily working to satisfy the need for currency (James 1999, 17). This money-printing frenzy resulted in an inflation episode followed by hyperinflation. As Sennholz (2006, 1) explains, In December 1923, the Reichsbank had issued 496.5 quintillion marks, each of which had fallen to one-trillionth of its 1914 gold value … Practically every economic good and service was costing trillions of marks. The American dollar was quoted at 4.2 trillion marks, the American penny at 42 billion marks.

This period of hyperinflation has never been forgotten as is evidenced by the fact that “its results—the Nazis and World War II—are still taught to every schoolchild” (Whitney 1993, 6). Hence, maintaining price stability remains, for the Bundesbank, the number one priority in the effort to preserve political stability. As a consequence, the Bundesbank during the European Monetary System (EMS) talks had mixed feelings about the creation of the EMS and the eventual introduction of a common currency. The Bundesbank not only worried that the D-mark’s existence and the dominance of the Bundesbank would come to an end but, most importantly, it did not want to be part of a club where price stability was not the number one priority. The central bank’s anti-inflationary policy has been a source of envy for most European countries, which have, from time to time, tried to imitate its policies without much success. The Bundesbank’s commitment to keeping inflation under control was such that it would not hesitate to implement radical monetary policies that could lead to a recession or to enforce a change of government (Marsh 1993). The reason for the success of the German central bank in implementing anti-inflationary policies is simple. Since it was first

192

The Euro in the 21st Century

founded, the Bundesbank has enjoyed political independence. This independence from government and political-economic situations has allowed it to follow whatever monetary policies have been necessary without political constraints. On the contrary, most European central banks were tied to government desires and usually implemented monetary policies to aid government “self-indulgence” or fund political manipulations oriented towards winning elections. Nonetheless, despite the current economic turmoil, Germany does not wish to see the end of the EU, the Eurozone, or the disappearance of the euro. For Germany, the introduction of the euro has always been regarded as a positive factor for its own economy, Table 7.2 presents an outline of the pros and cons of introducing the EMS. Table 7.2

Cost–benefit analysis of introducing the Economic Monetary System (EMS) in Germany

Costs The D-mark as national symbol will disappear Central bank independence and price stability might disappear

Benefits Stop currency speculation and competitive devaluations Enlarge Germany’s market for goods and services Diversify with the rest of Europe the costs of German reunification

On the costs side, the introduction of the EMS meant that Germany would have to give up its national currency. The D-mark had become a national symbol, which represented the pride of a country with an incredible monetary, political, economic, and social heritage. However, as German Finance Minister Theo Waiger expressed on April 23, 1998 in a Bundestag debate, Germany was “not giving up the D-mark but continuing its history of success at the European level” (Dyson 2000, 8). Nevertheless, German authorities feared that the European central bank would not follow Germany’s golden rule: political independence and price stability. Due to such misgivings, Germany would make sure that “[i]n return for … giving up the mark, the rest of Europe would accommodate it by agreeing to be governed by the European Central Bank on the German model” (Lindsey 2005, 248). Forcing European countries to accept a Bundesbank-like central bank in Europe would guarantee that the new central bank would keep its independence from the political process. Nonetheless, the Bundesbank’s learning curve had proven that the success of the D-mark rested upon the political independence of the Bundesbank. This independence would, in turn, guarantee price stability since Germany “doubted the availability of a ‘stability culture’ outside Germany as an essential underpinning for a sustainable EMU” (Dyson 2000, 13). On the benefits side, introducing the EMS would reduce the economic risks of currency speculation and competitive devaluations. Germany would

The Future of the Eurozone and the EU at a Crossroads

193

no longer have to face the devaluation of the US dollar alone. Furthermore, the Bundesbank would not have to continue defending, unsuccessfully and at great cost, European currencies from speculators’ attacks as it had been doing historically. For instance, in 1992, when the Bundesbank spent 44 billion marks defending the pound and the lira from currency speculators, it was unable to prevent those currencies from speculators’ attacks, and Black Wednesday followed. The Bundesbank’s guardian role in reference to European currencies indirectly transformed it into a de facto European central bank without the benefits of being such. Nevertheless, among the benefits for Germany in introducing the EMS was the fact that the cost of helping East Germany catch up with West Germany would be shared with EMS Member States. Germany had been helping European economies and currencies since 1971 and it was now time for the rest of Europe to join Germany in its reunification efforts; the EMS was the instrument that would allow for the sharing of the costs. Ultimately, it was obvious to German authorities that a common market would require a common currency that would certainly “provide a more predictable environment for German exports and investment” (Dyson 2000, 12). Under the Bretton Woods System, Germany’s industry became the most efficient and competitive sector in Europe and its economy became the leader among those of other European nations. The secret of this success rested in Germany’s industrial ability to take advantage of increases in demand within its borders and within most European countries by maintaining a strong productivity growth, while keeping labor costs from rising and achieving sound export competitiveness. As Germany’s export surplus began to grow, establishing itself as a national symbol of monetary and economic performance, economic imbalances began to surface for other European countries. In fact, most European “firms constructed their growth strategy mostly on extracting productivity growth without much investment but by using existing capacity” (Halevi 2005, 4). Germany, instead, would use those surpluses to modernize the industry, which helped to develop new products and improve productivity. Graph 7.1 shows how Germany’s balance of payments has almost always been positive, particularly right after the introduction of the euro. Curiously enough, Graph 7.1 demonstrates that Germany was barely affected by the second oil crisis (1979). Nonetheless, Germany’s balance of payments remained negative from the time of its reunification on October 3, 1990 until the physical introduction of the euro in January 2002. The creation of the European Economic Community (EEC) in 1957, or Common Market, meant that European countries had to compete in the same market by exporting similar products to gain surplus at one another’s expense. However, soon after the Common Market was created, not only was Germany’s GDP the largest in Europe but Germany was also considered the “European Community’s biggest market and most countries’ largest European trading partner” (Mitchener 1993, 1). This was particularly true for France and Italy and, as Halevi (2005, 14), explains:

ϭϱ ϭϬ ϱ

ͲϭϬ 'ĞƌŵĂŶLJ

Graph 7.1

ƵƌŽnjŽŶĞ

Trade balances for Germany and the Eurozone

Source: Bloomberg Finance LP

ϮϬϬϵ

ϮϬϬϴ

ϮϬϬϳ

ϮϬϬϲ

ϮϬϬϱ

ϮϬϬϰ

ϮϬϬϯ

ϮϬϬϮ

ϮϬϬϭ

ϮϬϬϬ

ϭϵϵϵ

ϭϵϵϴ

ϭϵϵϳ

ϭϵϵϲ

ϭϵϵϱ

ϭϵϵϰ

ϭϵϵϯ

ϭϵϵϮ

ϭϵϵϭ

ϭϵϵϬ

Ͳϱ

ϭϵϴϵ

Ϭ

The Future of the Eurozone and the EU at a Crossroads

195

[t]he more Italy exported its textiles, shoes, household appliances, furniture, Fiats, and intermediate mechanical products, the more France suffered. Italian outputs [were] partially Germany displacing, but they were definitely French displacing. If France devalued to counter the Italian systemic devaluation, the area of German capital would disintegrate.

Competitive devaluations did take place, not only against the D-mark but also against the US dollar. The case of Spain is particularly interesting because of the number of times Spain devalued against the US dollar since its national currency, the peseta, was introduced in 1959. Carmen Pelet Redon explains that the Spanish government devalued the peseta against the US dollar in 1967, 1976, 1982, in September and December of 1992, and in May of 1993. Competitive devaluations in France and Italy served as ammunition for the damage caused to German manufacturing industry. A competitive devaluation in these two countries meant that German goods and products would become more expensive overnight in France and Italy; hence, German goods and services would suffer from a substitution effect. The loss of market share in France and Italy would do away with a large percentage of Germany’s profits, “since France and Italy together absorbed more that 25 percent of total German exports” (Halevi 2005, 13). Finally, the devaluation situation was such in the 1990s that countries with strong currencies asked the EU to “punish governments whose currencies [were] devalued” (Friedman 1995, 1). Some countries even considered employing “retaliatory measures against those governments that had made use of competitive devaluations” (Friedman 1995, 1). In order to end currency fluctuations and competitive devaluations, the European Monetary System (EMS) came into effect on March 13, 1979. The EMS had the blessing of the Federal Republic of Germany (FRG), which wanted to ensure its export grounds and surpluses by putting European currencies under the leash of the Exchange Rate Mechanism (ERM). The EMS became a successful mechanism and was operative until December 31, 1998 when Member States fixed their currencies to the euro. The introduction of the EMS in 1979 launched West Germany’s economy further into an expansionary economic cycle that boosted productivity, exports, employment, internal demand, and investment in both equipment and constructions. However, Germany does not wish to see the end of the Eurozone nor the demise of the EU project. The euro is a blessing in disguise in its ability to stop competitive devaluations. Nevertheless, Germany does not want to waste its taxpayers’ money on a lost cause. Germany has offered a solution, the creation of a European Monetary Fund (EMF). The idea is inspired by the main task of the IMF in times of crisis which is that of offering financial support to countries faced with   From 1959 to 1974 the Spanish peseta was part of the Bretton Woods System. In 1988 the exchange rate peseta–Dem was born. In 1989, it became part of the European Monetary System and, in 1999, part of the euro.

196

The Euro in the 21st Century

the threat of default while simultaneously working on improving those countries’ finances. The fact that a possible, yet needed, “interference” on behalf of the IMF in European affairs has contributed to a heated debate, and led the German Finance Minister, Wolfang Shauble, to propose an EMF for the EU to help control any risk of default. He explains that Strict conditions and a prohibitive price tag must be attached so that aid is only drawn in the case of emergencies that present a threat to the financial stability of the whole euro area … Emergency liquidity aid may never be taken for granted. It must, on principle, still be possible for a state to go bankrupt … The monetary union and the euro are best protected if the Eurozone remains credible and capable of taking action … Yet there is no alternative to monetary union. There are some people who might feel that their skepticism towards the euro has been vindicated. They are overlooking the strengths of Europe … (Schauble 2010, 1).

However, Germany is firm in the idea that if a Eurozone Member State is unable to maintain its finances and budget within the required targets established in Maastricht, this country should exit the EMU and the euro. Some analysts believe that this will lead to the departure of the Mediterranean countries from the Eurozone. The point is to understand the economic harm that these departing countries could inflict on Germany’s economy and finances. Germany is the second greatest exporter in the world despite the fact that the euro and its industrial niche is focused on the production of high-tech products as well as an extremely well-diversified range of high-end products that range from food to pharmaceuticals, clothes, and services. According to the Fortune 500 survey which is a list of the top 500 companies in the world, Germany has a total of 15 companies in the top 100, while France has ten; Greece has no company included in this list, Spain has three companies and Italy has five in the first 100 companies listed, while Portugal has just one company in this ranking, although it is listed as number 278 (CNN Money 2009). Before the introduction of the euro, these Mediterranean countries were hurting Germany with competitive devaluations. Back then, Germany had not positioned its industry to the niche that it enjoys today. However, nowadays, as a result of arduous and continued improvement of its factors of productions and structural reforms to improve its labor force, Germany’s tangible and intangible assets have achieved a product sophistication that is no longer challenged competitively by anything that is produced in Portugal, Spain, Greece, or even, to a lesser extent, Italy and France. If these countries were to exit the Eurozone and reintroduce their old currencies, the fact that they would have to resort to systematic competitive devaluations to gain competitiveness would not hurt Germany this time around. On the contrary, it will become cheaper for Germany to have those European countries as inexpensive second residences or vacation destinations close to home.

The Future of the Eurozone and the EU at a Crossroads

197

Speculative Attacks and Currency Crisis: The Never-Ending Story Heads of states and governments have not been able to convey a solid message about how they are proceeding to tackle the crisis nor are they implementing the right set of structural reforms to improve not only the labor market but also the intangibles necessary to make one country competitive. As a consequence, recent politicians in Spain and France are criticizing the fact that the euro is suffering “speculative attacks.” The explanation is that currency speculators are attacking the euro and Greece, creating a situation of imbalance in the EU and the Eurozone. Certain actors in society, particularly politicians, want to suggest that the current crisis is the result of speculators and speculative attacks rather than accept that the crisis has attracted speculators. Speculators are just taking advantage of an imbalance which is basically the result of political mismanagement. The euro is losing ground against the US dollar for reasons that are not triggered by speculators taking advantage of the current situation of uncertainty on how the Eurozone is going to react to the problems of one of its own members in a moment of weakness. Speculators in the foreign exchange market are criticized for turning to dust all they touch as they tend to massively sell a country’s currency. This usually takes place when there is a mismatch between the value of a currency and the strength of the underlying economy. In the case of the Eurozone, certain countries are suffering from serious economic imbalances, particularly in current account balances, while the euro is highly priced against the US dollar. Speculative attacks were also blamed for the UK pound’s exit from the ERM, as well as for the currency crisis in Mexico (1994), Asia (1997), Russia (1998), and Argentina (1999). However, these countries have witnessed a bitter attack on their currencies when there has been a balance of payment crisis, which is the case nowadays for most of the PIGS countries. Thus, these countries are lacking economic asepsia and are placing the euro project in jeopardy. In the case of a massive speculative attack, central banks intervene by buying the massively sold currency using reserve currencies or changing interest rates. The biggest speculative attack occurred on September 16, 1992, Black Wednesday, when the UK pound suffered the most bitter episode of short selling attacks by the market. The UK Treasury and the central Bank of England almost went bankrupt trying to defend the pound but the effort was ineffective and the pound had to withdraw from the ERM. This attempt to defend the pound cost the taxpayers approximately £3.3 billion (Tempest 2005). In detail, the Bank of England intervened in the market by selling some US$40 billion in reserves from August to September, which left the Treasury with a “short position” of US$16 billion. Furthermore, since those reserves were used to defend the pound there was an “opportunity cost” as the Treasury would have benefited from this money if those reserves had been kept while sterling dropped. Finally, it is important to add the cost of rebuilding lost reserves. Altogether, it is estimated that the cost of Black Wednesday was close to £3.3 billion (Naughton 2005). The defense of the pound further forced the UK government to raise interest rates in an attempt to make the pound attractive and

198

The Euro in the 21st Century

stop the selling of the pound, but this measure was also ineffective. As a final consequence, the UK government saw in a matter of days that the pound had to leave the ERM–the Treasury was empty, and interest rates were high enough to send the country into an economic recession. As a consequence, the idea of adopting the euro and of joining the Eurozone vanished for the UK. The problem with the euro is that, in case of speculative attacks against it, the ECB would have very few chances to implement an appropriate defense of the currency. If the ECB opts to defend the euro from attack by using reserve currencies to stop a massive sell, there would not be enough reserves to stop the attack. If the ECB chooses to devalue the euro, the most feared consequence is that this measure would spark inflation. Finally, if the ECB decides to raise interest rates to make the euro attractive to put a stop to the massive sell-off, higher interest rates would, at this point, automatically kill the prospects of any economic recovery in the near future. The fact that there has not been a decisive action taken to save one of their own has been viewed as a sign of weak cooperation or, worse yet, as a sign that Greece is not worth saving. If nothing is done in terms of a serious and quick response in terms of restructuring, speculative attacks might soon become a real issue. The EU’s Main Obstacle: Fiscal and Labor Market Union It was recently recognized that the problem with the EU and the Eurozone has not only been due to an economic and financial twist but also to the recognition that “we are moving beyond short-term fiscal deficit issues, and immediate liquidity issues, towards problems like competitiveness, and what was previously a taboo subject—the issue of Eurozone imbalances” (Charlemagne’s Notebook 2010, 35). In fact, it is agreed that “huge fiscal deficits are a symptom of the crisis, not a cause” (Wolf 2010, 1). Furthermore, the EU Commission is worried about the survival of the monetary union due to the disparities in competitiveness levels, unemployment differentials, and productivity levels which are resulting in imbalances that might put the project at risk. In fact, Of particular concern to the Brussels officials is the economic condition of those countries who in the past ran huge deficits in their current account balances, because they lived for many years thanks to ample credit which was available due to the low interest rates prevailing. Now these countries are suffering, especially Spain, Greece, and Ireland, under the weight of escalating government deficits. ‘The combination of declining competitiveness and excessive accumulation of public debt is worrying in this context’ (Hugh 2010b, 2).

The EU is suffering a true global crisis and the euro is confronting its first test. Since the introduction of the euro, world economies have been experiencing mild economic recessions that have benefited the euro as it was regarded the new safe

The Future of the Eurozone and the EU at a Crossroads

199

haven in which to invest. Due to economic and political issues, the US dollar appeared to no longer be the darling of the financial markets and the euro had began to erode some of the buck’s hegemony. However, as the world was going through one of the fastest-growing expansionary phases of the business cycle, certain countries were not taking the right kind of measures to prepare for possible adverse economic conditions. As the economic crisis has hit the world, certain Eurozone Member States— Greece, Portugal, and Spain—are being seriously affected. The Greek tragedy is making the EU realize that highly indebted countries can put the union at risk and that measures must be taken without delay. Unfortunately, the situation is so dramatic that plain public spending cuts and tax increases are no longer the solution. What this situation is calling for is a profound implementation of structural reforms, although some do not believe that this would save the day. Societies in these countries are hurting because of the difficult economic circumstances and because governments are implementing painful measures that are damaging society’s well-being and living standards to the point of social unrest and revolts. This situation could have been perfectly avoided if these governments would not have acted like the cicada in the fairytale, who spent the whole summer singing without making provision for the coming winter. In fact, governments in Spain, Portugal, and Greece have not taken advantage of the economic bonanza of the past years to implement a major restructuring of their production model, which should have started with radical structural reforms mainly in the labor market sector, updating of the education system, and investment in research and development to improve factors of production to gain much-needed productivity and competitiveness. This failure to act could be explained by governments’ lack of courage or by their incompetence and lack of political wisdom in the execution of the right measures. A thorough analysis demonstrates that governments had all the necessary tools to straighten the economic path. However, it seems that they have lacked the courage to take the necessary actions to implement measures, perhaps for fear of losing public support and being thrown out of power. Governments have thus acted out of incompetence, even though they had the information necessary to establish a course of action mainly in terms of much-needed structural reforms that were clearly stated in the Lisbon Agenda, put together in 2002. This agenda highlighted all the necessary measures that were needed by every single country in order to make the EU “the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion,” by 2010 (European Parliament 2000, 1). Commissioner Almunia (2007, 14) has said that “in order for the euro area economy to reach its full potential it is necessary to step up progress on structural reforms,” particularly those oriented toward increasing productivity and employment in the Eurozone. Furthermore, Špidla (2008) forecasted the creation of 5 million new jobs in the EU by 2009, which would push the unemployment rate below 7 percent in 2009, the lowest level experienced since the mid-1980s. Unfortunately, since

200

The Euro in the 21st Century

January 2010, the unemployment rate in the Eurozone has been close to 10 percent, well above the 7 percent benchmark forecasted by the Jobs Commissioner. High and burdensome unemployment rates have always been the Achilles heel of most of the countries that are now facing economic and financial difficulties. This issue was first addressed during the 1994 Essen European Council and became a priority in 1997 for heads of state and government leaders of EU Member States who gathered in Luxembourg for a special Employment Summit. Their purpose was to agree on “a limited package of measures aimed at improving employability, supporting entrepreneurship, increasing adaptability and strengthening equal opportunities” (European Industrial Relations Observatory Online 1997). Employment policies in the EU, drafted by the Employment, Social Affairs and Equal Opportunities Commission, state that “[t]he objectives of full employment, quality of work and productivity and employment and cohesion are at the centre of EU policy” (1). The Standing Committee on Employment composed of “Social Partners,” which include trade union and employer representatives, agree upon such policies. This Committee was reintroduced in 1999 by the Council of Ministers to advise the Council and the Commission on employment policy (Rosenberg 1991). The European Employment Strategies (EES) are a set of guidelines geared toward obtaining employment improvements. The main goal of the latest EES is to work on macroeconomic policies that will create favorable conditions for economic growth and jobs that will, in turn, ensure a dynamic and wellfunctioning euro area and improve the coordination of labor market issues between Member States and the European institutions of the EU (EES 2007). The EES is based on key reporting tools designed to guide Member States toward obtaining specific results at the end of the three-year cycle. According to the European Commission on Employment and Social Affairs, the reported tools include: Integrated Employment Guidelines, National Reform Programs, Joint Employment Report, Recommendations, and EU Annual Progress Reports. However, it was not until the Treaty on the European Union introduced a title on employment that unemployment was definitively established as a priority. Now, the Treaty of Lisbon introduces “Title IX” on Employment, which explains (Article 147.2) that “the objective of a high level of employment shall be taken into consideration in the formulation and implementation of Union policies and activities.” Title IX explains what steps and measures must be followed by all Member States, in coordination with the European Council, to achieve a high level of employment. Article 148 explains that “the European Council shall annually consider the employment situation in the Union and adopt conclusions thereon on the basis of a joint annual report by the Council and the Commission.” Furthermore, Article 148 explains that The council, on a proposal from the Commission and after consulting the European parliament, the Economic and Social Committee, the Committee of the Regions and the Employment Committee referred to in Article 150, shall each year draw up guidelines which the Member States shall take into account in their employment policies.

The Future of the Eurozone and the EU at a Crossroads

201

However, the goals stated in Article 125 (ex Article 109n) of the Treaty Establishing the European Community states that the Community must work together to develop “a coordinated strategy for employment and particularly for promoting a skilled, trained and adaptable workforce and labor markets responsive to economic change.” This objective could never be realized unless all EU Member States were to take the promotion of employment as a matter of common concern and as a major goal for the Community. These goals and concerns finally coalesced during the Lisbon European Council, March 23–24, 2000, when Member States agreed on implementing a new strategic goal for the Union to strengthen employment, economic reform and social cohesion as part of a knowledge-based economy. Therefore, the Lisbon European Council set the goal “to become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion” (Barroso 2002, 2). Furthermore, great emphasis was placed on the modernization of the European social model by investing in people and building an active welfare state. A welfare state and social model have been defined as “an elaborate and expensive network of publicly funded, cradle-to-grave programs designed to protect everyone in Europe against the vicissitudes of contemporary life” (Barroso 2002, 2). The Lisbon Agenda specified the main labor market related goals that the Commission urged countries to reach between 2005 and 2010. Basically, the main objectives behind this reasoning were to design a strategy with employment policies that would enable the EU to achieve full employment by 2010 with certain shortterm employment objectives. Each country was given carte blanche to implement the necessary measures to achieve these goals; most of these measures involved urgent labor market reforms. Every single country agreed on these objectives since these goals were considered fundamental to the improvement of labor market performance and the reduction of the high unemployment rate that was asphyxiating the economic performance and societal well-being of most of the countries. The Lisbon Agenda, therefore, laid down the basis for the foundation of a dynamic economy respectful of the social model and highlighted the urgency of implementing specific structural reforms to help the EU grow at a rate of 3 percent per year for the next several years. The objectives established by the Lisbon Agenda and their accompanying reforms would provide the basis for superior European competitive performance and aid in achieving the Agenda’s primary employment aims. Table 7.3

The Lisbon Agenda – Employment Rate Objectives

Type of employment

Year

Objective

Reality Check (Eurostat 2010)

General

2010

70%

65.9%

Women

2010

60%

59.1%

202

The Euro in the 21st Century

Five years after the launch of the Lisbon Strategy, the Commission recognized that the results were somewhat disappointing and that the European economy was failing to deliver the expected performance in terms of growth, productivity, and employment. In fact, in its first draft entitled Joint Employment Report (JER) for 2004–5, the European Commission showed that the overall employment rate had remained stagnant at 63 percent, despite continuing increases for women and for older workers. The Commission concluded that the Lisbon target of achieving a 70 percent employment rate by 2010 was to be a challenge. When the UK took over the Presidency of the EU, Mr. Blair and Mr. Barroso chose the informal meeting at Hampton Court, held on October 27, 2005, to address, among other issues, whether the Lisbon Agenda ought to be revised. Mr. Blair further defended the urgent necessity to reform the Lisbon Agenda and, in a speech before the EU Parliament on June 23, 2005 he asked, What type of social model is it that has 20m unemployed in Europe, productivity rates falling behind those of the USA; that is allowing more science graduates to be produced by India than by Europe; and that, on any relative index of a modern economy—skills, R&D, patents, IT, is going down not up (Blair, 2005, 2)?

The Commission decided to revise the Agenda, focusing its attention on those actions needing to be taken rather than targets to be attained during the spring 2005 Summit and to re-launch the Lisbon Strategy without delay. This revised agenda was basically focused on increasing growth and jobs by increasing knowledge and innovation and making Europe a more attractive place in which to invest and work. This reformulation of the Agenda led euro-skeptics to believe that the Lisbon process had been a sad disappointment and that it became an example of how having too many goals and targets results in a failure to achieve anything at all (McCreevy 2005, 2). The Commission was able to say that the re-launched Lisbon Agenda was working in terms of growth and job strategy performance due to the economic upturn of the past years. Consequently, Vice President Gunter Verheusen (2006, 2) declared that “[o]ur strategy for Growth and Jobs is working. Entrepreneurship and innovation are gaining ground in Europe and we are now starting to implement structural changes to our economy.” However, as of March 2010 the Commission recognized that the Lisbon Agenda has been something of a disappointment and that the European economy has failed to deliver the expected performance in terms of growth, productivity and employment. On March 3, 2010, the European Commission presented a new European strategy. This new strategy—“Europe 2020”—states that by the year 2020 the Commission aims to have 75 percent of the population between 20 and 64 years employed, 3 percent of GDP invested in research and development, 20 percent reduction in CO2 emission, and 40 percent of the young population with a degree or diploma (European Commission 2010). Mr. Barroso stated the following with respect to the recently drafted plan

The Future of the Eurozone and the EU at a Crossroads

203

Let us be clear: in the past, some national politicians have resisted stronger mechanisms of governance, I hope that … all EU national governments will now recognize the need for full ownership of ‘Europe 2020’ and for a truly coordinated and coherent action in economic policy” (EU Business 2010, 1).

Although this crisis in the EU and the Eurozone is financial in nature, it is closely linked to the lack of reforms in the labor market and other structural reforms that slow down economic activity. The “Global Competitive Report 2009–2010” shed light on some of the structural problems holding back economic development, such as not having an adequate labor market, which is a burden to any government (World Economic Forum 2009) . The Outcomes: The Right to Expulsion, Withdrawal, or Restructuring The EU and the Eurozone are at a crossroads as they confront a Greek crisis as well as the possibility of similar scenarios in other PIIGS countries that might unfortunately arrive in the near future. The problem is that the legal framework, the Treaty of Lisbon, does not provide the necessary tools to solve this problem nor any other similar problem that might arrive soon. The Treaty of Lisbon maintains, on the one hand, the “no-bailout rule” and, on the other hand, introduces a blurry “exit clause.” Neither of these two solutions are adequate to deal with the situation at hand, which has put the Eurozone and the EU into a gridlock that is damaging to the image and, perhaps, the survival of the project. Nonetheless, the current situation has made thinkable what was just recently the unthinkable when the Treaty of Lisbon was in the making—the expulsion or the withdrawal of a Member State from the Eurozone. Expulsion from the Eurozone is not considered an option as it would definitely hurt the image of the EU and its members. However, a growing number of scholars, economists, the market, and even society regard voluntary withdrawal from the Eurozone while remaining in the EU to sort out which state of affairs is the most beneficial option. In fact, the idea of a country voluntarily leaving the Eurozone while remaining in the EU to sort out its finances is the most recommended solution to the current problem. However, there is the possibility of a negotiated withdrawal, which is significantly different from a unilateral or voluntary one. Nonetheless, neither of these alternatives is contemplated in the Treaty of Lisbon which only provides for the complete exit of a country or group of countries from the EU. Article 50 of the Treaty of Lisbon includes the “exit clause” and explains that “Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements” (Official Journal of the European Union 2008, 47). But this article is considering leaving the EU altogether, with the possibility of rejoining the union following the procedures in Article 49. Article 49 explains that “Any European State which respects the values referred to in Article 2 and is committed to promoting them may apply to become

204

The Euro in the 21st Century

a member of the Union” (Official Journal of the European Union 2008, 6). Further, Article 2 states that The Union is founded on the values of respect for human dignity, freedom, democracy, equality, the rule of law and respect for human rights, including the rights of persons belonging to minorities. These values are common to the Member States in a society in which pluralism, non-discrimination, tolerance, justice, solidarity and equality between women and men prevail (Official Journal of the European Union 2008, 6).

In this case, the country will have to reintroduce the old currency or create a new one, and restructure the national central bank as well as returning full monetary powers to the national bank, and there would be a legion of difficulties pertaining to the rights and obligations of every natural or legal person inside or outside the withdrawing country. The important thing is that reintroducing the old currency or a new one might well lead to a euroization of the country due to the implied uncertainty of the currency reintroduced. The Maastricht Treaty included a “no bailout” clause that had been included in the Treaty of Lisbon, following Germany’s insistence, to prevent a budgetary problem in one country spilling over the EU as a whole. However, the Lisbon Treaty’s Article 122 states that any Member State “seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control” can receive financial assistance from other Member States. The question is if the current debt crisis that Greece is facing could qualify as an “exceptional occurrence.” The problem with Greece is that these exceptional occurrences are “man-made” but, regardless of that, it is negatively affecting the EU and the Eurozone as the strength of the Eurozone as a whole is undermined. In the current case where one country faces fiscal unbalances, the debate has arisen as to whether the “no bailout rule” should be applied or whether Greece should be helped. The fact is that the requirements of the Maastricht Criteria have been breached, with the consequent fiscal instability which leads to the conclusion that the current legal and institutional arrangements are not sufficient and that there should be more surveillance and coercion to comply with requirements contemplated in the treaties. Germany’s Economic Minister Rainer Bruederle stated that “I do not think that a bailout is the right way because German and French taxpayers can’t pay for Greece. Maybe they will give certain help, but first it is for the Greeks to solve their problems” (Willis 2010b, 2). The impossibility of implementing a voluntary withdrawal from the Eurozone rests on the wording and spirit of Articles 4(2), 118, and 123(4) EC and its Protocol 24, which explicitly refers to the “irrevocable fixing” of the conversion rates as well as the irreversibility of the process of adopting the euro, given that the membership is voluntary and that once a Member State decides to join it must comply and respect rights and obligations. Since joining the Eurozone and adopting the euro is on a voluntary basis, participating in the EMU becomes a legal obligation because

The Future of the Eurozone and the EU at a Crossroads

205

of the irrevocability of the agreement and irreversibility of the monetary union process. Thus, leaving the EMU to remain in the EU is impossible, and leaving the EMU could only happen if leaving the EU. However, it was understood that there could be the right to unilaterally withdraw as a remedy or relief measure if a Member State constantly breaches the treaties or has difficulties complying with obligations. As members do not have the right to withdraw voluntarily, is there a mechanism by which Member States could expel a fellow country? This situation was already contemplated when Irish voters rejected the Lisbon Treaty in June 2008. Could this procedure be used to expel a Member State whose economic and financial behavior might be endangering the survival of the Eurozone and the EU as a project? This option could only be a possibility if there were an amendment of the Treaty respecting Article 48 of the TFEU and provided that there is unanimous consent by all Member States. This raises the question of how likely Member States are to incorporate a clause that might turn eventually against them. Article 48 explains that 1. The government of any Member State, the European Parliament or the Commission may submit proposals to the Council for the amendment of this Treaty. The Council shall submit these proposals to the European Council and the national Parliaments of the Member States shall be notified. 2. If, after consulting the European Parliament and the Commission, the European Council adopts, by a simple majority, a decision in favour of examining the proposed amendments, the President of the European Council shall convene a Convention composed of representatives of the national Parliaments of the Member States, of the Heads of State or Government of the Member States, of the European Parliament and of the Commission. The European Central Bank shall also be consulted in the case of institutional changes in the monetary area. The Convention shall examine the proposals for amendments and shall adopt, by consensus, a recommendation to a conference of representatives of the governments of the Member States as provided for in paragraph 3. The European Council may decide, by a simple majority and after obtaining the consent of the European Parliament, not to convene a Convention should this not be justified by the extent of the proposed amendments. In the latter case, the European Council shall define the terms of reference for a conference of representatives of the governments of the Member States. 3. A conference of representatives of the governments of the Member States shall be convened by the President of the Council for the purpose of determining by common accord the amendments to be made to this Treaty.

206

The Euro in the 21st Century The amendments shall enter into force after being ratified by all the Member States in accordance with their respective constitutional requirements. 4. If, two years after the signature of the treaty amending this Treaty, four fifths of the Member States have ratified it and one or more Member States have encountered difficulties in proceeding with ratification, the matter shall be referred to the European Council.

There are a number of reasons that can explain why neither an expulsion clause nor withdrawal possibilities were included in the treaties. First, the idea was to present this union as a closed deal where Member States share a full commitment to the union and the project. Second, allowing for the possibility of expulsion or withdrawal would increase adverse selection and moral hazard. Finally, not having properly stipulated the procedures to follow increases the uncertainty of what a country might face economically and politically after once it is outside the EU. Heads of states and governments must be fully aware that the Greek tragedy is just the tip of the iceberg and that a similar, or worse, situation might easily unfold and spill over to other Member States. If this were to happen, given the rigidity of the legal framework which seals the fate of all Member States, the EU and the Eurozone might truly disappear. However, history has shown that the meaning of the phrase “pacta sunt servanda” rarely reflects reality and that “when there is a will, there is a way.” In fact, the spirit and the letter of the very last paragraph of the joint statement by the heads of state and governments, after agreeing to a blurry financial aid package for Greece, proposed that We ask the President of the European Council to establish, in cooperation with the Commission, a task force with representatives of Member States, the rotating presidency and the ECB, to present to the Council, before the end of this year, the measures needed to reach this aim, exploring all options to reinforce the legal framework (Trio Presidency 2010, 2).

Thus, exploring all options must even include amending the Treaty in order to better accommodate solutions that were unthinkable years ago but that might, nevertheless, become the only solution to save the project. The EU project is facing the best moment to seek changes that would never have taken place under an established status quo; the project is facing its biggest crisis and the EU should apply Albert Einstein’s idea when he said that “the greatest inconvenience of people and nations is the laziness with which they attempt to find the solutions to their problems. … Let us stop, once and for all, the menacing crisis that represents the tragedy of not being willing to overcome it” (Bryan 2009, 3). It is, to say the least, surprising that countries have been failing to comply with the requirements of the Treaty for years, and that suddenly the Treaty is being accepted as written in stone without the possibility of being amended to save the project. Nonetheless, Germany has proposed EMF as a solution out of the gridlock

The Future of the Eurozone and the EU at a Crossroads

207

since help cannot be given under the no-bailout rule nor can Member States be set free to save the union. As a result of this situation, Eurozone Member States have no other option than to turn to the IMF for help. The driving idea behind the creation of the EMF, if it were to become a reality, would be to “help deficitplagued states as long as its lending was tied to strict conditions” (Peel et al. 2010, 1) In the event of a financial emergency, the EMF would ease the “disruption caused by the failing of a euro member to pay its bills by offering investors new EMF bonds in exchange for the defaulted securities” (Stearns and Petrakis 2010, 1). The most important role for the EMF would be, in the case of a true default, to guarantee that the correct steps are taken to make sure that there is an orderly default that does not negatively affect or spill over into other weak countries in the area. However, the EMF also requires that governments give up their budgetary powers, a sacrifice they will strongly resist, and requires a new Treaty, a scary road to travel after the problems faced by the Treaty of Lisbon in the process of its being approved. The EMF would hide a moral hazard; a hazard that would disappear if those countries prone to breach the requirements were the biggest contributors (Gross and Mayer 2010, 2). As a consequence, the European Debt Agency (EDA) has also been proposed as an alternative by Yves Leterme, who states that this agency would not cause any disruption as is contemplated in Article 136 of the Treaty of Lisbon. He argues that the EDA “would be a new EU institution based at the European Investment Bank in Luxemburg. It would help EU governments borrow money more cheaply by selling bonds guaranteed by all participating states and channelling funds to national treasuries” (Rettman 2010, 1). Final Words In the last ten years, the euro has demonstrated that having a common currency has many advantages, particularly if the currency becomes not only an international currency but also a global currency. However, maintaining this standard requires difficult adjustments and constant surveillance on the part of every single Eurozone Member State. This chapter explains that for years a number of countries have not been able to maintain or respect the limits stated in the Maastricht Criteria. As a consequence, they are now facing extremely difficult circumstances—Greece, in particular, along with Portugal and Spain. The debate on what should or should not be done with these countries is dividing the EU and the Eurozone. Worse yet is the fact that the current legal framework does not give room for maneuvering either. Nevertheless, the debate on how to solve this situation has two fronts: one political and the other economic. From the political point of view, the current crisis has demonstrated that although all countries are democracies and respect Article 2, there is no political homogeneity among them. As a consequence, each Member State has its own particular interpretation of the economic model that should be implemented and

208

The Euro in the 21st Century

even how the economic model should work. For instance, the reason behind the catastrophic situation in Greece, Spain, and Portugal is that these countries do not truly believe in the capitalistic economic model embedded in a globalized economy that, from time to time, forces a government to implement a set of painful structural reforms to keep a country competitive. Northern European countries and particularly Germany have gone down that road for the benefit of the country and society in the long term as it has been demonstrated. PIIGS countries believe that the necessity for reform is a weakness of the economic model and that society should not endure reforms and should be protected instead. One example is the alarming increase in the number of public officials in the Southern countries, in comparison with the Northern countries who believe that the government is not the national employment agency. The idea of the “survival of the fittest” is not left to its own devices to organize both society and economy. Since these Mediterranean countries are not fully complying with the rules of the economic game, governments systematically witness a dramatic decline of economic performance which, in turn, results in the impoverishment of their citizens. When countries are losing competitive advantage against others, this current crisis has demonstrated that they either lie about the state of the economy, as Greece did, or they do not provide accurate information, as Spain usually does. This childish behavior put at risk the efforts and illusions of the rest of the participants. From the economic point of view, there are a set of issues that should be reviewed. First of all, EU and Eurozone Member States know that the Greek case is not an isolated one and that a number of other countries might sooner rather than later find themselves traversing the same rough waters. These countries share two main dangerous traits that are the reason for their current problems. These traits are the lack of respect for the requirements and the lack of implementation of the appropriate structural reforms required to properly deal with an economic recession. Worse yet, this situation makes one wonder if this lack of initiative to implement reform is due to a lack of courage or of knowledge. This chapter demonstrates that over the years there have been many recommendations given to governments on what exactly is needed to make a country more competitive and efficient. However, it seems that there has been a total lack of courage to implement these oftentimes controversial reforms. Thus, heads of state and governments in these countries should be held accountable for not being able to guide their respective countries in the right direction since it is the mandate that society bestowed on them when they were democratically elected. Second, the Treaty of Lisbon incorporates the “no-bailout” clause which prohibits Member States from rescuing other countries or from taking on the debts of other countries. This clause was inserted to reinforce a sense of unity and commitment; but the truth is that countries are facing financial issues with debts and deficits far surpassing the requirements. Therefore, under the current circumstances, there are not many alternatives for saving or aiding countries in financial distress and the EU as a project. However, what is included is an exit clause by which a country is allowed to exit the EU altogether. Thirdly, the position of Germany must be addressed. Germany has been the last country

The Future of the Eurozone and the EU at a Crossroads

209

to oversee and approve everything that has to do with the final functioning of the Euro project. Germany’s economic and fiscal past has impelled it to realize the importance of fiscal and economic stability as well as the importance of a sound, well-structured and competitive labor market for the proper performance of the economy as a whole. From day one, Germany was worried that certain countries were not fit to comply with the requirements. Now, Germany’s worst nightmare is the reality that must be faced. Germany has been silently observing the behavior of these countries and is neither ready nor willing to spend taxpayers’ money on a rescue operation that could be the first in a long list of tragedies. What must be made clear is that Germany does not wish to see the disintegration of the Eurozone nor the disappearance of the EU; yet neither is it ready to help spendthrift countries that, like the cicada, have sung the summer away, watching the ant work for the wintertime. Finally, a number of recommendations are being put forward to solve this crisis. While the Germans have proposed the creation of a European Monetary Fund, the French league has proposed the European Debt Agency. Unfortunately, the creation of either one will require that the Treaty of Lisbon be amended or that a new treaty be negotiated. This situation has led many to blame the lack of a common bond market that would have tied the destiny of Member States together. However, this idea is usually dismissed for the same economic and political reasons. Economically speaking, the dismissal relies on the fact that a common bond market would lower borrowing costs for weaker states but increase costs for those with stronger public finance such as Germany. Politically speaking, this would take away the budget tool from governments. Governments would no longer be able to make national budgets which would mean that their spending capabilities would completely disappear. Governments which lack the power to put a budget together will not be needed in society. Governments have already seen how their monetary authority has been pulled out of the country to serve the common good. Losing part of the fiscal policy would be too much to bear. Regardless, the EU and the Eurozone are facing a situation that could prevent growth rates for years to come, given the current unsustainable debt burdens supported by some countries, if they do not proceed with a serious de-leveraging. Reinhart and Rogoff explain in their book that their … research of the long history of financial crisis suggests that choices are not easy, no matter how much one wants to believe the present illusion of normalcy on markets. Unless this time is different—which so far has not been the case— yesterday’s financial crisis could easily morph into tomorrow’s government debt crisis (Reinhart and Rogoff 2010, 1).

This page has been left blank intentionally

Chapter 8

The Euro in the Twenty-First Century: The Need for a “Euro Index” Chapters 2 and 3 have demonstrated that the euro has become a solid common currency as it has become a stabilizing factor in a number of areas of the economy. Most significantly, the euro has helped keep inflation under control and it has synchronized financial markets and eased the cost of accessing certain markets for investors. The purpose of this chapter is three-fold. First and foremost, this chapter reviews and tests empirically the tenets defended by mainstream economists (the nonheterodox). Mainstream economists who follow the neoclassical line of thinking believe in the idea of rational choice theory and rational expectations as well as in the idea of maximizing utility. The ideas of the random walk and efficient market hypothesis theory (EMH) are part of this mainstream economics, stating that time series and indexes are chaotic and unpredictable and as a consequence markets are random and lack covariance and convergence. Thus, mainstream economists believe in the idea of “white noise” because they maintain that random variables are uncorrelated and have finite variance. Behaviorists are in the borderline area between mainstream economics and the heterodox school of economic thought. These group is included as part of mainstream economics because they deal with the bounds of rationality. However, they are borderline because they maintain that individuals’ behavior does have an effect on the index and time series patterns. Behaviorists draw from areas of psychology but still follow a neoclassical economic theory which considers this area to be a separate field of economics analysis. This book is, from a theoretical point of view, a multidisciplinary work that believes and aims at demonstrating that in fact markets are predictable to some degree even though time series and indexes are chaotic. This approach is interested in measuring the entropy of the system; that is, the level of organization of a system. Thus, this work follows some of the principles of the heterodox school but particularly the controversial field inaugurated by Friedrich Hayek. Hayek maintained that the market economy is a chaotic system that can somehow spontaneously self-organize. He was also a defender of the wonders of the price system as the best way to organize any market and distribute goods and services contrary to those that defend a fixed price system. As a consequence, Hayek and the Austrian School explain that free prices move according to demand and supply which, in turn, sends signals that helps economic coordination that leads to convergence. Price movements are closely

212

The Euro in the 21st Century

knit to business cycles. If prices are increasing, this is explained as a result of more demand and that supply is the result of an active business activity. For instance, the innovative and controversial Skyscraper Index created in January 1999 explains that there is a direct relationship between the business cycle and skyscraper construction: an increase in construction begins at the beginning of the expansionary phase of the business cycle as interest rates are low, making the price of money cheap. Thus, low interest increases the sense of wealth of individuals and in turn prices increase. This innovative index concludes that just when the price of a skyscraper square foot is at the highest, the business cycle has reached its peak and the recession is about to begin. At that point, price is at the highest level and the real estate market is bursting. The work presented in this chapter believes in the idea that time series and indexes are dynamic systems because they are chaotic and that they move randomly. However, they are capable of suddenly converging and self-organizing at a critical point at which one phase ceases to exist and a new one is born. Due to this convergence, a change of tendency might take place. The higher the level of convergence, the stronger the sharp jump that allows a change of trend. The important point is to clarify that chaos is the state of nature but that certain patterns are created and can be identified by the investor. The importance of this study also rests on the idea that indexes can be stripped from the price and time axis and can be treated as objects. At this point it would be important to mention the usage of object-oriented computer programs that are used to find similarities among objects. These types of programs are used nowadays to find matching fingerprints or lately in highly sophisticated companies that use eye iris recognition as a security key. Secondly, this chapter takes the euro a step forward as a common currency and proposes the creation of a innovative “Euro Index” similar to the US Dollar Index. Finally, this chapter thoroughly analyses whether the Euro Index could be considered a strong leading index. A strong leading index is an index which is capable of setting strong behavior patterns; that is, that there is a strong convergence among the underlying currencies. The US is the second biggest economy in the world and the US dollar is considered an international and global currency. As such, and in order to measure the strength of the US and the greenback, the US Dollar Index was introduced in 1973. This is an index that measures the value of the US dollar relative to a basket of six major currencies—euro, Japanese yen, UK pound, Canadian dollar, Swedish krona, and Swiss franc—and each currency has a weight that reflects the trading relationship with the US. Ever since, the US Dollar Index has become a point of reference to measure and analyze the strength of the US dollar and the US economy. The Eurozone has become the third biggest economy in the world and the euro has become an international currency. Consequently, the Eurozone should have an index to measure its value relative to the majority of its most significant trading partners as the euro is used to trade with major world countries and currencies. In the case of the Eurozone, the index should measure the value of

The Euro in the Twenty-First Century: The Need for a “Euro Index”

213

the euro relatively not only to the US dollar, the Japanese yen, the UK pound, the Canadian dollar, the Swedish krona, and the Swiss franc, but also this index should take into account the increasing trading significance of Brazil, Russia, India, and China (BRIC). The importance of introducing a “Euro Index” rests, on the one hand, on the fact that this index would present the euro as a common project that would enhance and force further economic, financial, and political integration. On the other hand, the performance of the “Euro Index” could be compared and analyzed with the performance of the “US Dollar Index,” which would improve market transparency and, in turn, favor investors and consumers choices. This index will, consequently, become an economic and monetary indicator for the Eurozone’s building on the prestige of the euro club and enhancing not only the analysis of the Eurozone’s economic performance but also predictions of future performance. In order to do this, this chapter first introduces three self-made foreign exchange indexes: the Euro Index, the New Zealand Index, and the Australian Index. Second, it uses an innovative multidisciplinary approach to interpret patterns in these indexes. The aim is to use this pioneering model to predict with some degree of certitude the pattern that a particular index will follow. This approach feeds from a number of theories and models put forward by scholars as diverse as Per Bak, George Cantor, and Henri Poincaré, among others, and contradicts the tenets of certain models and theories such as the EMH (which maintains that the market follows a random walk that makes it impossible to predict the next move and prevents investors from making profits) as well as the behaviorist approach (which believes that markets are moved by the collective action of investors). These three self-made indexes are composed by putting together various currencies’ crossrates. Although the main focus is to study and analyze the performance of the Euro Index, this study also introduces the self-made New Zealand Index and the Australian Index. The reason for the creation of the New Zealand and Australian Indexes is that these are used as a benchmark against which to compare the pattern used in the Euro Index. Furthermore, a self-made US Dollar Index using the same mathematical approach has also been created to enable comparison with the selfmade Euro index under the same premises. Curiously enough, the study shows that—using the same methodology and time period—all indexes could be classified as strong leading indexes; however, it also shows that the Euro Index lacks a strong convergence among its underlying crossrates. Thus, an important tenet of this innovative approach is that although these are all indexes, the idea expressed in this study is that in order for these currency indexes to be leading there must be a strong convergence among their underlying cross-rates. This convergence is measured using a mathematical approach since these cross-rates are a chaotic dynamical system that tends to converge and arrive at a critical point which is called the “attractor.” Convergence takes place when the covariance tends to zero. The creation of the self-made “Euro Index” would be an important contribution to both understanding and shedding light on the euro as a common, international, and global currency.

Graph 8.1

US Dollar Index

The Euro in the Twenty-First Century: The Need for a “Euro Index”

215

The Creation of an “Index” The globalization of the current economy and financial markets has, on the one hand, increased the number of individuals that can participate in the financial market; on the other hand, it has broadened the number and type of markets in which to invest. In the past ten years the financial market has witnessed an increase both in the number of submarkets such as the capital market, foreign exchange market, commodity markets, derivative markets, money market, pension market, etc., and the number of time series and indexes available in each of these subfields to follow and trade. For instance, within the capital market an investor can choose between the stock market and the bond market. If investors decides to invest on the stock market, they have a wide range of time series and indexes to choose from. In fact, they can invest in Coca Cola, Caterpillar, AT&T, and Sears (each one of these companies is a time series) or they can choose to invest in an index to track a particular market activity. In the US, investors can analyze indexes such as the Dow Jones Industrial Average (DJIA), the Standard and Poor’s, or even the NASDAQ. A number of independent time series grouped together form an index which helps create a model to simplify reality. The existence of indexes in the financial market is rather recent due to the number of new instruments and markets that have helped them flourish as indicators of markets performances and strengths. There are four major characteristics of an index. First of all, all time series that compose an index can change over time if the index needs to be updated or adjusted. Second, the price of each of the time series that form the index must be independently determined by market participants. Third, the index price is calculated based on the prices of the undervalued time series but it is exposed to heavy mathematical and statistical arrangement. Finally, indexes are composed using differential equations. For example, the US Dollar Index was created in March 1973 after the demise of the Bretton Woods System, and the composition of the currencies that were included in the index only changed when the euro was introduced in 1999 to substitute the French franc and the German mark. Furthermore, each of the six currencies have a percentage weight in the composition of the index that have changed occasionally to better represent the importance of that currency at each precise moment. Graph 8.1 represents the actual weight of each of the currencies that compose the US Dollar Index. Moreover, indexes can be use to represent different realities. This is the case of the Trade Weighted US Dollar Index (Graph 8.2) which the Federal Reserve created in 1998 in order to expand the scope of the US Dollar Index and include certain countries with which the US has strong trade links. This new index follows the idea of the US Dollar Index but includes a broader collection of currencies with the intention to better represent US trade relations. Although these two indexes differ on what they aim to convey, and on currencies included and their relative weights, they both are used to measure a particular issue of the US economy.

 

Graph 8.2 Trade-weighted US Dollar Index &RORPELD

&KLOH

9HQH]XHOD

$UJHQWLQD

6ZHGHQ

5XVVLD

6DXGL $UDELD

,VUDHO

,QGLD

,QGRQHVLD

$XVWUDOLD

3KLOLSLQHV

7KDLODQG

6ZLW]HUODQG

%UD]LO

0DOD\VLD

+NRQJ

6LQJDSRUH

.RUHD

7DLZDQ

8.

&KLQD

0H[LFR

-DSDQ

&DQDGD

(XURDUHD

 

 

  

The Euro in the Twenty-First Century: The Need for a “Euro Index”

Graph 8.3

217

US Dollar Index and trade-weighted US Dollar Index

Graph 8.3 shows the evolution and trend of these two indexes. One major characteristic is that, although each one has different prices, they both have the same trend. Curiously enough, the US Dollar Index does have more strength than the weighted index as it is always ranging above the weighted or commercial US dollar. The main reason is that the trade-weighted index is composed of currencies which lack both the liquidity and the free market participation necessary to provide strength to the index. It includes emerging market currencies that are not as demanded in the foreign exchange market as the ones included in the US Dollar Index. However, it seems that since 2010 there has been a divergence in both indexes that should be further watched. Furthermore, each index can follow its own particular mathematical methodology and calculation; hence, the calculation of the US Dollar Index involves a mathematical and statistical approach different from the methodology used in the DJIA. The discussion is inaugurated when scholars, investors, etc., debate on whether indexes by themselves can or cannot convey any information on how these indexes are going to perform in relation to one another, or be affected by both endogenous and exogenous factors. The reason for this argument is that being able to follow indexes and time series to predict to a certain degree patterns or performances is important because this will allow investors to obtain economic returns from investments. A body of economic and finance theories follow a linear modeling based on the idea that indexes and series are not predictable and that identifying trends and cycles is not possible which means that no economic return can be expected. There is an alternative field of theories that maintain that financial markets behave in a non-linear fashion and with the help of a multidisciplinary approach it is possible to identify patterns and cycles; hence, that the markets’ next step can be forecasted to a certain degree.

218

The Euro in the 21st Century

The Efficient Market Hypothesis and the Behaviorists There is a group of theories that believe that markets cannot be predicted. This is based on theories and concepts like the random walk that have generated the socalled capital market theory, which is a generic term for the analysis of securities based on the assumptions defended by the efficient market hypothesis (EMH). This hypothesis was first developed by Eugene Fama who published an innovative article in May 1970 titled “Efficient capital markets: A review of theory and empirical work” in the well-recognized Journal of Finance in which he proposed concepts that have since shaped the debate of efficient markets. Fama mainly explained that there are three types of market efficiency. Weak efficiency explains that prices of all traded assets in the stock market represent the value of that company based on all information available. Semi-strong efficiency explains that asset prices reflect both past and new information available, and finally, strong efficiency explains that asset prices represent not only past and present public information but also private information about the value and price of an asset. Thus the EMH maintains that it is impossible to profit from the market because the market is “perfect” due to the fact that securities are in equilibrium and fairly priced. The price of an asset would only change when there is a new piece of information that affects it. Therefore, the EMH does not believe that any conclusion on the future behavior of a particular asset price can be drawn from studying past and present trends. Based on this theory, only information is believed to be responsible for changes in prices and market movement. Furthermore, oftentimes, new pieces of information are available that have no effect on the asset price; nonetheless, when there has been an event that has not moved the market, it is said that the market has not been affected because that information was already discounted and is already taken into account in the current price. This principle that the market discounts everything is one of the six premises of the “Dow Theory” which defends that all information—past, current, and even future—is not only automatically discounted into the markets, but also reflected in the pricing process of stocks and indexes. These theories advocate that forecasting future market trends is impossible because prices’ future movement cannot be predicted since the market takes what is called a “random walk;” that is, that stock market prices move randomly without following successive steps (Graph 8.4). Consequently, if market prices do follow a random walk, investors will not be able to profit from the market as it would be impossible to predict a somewhat steady pattern. The random walk theory feeds from two principles: Brownian motion theory and chaos theory. Brownian motion is a mathematical model put forward in 1827 by Robert Brown, an English botanist, who observed that pollen  Robert Brown, “A brief account of microscopical observations made in the months of June, July and August, 1827, on the particles contained in the pollen of plants; and on the general existence of active molecules in organic and inorganic bodies.” See (accessed March 2, 2010).

The Euro in the Twenty-First Century: The Need for a “Euro Index”

Graph 8.4

219

Random walk

Source: 

Graph 8.5

White noise

220

The Euro in the 21st Century

grains moved with a continuous “jitter” or random movement. Thus, economists take this idea to explain that indexes and time series have random movements (fluctuations) which are considered to be chaotic and impossible to predict. The main statement of chaos theory is that indexes and time series have chaotic behavior and long-term predictions are impossible in general (Kellert 1993). This field of study therefore believes in the idea of white noise which maintains that there is no possibility of any pattern recognition in time series and indexes. Graph 8.5 represents white noise, the idea that series and indexes fluctuate with a chaotic behavior that leads to random movements which are impossible to predict. There is another group of theorists, economists, investors, and professors who believe that market trends or cycles can indeed be predicted to some degree. Evidence shows that market patterns can be predicted to some degree and when this prediction is possible, investors can take advantage of an inefficient market. The fact that there is an inefficient market gives investors the possibility of engaging in “arbitrage.” Arbitrage is the result of a price differential between market prices. Basically arbitrage takes place when the “law of one price” does not apply. The law of one price states that in an efficient market all identical goods must have the same price. Behaviorists emerged when evidence demonstrated that there are discrepancies between the EMH and the real behavior of time series. This group explains that emotions and other subjective factors do play a role in investment decisions; as a consequence, investors are not all rational actors with access to the same information and with identical concluding facts. At this time a new field called “behavioral finance” was born. Behavioral finance achieved recognition when its major advocate, Daniel Kahneman, was awarded the Nobel Prize in economics in 2002 for his work on prospect theory. This theory shed light on how investors evaluate choices in situations where they have to make a decision between different investment options, each of which involves different level of risks and returns. Furthermore, the field expanded to also include “behavioral economics” which is characterized by a combination of psychology and economics. Behavioral economists maintain that in order to understand how investors take certain economic decisions that affect allocation of scarce resources, it is important to take into account certain emotional and social factors. Basically, these fields understand that investors are not rational actors who react identically to the same signals; on the contrary, each investor has a particular idiosyncrasy that makes investment decision unique and personal. The behaviorists have become the foundation for studies of statistical analysis (Kirkpatrick and Dahlquist 2007). Statistical analysis maintains that prices move in trends and that history repeats itself because investors tend to repeat previous investment behaviors which eventually would show on a graph (Murphy 1999). These repetitive behaviors would create a price pattern that could be identified and profits might be made. Statistical analysis is a discipline that aims at forecasting the future pattern of series and indexes prices through the study of past price and volume using a number of statistical methods and tools to recognize patterns

The Euro in the Twenty-First Century: The Need for a “Euro Index”

221

(Kirkpatrick and Dahlquist 2007). Some of the most frequently used tools are moving averages, regressions, covariance, and correlations. The use of this analysis was dismissed in the 1960s and 1970s by academics but, according to recent studies by Irwin and Park (2007), modern studies of statistical analysis have demonstrated that this analysis strategy has generated economic returns in foreign exchange, futures and even stock markets. This type of statistical analysis is in opposition to fundamental analysis, a more traditional way of studying price patterns. Fundamental analysis is the study of how economic factors as diverse as financial statements, management styles, and the state of the economy, among others, influence prices and markets. The EMH and the Behaviorist Approach: A Test This section presents an unusual way of testing the EMH and the behaviorist approach by introducing a number of graphs that demonstrate that patterns of behavior are pretty much independent from investors’ psychology and random walks. In order to test these two theories, this section presents four case studies (summarized in Table 8.1) that aim at exposing the pattern of a number of diverse time series and indexes. Table 8.1

Case studies

First case study

Third case study

Dow Jones Industrial Average (DJIA) from the US Deutscher Aktien IndeX (DAX) from Germany Eurotop 100 from the UK Australian dollar and the DJIA New Zealand dollar and the DJIA Singapore/euro and the US Dollar Index

Fourth case study

US Dollar index

Second case study

The first graph in this section, Graph 8.6, plots the pattern of three of the most important stock market indexes: the DJIA, the DAX (Germany’s Deutscher Aktien IndeX 30), and the Eurotop 100. Their locations are not only in three different cities but in three different continents: the DJIA is traded in the US, the DAX is traded in continental Europe, and the Eurotop 100 is in the UK. Furthermore, not only is each index priced in a different currency but also each index has a different price value. Despite these three differences, Graph 8.6 shows that there are almost identical patterns of behavior in all three. From the point of view of the behaviorists, this behavior can be explained as being based on the assumptions that investors in all three continents shared the same feeling towards these indexes and they all acted at the same time with the same purpose. In fact, in all three markets there should have been the same number of investors willing to buy and the same number willing to sell. Moreover, since behaviorists defend that markets are inefficient and that different markets

222

Graph 8.6

The Euro in the 21st Century

DJIA, DAX, and Eurotop 100

can have different prices, these three indexes would in theory allow arbitrage. As a consequence, the level of synchronization found in Graph 8.6 must therefore have been the result of intensive coordinated arbitrage by all actors involved in these markets. However, when actors get involved in a market to profit from arbitrage, investors automatically cancel price differentials between the markets. Had investors, or any other market actors, particpated in this market looking to arbitrage, they would have automatically taken advantage of any price differential, closing the price gap between these indexes and eliminating this identical pattern. Nonetheless, arbitrage would have been possible due to the fact that there are indexes and time series that are trading around the clock because of the Chicago Mercantile Exchange Globex. The Globex platform was launched in 1992 and is available to all investors regardless of their investment profiles. Finally, the attractiveness of this chart rests on the fact that if this graph is stripped from the value-axis and the time-axis and these three indexes become mere objects, it is possible to visually stack one index on top of the other and come up with an almost perfect match. The next two graphs represent the Australian dollar and the New Zealand dollar against the DJIA. Graph 8.7 shows two time series: one is the Australian dollar and the other is the Dow Jones Industrial Average. This graph shows that both are having the same pattern despite the fact that each captures different realities. On the one hand, the DJIA represents the prices of each of the 30 companies (or time series) that forms the index, each of which produce different goods or provides different services, are located in different states, do have different CEOs and Boards of Directors, and even follow different marketing strategies and management styles. On the other hand, the Australian dollar is a currency traded on the foreign exchange market; hence, it does not have any of the characteristics of the companies in the DJIA. However, both have almost identical behavior

The Euro in the Twenty-First Century: The Need for a “Euro Index”

223

although they represent different spectrums of the financial market. The study of these two indexes makes it difficult to find common endogenous and exogenous factors, public or private (either past or present) information, or global common sentiment that could make the DJIA and the Australian dollar behave in such an identical way. Even so, it cannot be argued that investors are selling the Australian dollar to buy dollars to invest in the DJIA since in this case, what investors are doing is selling US dollars and buying Australian currency.

Graph 8.7

Australian dollar and DJIA

Furthermore, the same can be observed when analyzing the New Zealand dollar and the euro cross-rate with the DJIA (Graph 8.8). On the one hand, the New Zealand–euro currency is a cross-rate of the New Zealand dollar and the euro with the US dollar. On the other hand, the DJIA is, as already explained, the average of the prices of 30 diverse companies. Again, it is at least very complicated to explain what endogenous and exogenous factors could identically affect the pattern of such different two realities. While the DJIA is priced in US dollars, the New Zealand–

Graph 8.8

New Zealand dollar and DJIA

224

The Euro in the 21st Century

euro is measuring the strength of the New Zealand national currency against the euro—a financial reality that has nothing to do with the US and the companies included in the DJIA. However, it can be confirmed that there is a high correlation between both times series, particularly between March and November 2009. Graph 8.9 represents the Singapore euro and the US Dollar Index. Once again, the US Dollar Index has the euro as one of underlying currencies but does not have the Singaporean currency. The significance of this graph rests on the fact that it shows that two independent indexes have been converging from September to November 2009 and that, suddenly, both indexes have a change of tendency in December 2009. With the change of tendency, the “partnership” is maintained as both time series begin an uptrend. This graph aims at demonstrating, once more, that time series do not follow random paths and that investors’ behaviors cannot explain this activity. As previously discussed, it is quite complicated to find a common denominator that could explain how and why two indexes that represent such different realities could have this similarity.

Graph 8.9

Singapore euro and US Dollar Index

Finally, Graph 8.10 is used to analyze the recent pattern of the US Dollar Index using the EMH and behaviorist approaches. This index demonstrates that market idiosyncrasy is very complex and that it cannot be explained just by using either the market efficiency theory or the behaviorist approach. The graph plots the weekly performance of the US Dollar Index from June 2004 to March 2010. Curiously, from 2008 to March 2010, the US Dollar Index experienced changes in trends had nothing to do with the economic events that were taking place in the US at that time. For instance in September 2008 the US had to proceed with a US$700 billion bailout for one of the nation’s financial institutions, the Trouble Asset Relief

The Euro in the Twenty-First Century: The Need for a “Euro Index”

225

Graph 8.10 US Dollar Index movement—June 2004 to March 2010 Program (TARP). This plan was needed because in March a number of financial institutions had financing problems: in March 2008 Bear Stearns, Morgan Stanley in September 2008, Fannie Mae and Freddie Mac in October 2008, Citigroup in November 2008, and the auto industry of Detroit needed help in January 2009. Furthermore, since February 2007 the Federal Reserve has engaged in an aggressive expansionary monetary policy cutting the Federal Funds rate: from 5.26 percent in February 2007 to 0.13 percent in February 2010. All these events were publicly announced and debated for their impact on the economy not only of the US but also of the rest of the world. These incidents showed that the economy of the US was in a situation difficult enough to negatively affect investors’ sentiments and confidence in the US economy. However, the graph shows that the US Dollar Index has followed a path that does not convey the sentiments of mistrust in the US economy nor the monetary policy implemented by the Federal Reserve over these years which supposedly would have driven investors away. A Global and Dynamical Approach to Explain Indexes: A Step Forward This chapter takes an innovative step forward from the ideas expressed by the defenders of the market efficiency and behaviorists, and presents that series and indexes are dynamical systems that must be studied using a multidisciplinary approach. This approach brings together ideas from many other sciences and disciplines proving that economics, of which finance is a subfield, is more than a social science. The use of a multidisciplinary approach is not new in the study of market behavior as it has been already introduced in the Nobel Prize-winning Black-Scholes model

The Euro in the 21st Century

226

which was disputed for its originality. The multidisciplinary approach of this model rests on the fact that it uses a thermodynamic equation to calculate the price of put and call options (Chen and Lauschke 2001). Thus, the self-made indexes— Euro Index, Australian Index, and New Zealand Index—are dynamical systems that follow a multidisciplinary approach that feeds from many different fields of studies. Table 8.2 summarizes the ideas that are used in this approach. Table 8.2

Summary of ideas and fields used

Ideas Dynamical system Self-organized criticality Complexity Attractor Critical point Convergence Sharp jump Singularity Fractal

Fields Mathematics Statistical physics Network theory Geometrics Thermodynamics Mathematics Magnetic systems Mathematics and cosmology Mathematics

The purpose of these indexes is to demonstrate that in any market there are indexes that are clear trend makers and some that are not. An index is a trend maker when the it has clear cycles because there is a good synchronization among the time series that form it. The purpose of this section is to demonstrate that, on the one hand, both self-made indexes, the New Zealand and Australian Index, are trend makers. On the other hand, the self-made Euro Index is a trend maker but must be considered a laggard one as it clearly shows a delay. However, this might change in the future because time series are “alive” and constantly change and shift. In order to analyze if the self-made Euro Index could be considered a leading index, this chapter further presents the self-made Australian and New Zealand indexes. These two indexes are going to be used as a benchmark against which to compare and contrast the pattern found in the Euro Index. Furthermore, it is important to highlight that the main purpose of this chapter is to create an index that could be compared with the US Dollar Index. For this purpose, it was necessary to create a self-made US Dollar Index following the same technique used in the creation of the Euro Index in order to be able to draw the right conclusions. Thus, this section presents the US Dollar Index to be able to study, compare and contrast the patterns found in the self-made Euro Index under the same set of circumstances. These indexes are first and foremost dynamical systems. A dynamical system is a concept borrowed from mathematics that means that a system can be explained in terms of differential equations that describe behavior for a period of time (Katok   The originality of this model is highly disputed because there is a very similar formulation developed in 1908 by the Italian mathematician Vinzenz Bronzin.

The Euro in the Twenty-First Century: The Need for a “Euro Index”

227

and Hasselblatt 1996). In the case of each of these indexes, the reason why they gain or lose value can be explained by understanding the relationships among each of the currencies (time series) that compose the index over a period of time. Each of the time series or currencies is going to be a differential equation which is going to be in relation with the rest of the time series or currencies. Thus, the index is going to behave according to how the underlying currencies or differential equations interact. This innovative dynamical system has a number of specific characteristics. One of the characteristics of a dynamical system is the self-organized criticality (SOC) property which was a revolutionary concept introduced by Per Bak, Chao Tang, and Kurt Wiesenfeld in 1987 as part of the body of theory in statistical physics. The importance of their discovery rests on the fact that the SOC helps us to study the complexity of nature and understand why the emergence of complexity can be spontaneous. Complexity—a concept taken from network theory—is a system composed of elements that have a relationship among them which is different from relationships these elements might have with others. Complexity is a random and spontaneous variation and has nothing to do with the idea of being complex or complicated (Czerwinski and Alberts 1997). Therefore, the SOC helps us understand indexes as these are complex (spontaneous or random) in nature since they are composed of a number of underlying time series (currencies) whose patterns are similar and variation in values spontaneous. For this reason, the study of complexity has become rather appealing to the study of asset pricing and markets as it is used to try to explain why suddenly asset prices might change. Understanding complexity can help us understand why time series and indexes have certain behavior and thus provide valuable information on where the next move will be to profit from it. Therefore, there is a need to be able to shed some light on what makes certain asset prices behave in a particular way and consequently be able with some degree of certitude to know what the next price move might be. Furthermore, as the SOC is about sudden and unexpected changes, this idea of the SOC is also been studied, used, and applied to fields as diverse as economics, biology, physics, neuroscience, etc. The SOC has as its main characteristic what is called a “critical point” which is a point at which a phase ceases to exist and a new phase begins, usually following a different pattern or trend; that is, the moment in the time series when an uptrend turns into a downtrend, or vice versa. There are multiple types of critical points but in an SOC the critical point is an “attractor” (Milnor 1985). An attractor is the point at which all the dynamical systems of multiple time series converge after a periodic trajectory. The periodic trajectory—represented in Graph 8.11—is the fact that certain values repeat in regular periods and therefore are commonly used to describe anything that exhibits periodicity. A function is periodic if ƒ(x + P) = ƒ(x) for all values of x where P—a positive natural number—is a period of time that repeats. In the critical point found in an SOC, time series and indexes fluctuate following a periodic trajectory and eventually there is convergence at a critical point at which a particular pattern ends and a new pattern begins.

228

Graph 8.11

The Euro in the 21st Century

A periodic trajectory

Graph 8.12 Critical point, convergence, and attractor Thus, indexes arrive at a critical point because the underlying time series are converging. Convergence is a classical theory from mathematics that was first introduced by Jean d’Alembert and later reintroduced in the study of time series trends by Henri Poincaré and Georg Cantor during the late nineteenth and early twentieth centuries. The main idea is that there is convergence between a set of time series when these time series are converging to zero because the difference between them—as differential equations—is decreasing over time until the difference reaches zero. Graph 8.12 shows three curves converging until the difference between them is virtually zero. This convergence will take place at the critical point and a change of trend can be expected. Convergence is a key characteristic that is found in indexes that are leading and trend makers. Convergence means that time series included in an index are moving in tandem and strengthening the index; that is, if all the underlying

The Euro in the Twenty-First Century: The Need for a “Euro Index”

229

Graph 8.13 Sandpile Source:

series are moving up, the index will be moving up as a consequence. If times series do not converge they move in opposite directions which means that they are canceling each other out, offering the index no strength to move in either direction. In this case, the resulting index will be “flat.” The study of the selfmade Euro Index, Australian Index, and New Zealand Index will show that all the underlying currencies converge, strongly encouraging the index to move in that direction. Finally, at the critical point phase there will be a change of tendency that is known as a “sharp jump.” The idea of the sharp jump is taken from the magnetic systems that, according to Kuntz et al. (1999, 2), will occur when “disorder is decreased, one finds a transition from smooth hysteresis loops to loops with a sharp jump.” This sharp jump should be considered a “singularity.” The idea of singularity is a concept that has recently opened a new field of research, particularly in the social science. A singularity has been used at a multidisciplinary level to explain changes that take place suddenly and this is the reason why this idea is used to explain abrupt changes that take places in areas of mathematics, physics, cosmology, economics, and it sheds light on issues as diverse as avalanches in sand piles, and changes in ionization, among others. Recently, the idea of singularity has been used to explain the speed of human evolution, as studied by Raymond Kurzweil (Beck 2008). Kurzweil believed that human evolution suffered a sharp jump due to the technological revolution and progress that took place at the beginning of the twentieth century; however, he claims that lately, although technological progress has been accelerating,

230

The Euro in the 21st Century

Graph 8.14 Critical point in thermodynamics there has not been a new sharp jump in human evolution because technological progress has been limited by human intelligence which has not changed significantly lately. Since, technology must be designed by humans and human intelligence is stuck, there is a gap between what could be developed and what is actually being developed. This idea of singularity, that is, the sharp jump, has become even more important to explain events such as the subprime crisis and the current economic crisis and financial uproar. Suddenly, there has been a change in tendency that has gone from an expansion to a bust of the business cycle where the totally unexpected subprime problems created a full-blown economic crisis with ramification in all sectors and all countries. Similarly, what began as a financing problem in Greece has become a problem that is shaking the pillar of the EU project and is affecting the world economy. Graph 8.14 shows the idea of the critical point in thermodynamics, which is the field from which this concept was born. It shows how the lower critical solution temperature (LCST) and the upper critical solution temperature (UCST) have been converging and arriving at their critical point, after which there is a sharp jump with a change of tendency and pattern. Finally, there is a theory developed by Benoît Mandelbrot, who contributed to applied fields such as information theory or economics with the innovative idea of fractal analysis. He believed that the understanding of pattern behaviors in time series in financial markets is possible using fractal analysis. He coined the term “fractal” in a revolutionary work titled Fractals: Forms, Chance, and Dimension published in 1975 but expanded and updated his idea in the work titled The Fractal Geometry of Nature published in 1982. Mandelbrot discovered

The Euro in the Twenty-First Century: The Need for a “Euro Index”

231

Graph 8.15 Fractals: year, month, week, day Source:

that prices of certain assets are similar and tend to repeat but that in order to perceive this similarity it is necessary to get rid of time as a variable. In fact, Mandelbrot “found empirically that a chart of market price changes of cotton price looks similar to another chart with different time resolution” (Takayasu et al. 1). According to Mandelbrot, the idea is that an index tends to be fractal, which is nothing but a fragmented geometric shape which can easily be split into parts, and each of these parts is a smaller copy of the whole shape (Mandelbrot 1982). Fractals in time series analysis are important because time series can be studied by analyzing the trend in different time frames such as daily, weekly, monthly, quarterly, and yearly. For instance, if the Euro Index is gaining value on a daily basis, this means that it must be gaining value on a weekly, monthly and even yearly basis. Therefore, the analysis of a particular index in one of these time frames indicates what the index should be doing in the rest of them. Graph 8.15 is a fractal that explains the theory of fractals applied to time frames and patterns. However, the importance of this theory in this multidisciplinary approach rests on the fact that if time series tend to have the same pattern behavior it would be possible to implement a pattern recognition search to predict future movements. This will imply that time series will become timeless since what gains importance is the pattern, its shape and length, to find patterns with a significant predictive value. This is the reason that explains that the indexes presented lack the value-axis. These indexes are value-less as what this study is trying to identify is not the value but the trend; thus, this indexes are objectoriented.

232

The Euro in the 21st Century

The Self-Made Indexes and the Multidisciplinary Approach History has taught that great powers usually have great currencies. During the Pax Britannica, sterling was the leading currency used in what was called the sterling area. Back in those days, the greatness and importance of a currency was based on how often it was used in international trade and how many countries were using the currency or had their national currency pegged to it. Nowadays, the importance of a currency is explained from many perspectives. After the dismantling of the Bretton Woods System in March 1973, the US decided to create the US Dollar Index to measure the performance of the US dollar against the most important trading currencies mainly because of the importance that the US was gaining politically and economically. Therefore, the performance of the US Dollar Index is an extremely well-followed index as it shows in a glance how the US dollar is performing. Since the US is one of the world’s economic and political powers, this study presents the self-made Euro Index. The idea for this Euro Index rests on the fact that the euro is a de facto common and international currency with the expectation of soon becoming a global currency, and the Eurozone as a consequence has become an important political and economic power. Hence, it would be appropriate for the Eurozone to be able to have an index with the euro and its most significant crossrates just as the US has the US Dollar Index. The self-made Euro Index has been constructed taking six major euro cross-rates: the eurodollar, the euro Swiss franc, the euro UK pound, the euro Canadian dollar, and the euro Japanese yen. There are three major reasons that explain the choice of these particular cross-rate currencies. First of all, these currencies are freely traded in the foreign exchange market. It would be interesting to add emerging-country currencies such as those of the BRIC countries but these currencies lack the liquidity necessary and the market freedom. Secondly, these currencies do not participate in the European Exchange Rate Mechanism (ERM). There are a number of countries that are part of the EU and that are working towards meeting the Maastricht requirements that are major Eurozone trade partners. But these currencies cannot freely fluctuate as they must comply with the requirements. Finally, these cross-rates have a long history since they have all existed since the mid-1850s; in fact, the pound sterling is the oldest currency still in use. These three facts together demonstrate the strength and seniority of these currencies and prevent any political or economic bias. In order to be able to have conclusive and robust findings, this chapter presents two more innovative self-made indexes to coherently compare and contrast results. First, the New Zealand Index is based on the New Zealand dollar and a number of cross-rates: the New Zealand euro, the New Zealand Swiss franc, the New Zealand Japanese yen, and the New Zealand UK pound. Second, the Australian Index is composed of the Australian dollar, the Australian euro, the Australian Swiss franc, the Australian Japanese yen, and the Australian UK pound. Third, the US dollar Index is composed of the Eurodollar, Swedish krona, the Swiss franc, Canadian dollar, Japanese yen, and the UK pound. Table 8.3 specifies which cross-

The Euro in the Twenty-First Century: The Need for a “Euro Index”

Table 8.3

233

Composition of self-made indexes

Euro Index Eurodollar Euro Canadian dollar Euro Swiss franc Euro Japanese yen Euro UK pound

Australian Index Australian dollar Australian euro Australian Swiss franc Australian Japanese yen Australian UK pound

New Zealand Index New Zealand dollar New Zealand euro New Zealand Swiss franc New Zealand Japanese yen New Zealand UK pound

US Dollar Index Eurodollar Swiss franc Canadian dollar Japanese yen Swedish krona

rates have been used in each of the self-made indexes. It is important to show that the Euro Index does not include the Australian dollar or the New Zealand dollar to avoid any selection bias. Finally, these currency indexes lack the value-axis. The reason for this is that this study focuses on the trend and pattern of the indexes but not on the values; that is, this study is object-oriented as it is looking for patterns that, when put one on another, give a perfect match. The methodology used to create this index is very simple since the intention was to leave each cross-rate as intact as possible and to expose cross-rates to the least amount of mathematical transformation. The only time series that have been transformed are, firstly, the Japanese yen, which has been divided by 100 in all the indexes to make it fall within the ranges of the other four currencies, and secondly, the Swedish krona which has been divided by 10 in the self-made US Dollar Index with the same purpose. The aim of this study is therefore not to construct indexes using a complex mathematical approach, but to construct indexes—which do not exist—using a simple mathematical approach to study them using a multidisciplinary approach. Nonetheless, the purpose of these indexes and their analysis is quite innovative. This study aims at explaining which of these indexes, including the US Dollar Index, could be considered strong leading indicators and trend setters. A strong leading index is understood as an index whose underlying time series converge in such a way that there is enough momentum to make the index change its pattern. The Australian Index has been created using five currencies’ cross-rates time series. Graph 8.16 shows that all five cross-rates have been moving in tandem and suddenly on March 2008 there is a strong convergence. This demonstrates that not only that all these five currencies self-organize critically as they all follow the same pattern, but most importantly that these series all get to what is call a critical point as a result of sudden convergence. Graph 8.17 shows the behavior of these indexes from January 2008 to January 2010. This graph clearly demonstrates the critical point, where it is obvious that time series are converging. This critical point is an attractor as these dynamical systems have been exhibiting a periodic trajectory since values have been repeating regularly. When these series converge the sharp jump takes place and a change of patterns takes place; that is, a phase ceases and another is born.

Graph 8.16 Cross-rates used for the Australian Index

Graph 8.17 Cross-rates for the Australian Index at the critical point

Graph 8.18 Australian Index and its cross-rates

1HZ=HDODQG'ROODU 1=HXUR 1=6ZLVV

Graph 8.19 Cross-rates used for the New Zealand Index 1=\HQ 1=SRXQG































































































1HZ=HDODQG'ROODU 1=HXUR 1=6ZLVV 1=\HQ

Graph 8.20 Cross-rates for the New Zealand Index at the critical point 1=SRXQG



























































































1=HXUR 1=6ZLVV 1=\HQ

Graph 8.21 New Zealand Index and its cross-rates 1=SRXQG 1(:=($/$1',1'(;































































































(XURGROODU (XUR6ZLVV

Graph 8.22 Cross-rates used for the Euro Index (XUR3RXQG (XUR&DQDGLDQ (XUR\HQ



























































































*UDSK&URVVUDWHVXVHGIRUWKH(XUR,QGH[

(XURGROODU (XUR6ZLVV

Graph 8.23 Euro Index and its cross-rates (XUR3RXQG (XUR&DQDGLDQ (XUR\HQ (XUR,QGH[















































































































*UDSK7KH(XUR,QGH[DQGLWVFURVVUDWHV

242

The Euro in the 21st Century

Graph 8.18 represents the Australian Index and how it interacts with the underlying currencies. It is important to mention that this index should be considered a strong leading index as the underlying cross-rates are converging, providing the index with momentum and strength. As a consequence, converging cross-rates signal that a sudden change of tendency might take place and that the index is going to follow accordingly. If these time series were diverging (that is, if each of them were moving in opposite directions) they were be canceling each other out. As a consequence, the index will be rather flat and there would not be a strong sharp jump. A flat index does not convey information on the index pattern. Secondly, the cross-rates included in the New Zealand Index curiously enough follows almost the same pattern found in the cross-rates in the Australian Index. Not only is it the same pattern but it can also be implied as having the same degree of strength. Graph 8.19 plots a high degree of convergence between the cross-rates. In fact, as these cross-rates lack the value-axis, it is easy to treat the New Zealand dollar, and the New Zealand yen and New Zealand Swiss franc as individual objects. If they were visually put one on another there would be almost a perfect pattern match. Finally, the level of convergence is particularly high between October 2008 and October 2009 when the critical point takes place. Graph 8.20 demonstrates the pattern of these cross-rates at the critical point after which the sharp jump takes place. This jump takes place due to the high degree of convergence, particularly among the New Zealand Swiss franc, New Zealand yen, and New Zealand dollar. In comparison, the New Zealand euro and the New Zealand dollar have maintained a rather flat pattern, nonetheless these two currencies suddenly converge at the critical point. Finally, Graph 8.21 demonstrates that the New Zealand Index could be considered a strong leading index because the strong convergence among the series particularly at the critical point provides the index with momentum. This momentum will allow for pattern recognition. This section has set the basis on which to demonstrate what leading and trend setter indexes look like. The behavior of these two indexes—the Australian Index and the New Zealand Index— have demonstrated that these could be considered strong leading indexes as in both cases there is a strong covariance which provide the index with enough momentum to have a clear sharp jump followed by a clear change of trend. We now move to study the Euro Index and find that this index enjoys the same strong properties that are found in the New Zealand and Australian Indexes. However, the study analysis shows that the underlying cross-rates do not converge as strongly as the underlying cross-rates in the New Zealand and Australian Indexes. Graph 8.22 shows the evolution of currency cross-rates used for the Euro Index from March 1999 to January 2010. As a consequence, since cross-rates have not strongly converged, there is a lack of a clear sharp jump, with the result that after the jump the Euro Index remains quite flat. In this case, the Euro Index lacks the convergence that has

The Euro in the Twenty-First Century: The Need for a “Euro Index”

243

prevented the index from gaining momentum. The analysis of the critical point clearly demonstrates that there is a lack of convergence and although there is an attractor point the lack of converge among the series does not provide the index with enough strength nor momentum for a strong sharp jump. Graph 8.23 of the Euro Index and its underlying cross-rates could be considered an example of the chaos theory as each cross-rate is fluctuating. Graph 8.24 is the self-made US Dollar Index. It is easy to recognize that crossrates are converging and following a coordinated pattern. Still, this graph shows that at the critical point cross-rates could be grouped in two diverging groups.

Graph 8.24 Self-made US Dollar Index and its cross-rates at the critical point The first group is comprised of the Swedish krona, the Swiss franc, and the dollar which are converging upwards; the second group is the yen, the Canadian dollar and the pound that are converging downwards. However, at the time of the sharp jump they all converge in such a way that allows for a change of tendency. Final Words The purpose of this study was to create an index for the Euroarea whose role could be similar to the role of the US Dollar Index so that the two could be compared, contrasted, and studied. A powerful economic actor such as the Eurozone should have an index that measures the strength of the euro against main international currencies. This chapter has summarized the theoretical difference between mainstream economics and the heterodox approach under which this study is carried out. This work rests outside the range of the mainstream economic school of thought as it is using an innovative as well as sophisticated approach to explain indexes and time series pattern behaviors. The main tenet of this approach is that although these are dynamical systems that do exist in a state of chaos, this is not a white chaos

*UDSK,1'(;(6

                      1(:=($/$1',1'(;

Graph 8.25 Indexes compared

$8675$/,$1,1'(;

(852,1'(;

86'2//$5,1'(;

The Euro in the Twenty-First Century: The Need for a “Euro Index”

245

but rather a chaotic system that eventually can self-organize due to the force of convergence. Furthermore, this study is not interesting in finding values as this study is in fact not using the value-axis as a point of reference. As a consequence, time series are rather being used as objects that might have a repetitive pattern. The attractiveness of this study rests on the fact that the time series have not been exposed to dramatic mathematical transformations; instead, the daily end of the day price of each of the used currencies has been respected. Furthermore, this study has created all the indexes using the same methodology. Graph 8.25 plots all four self-made indexes and the analysis helps to state three key findings. The first key finding is that this study presents that the foreign exchange market is a zero-sum game; that is, what one index is gaining, another is losing. This is concluded after analyzing three important points in the graph. The first is that on August 1, 2008 all four series suffered a significant change of tendency: the Australian, New Zealand, and Euro Indexes suffered a loss in value which meant that all the underlying currencies lost value with respect to the US dollar. Consequently, the self-made US Dollar Index suffered an increase in value. Second, in November 2008 the New Zealand, Australian, and Euro Indexes suffered a low which corresponded to the peak found in the self-made US Dollar index. Finally, in May 2009 all indexes saw the beginning of a significant change of trend. The second key conclusion is that this graph demonstrates that the idea of entropy does apply in the foreign exchange market represented in these four indexes. Entropy measures the level of order or disorder in this market which is associated with how much is lost by one index and gained by another. Entropy therefore sheds lights on the variation in the status quo of these indexes. The final key point is that not all indexes reach peaks and troughs simultaneously. For instance, the bottom of the Australian and New Zealand Indexes took place in November 2008, while the corresponding peak in the US Dollar Index took place around December 2008, and the peak in the Euro Index in January 2009. The concluding remark for this chapter is to highlight that the introduction of the Euro Index is an innovative attempt to provide the Eurozone with an index that will help shed light on the evolution of the euro vis-à-vis other major currencies.

This page has been left blank intentionally

PART IV CONCLUSION

This page has been left blank intentionally

Chapter 9

The Eurozone in the 21st Century He who blames his failure to a crisis neglects his own talent and is more interested in problems than in solutions (Albert Einstein).

The purpose of Chapter 9 is threefold: first, it summarizes the book’s main findings; second, it takes into account the limitations of this work; third, it sets a number of recommendations. Chapter 9 summarizes the book’s main empirical findings: the first is that the euro has become a successful common and international currency that has transformed the Eurozone into an economic, monetary, and political model to imitate. However, this study highlights that the current economic crisis and financial uproar is taking a toll on the project because some of the countries are suffering harsh financial difficulties that, on the one hand, are dividing countries on how to handle this situation and, on the other, are making others reconsider their aspiration to join the EU. As a consequence, this financial crisis—just after the project is recovering from the Lisbon Treaty impasse—is bringing the integration process to a halt. Nonetheless, this book draws on the implications of these findings for theoretical and methodological debates on international economics and regionalism. This chapter discusses the book’s implications for current debates on the prospects of the Eurozone’s survival, arguing that recent economic developments highlight the bloc’s enduring economic and political rationale and raising questions about its longer-term coherence and sustainability. Current economic hardships are testing the economic “maturity” of Eurozone Member States, some of which are going through difficult times and are putting an extra burden on the other Member States. As a consequence, since the introduction of the euro some have been arguing for the Eurozone’s demise, while others have praised it as a way to weather an economic storm. Ultimately, the future of the Eurozone depends on the ability of Member States to resolve current economic and monetary tensions between supranational strategic incentives as well as individual Member States’ political and economic constraints on cooperation. In fact, this chapter concludes that the breakup of the Eurozone—which was considered to be unlikely—has suddenly become no longer trivial. Despite the fact that leaving the Eurozone is such a complicated option, some countries may consider themselves to be better off leaving the EU altogether. A breakup of the Eurozone will lead to the collapse of economic, monetary, social, and political structures not only of the Eurozone but also of the EU as a bloc. Hence, this chapter emphasizes the necessity of a strong political class fully committed to the EU project and prepared to implement a painful set of necessary reforms for its sake. This greatly needed political class must emphasize the importance of maintaining the necessary reforms that will sustain

250

The Euro in the 21st Century

the euro, because such efforts have been proven to work. This chapter, therefore, concludes that (a) there is a lack of observance of the rules and requirements that must be rectified in order for the euro to truly act as an integrating force, and (b) highlights that the Eurozone and the EU are missing the vision of true statesmen for the future of the project that certainly is in need of a new productive model. This chapter also exposes the limitations found along the way. The main limitation has been the difficulty of finding unified macroeconomic data to be able to analyze and strongly assert conclusions. The main problem found in this field was that not all countries submit the same information, and oftentimes, when they do, time frames do not coincide, which renders difficult any cross-time analysis of particular series in a number of countries. This book exposes, therefore, the fact that the Eurozone and the EU should definitely improve data collection, and it would even be more valuable if there could be an institution—such as the National Bureau of Economic Research—in charge of analysis and reporting on business cycle issues. For the EU and the Eurozone to group their data indicators into “leading,” “coincident,” and “laggard” would be of great help to the academic community. Finally, this chapter presents two recommendations that would help improve and secure the EU and the Eurozone project. The first is that the EU should avoid creating more institutions and strive to make the ones that already exist respected and obeyed. Amid the current economic crisis and financial uproar, many officials have proposed the creation of more institutions to introduce more rules and regulations that must be respected as a “vaccine” to “cure” the current “illness.” They fail to realize that the current “disease” is not because there was a lack of measures but because these were not obeyed. Secondly, the EU should understand that in case of financial difficulties, countries cannot exit; the EU and Eurozone must implement the right type of measures to ensure the correct observance of the requirements necessary to make the system work. On the other hand, if they are not going to execute this surveillance role, there should be the possibility for a “misbehaved” country to leave the Eurozone or the EU altogether, to avoid jeopardizing the project. Nonetheless, the actual Treaty of Lisbon has been already breached because there are a number of countries that have been for some time not respecting the requirements specified in the Treaty, thus breaking the Treaty completely. The First Global Economic Crisis and Financial Uproar: Saving Versus Spending In 2008 the world faced its first global economic crisis as the steepest drop in global activity and trade worldwide since World War II demonstrated that the world economy is fully integrated and globalized. This crisis has unveiled one of the major problems of today’s society: that society was in a exuberant spending mode spurred by a high level of employment, growing personal wealth, easy access to finance, and an abundance of goods and services due to the wonders of

The Eurozone in the 21st Century

251

globalization. As the economic crisis unfolded, unemployment began to increase, which meant that paychecks began to either disappear or be cut. As a consequence, there was a consumption freeze, which negatively affected production and demand, particularly at the household level. This effect spilled over into the rest of the economy and affected the banks’ liquidity. Consequently, the world suddenly suffered from a dramatic reduction in the amount of currency in circulation. This alerted governments that urgent action was needed. Governments in major, advanced economies first responded by launching major fiscal stimulus programs and supporting banks with capital injections to avoid an even bigger economic crisis and financial uproar. This first response of aggressive public policy was oriented towards guarantees for financial institutions, capital injections and liquidity, and intervention in the credit market, which led to a rebound in the financial market. However, economic activity of what is now labeled “main street” has been resilient for three years (as at the time of writing in early 2010). Central banks, led by the Federal Reserve in the US, knew the necessity to act swiftly and together in a united front. The lessons learnt from the Great Depression were put into practice, and in October 2008 the Federal Reserve, the European Central Bank, the Bank of England, the Swiss National Bank, Bank of Canada, and the central bank of Sweden coordinated for the first time their monetary policies and announced comprehensive plans to stabilize the banking system and the economy. As Chair Bernanke explained (2010), it was necessary to prevent the possibility of any financial panic and any bank failures, as took place in the market crash of 1929. He explained that central banks around the world were not ready this time around to follow the ideas of Andrew Mellow, Treasury Secretary with President Herbert Hoover, who believed that the 1929 crisis should be used to purge the excesses that had built up in the 1920s and that the best medicine was to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … it will purge the rottenness out of the system” (Hoover 1952, 30). A symptom of the 2008 economic crisis was that the global economy started aching from low job creation. This was because a high rate of small and mediumsize companies were bankrupted due to tight credit conditions and excess capacity caused by timid private consumption and investment. This crisis has not been one that has widened the gap between advanced and developing economies; on the contrary, it has affected both. However, subdued demand in advanced economies (because household finances are under pressure) delays recovery in emerging economies. The difference, however, rests on how governments are reacting to it. Albert Einstein said that “a crisis can be a real blessing to any person, to any nation. For all crises bring progress.” The most painful effect of the crisis is that people have been losing their jobs, which has negatively affected their living standards. In advanced economies, unemployment in the US has officially reached almost 10 percent, which is the highest level in almost 26 years. In the EU the labor market is also reaching all-time highs because unemployment in countries affected by real-state-related shocks and economic meltdowns (such as Spain, Ireland, and Greece) are surpassing 15

252

Graph 9.1

The Euro in the 21st Century

Job openings and labor turnover survey

Source: Bureau of Labor Statistics, “Job Openings and Labor Turnover,” March 5, 2010, at (accessed March 5, 2010)

Graph 9.2

Comparison of US and EU productivity

Source: Bloomberg Finance LP

percent. In the US, however, the unemployment situation is such that President Obama repeated the word “jobs” 23 times in his 2010 State of the Union speech. The unemployment rate is believed to really be closer to 17 percent if discouraged workers and underemployed are taken into account (Pinalto 2010). In fact, the Bureau of Labor Statistics reported (see Graph 9.1) that there are 6.1 job applicants per job opening in December 2009 (Reuters 2010a), in comparison with 1.1 in 2000, and 1.7 in 2007 (Shierholz 2009). Further, an increase in the unemployment rate is going to negatively affect productivity levels in terms of output per capita. In fact, productivity has been

'ƌĂƉŚϵ͘ϯĂƉĂĐŝƚLJhƚŝůŝnjĂƚŝŽŶ ϵϬ ϴϱ ϴϬ ϳϱ ϳϬ ϲϱ ϲϬ ϮϬϬϱ ϮϬϬϱ ϮϬϬϱ ϮϬϬϲ ϮϬϬϲ ϮϬϬϲ ϮϬϬϲ ϮϬϬϳ ϮϬϬϳ ϮϬϬϳ ϮϬϬϳ ϮϬϬϴ ϮϬϬϴ ϮϬϬϴ ϮϬϬϴ ϮϬϬϵ ϮϬϬϵ ϮϬϬϵ ϮϬϬϵ YϮ Yϯ Yϰ Yϭ YϮ Yϯ Yϰ Yϭ YϮ Yϯ Yϰ Yϭ YϮ Yϯ Yϰ Yϭ YϮ Yϯ Yϰ

h^ĂƉĂĐŝƚLJhƚŝůŝnjĂƚŝŽŶ

Graph 9.3

Comparison of US and EU capacity utilization

Source: Bloomberg Finance LP

hĂƉĂĐŝƚLJhƚŝůŝnjĂƚŝŽŶ

*UDSK866PDOO%XVLQHVV2SWLPLVP,QGH[             4

Graph 9.4

 4

 4

 4

 4

US Small Business Optimism Index

Source: Bloomberg Finance LP

 4

 4

 4

 4

 4

 4

 4

'ƌĂƉŚϵ͘ϱƵƌŽƉĞĂŶŽŵŵŝƐƐŝŽŶƵƌŽƌĞĂƵƐŝŶĞƐƐůŝŵĂƚĞ/ŶĚŝĐĂƚŽƌ Ϯ ϭ

Ͳϯ Ͳϰ ƵƌŽƉĞĂŶŽŵŵŝƐƐŝŽŶƵƌŽƌĞĂƵƐŝŶĞƐƐůŝŵĂƚĞ/ŶĚŝĐĂƚŽƌ

Graph 9.5

European Commission Euro Area Business Climate Indicator

Source : Bloomberg Finance LP

ϮϬϬϵYϰ

ϮϬϬϵYϯ

ϮϬϬϵYϮ

ϮϬϬϵYϭ

ϮϬϬϴYϰ

ϮϬϬϴYϯ

ϮϬϬϴYϮ

ϮϬϬϴYϭ

ϮϬϬϳYϰ

ϮϬϬϳYϯ

ϮϬϬϳYϮ

ϮϬϬϳYϭ

ϮϬϬϲYϰ

ϮϬϬϲYϯ

ϮϬϬϲYϮ

ϮϬϬϲYϭ

ϮϬϬϱYϰ

ϮϬϬϱYϯ

ϮϬϬϱYϮ

ϮϬϬϱYϭ

ϮϬϬϰYϰ

ͲϮ

ϮϬϬϰYϯ

Ͳϭ

ϮϬϬϰYϮ

Ϭ

256

The Euro in the 21st Century

decreasing at a much higher rate than during previous recessions, suggesting that labor hoarding has been higher during this recession, especially in the EU (see Graph 9.2). This trend in productivity will remain on both sides of the Atlantic for as long as capacity utilization level does not improve, and until consumption and investments pick up (Graph 9.3). Capacity utilization, consumption, and investment are tightly related. The latest report by the National Federation of Independent Business (Dunkelberg and Wade 2010), published on February 2010, explained that small and medium-size companies are still reporting that poor level of sales is the number one concern and the major reason for explaining economic losses. Poor sales due to low consumption are keeping capacity utilization low. The second concern is the difficulty in getting or extending credit because most of the small and medium-size businesses get their loans based on the value of residential and commercial properties which, in turn, have declined significantly; hence, a borrower’s collaterals no longer bear the same value. As a result, not only it is getting increasingly difficult for workers to earn their pay, but also new hirings are not needed in this economic environment. Therefore, capital spending is expected to remain weak until the business outlook improves, and only 5 percent of small, and medium-size firm owners believe this is a good time to invest in improving and expanding (Graph 9.4). Although, there have been signs of recovery at a macro level, the Federal Reserve has recognized that a full recovery without a healthy small business sector will not last. Finally, 2009 saw a record in the number of corporate defaults (that is, companies unable to pay their rated or unrated financial obligations): these totaled 188 in the US, 20 in Europe, and 36 in emerging markets (Bi-Me Staff 2009) (Graph 9.5). As a consequence, households all around the world are struggling with low pay, wealth losses, and unsecured unemployment, meaning that consumption will be subdued for the near future, which is helping rebuild net household wealth but is postponing recovery. Consequently, it can be inferred from Graph 9.6 that, on both sides of the Atlantic, there is a strong relationship between the lack of consumer confidence and consumption, which have both fallen in the US and the EU. Nonetheless, the current economic crisis and financial uproar is forcing people to put their personal finances in order and to rethink the saving–spending relationship. For the past twenty years personal savings—the difference between disposable income and consumption—have been decreasing in the US as labor markets prospects were strengthening and personal wealth increasing. As a consequence, in 2005 the personal saving rate in the US hit an all-time low that had not been tested since 1933 (Associated Press 2006). Due to the current economic crisis, personal consumption declined and personal savings rates began to increase to arrive at a long-unseen 6.9 percent of after-tax savings, which is equivalent to annual savings of US$750 billion (Feldstein 2009). In the EU saving levels have increased considerably since 2008 after reaching record lows in 2006 and 2007. Graph 9.7 demonstrates that savings rates vary from

'ƌĂƉŚϵ͘ϲŽŶƐƵŵĞƌĐŽŶĨŝĚĞŶĐĞ ϭϮϬ ϭϬϬ ϴϬ ϲϬ ϰϬ ϮϬ Ϭ ϬϭͬϬϰͬϮϬϬϰ ϬϭͬϭϬͬϮϬϬϰ ϬϭͬϬϰͬϮϬϬϱ ϬϭͬϭϬͬϮϬϬϱ ϬϭͬϬϰͬϮϬϬϲ ϬϭͬϭϬͬϮϬϬϲ ϬϭͬϬϰͬϮϬϬϳ ϬϭͬϭϬͬϮϬϬϳ ϬϭͬϬϰͬϮϬϬϴ ϬϭͬϭϬͬϮϬϬϴ ϬϭͬϬϰͬϮϬϬϵ ϬϭͬϭϬͬϮϬϬϵ

ͲϮϬ ͲϰϬ ͲϲϬ

ŽŶĨĞƌĞŶĐĞŽĂƌĚŽŶƐƵŵĞƌŽŶĨŝĚĞŶĐĞ

Graph 9.6

ƵƌŽƉĞĂŶŽŵŵŝƐƐŝŽŶŽŶƐƵŵĞƌ/ŶĚŝĐĂƚŽƌƵƌŽnjŽŶĞ

Comparison of Consumer Confidence Indicators—US Conference Board and European Commission Consumer Indicator for the Eurozone

Source: Bloomberg Finance LP

*UDSK*URVV+RXVHKROG6DYLQJ5DWH 6KDUHRIJURVVVDYLQJVWRJURVVGLVSRVDEOHLQFRPH      

*HUPDQ\

)UDQFH

6SDLQ

,WDO\

/DWYLD

3RUWXJDO

(8

(XURDUHD

86

 



Graph 9.7

























Gross household saving rate—share of gross savings as % of gross disposable income

Source: Peeter Leetmaa, Herve Rennie, and Beatrice Thiry, “Household saving rate higher in the EU than in the USA despite lower income,” Eurostat, 29/2009, at (accessed February 2, 2010)

The Eurozone in the 21st Century

259

country to country, with Germany demonstrating again the well-known “German virtue” and Latvia as the country with the worst saving rate. In the US, EU, and the Eurozone, the graph shows that the Eurozone has the highest saving rate whereas the US has the lowest, although in both blocs the saving rates have been stable for the past years. The Euro in the Twenty-First Century: A Summary of Findings For years, the creation of an economic and monetary union has been a dream for European nations. This finally became a reality, after many trials and errors, with the introduction of the euro on January 1, 1999. The adoption of the euro had an economic, monetary, political, and social component that forced the transformation of nations and the emergence of a new bloc. This chapter uses a new regionalism approach to examine how the introduction of the euro has affected the so-called “new world order” in the twenty-first century and how the current economic crisis and financial uproar is affecting both the new order and the tenets of the new approach. Chapter 1 explains that the introduction of the euro created the Eurozone, that is, a new region considered a supranational or world region, with an important role in the current global transformation. The euro has demonstrated that although it was introduced as an economic tool for integration, it has a political, social, and cultural dimensions. Thus, the euro has become a multidimensional form of integration because the actors behind integration are not only states, but also a large number of institutions and organizations with the political desire to strengthen regional coherence and identity. The Eurozone should be considered the core region, because it is economically and politically dynamic and structured, and because of how the rest of the EU and non-EU members relate to it. Particularly, this chapter explains how, under new regionalism, the Eurozone and the euro have helped increase not only economic, but also political, social, and even cultural homogeneity. Further, this chapter reflects that the current economic crisis and financial uproar has affected the new regionalism trend that began in the 1980s with the political and economic integration efforts in the EU and the Eurozone. The current economic events are affecting the integration process in the EU and the Eurozone in two dangerous but interesting ways. First, the economic crisis has negatively affected to different degrees the economies of some countries such as Portugal, Italy, Ireland, Greece, and Spain. In particular, Greece, Spain, and Portugal are in financial and economic positions that are halting the integration program, particularly, financial and economic integration. On the other hand, these economic difficulties are pushing certain countries to look inward in a sort of defensive mechanism. Such are the case of Belgium, the UK, and Spain, where nationalism is suddenly being revamped and is now becoming even more skewed than ever as the economic situation gets worse. As a consequence, countries that

260

The Euro in the 21st Century

were in line to adopt the euro are rethinking their view on becoming part of the Eurozone. Mainly, the impossibility of using monetary policy for adjustment in case of deep monetary problems as well as the lack of coordination among Eurozone Member States on how to tackle the current crisis has also led certain countries wanting to join the EU and the Eurozone to change their prospects. Furthermore, the current crisis has affected other integration projects such as Mercosur and African integration. However, Asian countries seem to be immune, and on January 1, 2010, China joined the ASEAN Free Trade Agreement. Finally, it introduces an overview of the rest of the book’s contests and presents the book’s research design and methodological approach, because this book uses a number of time series and statistical approaches to strengthen the findings in order to provide the conclusion with a solid theoretical and statistical foundation. Also, Chapter 1 explains what have been the technical and theoretical difficulties found along the way. This chapter explains that the EU and the Eurozone suffer from an important lack of time series availability and variety. The fact that it is complicated, at best, to find the same time series for a number of countries in the same time frame and period of time makes any quantitative analysis complex. Chapter 2 concludes that the creation of the EU and the introduction of the euro as a common currency has demonstrated that economic and monetary cooperation is possible among countries. The essential point is that not only is cooperation possible but, more importantly, desirable to improve economic development, political stability, and social well-being in a country and a group of countries. The fact that the European countries involved in two devastating wars have been capable of cooperating under the umbrella of the EU and the euro has become a model to imitate. This chapter explains that the introduction of the euro has not been an easy task although the idea had been around for many years and with different formats. Finally, after a number of failed attempts, the euro has been introduced in a number of Member States. This chapter demonstrates that the introduction of the euro has been such a total success that the euro as a national currency has been adopted by other countries that are not even part of the Eurozone. This is important because the importance of a national currency is also measured by the number of countries that unilaterally, or via a specific agreement, adopt that currency as a national one. This chapter also explains that there are a number of countries that have followed the evolution of these European countries in their quest to create a union and introduce a common currency. The fact that, after the creation of the EU and the introduction of the euro, countries have improved economically, politically, and socially has been an incentive for a number of countries and regions. The first important region that has been trying for quite some time to create a union are the countries of Latin America. There have been many attempts but almost all have also failed. Mercosur is the most important one as it has the presence of the two economic giants of the area: Brazil and Argentina. However, evidence demonstrates that the incentive to continue with the common effort of all the four countries to continue is at an impasse. Brazil seems to be aware that its economic development is on its way with or without the cooperation of Argentina, Paraguay

The Eurozone in the 21st Century

261

and Uruguay. Brazil has become, together with China, India, and Russia, one of the most important developing countries. As a consequence, Brazil has raised the living standard of its citizens and has become an important economic global actor, allowing it to focus on developing other areas. For instance, Brazil is for the first time looking into improving its national security and defense and in 2008 put together for the first time in history a national defense strategy framework, raising national defense spending by 50 percent. On the other hand, Argentina is in a middle of a political crisis that is affecting the economy, as the political fight between the President and the Central Bank of Argentina is disturbing the economic state of affairs. Another problem for integration in this region is that there is a complete lack of trust between countries, which prevents any efforts at integration. Mercosur, after all these years, cannot be considered a fully developed customs union. Furthermore, this chapter explains the integrating attempts of some of the African countries which are already trying to introduce a common currency. However, there are many setbacks and obstacles to be overcome. This chapter explains that although having a single market and an economic and monetary union is extremely appealing as it truly increases economic expansion and social progress, this is no easy task to achieve. The example of the EU and the Eurozone demonstrates that it takes clear institutional organization, political commitment, and social sacrifices to have a successful story. The study of the integration efforts of these two blocs has revealed that both the African and the Latin America blocs lack, to a different degree, these three main characteristics. Dangerously, the current economic crisis and financial uproar is negatively affecting the progress that these regions have achieved throughout the years. Chapter 3 demonstrates from a qualitative standpoint that the euro has become a solid common currency, and a monetary and economic stabilizer. It also explains from a quantitative standpoint that the euro has in fact become a stabilizing factor for the Eurozone and the EU as a bloc. As a consequence, the euro has become a successful common currency for the Eurozone. This statement is corroborated in the analysis of the euro in three important markets. The section entitled “The Euro and the Foreign Exchange Market” quantitatively confirms that the euro has become a solid common currency by examining the relationship between the US Dollar Index and the D-mark to explain the creation of the euro. Further the evolution of the Spanish peseta, the Italian lira, and the French franc showed that if those currencies were today in circulation they would be following the euro cycle. These quantitative results prove that the euro has become a de facto common currency for Eurozone Member States. Also, this section explains the relationship between the UK pound and the euro and emphasizes that since early 2008 both currencies have been moving in tandem (and there has been a synergy in both currency cycles hinting at a possible long-time desired merger between the pound and the euro). The second section—“The Euro and the Stock and Commodities Markets”—provides a thorough view of the behavior of the euro in compliance with the monetary policy requirements imposed by the Maastricht Treaty. To do so, this section first presents how the stock markets have reacted to the introduction of

262

The Euro in the 21st Century

the euro. It further shows that there is a lack of relationship between the valuation of the Dow Jones Industrial Average (DJIA) and the German DAX, and the US Dollar Index and the euro. However, the data proves that since the introduction of the euro, the DJIA, the DAX, and the Eurotop 100 have been increasingly correlated. Moreover, this section presents data that show that the euro has helped maintain prices under control since 2007 when the value of both the CRB and Crude Oil Indexes reached all-time record highs; in fact, these high prices were balanced out by the euro reaching record highs. Since 2007, the appreciation of the euro has helped offset the rise in commodity prices, especially oil. Therefore, the euro has so far helped to keep prices and inflation under control. The final section—“The Euro and the Money Market”—specifically presents a detailed analysis of the euro money markets, which are influenced by the ECB setting interest rates to control prices and inflation. This section presents the relationship between the euro and the EURIBOR, compared with the behavior of the US Dollar Index, the US Treasury Note (T-Note), and the LIBOR. The statistic results demonstrate that the LIBOR and the US T-Note money market cycle moved in unison until the euro was introduced. With the introduction of the euro, the LIBOR, particularly for the past year (2009), has been converging with the EURIBOR. This proves that the euro has also acted as a stabilizer for the money market but that the business cycle in the Eurozone lags behind. As in most scholarly works, this study has its own specific limitations. One such limitation concerns the quality and variety of the economic and monetary time series available to study the economy of the Eurozone and its Member States. The quality of the data found was at times weak for two reasons. First of all, the Eurozone was formally created on January 1, 1999; hence, most time series just cover the Eurozone from 1995. This means that most economic and monetary time series just provide 14 years of information. The length of these series is in some cases not enough to apply a variety of relevant statistical methods, which require a larger number of periods in order to eliminate statistical “noise.” There is, moreover, a very limited variety of time series available to study economic, monetary, fiscal, and social issues in the Eurozone. This study has, in fact, been limited at times by the difficulty in comparing a number of time series that would have helped the inference of a stronger conclusion. Had some of these indexes been available for the Eurozone, they would have warned of the situation that has unfolded in certain countries which have been greatly affected by the demise of their construction/real estate markets. This study has therefore been limited by the availability of the data and not by the tools necessary to analyze and interpret the data. In fact, the value-added of this work rests on the use of sophisticated computer programs used to transform the numerical data and to apply innovative statistical methods to infer conclusions. This study has demonstrated that the use of optimized statistics methods, such as moving averages, covariances, and de-trending used to study a series of figures and indexes could be of great help in “predicting” the trend of some time series. Although, these statistical methods

The Eurozone in the 21st Century

263

have helped find repetitive patterns in this particular time series, there is no guarantee that these repetitive patterns could be found in every single one. In conclusion, had all the data necessary have been available for the Eurozone, stronger statistical conclusions could have been reached on whether the euro has been a monetary, economic, fiscal, and social stabilizer for the Eurozone. Accurate and lengthy time series are a powerfully academic tool that arms any scholar with a competitive advantage to produce significant results. In fact, the superiority and importance of the US’s reports is based on the strength and accuracy of the data used. The US has a structured system of well-defined time series organized by leading, coincident, and lagging economic indicators. Researchers using these tools are able, without a doubt, to come up with powerful conclusions about the state of the US economy and even elaborate on its future. The Eurozone that is “under construction” must understand the importance of having an organized and reliable set of harmonized data in order to facilitate robust and accurate research. Chapter 4 demonstrates that the euro has become an important international currency because it is considered a unit of account, store of value, and medium of exchange. The euro is considered a unit of account because it is a currency with a demand that has increased in the private sector for invoicing in international trade, which has risen significantly due to globalization. This invoice currency role of the euro has not only increased due to intra-Euroarea trade, but also because Member States, led by Germany, are net exporters to non-Eurozone Member States. In fact, Germany, The Netherlands, France, Italy, and Belgium are among the top ten world net exporters. Also, in the official sector, the use of the euro has increased because a number of countries have chosen to peg their national currencies to it. The euro has also become a store of value because in the private sector the number of products denominated in euros in the bond, money, and foreign exchange markets has significantly increased due to the international weight of the Eurozone as a solid economic and monetary bloc. Although bond-issuing activity has increased in the corporate and financial sectors, it has not been properly maintained under control at the central and local government levels. In fact, against the Maastricht Treaty requirements, governments have greatly raised their bond issuing to be able to finance rescue plans and inject money into the economy to soften the impact of the current economic crisis. As a consequence, sovereign bond ratings are suffering from an increase in yield with respect to the German bond, and altogether this is resulting in a downgrade of bond ratings by Standard & Poor’s, Moody’s, and Fitch, and a loss in confidence in the strength of the union. In the official sector, the performance of the euro is analyzed based on its use as a reserve currency. The data have curiously shown that the total allocation of euros has increased from 13 percent in 1999 to 16 percent in the third quarter of 2009, whereas the US dollar has sharply declined from 55 percent in 1999 to 36 percent in 2009. The euro share has increased more significantly in emerging and developing countries than in industrial countries, which shows the desire of certain less-developed countries to diversify from the US dollar. However, when it comes to whether the euro has become a global currency, the data show that the euro has not been able to reach

264

The Euro in the 21st Century

the level of the US dollar. Furthermore, the capital market in the Eurozone has not been able to reach the level of breadth, depth, and liquidity observed in the US. Hence, the euro is a common currency and an international currency but it has not become a global currency. This means that the US dollar remains the sole global and major reserve currency. Findings in Chapter 5 demonstrate that the current economic crisis and financial uproar is pushing for the redesign of the monetary order because a group of emerging countries led by China and Brazil (BRIC) have been heavily campaigning to dethrone the US dollar from its role as the global reserve currency. These countries are campaigning to replace the US dollar as the reserve currency with the Special Drawing Rights (SDR) issued by the IMF. Some of the BRIC countries have recently advanced the idea that the US dollar should disappear as a global reserve currency in favor of the SDR. This is a utopian illusion because the SDR as a currency lacks the strength to become a global common currency. The main reason is that there is not enough SDR to back up international trade nor to act as a reserve currency, particularly when there are countries themselves issuing the SDR based on the quota share. This will, in turn, benefit the most developed and wealthy nations at the expense of less-developed but fast-growing countries such as Brazil, Russia, India, and China. China is in a particular quest to end the US dollar hegemony because China is caught up in a “dollar trap.” China is maintaining an artificially low yuan and Hong Kong dollar to gain a competitive advantage based on currency dumping rather than on product sophistication and innovation. As a consequence, China is running a current account surplus big enough to finance the US current account deficit in order to maintain US demand which, in turn, helps China’s exports, which are mainly to the US. With the decline of the US dollar value, however, the Chinese reserve of US dollars is losing value. Curiously enough, China’s true reserves of US dollars are unknown. However, Russia, which is another country advocating the end of the US dollar as the global reserve currency, is increasing its share of euros in its reserves, mainly due to geographical proximity with the Eurozone and political and military rivalry with the US. On the contrary, Brazil has increased its reserves of US dollars and decreased the share of euros in the last years. Finally, based on the success of the euro as a common currency, Robert Mundell is now defending the need for a global common currency, arguing that a globalized economy requires a global common currency. This high level of globalization has boosted the demand for foreign exchange to a point where the turnover has increased from US$590 million in 1989 to US$3.2 trillion in 2007. If there were to be a common single currency, transaction costs could disappear. For instance, the turnover of the UK pound from 2004 to 2007 has increased considerably, which means that the transaction costs have increased as well. The disappearance of the pound, or any other currency, will on the one hand significantly reduce transaction costs and benefits for the market makers and, on the other, raise price transparency for the consumer. Chapter 6 reveals that the euro and the Eurozone are suffering their first true global economic crisis and financial uproar, which has been worsened as a

The Eurozone in the 21st Century

265

number of countries are putting the union at risk due to their lack of economic and financial rigor. These countries qualified to join the euro after making the economic and financial efforts required by the Maastricht Treaty. These efforts not only have not been maintained, but further improvements necessary to strengthen rather weak economies were never implemented. Curiously enough, the countries that are jeopardizing not only the EMU but the EU as a whole are those that before joining were suffering from high unemployment, current account deficits, trade deficits, and were using currency devaluation to regain competitiveness that their productive sectors were not able to gain by themselves due to high salaries, red tape, low productivity, and lack of competitiveness. Although Ireland had already gone from “boom” to “bust” in 2008, and Greece has been making headlines in the first quarter of 2010, Spain is the country that can pose the greatest danger. Spain is a country that has neither fully respected the Maastricht requirements, nor been capable of improving its economic performance during the economic bonanza of the past years. Nor has it reinvented its means of production based on construction and tourism. The harshness of the current crisis has worsened these symptoms, which should have been resolved a long time ago by clearly stating and implementing the necessary measures to stop any economic and fiscal behavior that could put the EU project in danger. In this case, both countries and politicians in the Commission would be responsible for the demise of the EU as a credible and solid economic and monetary bloc. As a consequence, Chapter 7 concludes that there are a number of Eurozone Member States that are creating numerous problems and threatening the unity of the union. Greece has been involved in a financial and economic crisis that not only is jeopardizing the Eurozone but also the political stability of the country because it must implement painful adjustments. This situation has spilled over to other countries such as Spain. Neither Greece nor Spain were fully complying with the necessary requirements and were not maintaining a coherent economic growth model that would sustain the country in times of economic hardship. Hence, the crisis that started in Greece has put the entire Eurozone in danger. The debate on what to do has been long and tortuous, because the pros and cons of each measure entailed certain outcomes and consequences for both the EU and the Eurozone. The debate has been centered on whether Greece should be bailed out by the rest of the members of the EU, whether the IMF should play a role in this matter, or whether delinquent countries such as Greece and Spain should be expelled from the Eurozone and remain in the EU while they put their finances in order. The bailout discussed would be in the form of money transferred to Greece in a mix of bilateral guarantees and loans via the EU Structural Funds, concerted actions to buy Greece sovereign bonds, or just the all-time classic direct loans to Athens to help Greece with the estimated €54 billion needed for 2010. This financial help will be tied to strict surveillance and enforcement of polemic fiscal and structural reforms. If the EU were to bail out Greece it would prevent Greek bankruptcy but increase the moral hazard, because other countries might misbehave knowing that rescue is a possibility. Furthermore, it would show that the EU is a united

266

The Euro in the 21st Century

group of countries that will not leave behind a country in difficulties. However, this would encourage massive financial attacks against weak countries by the socalled “speculators” who would just take advantage of a situation that has been presented to them as a result of government mismanagement. Also, if Greece is left to bankruptcy, the banking sector would suffer greatly because most of Greece’s sovereign debt bonds outstanding (that amount to about €200 billion) are held by European banks. And finally, it would hurt the image of the EU as a hegemonic political and economic bloc. The debate on whether to bail out Greece is enmeshed with the role that the IMF should or should not have. Greece has threatened to call the IMF for help. However, if the IMF is called to the rescue the no bailout rule introduced by Germany’s demand would not be broken. Further, the IMF would add precise knowhow on how to solve the Greek situation. Furthermore, the IMF would be the one to blame when it forces the harsh measures necessary to solve the problem. Furthermore, the presence of the IMF would exclude other Member States from increasing their exposure while helping with the bailout. However, if the IMF fails, the EU would be doomed because the IMF will not have saved Greece and the EU will have left a member behind. Another solution would be that certain countries that are not maintaining economic and financial requirements, that have lost competitiveness, and that are not active in implementing the necessary supervision are invited to leave the Eurozone but remain in the EU while working their problems out. However, this solution is not contemplated by the Treaty of Lisbon. These countries would have to join again the European Exchange Rate Mechanism (ERMII) and apply again to adopt the euro. Germany is proposing the involvement of the European Monetary Fund to help in this exit phase. This solution is necessary because Germany has the highest interests in avoiding the breakup of the Eurozone because it is the country that benefits from the existence of the Eurozone the most. Finally, Chapter 8 concludes that the introduction of a Euro Index similar to the US Dollar Index would be a highly useful tool. A thorough analysis helps conclude that under the current circumstances, the Euro Index would be as good a trend-predicting tool as the US Dollar Index. The idea of an Euro Index adds an innovative, quantitative study to the analysis of the euro, based on a multidisciplinary approach, to create a self-made Euro Index, Australian Index, and New Zealand Index. The purpose of the creation of these indexes is to study whether the euro, the Australian dollar, and the New Zealand dollar are strong enough currencies to make their most important cross-rates converge. The study has revealed that all of the indexes created make strong and leading indexes because their cross-rates are converging. The methodological, multidisciplinary approach used feeds from ideas and theories from many scientific and social fields. This method is a ground-breaking approach to the study of series and indexes quite distant from well-recognized traditional theories that explain market behavior such as those generated by the so called capital market theories. This multidisciplinary approach is based on the idea that indexes are dynamical systems because they are explained in terms of differential equations that describe

The Eurozone in the 21st Century

267

behavior for a period of time. This is a borrowed concept from mathematics that is linked to the idea of self-organizing critically, from statistical physics, which explains why complexity—relationship among the series in an index—can happen spontaneously. This relationship is nothing but the mathematical idea that series can converge. This convergence takes place at a point that in thermodynamics is called a critical point. This critical point can take many forms but, in indexes, a critical point can only be what in geometrics is called an “attractor,” because attractors follow a periodic trajectory that tends to repeat and help with pattern recognition. Finally, when an index arrives at an attractor because series have been converging, a change of tendency will take place in what is called a “sharp jump” in the study of magnetic systems. Finally, the important point is that due to pattern repetitions indexes become fractals. The idea of a fractal, borrowed from mathematics, means that fractal time series have cycles and trends that repeat themselves. This multidisciplinary methodological approach helps us to conclude that the index is not a leading index because the currencies that compose it are not converging. As a consequence, cross-rates series in the indexes are canceling each other out, which prevents the index from having a strong critical point and clear, sharp jump. The cross-currencies series that compose the Australian and New Zealand Indexes are convergent series, which means there is a strong critical point and a solid sharp jump. The Euro Index, which has been constructed to see if the euro has become a true leading currency, demonstrates that the underlying crossrate enjoys sufficient convergence strength to provide this index with a strong sharp jump to predict the future trend of this index. Limitations of the Study and Recommendations for Future Research As in most scholarly works, this study has its own specific limitations. One such limitation concerns the quality and variety of the economic and monetary time series available to study the economy of the Eurozone and its Member States. The quality of the data found was at times weak, mainly because the Eurozone was formally created on January 1, 1999; most time series just cover the Eurozone from 1995. This means that most economic and monetary time series just provide 14 years of information. The length of these series is in some cases not enough to apply a variety of relevant statistical methods, which require a larger number of periods in order to eliminate statistical “noise.” There is, moreover, a significant problem with the quality of the time series available to study economic, monetary, fiscal, and social issues in the Eurozone. On the other hand, numerical data from certain countries oftentimes were reported using different time frames, which made it impossible to compare and contrast time series. For instance, not all the data were found in monthly, quarterly, or yearly categories. This has limited the possibility of widening the scope of the analysis. Nonetheless, this work presents noteworthy new self-made indexes, such as the Euro Index, New Zealand Index, and the Australian Index, as well as those for a number of currencies that are

268

The Euro in the 21st Century

no longer in circulation, such as the Spanish peseta, the Italian lira, the French franc, or the deutsche mark. Also, this study presents the historical evolution of newly created indexes such as the Markit iTraxx Europe Index or the spread in the credit default swaps between Spain and Germany. Secondly, when it comes to the variety of indexes, two situations were found. On the one hand, in some specific cases, information was lacking because some Eurozone Member States have not provided it. One important example is the lack of available information from Greece and Spain in comparison with the richness of information found for Germany. In detail, Greece does not report productivity levels nor competitiveness indexes which could be compared and contrasted with the information found from other countries. Furthermore, the study using the Eurobarometers was rather complicated. Although, there is a wide variety of analysis that covers many areas, it has been very difficult to make a cross-time analysis of a particular issue. For instance, it has been difficult to follow over time Europeans’ feelings towards a number of specific issues such as the integration process that was analyzed in the Eurobarometer 64 (Eurobarometer 2005). This study has, therefore, been limited at times by the difficulty in comparing a number of time series that would have helped infer a stronger conclusion, but not by the availability of innovative tools to analyze, study, and interpret the data. In fact, the value-added of this work rests on the use of sophisticated computer programs used to transform the numerical data and to apply innovative statistical methods to infer conclusions. The use of these innovative optimized statistical methods has helped identify trends, given the current information, as well as opening a new field that might help in the endeavor to find repetitive patterns in this particular time series. However, there is no guarantee that these repetitive patterns could be found in every single one. In conclusion, had all the data necessary have been available for the Eurozone, stronger statistical conclusions could have been reached not only on whether the euro has been a monetary, economic, fiscal, and social stabilizer for the Eurozone, but also concerning the signs that were signaling that certain countries of the Eurozone were entering a dangerous zone. Accurate and lengthy time series are powerful academic tools that arm any scholar with a competitive advantage to produce significant results. This is proven by the fact that the superiority and importance of the US’s reports is based on the strength and accuracy of the data used. The US has a structured system of well-defined time series organized by leading, coincident, and lagging economic indicators. Furthermore, there is a coherent set of data across time and states that help study the same variable across the same period of time and in a set of specific states. Researchers using these tools are able, without a doubt, to come up with powerful conclusions about the state of the US economy and even elaborate on its future. Furthermore, the US counts on the vigilant role of the National Bureau of Economic Research to point out the phases of the business cycle. The Eurozone and the EU are “under construction” and must understand the importance of having an organized and reliable set of harmonized data in order to facilitate robust and accurate research.

The Eurozone in the 21st Century

269

There are two recommendations for future research. The first recommendation has to do with the economic situation that has recently developed. The Eurozone has entered a new period characterized by an economic recession that has turned into a worldwide phenomenon affecting every country and every economic sector. Actions and measures taken by Member States to help countries through these tough times are having a short-term impact on economic recoveries and a long-term one on the euro and on the stability of both the Eurozone and the EU. Therefore, analyzing the balance between saving the economy and respecting requirements for the project should be followed. It is important to understand that Member States must comply with the requirements imposed by the Maastricht Treaty. However, it would be interesting to follow how the EU would deal with noncompliers who would endanger the fate of both the EU and Eurozone. Further, the actual situation will also help evaluate if the requirements imposed are too rigid or if this rigidity is a necessary tool to safeguard the union. Second, given the economic crisis that has unfolded it would be interesting to follow how the appeal of joining the euro has attracted certain countries. Before 2008, there was a series of eastern European countries that joined the Eurozone with the strong intention of adopting the euro as common currency because it was viewed as the perfect umbrella for weathering economic crises. However, the severity of this crisis has made these same countries wonder if joining the Eurozone and being forced to respect strict requirements would be the right plan. Furthermore, these countries have seen how their expected adoption has been set back at least a couple of years. These two recommendations would seriously profit if there was a profound effort to improve economic, financial, and monetary time series for Member States. It would help future research if the current time series were completed with accurate data. Moreover, it would help if the limited set of indexes was expanded and harmonized with data and time series available in different countries. Finally, both the actual and the future economic series should be grouped into leading, coincident, and lagging time series as a way to provide more information regarding changes in the European economic business cycle. The advantages of implementing these recommendations are twofold. On the one hand, both the quality and quantity of research will grow exponentially; on the other hand, the scholars and experts on the Eurozone and EU will gain research competitiveness. This study opens a new window of opportunity to incorporate not only innovative statistical tools, but also sophisticated and avant-garde computer programs and proved, accurate, and trustworthy statistical results to the study of economic indexes and time series. Final Thoughts The EU and the Eurozone are facing a major survival test, and much is still to be done, particularly now that the union is facing a dramatic situation that is getting more complicated by the hour. Back in 2007, I published, under the umbrella of

270

The Euro in the 21st Century

the European Union Center at the University of Miami, a number of research papers that pinpointed a gap between the economic performance and structural reforms efforts of northern and southern European countries. The Greek crisis has opened Pandora’s Box and highlighted these differences, and, consequently, Member States have a number of alternatives. On the one hand, some voices are saying that in order to save the union certain Mediterranean countries should be expelled because their financial disarray is jeopardizing the EU. Greece might be financially saved by the coordinated action of the rest of the Member States and the IMF, but this does seal the problem because other countries are about to expose serious financial problems soon. In fact, some of the countries that are expected to provide financial help, such as Spain, might face their own worse financial situation very soon. On the other hand, Germany might decide to leave the union and go “solo” as its economic and productivity level will guarantee its survival in the current globalized world. The main problem is that saving these “delinquent” countries might cause the Eurozone to face a dramatic hyperinflation; this would require countries to issue massive amount of debts that might send them to face a déjà-vu “Republic of Weimar” hyperinflation. Furthermore, the rescue operation demands that countries in disarray tighten their economic and financial belts, which might, in turn, see the opposition of civil society whose members might not accept such measures. The introduction of the euro, in 1999, has meant that a number of countries with diverse economic, monetary, fiscal, political, and social backgrounds have made a number of sacrifices and compromises to adopt the common currency. The adoption of the euro has been, therefore, a tough economic, monetary, fiscal, political, and social learning process for some countries. Thus, the European project is nothing other than a team project, which requires a common vision and common agreement on the efforts, steps, and sacrifices that are going to be taken in order to achieve the mission proposed. However, the EU is not properly attaining the common objectives envisioned by the founding fathers. This work has proved that the euro has helped Member States in many different ways and that overall, the euro has been so far a monetary, economic, fiscal, political, and social stabilizer for all the Eurozone Member States. In fact, this study has proved that every single Member State that has joined the Eurozone has improved its economic, monetary, fiscal, political, and social schemes. The euro was introduced, nonetheless, at the very beginning of the expansionary phase of the business cycle. The National Bureau of Economic Research (NBER) announced (2001, 1) that “the Business Cycle Dating Committee of the National Bureau of Economic Research … determined that a trough in business activity occurred in the US economy in November 2001. The trough marks the end of the recession that began in March 2001 and the beginning of an expansion” (Business Cycle Dating Committee 2001, 1). This expansionary phase lasted until December 1, 2007, when the NBER announced that the economy of the US had reached a peak in economic activity and that the beginning of the recession was imminent

The Eurozone in the 21st Century

271

(Business Cycle Dating Committee 2008). The current US recession is having an impact worldwide. During these years of prosperous economic activity the requirements set to maintain the EMU and the euro have been reasonably respected by most Member States; in turn, the euro has functioned adequately and has conveyed to the rest of the world an image of stability, success, and integration. Consequently, most of the countries that joined the EU in 2004 and 2007 are working towards meeting the convergence criteria and adopting the euro. Further, other countries in Africa and in South America are looking at the euro and the Eurozone as the role model to follow in order to achieve economic, monetary, fiscal, and social stability. However, the euro has turned ten and, as a child who has grown to adulthood, is being put to the test as a brutal recession is unfolding worldwide and affecting the EU and the Eurozone. When the euro was first introduced, Milton Friedman, the late Nobel laureate, predicted that the euro would not survive a recession. A limited group of scholars and experts, the Euroskeptics, is claiming that the euro will not be able to survive the current economic crisis. Needless to say, this current financial crisis and recession have frightened consumers and businesses, and the usual recovery tools used by government, mainly monetary and fiscal stimuli, may be not only ineffective but also counterproductive under the circumstances. Recently, countries such as Spain, Italy, Greece, Portugal, and Ireland (the PIIGS countries) have been reporting that the “one-size-fits-all” monetary and economic requirements imposed by the single currency are asphyxiating their economies. However, these countries are the same countries that this study has demonstrated have neither followed nor kept up with the requirements necessary to maintain a stable economy. These countries are now in trouble and are unfairly jeopardizing the entire system. In fact, Desmond Lachman (2008, 1) explained that in 1998, when the euro was launched, Milton Friedman famously warned that the euro would be truly tested by the first major global economic recession. He issued this warning in the belief that, lacking labor and product market flexibility, Europe was not an optimum currency area in the sense that was the case for the US economy. For that matter, the project needs to act on the economic and monetary front, and in the political and social front. The current crisis has demonstrated that both fronts have failed to address the proper issues. From an economic and monetary point of view, certain countries have acted recklessly because they have lacked the courage to face public opinion and undertake the necessary and often painful measures to cure today what can become a “disease” tomorrow. For that matter, labor reforms have not been introduced, current account deficits have ballooned, trade balances are sinking into negative values, all of which, together with the worst recession since the Great Depression of 1929, has resulted in a number of Eurozone Member States almost going bankrupt, leaving the EU with a serious situation that is affecting the bloc’s reputation. The legislative branch of both Member States and the EU as a unity are responsible and liable for the current dire straits. ECOFIN is composed of the

272

The Euro in the 21st Century

Economics and Finance Ministers of Member States who meet once a month to discuss areas of “economic policy coordination, economic surveillance, monitoring of Member States’ budgetary policy and public finances, the euro (legal, practical and international aspects), financial markets and capital movements and economic relations with third countries” (Council of the European Union n.d.). Out of all these meetings and the work of the Economic and Financial Commissioner, a number of reports have been put together, all of which have warned against the danger of certain Member States’ activities if they did not really change their course of action. After 11 years of monthly ECOFIN meetings, two revisions of an unimplemented Lisbon Agenda to make the EU the most competitive economy in the world, two revisions of the Stability and Growth Pact to help Member States comply with the Maastricht requirements, and the De Larosiere Report on Financial Supervision on the EU, the EU and the Eurozone projects are in the brink of collapse due to a number of countries who have never been held accountable for their economic, monetary, and fiscal mismanagements. For this reason, both Member States and EU politicians should be held accountable for lack of supervision and failure to properly implement the rules, and reprimanded as necessary to maintain the wellbeing of the union. Citizens have entrusted politicians to manage and to at least maintain the EU; however, politicians, due to inability or incompetence, have not been able to maintain what has been given to them, a viable economic, monetary, political, and social project. Hence, as “the unprofitable servant” in the Parable of the Talents, politicians should be thrown “into outer darkness. There will be weeping and gnashing of teeth” (The Bible, Matthew, 25:14–30). The current economic crisis and financial uproar, together with the financial difficulties in a number of countries, have been raising a number of questions lately. First of all, although joining the Eurozone has been a highly regarded goal, it seems that the cost of participating has increased over the last year (2009), and it has discouraged some countries from joining the Eurozone. Countries outside the Eurozone are appreciating the fact that they are free to implement whatever monetary and fiscal policies they see fit their countries’ situations better. Further, increasing the number of participants in the euro club will increase the divergence of economic experiences and put more pressure in an already stretched situation when it has been demonstrated that widely economic diverse countries are difficult to merge together. Although the current financial difficulties of a number of countries such as Greece have been taken under control, the risk of a possible default in the future is still lingering on the horizon. The possibility of more financial difficulties that might end up involving the project remains high, and there are a number of countries that, under the current situation, could be better off if they were outside the Eurozone. The EU and the Eurozone should definitely make up their minds and take up a position on what they want. If they do not want to amend the Treaty of Lisbon, they must make sure that countries are complying with the requirements voluntarily agreed upon when they joined the EU and adopted the euro. If EU Member States are incapable of imposing and enforcing the compliance of these

The Eurozone in the 21st Century

273

requirements, they should agree on amending the Treaty to accommodate the necessary exits. This would mean that the Eurozone has not been an “optimal currency area,” implying that there is an economic cost associated with belonging to the Eurozone. Member States must be fully aware that although the exit clause is an option, it would have such a high economic and political cost for those countries leaving the union that the cost of staying within the monetary union will remain small in comparison. Despite the current economic situations, the introduction of the euro has demonstrated that Member States have adequate monetary, economic, fiscal, political, and social maturity to make the necessary efforts to meet the requirements to adopt the euro. Nonetheless, the current economic downturn is hinting that some adjustments to the institution are necessary and, as Romano Prodi (2001, 12) declared, “[he is] sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose this now. But some day there will be a crisis and new instruments will be created.” The EU and the Eurozone are therefore at a situation that, paraphrasing Winston Churchill, is at the finest hour where those responsible for the future of the project should have “nothing to offer but [reforms], sweat, and tears” (Churchill 1940, 1) in order to safeguard the EU and all that has been built over the past fifty years.

This page has been left blank intentionally

Bibliography ABC. 1993. “La debilidad de la economía Española.” ABC Sevilla. May 14. . Abowd, John, Francis Kramarz, and David. N. Margolis. 1999. Minimum Wages and Employment in France and the United States. Cambridge MA: National Bureau of Economic Research, Working Paper 6996, pp. 126–256. Ahearn, Raymond J. 2006. “Europe: Rising economic nationalism?” CRS Report for Congress, July 6. (accessed March 28, 2010). Ahn, Namkee. 2001. “Age at first-time homeownership in Spain.” FEDEA Documento de Trabajo 01–03, pp. 11–26. (accessed November 15, 2007). Alesina, Alberto, and Roberto J. Barro. 2000. Currency Unions. Cambridge MA: National Bureau of Economic Research, NBER Working Paper 792, pp. 92– 201. Almunia, Joaquín. 2007. “Seven years with the euro.” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro Gomis-Porqueras, Burlington VT: Ashgate, pp. 11–16. Andreu, Juan. M. 1997. Una introducciòn a la macroeconomia. Madrid: Dykinson. APF. 2009. “Standard and Poor’s cuts Spain’s debt rating.” France24. January 19. (accessed September 11, 2008). Ark, Bart van, and Erik Monnikhof. 2000. Productivity and Unit Labour Cost Comparisons: A Data Base. Geneva: International Labour Office. (accessed November 26, 2007). Associated Press. 2006. “U.S. savings rate hits lowest level since 1933.” MSNBC. January 30. (accessed February 12, 2010).

276

The Euro in the 21st Century

Atkins, Ralph. 2008. “Mixed reviews greets 10th anniversary.” Financial Times. October 26. —. 2006. “A coming of age for the European currency.” Financial Times. December 28. —, and Quentin Peel. 2010. “Germans oppose Greek aid, poll shows.” Financial Times. March 21. (accessed March 24, 2010). Aunión, J.A. 2007. “La educación Española retrocede.” El País. December 5, 2007. http://www.elpais.com/articulo/sociedad/educacion/espanola/retrocede/ elpepusoc/20071205elpepisoc_1/Tes> (accessed September 10, 2009). Baily, Martin N., and Jacob F. Kirkegaard. 2004. A Transformation of the European Economy. Washington DC: Peter G. Peterson Institute for International Economics. Bak, Pek, C. Tang, and K. Wiesenfeld. 1987. “Self-organized criticality: an explanation of 1/f noise.” Physical Review Letter 59: 381–4. Bak, Per. 1996. How Nature Works: The Science of Self-Organized Criticality. New York: Copernicus Press. Balassa, Bela. 1961. The Theory of Economic Integration. Homewood IL: R.D. Irwin. Ball, Laurence. 1990. “Disinflation and the NAIRU.” In The Sustainability of Monetary Stability, ed. Stefan Collignon, London: Routledge, pp. 1–68. (accessed October 27, 2007). Banco Central do Brasil. 2009. Relatorio de Gestao das Reservas Internacionais. (accessed December 2, 2009). Bank for International Settlements (BIS). 2007a. Triennial Central Bank Survey 2007. December 2007. (accessed December 23, 2009). —. 2007b. Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007—Final results. December 2007. (accessed December 27, 2009). Bank of Hong Kong. History of the Hong Kong Dollar. (accessed November 25, 2008) Bank of Russia. 2008. Bank of Russia 2008 Annual Report. (accessed December 2, 2009). Barber, Tony. 2008. “Fiscal rules reforms allow budget deficits to rise.” Financial Times. November 4. Barroso, Josè M. 2002. “Working together for growth and jobs. A new start for the Lisbon Agenda. Communication to the Spring European Council, COM (2005) 24, February 2.” Brussels: Commission of the European Communities.

Bibliography

277

(accessed March 2, 2008). Bartel, Robert J. 1974. “International monetary unions: The 19th century experience.” Journal of European Economic History 3, no. 3: 689–704. Barysch, Katinka. 2003. “A pact for stability and growth.” Center for European Reforms. October. (accessed July 25, 2008). BBC History. n.d. “Otto von Bismarck (1815–1898).” (accessed October 28, 2008). BBC News. 2008. “France unveils huge stimulus plan.” December 4. (accessed December 28, 2008). —. n.d. “Profile: African Union.” (accessed October 15, 2009). —. 2001. “George rules out euro entry.” June 12. (accessed November 19, 2009) Beck, Glenn. 2008. “Interview with Ray Kurzweil.” CNN.com. May 30. (accessed March 19, 2010). Belien, Paul. 2006. “The rape of Europa.” The Brussels Journal, October 25. (accessed December 4, 2008). Bentolila, Samuel, and Giuseppe Bertola. 1990. “Firing cost and labour demand: How bad is eurosclerosis?” Review of Economic Studies 57, no. 381: 82–107. Bergsten, Fred C. 2005a. “The dollar and the euro.” In The Global Economy: Contemporary Debates, ed. Thomas Oatley, New York: Pearson Longman, pp. 278–89. —. 2005b. “The euro and the dollar: Toward a ‘Finance G-2’? Peterson Institute for International Economics, Working Paper no. 3: 1–27. (accessed May 25, 2008). —. 2002. “The euro versus the dollar: Will there be a struggle for dominance?” Paper presented to a roundtable at the annual meeting of the American Economic Association, Atlanta GA, January 4. (accessed June 4, 2008). —. 1997. “Open regionalism.” Peterson Institute for International Economics, Working Paper 97-3. (accessed April 10, 2010). The Bible, Gospel According to St. Matthew, 25:14–30, “The Parable of the Talents.”

278

The Euro in the 21st Century

Bibow, Jorg. 2004. “Investigating the intellectual origins of Euroland’s macroeconomic policy regime: Central banking institutions in West Germany after the war.” Levy Economics Institute, Working Paper No. 406 (May), pp. 1–49. (accessed February 14, 2010) Bi-Me Staff. 2009. “Global corporate default tally rises to 260 issuers in 2009, says S&P.” Business Intelligence. December 14. (accessed February 23, 2010). Bini-Smaghi, Lorenzo. 2007. “Asymmetric adjustment in monetary union evidence from the Euro area.” European Central Bank, June 19, at . Blair, Tony. 2005. Program of the British Presidency. European Parliament, Brussels. June 23. (accessed June 28, 2008). Blanchflower, David, Neil Millward, and Andrew J. Oswald. 1991. “Unionism and employment behaviour.” The Economic Journal 101, no. 407: 815–841. Bloomberg. 2010. “Rogoff says Greece might not be Europe’s last bail-out.” April 26. (accessed April 27, 2010). —. 2009. “Yuan may enter IMF kitty to evaluate.” The Times of India. November 18. (accessed December 28, 2009). Bolton, Sally. 2001. “A history of currency unions.” The Guardian. December 10. (accessed December 28, 2008). Bonpasse, Morrison. 2005. “The world needs to begin planning now for a single global currency—and save the world trillions.” Journal of Financial Transformation, 91–3, at . Bouzas, Roberto, and Hernán Soltz. “Institutions and regional integration: The case of Mercosur.” NetAmercas.net. (accessed November 2, 2009). Bretton Woods Project. 2009. “The IMF’s special drawing rights (SDRs).” Bretton Woods Project. April 1. (accessed March 28, 2010).

Bibliography

279

Buckley, Chris. 2009. “China bestseller sees plots and profit in financial crisis.” Reuters. September 21, 2009. (accessed December 25, 2009). Burda, Michael C. 1999. “European labor markets and the euro: How much flexibility do we really need?” London: Centre for Economic Policy Research, CEPR Discussion Paper 2217, pp. 1–32. Burghart, Günter. 2004. “Euro at five. Ready for a global role?” Paper presented at the Institute for International Economics, Washington DC. February 26. Burnett, Victoria. 2008. “Spain unveils 11 billion economic stimulus package.” International Herald Tribune. November 27. (accessed January 21, 2009). —. 2001. “Business cycle reference date.” National Bureau of Economic Research, July 17. (accessed January 21, 2009). Businessweek. 2008. “EU Commission proposes €200 billion stimulus package.” November 26. (accessed January 16, 2009). —. 2001. “Now, Argentina’s default looks inevitable.” October 28. (accessed November 3, 2009). Calaza, Juan José R. 1998. El euro contra España. Madrid: Pirámide. Calmfors, Lars. 1998. “Macroeconomic policy, wage setting and employment— what difference does EMU make?” Oxford Review of Economic Policy no. 14: 125–51. Campanella, Miriam L. 2007. “Is the euro ready to play the global currency role?” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro Gomis-Porqueras, Burlington VT: Ashgate, pp. 83–102. Canziani, Patrizia, and Barbara Petrongolo. 2001. “Firing cost and stigma: A theoretical analysis and evidence from microdata.” European Economic Review 45, no. 10: 1877–1906. Cappiello, Lorenzo, Peter Hordahl, Arjan Kadareja, and Simone Manganelli. 2006. “The impact of the euro on financial markets.” European Central Bank, Working Paper Series, No. 598, March 2006. (accessed October 2, 2008). Carling, Kenneth, Bertil Holmlund, and Altin Vejsiu. 2001. “Do benefit cuts boost job finding? Swedish evidence from the 1990s.” The Economic Journal 111, no. 409: 766–802. Caruana, Jaime. 2004. “60 years after Bretton Woods—a central banker’s view.” Opening remarks at the conference “Dollars, debt and deficits—60 years after

280

The Euro in the 21st Century

Bretton Woods,” held at the Bank of Spain, Madrid, June 10. (accessed on September 14, 2009). Catan, Tomas. 2009. “Spain raises taxes as budget crisis deepens.” The Wall Street Journal, September 10. (accessed September 10, 2009). Chang, Clara, and Constance Sorrentino. 1991. “The union membership statistic in 12 countries.” Monthly Labor Review (December): 46–53. (accessed November 1, 2007). Charlemagne’s Notebook. 2010. “Not a bang but a whimper: The threat facing the Eurozone.” The Economist, January 25. Chinn, Menzie, and Jeff Frankel. 2005. “Will the euro eventually surpass the dollar as leading international reserve?” Cambridge MA: National Bureau of Economic Research, NBER Working Paper 11510, pp. 1–56. (accessed October 6, 2008). Christiansen, Thomas, Knud E. Jorgensen, and Antje Wierner. 2001. The Social Construction of Europe. London: Sage. Christov, Dragan S., and Robert B. Macdonald. 2002. How to Tackle Unemployment. Sofia, Bulgaria: Heron Press. Churchill, Winston. 1940. “Winston Churchill speech—‘blood, toil, tears and sweat.’” Presentation Magazine. (accessed April 18, 2010). Clark, Kim, and Laurence Summer. 2003. “Demographic differences in cyclical employment variation.” Cambridge MA: National Bureau of Economic Research, NBER Working Paper 0514, pp. 1–41. (accessed September 2, 2007). Clemens, Dave. 1992. “Italy makes bold cuts in its budget deficit: EC comes under more strain as Britain and Germany blame each other for currency crisis.” International Herald Tribune. September 18. (accessed December 1, 2008). CNNfn. 2000. “Greece joins euro club.” CNN Money. June 19. (accessed March 27, 2008). CNN Money. 2009. “Global 500.” Fortune 500. July 20. (accessed April 2, 2010). Cohen, Benjamin J. 2007. “Enlargement and the international role of the euro.” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro Gomis-Porqueras, Burlington VT: Ashgate, pp. 103–130.

Bibliography

281

—. 2003. “Global currency rivalry: Can the euro ever challenge the dollar?” Journal of Common Market Studies (May): 1–23. (accessed February 16, 2008). —. 2000. “Life at the top: International currencies in the twenty-first century.” Cuadernos de Economía (Latin American Journal of Economics) 37, no. 110: 9–34. (accessed September 13, 2007). Colchester, Nico. 2001. “D-mark day dawns.” Financial Times. February 1. (accessed October 26, 2008). Collignon, Stefan. 1999. “The sustainability of monetary stability.” Economia Internazionale LII, no. 1 (February): 1–68. (accessed October 20, 2007). Comunidad Andina. 2004. “Cusco Declaration on the South American Community of Nations Third South American Presidential Summit,” Cusco, December 8. (accessed November 12, 2009). Connolly, Michael. 2007. International Business Finance. New York: Routledge. Corporate Executive Board. 2009. “Signposts of economic recovery.” Monthly Dashboard of Eurozone Economic Recovery, July 2009. (accessed November 12, 2009). Council of the European Union. 2005. “Council decision of 12 July 2005 on guidelines for the employment policies of the member states.” Official Journal of the European Union, 2005/600/EC. July 12. (accessed September 24, 2008). —. n.d. “Ecofin Council.” (accessed February 14, 2008). Cukierman, Alex, and Francesco Lippi. 2001. “Labour markets and monetary union: A strategic analysis.” The Economic Journal 111, no. 472: 541–65. (accessed March 26, 2008) Czerwinski, Tom, and David Alberts. 1997. Complexity, Global Politics, and National Security. Washington DC: National Defense University, Fort Lesley J. McNair. (accessed February 24, 2010). Daniels, Joseph P., and David D. VanHoose. 2004. “Exchange rate systems.” In International Monetary and Financial Economics, ed. Joseph P. Daniels and David D. VanHoose, New York: South-Western, pp. 7–26.

282

The Euro in the 21st Century

De Grauwe, Paul. 2007. The Economics of Monetary Integration. Oxford: Oxford University Press. —. 2006. “What have we learnt about monetary integration since the Maastricht Treaty?” Journal of Common Market Studies 44, no. 4: 711–730. (accessed March 28, 2008). De la Dehesa, Guillermo. 2009. “Will the euro ever replace the US dollar as the dominant global currency?” Real Instituto Elcano, Working Papers 54/2009. Deppler, Michael. 2007. Economic and Monetary Integration in Europe as seen from Outside. Directorate General for Economic and Financial Affairs, European Commission. European Economic News, issue 6 (April). (accessed February 10, 2008). Deschamp, Etienne. “Le project de Jean Monnet.” European Navigator. <www. ena.lu> (accessed December 4, 2008). De Vroey, Michael. 2005. “Involuntary unemployment: The elusive quest for a theory.” Département des Science Economiques de L’Université Catholique de Lovaina, Working Paper no. 2005-4: 1–25. (accessed July 7, 2008). Díez, Thomas. 1999. “Speaking ‘Europe’: The politics of integration discourse.” Journal of European Public Policy 6, no. 4 (Special Issue): 1–17. (accessed December 16, 2008). Dinmore, Guy. 2008. “Italy approves modest stimulus package.” Financial Times. November 28. (accessed January 16, 2009). Doyle, Diane. 2005. “Eurosclerosis revisited.” Strategy and Business, Summer. (accessed December 2, 2008). Duncan, Gary. 2009. “Tim Geithner gets tough with China over yuan policy.” Times Online. January 23. (accessed April 12, 2010). Dunkelberg, William C., and Holly Wade. 2010. “NFIB small business economic trends.” National Federation of Independent Business, February. (accessed February 23, 2010). Dutzler, Barbara, and Angelika Hable. 2005. “The European Court of Justice and the Stability and Growth Pact—just the beginning.” European Integration Online Papers 9, no. 5 (January): 1–24. (accessed July 19, 2008). Dyson, Kenneth. 2000. “Germany and the euro: Redefining EMU, handling paradox, and managing uncertainty and contingency.” Queen’s Papers on Europeanisation, no. 6/2000 (September): 173–190. (accessed September 2, 2008).

Bibliography

283

Ebbinghaus, Bernhard, and Jelle Visser. 1999. “When institutions matter: Union growth and decline in Western Europe, 1950–1995.” European Sociological Review 15, no. 2: 135–58. (accessed March 26, 208). The Economist. 2010a. “Bending, not bowing.” April 10. —. 2010b. “The mañana syndrome: Spain’s economic woes.” March 27. —. 2009. “A good bet?” April 30. (accessed September 27, 2009). —. 2008. “The Economist Intelligence Unit’s Index of Democracy 2008.” The Economist Intelligence Unit. (November 10, 2009). EFE. 1995. “La peseta se ha devaluado en seis ocasiones desde 1959.” El País, September 18. (accessed September 12, 2009). Eichengreen, Barry. 2002. “International monetary options for the twenty-first century.” Annals of the American Academy of Political and Social Science 597, no. 1: 11–25. —. 1996. “On the links between monetary and political integration.” Center for International and Development Economics Research 96, no. 77: 1–11. (accessed April 10, 2008.). —, and Jeffry Frieden. 2001. “The political economy of European monetary unification: An analytical introduction.” In The Political Economy of European Monetary Unification, ed. Barry Eichengreen, Jeffry A. Frieden, Michele Fratianni, Benjamin Cohen, and John Woolley, Boulder CO: Westview, pp. 48–61. Einstein, Albert. n.d. (accessed September 10, 2009). Eiras, Ana I., and Brett D. Schaefer. 2001. “Argentina’s economic crisis: An ‘absence of capitalism.’” The Heritage Foundation, April 19. (accessed September 9, 2009). El Mundo. 2002. “Aznar considera ‘irreversible’ el proceso de reformas económicas y sociales en la Unión Europea.” March 18. (accessed May 23, 2008).

284

The Euro in the 21st Century

Engdahl, F. William. 2004. A Century of Wars: Anglo-American Oil Politics and the New World Order. London: Pluto. Escudero, M. 1998. Pleno empleo. Madrid: Espasa Calpe. Estrella, Arturo, and Frederick S. Mishkin. 1998. “Rethinking the role of NAIRU in monetary policy.” Cambridge MA: National Bureau of Economic Research, NEBR Working Paper 6518, pp. 1–43. (accessed March 18, 2008). EU Business. 2010. “Greece forces Europe to confront economic ‘united states.’” January 24. (accessed January 2, 2009). Eurobarometer. 2009a. “Special Eurobarometer 307.” European Commission, February. (accessed April 20, 2010). —. 2009b. “Eurobarometer 71.” European Commission, June–July. (accessed April 15, 2010). —. 2009c. “Eurobarometer 72.” European Commission, October–November. (accessed April 15, 2010). —. 2009d. “Special Eurobarometer 308.” European Commission, January– February. (accessed April 20, 2010) —. 2008a. “Eurobarometer 70.” European Commission, Autumn 2008. (accessed December 19, 2009). —. 2008b. “Eurobarometer 69.” European Commission, April–May. (accessed April 15, 2010). —. 2008c. “Flash Eurobarometer.” European Commission, September. (accessed April 20, 2010).

Bibliography

285

—. 2007a. “Eurobarometer 68.” European Commission, December (accessed April 10, 2010). —. 2007b. “Eurobarometer 67.” European Commission, October–November. (accessed April 15, 2010). —. 2005. “Eurobarometer 64.” European Commission, October–November. (accessed April 15, 2010). —. 2003. “Eurobarometer 60.” European Commission, December. (accessed April 17, 2010). Eurointelligence. 2010. “Tilford on the euro area.” January 15. (accessed January 15, 2010). —. 2009. “Merkel proposes fiscal union (well almost).” December 11. (accessed January 2, 2010). Europa. “Growth and jobs.” (accessed September 2, 2008). —. “The Stability and Growth Pact.” European Commission for Economic and Monetary Affairs. (accessed August 30, 2008). —. 1997. “Partnership for a new organization of work.” Bulletin of the European Union, vol. supplement 4/97: 1–34. (accessed January 2008). Europa Press. 2008a. “El déficit comercial español subió el de enero a abril hasta los 35 millones.” La vanguardia. June 25. (accessed November 29, 2009). —. 2008b. “La CNE declara desierta la subasta de déficit de tarifa por el estrangulamiento de la liquidez en los mercados.” September 30. (accessed October 6, 2008). European Central Bank. 2008. “1998–2008: 10th anniversary of the EC.” Monthly Bulletin, June: 1–156. Frankfurt am Main: European Central Bank. (accessed August 28, 2008). European Commission. 2010. “Europe 2020.” (accessed September 3, 2009). —. 2008a. “The EMU @10: Successes and challenges after 10 years of economic and monetary union.” Directorate General for Economic and Financial

286

The Euro in the 21st Century

Affairs, European Commission. European Economy, no. 2, provisional version: 1–344. (accessed December 2, 2008). —. 2008b. “Macro-economic forecast.” Directorate General for Economic and Financial Affairs, European Commission. European Economy, no. 1 (Spring): 1–13. (accessed July 26, 2008). —. 2008c. “Eurobarometer.¨ Autumn 2008. (accessed December 19, 2009). —. 2007. Integrated Guidelines for Growth and Jobs (2008–2010). Communication from the Commission to the Spring European Council. December 11. (accessed November 6, 2008). —. 2006. “Employment in Europe.” Directorate General for Employment, Social Affairs and Equal Opportunities. October: 1–292. (accessed March 26, 2008). —.1999. “Quarterly note on the euro-denominated bond markets.” Directorate General for Economic and Financial Affairs, European Commission. European Economy, no. 2 (April): 1–6. (accessed October 2, 2008). —. 1990. “One market, one money: An evaluation of the potential benefits and costs of forming an economic and monetary union.” Directorate General for Economic and Financial Affairs, European Commission. European Economy, no. 44 (October). (accessed March 8, 2008). —. n.d. EMU: A Historical Documentation. Directorate General for Economic and Financial Affairs, European Commission. (accessed October 20, 2007). —. n.d. “The White Paper and the Essen Strategy.” Directorate General for Employment and Social Affairs, European Commission. (accessed January 26, 2008). European Commission. n.d. “The start of EMU and the euro.” At (accessed 2007). European Employment Strategy. 2007. “Ten years of the European Employment Strategy.” European Commission, Directorate of Employment, Social Affairs and Equal Opportunity, May 2007. At .

Bibliography

287

European Industrial Relations Observatory Online. 1997. “Employment summit agrees limited package of measures to combat unemployment.” (accessed September 1, 2008). European Movement. 2006. “The EU and ‘economic nationalism.’” October 2006. (accessed February 10, 2010). European Parliament. 2000. “Presidency conclusions.” March 23–24. (accessed September 2, 2008). Eurostat. 2010. “Employment rate.” (accessed April 3, 2010). —. 2005. “EU labor force survey.” (accessed April 1, 2008). Evans-Pritchard, Ambrose. 2008. “Spain pulls bond sale amid economic crisis.” Daily Telegraph. July 11. (accessed September 2, 2009). Fantacone, Stefano, and Paola Parascandolo. 2000. Macroeconomic performance, investment and employment. In Monetary Union, Employment and Growth, ed. Pier Carlo Padoan, 43–61. Northampton MA: Edward Elgar. Farrell, Diana. 2008. “The rise of the euro.” Businessweek. March 21. (accessed October 6, 2008). Feather, Norman. 1992. The Psychological Impact of Unemployment. New York: Springer-Verlag. Federal Reserve. 2009. Industrial Production and Capacity Utilization. Federal Reserve Statistics Release, October 16. (accessed November 17, 2009). Feldstein, Martin. 2009. “America’s saving rate and the dollar’s future.” Project Syndicate. July 4. (accessed April 21, 2008).

288

The Euro in the 21st Century

—. 2006a. “The case for a competitive dollar.” Remarks at the annual SIEPR Summit, Stanford University, CA. March 3. (accessed October 11, 2008). —. 2006b. “What remains of Keynes’ work in today’s economics?” Comment for symposium of Financial Times Deutschland, April 26. (accessed April 5, 2008). —. 2006c. “The falling dollar sets a test for Asia and Europe.” Financial Times. May 26. —. 2006d. “Europe has to face the threat of America’s trade deficit.” Financial Times. August 1. (accessed November 29, 2007). —. 2006e. “Europe has to face the threat of American’s trade deficit.” Financial Times. August 2. —. 2005. “The euro and the stability pact.” Cambridge MA: National Bureau of Economic Research, NBER Working Paper 11249. (accessed April 13, 2008). —. 2003. “Germany’s economic ills.” (accessed June 2, 2008). —. 2000a. “Europe can’t handle the euro.” The Wall Street Journal. February 8. (accessed March 26, 2008). —. 2000b. “The European Central Bank and the euro: The first year.” Cambridge MA: National Bureau of Economic Research, NBER Working Paper 7517, pp. 1–13. (accessed November 2, 2008). Fishman, Robert M., and Anthony M. Messina. 2000. The Year of the Euro: The Cultural, Social, and Political Import of Europe’s Common Currency. Notre Dame: University of Notre Dame Press. Fitoussi, Jean-Paul, David Jestaz, Edmund Phelps, and Gylfi Zoega. 2000. “Roots of the recent recoveries: Labour reforms or private sector forces?” Brookings Papers on Economic Activity 1, no. 237: 1–53. (accessed June 21, 2008). Frankel, Jeffrey. 2008. “The estimated effects of the euro on trade: Why are they below historical effects of monetary union among smaller countries?” Paper presented at the NBER conference on Europe and the Euro, Boston MA. October 17–18. —, and Andrew K. Rose. 1998. “The endogeneity of the optimum currency criteria.” The Economic Journal 108, no. 449 (July): 1009–1025. Friedman, Alan. 1995. “Defending free market, EU officials condemn compensation demands: Currency turmoil tests Europe’s single market.” International Herald Tribune. July 28. (accessed December 1, 2008). Friedman, Milton. 1976. “Nobel lecture: Inflation and unemployment.” The Journal of Political Economy 85, no. 3 (June): 451–72.
Bibliography

289

org/nobel_prizes/economics/laureates/1976/friedman-lecture.pdf> (accessed March 12, 2008). Fujita, H. 1969. “On the nonlinear equations ∆u + eu = 0 and ut = ∆v +ev.” Bulletin of the American Mathematical Society 75, no. 39: 615–632. García Delgado, José Luis, and José María Serrano Sanz. 2001. “From real to euro: The history of the peseta.” La Caixa, Research Department. Economic Studies Series no. 21. (accessed September 9, 2009). Gil-Ruiz Gil-Esparza, Carmen Luisa, and Jaime Iglesias Quintana. 2007. “El gasto público en España en un contexto descentralizado.” Instituto de Estudios Fiscales. Secretaria General de Presupuestos y Gastos, Presupuesto y Gasto Público 47/2007. (accessed September 10, 2009). Girgis, Nancy. 2008. “EU Commission proposes €200 billion stimulus package.” CEP News. November 26. (accessed November 26, 2008). Gomis-Porqueras, Pedro. 2007. “Introduction to the dollar and the euro.” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro Gomis-Porqueras, Burlington VT: Ashgate, pp. 3–10. —, and Joaquín Roy. 2007. “Conclusions: Is there a future for the euro in the global economy.” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro Gomis-Porqueras, Burlington VT: Ashgate, pp. 229–230. González-Páramo, Josè Manuel. 2007. “Global imbalances and the need for policy adjustment.” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro Gomis-Porqueras, Burlington VT: Ashgate, pp. 189–98. —. 2005. “The reform of the stability and growth pact: An assessment.” Frankfurt am Main, Germany: European Central Bank. (accessed July 16, 2008). Granell, Francesc. 2007. “The euro and the developing countries.” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro GomisPorqueras, Burlington VT: Ashgate, pp. 199–214. —. 1989. “S’Agaro y nuestra economía.” La Vanguardia. May 9. Gros, Daniel, 2007. “Restoring popular support for integration in the EU.” Eurointelligence. March 4. (accessed January 20, 2008). —, and Thomas Mayer. 2010. “How to deal with sovereign default in Europe: Towards a Euro(pean) monetary fund.” Vox. March 15.
290

The Euro in the 21st Century

no. 1 (March): 33–47. (accessed June 10, 2008). Haas, Ernst B. 1958. The Uniting of Europe: Political, Social, and Economic Forces 1950–1957. Stanford: Stanford University Press. Hadjimichael, Michael T., and Michel Galy, 1997. “The CFA Franc Zone and the EMU.” International Monetary Fund Working Papers, W.P. 97156. (accessed November 26, 2008). Halevi, Joseph. 2005. “Stagnation and economic conflict in Europe.” University of New South Wales, Discussion Paper 2005/03: 1–33. (accessed December 1, 2008). Hoover, Herbert. 1952. The Memoirs of Herbert Hoover. The Cabinet and the Presidency, 1920–1933. New York: Macmillan. Hugh, Edward. 2010a. “Eurozone imbalances weaken trust in the euro and undermine euro area cohesion.” Fistful of Euros, January 24. (accessed April 1, 2010). Hutton, Robert, and Alan Purkiss. 2008. “Germany attacks ‘crass keynesianism’ of U.K. stimulus.” Bloomberg. December 11. (accessed January 16, 2009). Ibryamova, Nuray, and Roberto Domínguez. 2006. “EU enlargement in theoretical perspective: Puzzles and explanations.” In Towards the Completion of Europe, ed. Joaquín Roy and Roberto Domínguez, Coral Gables: Miami-Florida European Union Center, pp. 9–54. Ikerson, Daniel J. 2010. “China trade and American jobs.” CATO Institute. . International Monetary Fund (IMF). 2010. “IMF Quota.” March 2010. (accessed December 2, 2009). —. 2009a. “IMF governors formally approve US$250 billion general SDR allocation.” Press Release No. 09/283, August 13. (accessed December 29, 2009). —. 2009b. “IMF standing borrowing arrangements.” Factsheet. September 25. (accessed December 1, 2009). —. 2009c. “NAB participants agree to expand Fund’s borrowing arrangement to up to US$600 billion.” Press Release No. 09/429, November 24. (accessed December 1, 2009).

Bibliography

291

—. 2009d. “Currency Composition of Official Foreign Exchange Reserves (COFER).” September 30. (accessed November 13, 2009). —. 2009e. “IMF resources and the G-20 Summit.” September 17. (accessed November 16, 2009). —. 2008a. “World Economic Data Base.” April. (accessed October 21, 2008). —. 2008b. “Special Drawing Rights (SDRs).” September. (accessed November 5, 2009). —. 2006. “Economic policies in the euro area.” In IMF World Economic Outlook, Washington DC: IMF, pp. 1–28. —. 2003. “West African Economic and Monetary Union: Recent economic developments and regional policy issues; and public information notice on the Executive Board Discussion.” IMF Country Report No 03/07. —. 1999. “Chronic unemployment in the euro area: Causes and cures.” In IMF World Economic Outlook, Washington DC: IMF, pp. 1–34. (accessed June 23, 2008). —. 1997. World Economic Outlook. Washington: IMF. (accessed September 4, 2002). —. n.d. “What is the IMF?” (accessed March 18, 2010). Irvin, George. 2010. “Merkel’s madness.” EUObserver blog. March 25. (accessed March 29, 2010). Issing, Otmar. 2001. Economic and Monetary Union in Europe: Political Priority versus Economic Integration? Frankfurt am Main: European Central Bank. February 23. (accessed April 20, 2008). Iwamoto, Takekazu. 1997. “Keynes plan for an International Clearing Union reconsidered.” (accessed November 2007). Jacob de Haan, Sylvester, C.W. Eijffinger, and Sandra Waller. 2005. The European Central Bank: Credibility, Transparency, and Centralization. Cambridge MA: MIT Press. James, Harold. 1999. “The Reichsbank 1876–1945.” In Fifty Years of the Deutsche Mark, ed. Ernst Baltensperfer, Oxford: Oxford University Press, pp. 62–81.
292

The Euro in the 21st Century

cZPMtMXNoeNPGi7yJ30&hl=en&sa=X&oi=book_result&resnum=1&ct=re sult#PPR9,M1>. Jeffris, Gerald, and Tom Murphy. 2010. “Multinationals aid Brazil on current account front.” Wall Street Journal. January 22. (accessed February 12, 2010). Jeson, Jane, and Philippe Pochet. 2006. “Employment and social policy since Maastricht: Standing up to European monetary union.” In The Year of the Euro: The Cultural, Social, and Political Import of Europe’s Common Currency, ed. Robert M. Fishman and Anthony M. Messina, Notre Dame: University of Notre Dame Press, pp. 161–86. Kaplan, Seymour. 1967. “Computer algorithms for finding exact rates of return.” The Journal of Business 40, no. 4 (October): 389–92. Katok, Anatole, and Boris Hasselblatt. 1996. “Introduction to the modern theory of dynamical systems.” Bulletin (New Series) of the American Mathematical Society 33, no 4 (October). (accessed March 1, 2010). Katzenstein, Peter J., Robert O. Keohane, and Stephen D. Krasner. 1998. “International organization and the study of world politics.” International Organization 52, no. 4 (Autumn): 645–85. (accessed April 3, 2008). Kellert, Stephen H. 1993. In the Wake of Chaos: Unpredictable Order in Dynamical Systems. Chicago: University of Chicago Press. Kenen, Peter. B. 1969. “The theory of optimum currency areas: An eclectic view.” In Monetary Problems of the International Economy, ed. Robert A. Mundell and Alexander K. Swoboda, Chicago: University of Chicago Press, pp. 41– 59. Kester, Anne Y. 2007. “Euro holdings rise in emerging markets.” International Monetary Fund. September 12. (accessed October 2, 2008). Kilponen, Juha, David Mayes, and Jouki Vilmunen. 2000. “Labour market flexibility in the euro area.” European Business Journal 12, no. 2 (June): 100–111. Kirkpatrick, Charles D., and Julie Dahlquist. 2007. “Technical analysis: The complete resource for financial market technicians. Financial Times. August 18.
Bibliography

293

Krueger, Alan B. 2001. “From Bismarck to Maastricht: The march to European union and the labor compact.” Cambridge MA: National Bureau of Economic Research, NBER Working Paper 7456 (January): 1–48. (accessed June 26, 2008). Kubosova, Lucia. 2008. “Slovenia joins the eurozone.” Businessweek. December 31. (accessed January 24, 2008). La Moncloa. 2005. “The Spanish National Reform Program.” Gobierno de España. October. (accessed September 14, 2008). Laursen, Finn. 2006. “The EU enlargement policy: Can widening and deepening be combined?” In Towards the Completion of Europe, ed. Joaquín Roy and Roberto Domínguez, Coral Gables: Miami-Florida European Union Center, pp. 125–38. Levy, Mickey D. 2004. “Ending Europe’s economic underperformance.” Cato Journal 24, no. 1/2 (Spring/Summer): 71–4. (accessed May 25, 2008). Lien, Kathy. 2008. “How does an oil crisis impact the US dollar?” Daily FX. May 22. (accessed May 29, 2008). Lim, Ewe-Ghee. 2006. “The euro’s challenges to the dollar: Different views from economists and evidence from COFER and other data.” International Monetary Fund Working Paper no. 06/153 (June), pp. 1–40. (accessed September 22, 2008). Lindbeck, Assar. 1994. “The welfare state and the employment problem.” The American Economic Review 84, no. 2: 71–75. (accessed January 26, 2008). —. 1988. “The insider-outsider theory of employment and unemployment.” Journal of Economic Behavior and Organization 12, no. 3 (December): 365–

294

The Euro in the 21st Century

9. (accessed July 23, 2008). —, and Dennis J. Snower. 2001. “Centralized bargaining and reorganized work: Are they compatible?” European Economic Review 45, no. 10 (December): 1851–75.  (accessed June2, 2008). Lindsey, Lawrence. 2005. “In the dollar we trust.” In The Global Economy: Contemporary Debates, ed. Thomas Oatley, New York: Pearson Longman, pp. 247–250. —. 1999. “The morning after.” EU Symposium. (accessed December 3, 2008). Lips, Brad. 1998. “Temps and the labor market. Why unions fear staffing companies.” Regulation 21, no. 2: 31–9. Ljungqvist, Lars, and Thomas J. Sargent. 1998. “The European unemployment dilemma.” The Journal of Political Economy 106, no. 3 (June): 514–550. (accessed June 2, 2008). —. 1995. “Welfare states and unemployment.” Economic Theory 6, no. 1 (February): 143–160. (accessed February 26, 2008). Llamas, Manuel. 2010a. “La quiebra de los PIGS causaría un agujero de 1,5 billones a la banca europea.” Libertad Digital. February 26. (accessed March 21, 2010). —. 2010b. “Jueves negro para la Bolsa, que se desploma un 6%.” Libertad Digital. February 5. (accessed February 15, 2010). —. 2010c. “EL punto débil: el Estado necesita colocar un mínimo de 225.000 millones de deuda en 2010.” Libertad Digital. February 5. (accessed February 5, 2010). —. 2009. “El riesgo de que España entre en quiebra se dispara un 700% en apenas un año.” Libertad Digital. March 10. (accessed September 9, 2009). Lorca, Francisco J. 2008. “The Treaty of Lisbon and the Irish impasse.” Jean Monnet/Robert Schuman Paper Series 8, no. 18 (August): 1–19. (September 25, 2008).

Bibliography

295

Luypaert, Jochen. 2007. “Eurozone needs structural reforms, Trichet says.” EUObserver. June 21. (accessed October 10, 2007). McCreevy, Charlie. 2005. “The future of Europe—are we asking the right questions?” Institute of European Affairs. October 14. (accessed June 20, 2008). McKinnon, Ronald I. 2004. “Optimum currency areas and key currencies: Mundell I versus Mundell II.” Journal of Common Market Studies 42, no. 4 (November): 689–715. (accessed March 26, 2008). —. 1963. “Optimum currency areas.” American Economic Review 53, no. 4 (September): 717–725. McKinsey Global Institute. 2009. “Global capital markets: Entering a new era.” September. (accessed November 1, 2009). —. 2008. “Global financial assets. Mapping global capital markets.” January. McMahon, Edward R., and Scott H. Baker. 2006. “Piercing a democratic quilt? Regional organization and universal norms.” West Hartfort CT: Kumarian. McMullen, Troy. 2008. “The Russian rubble.” Conde Nast, March 4. (accessed October 25, 2008). Magnus, George. 2010. “Sovereign default risks loom.” Financial Times. January 13. (accessed January 15, 2010). Mahony, Honor. 2010. “Irish banks may need as much as €2 billion for losses.” EUObserver. March 31. (accessed March 31, 2010). Malinvaud, Edmund. 1994. Diagnosing Unemployment. Cambridge: Cambridge University Press. Mallet, Victor. 2010. “Spain seeks credit with harsh budget.” Financial Times. January 30/31. Malo, Miguel. 2001. “Elecciones sindicales y comportamiento de los sindicatos españoles: Una propuesta.” FEDEA, Documento de Trabajo 93 (July): 1–22. (accessed November 26, 2007). Mandelbrot, Benoît B. 1982. The Fractal Geometry of Nature. New York: Freeman. Manzocchi, Stefano, Pier Carlo Padoan, and Claudio Vicarelli. 2001. “Specialization and flexibility.” In Monetary Union, Employment, and Growth: The Impact of the Euro as a Global Currency, ed. Pier Carlo Padoan, Northampton MA: Edward Elgar, pp. 23–48.

296

The Euro in the 21st Century

Manzocchi, Stefano, Pier Carlo Padoan, Paola Parascandolo, and Massimo Tozzi. 2001. “Employment and European regions.” In Monetary Union, Employment and Growth: The Impact of the Euro as a Global Currency, ed. Pier Paolo Padoan. Northampton MA: Edward Elgar, pp. 139–52. Marsh, David. 1993. The Bundesbank: The Bank that Rules Europe. London: Mandarin. Martin, John P. 1998. “What works among active labour market policies: Evidence from OECD countries’ experiences.” OECD Labour Market and Social Policy Occasional Papers 35, pp. 1–27. Paris: OECD Directorate for Employment, Labour and Social Affairs. (accessed January 13, 2008). Martínez, Ricardo. 2003. “El superávit del Estado alcanza el 0,3% del PIB hasta julio.” Cinco Días. August 29. (accessed September 5, 2009). Mathers, Colin D., and Deborah J. Schofield. 1998. “The health consequences of unemployment: The evidence.” The Medical Journal of Australia 168 (February): 178–82. (accessed February 2, 2007). Meadows, Andrew, and Jonathan Williams. 2001. “Moneta and the monuments: Coinage and politics in Republican Rome.” The Journal of Roman Studies 91: 27–49. (accessed December 2, 2008). Merritt, David. 2009. “Stocks tumble, bonds rally on Dubai: Credit-default swaps soar.” Bloomberg News. November 26. (accessed March 2, 2010). Mill, John Stuart. 1894. Principles of Political Economy. Ed. William J. Ashley. New York: Longman, Green & Co. Milnor, John. 1985. “On the concept of attractor.” Communications of Mathematical Physics 99, no. 2 (June): 177–95. (accessed March 2, 2010). Mitchener, Brandon. 1993. “Economic scene: An anchor begins to drag as the tide tests the mark.” International Herald Tribune. June 25. (accessed December 7, 2008). —. 1992. “EC devalues the lira by 7%; Bundesbank to lower rates.” International Herald Tribune. September 14. (accessed December 2, 2008). Monaghan, Angela. 2008. “IMF president warns that governments must do more.” Telegraph.co.uk, December 15. (accessed January 16, 2009). Monnet, Jean. 1943. “Algiers memorandum.” In Building European Union, ed. Trevor Salmon and William Nicoll, Manchester: Manchester University Press, pp. 20–21.

Bibliography

297

Moravcsik, Andrew. 2005. “The European constitutional compromise and the neofunctionalist legacy.” Journal of European Public Policy 12, no. 2 (April): 349–86. (accessed March 16, 2008). Moslares García, Carlos, and Lucinio González Sabaté (2002). Elementos prácticos para la enseñanza de la economía. Barcelona: Hosori. (accessed September 2, 2009). Munchau, Wolfgang. 2010. “Europe has resolved nothing over Greece.” Financial Times. March 29. (accessed March 31, 2010). —. 2006. “Why the credit rating agencies were right to downgrade Italian debt.” Financial Times. October 22. (accessed October 6, 2008). —. 1999. “Welcome to the euro-zone.” Financial Times. December 28. Mundell, Robert A. 2003. “The international monetary system and the case for a world currency.” Distinguished Lectures Series no. 12. Paper presented at the Leon Komiński Academy of Entrepreneurship and Management (WSPiZ) and TIGER, Warsaw, Poland, October 23. (accessed April 23, 2008). —. 2002a. “Monetary unions and the problem of sovereignty.” Columbia University Discussion Paper 0102-06, pp. 1–32. (accessed March 25, 2008). —. 2002b. “The significance of the euro in the international monetary system.” Speech, Henry George Lecture series, Pace University, New York. February 26. (accessed March 24, 2008). —. 1999. “The euro and the stability of the international monetary system.” Paper presented at a conference sponsored jointly by the Luxembourg Institute for European and International Studies and the Pierre Werner Foundation on “The euro as a stabilizer in the international economic system.” Luxembourg, Grand Duchy of Luxembourg. December 3–4. (accessed September 22, 2008). —. 1998a. “What the euro means for the dollar and the international monetary system.” Atlantic Economic Journal 26, no. 3: 227–37. (accessed August 6, 2008). —. 1998b. “The impact of the euro on the international monetary system.” The International Spectator XXXIII, no. 2 (April–June): 1–18. (accessed July 28, 2008).

298

The Euro in the 21st Century

— 1998c. “The case for the euro—I and II.” Wall Street Journal. March 24 and 25. —. 1991. “Monetary policies for the new Europe.” Rivista Di Politica Economica 21, no. 5: 71–88. —. 1973a. “A plan for a European currency.” In The Economics of Common Currencies, ed. H. Johnson and Alexander Swoboda, London: George Allen & Unwin, pp. 143–77. —. 1973b. “Uncommon arguments for common currencies.” In The Economics of Common Currencies, ed. H. Johnson and Alexander Swoboda, London: George Allen & Unwin, pp. 114–132. —. 1961. “A theory of optimum currency areas.” American Economic Review 60, no. 4 (November): 657–8. —. n.d. “World Currency.” In The Works of Robert Mundell. (accessed December 28, 2009). Murphy, John J. 1999. Technical Analysis of the Financial Markets. New York: New York Institute of Finance. Nasar, Sylvia. 1999. “Where joblessness is way of making a living.” The New York Times. May 9. (accessed March 26, 2007). National Bureau of Economic Research (NBER). 2007. “Determination of the December 2007 peak in economic activity.” At —. 1991. “NBER Business Cycle Dating Committee Determines that Recession Ended in March 1991.” In NBER Business Cycle Dating Committee. March. (accessed September 14, 2009). Naughton, Philippe. 2005. “Black Wednesday cost UK £3.3 billion, documents show.” The Times (London). February 9. (accessed April 1, 2010). Neuger, James G. 2010. “Schaeuble backs euro ouster for delinquent states.” Bloomberg. March 12. (accessed April 1, 2010). Nickell, Stephen. 1997. “Unemployment and labor market rigidities: Europe versus North America.” The Journal of Economic Perspective 11, no. 3: 55– 68. (accessed June 13, 2007). Nieminen, Ari. 2005. “Towards a European society? Integration and regulation of capitalism.” Paper presented, with the permission of the faculty of Social Sciences of the University of Helsinki, for public discussion in the Auditorium of the Helsinki University Museum. March 19. (accessed April, 23, 2008). Nitsch, Volker, and Nikolaus Wolf. 2009. “Tear down this wall: On the persistance of borders in trade.” Warwick Economic Research Papers. Department of

Bibliography

299

Economics, University of Warwick, no. 919, October. (accessed January 28, 2010). Nixon, Richard M. 1971. “Address to the Nation outlining a new economic policy: The challenges of peace.” The Nixon Library Foundation. August 15. (accessed December 6, 2008). Nye, Joseph S. 1970. “Comparing common markets: A revised neo-functionalist model.” International Organization 24, no. 4 (Autumn): 796–835. (accessed June 17, 2008). —. 1968. “Comparative regional integration: Concept and measurement.” International Organization 22, no. 4 (Autumn): 855–880. (accessed June 17, 2008). Oakley, David. 2010. “End of tough week for eurozone bonds.” Financial Times. January 30/31. —, and Victor Mallet. 2009. “Spain hit by public finance warning.” Financial Times. January 13. Oatley, Thomas. 2005. The Global Economy: Contemporary Debates. New York: Pearson. Obayuwana, Oghogho. 2009. “Waiting for West African common currency.” Guardian News. June 15. (accessed October 19, 2009). Official Journal of the European Union. 2008. Consolidated Version of the Treaty on European Union. May 9. (accessed April 2, 2010). —. 1992. The Maastricht Treaty. February 7. (accessed April 2, 1010) Organization for Economic Co-operation and Development (OECD). 2009a. “Fiscal balance projections.” November 19. (accessed January 18, 2010). —. 2009b. “Balance on current account.” OECD Economic Outlook 86, November. (accessed February 10, 2010). —. 2008. Economic Survey of Sweden 2007. Paris. (accessed December 5, 2008). —. 2007. OECD Economic Survey: Spain 2007. (accessed September 14, 2009). —. 2006. OECD Economic Outlook. Paris: OECD.

300

The Euro in the 21st Century

—. 2005. OECD Economic Outlook. Paris: OECD. —. 2000. “Recent labour market developments and prospect.” In OECD Unemployment Outlook, ed. OECD, Paris: OECD (2000), pp. 1–42. —. 1998. “Lessons from the member countries’ experience.” In Implementing the OECD Jobs Strategies, ed. OECD, Paris: OECD, pp. 1–27. —. 1997a. “Flexibility in the labour market: The current debate.” In OECD Employment Outlook, ed. OECD, Paris: OECD (1997), pp. 1–32. —. 1997b. “Pushing ahead with the strategy.” In The OECD Jobs Strategy, ed. OECD, Paris: OECD, pp. 1–39. —. 1995. “Unemployment in the OECD area 1950–1995.” In The OECD Job Study, Evidence and Explanations, ed. OECD, Paris: OECD, pp. 1–31. —. 1994a. “The adjustment potential of the labor market.” In The OCDE Jobs Study: Evidence and Experience, ed. OECD, Paris: OECD, pp. 1–35. —. 1994b. OECD Economic Outlook. Paris: OECD. —. 1963. Employment Forecasting. Brussels: Chateau de Karreveld. —. 1962. International Seminar on Employment Forecasting Techniques. Brussels: Chateau de Karreveld. Oxford Analytica. 2008. “European central bank sparks EU debate.” Forbes. August 29. (accessed September 10, 2008). Padoan, Pier Paolo. 2001. “Europe’s unemployment: A review of the debate.” In Monetary Union, Employment and Growth, ed. Pier Paolo Padoan, Northampton MA: Edward Elgar, pp. 26–42. Parker, George, and Ralph Atkins. 2007. “Sarkozy told to lay off ECB.” Financial Times. May 9. (accessed September 14, 2008). Peel, Quentin. 2010. “IMF likely to take lead if loans sought.” Financial Times. March 29. (accessed March 31, 2010). —, Ben Hall, and Tony Barber. 2010. “Merkel warns of hurdles in EMF plan.” Financial Times. March 8. (accessed March 8, 2010). Pelet Redon, Carmen. 2002. “Los últimos cuarenta años de la peseta: De Bretton Woods a la Unión Monetaria.” Acciones e Investigaciones Sociales 15 (November): 1–32. (accessed November 14, 2008) People’s Daily Online. 2010. “China-ASEAN Free Trade Area sets example for mutual beneficial, win-win regional co-op.” January 2. (accessed January 3, 2010). Peristiani, Stavros. 2007. “Evaluating the relative strength of the US capital market.” The Federal Reserve Bank of New York 13, no. 6 (July): 1–7.
Bibliography

301

www.newyorkfed.org/research/current_issues/ci13-6/ci13-6.html> (accessed October 6, 2008). Phillips, Leigh. 2008. “Iraq plans EU-style Middle East union.” EUObserver. December 10. (accessed December 10, 2008) Pinalto, Sandra. 2010. “When the small staff is anything but small.” Federal Reserve Bank of Cleveland, Dayton OH. February 2010. (accessed March 1, 2010). Politi, James, Jamil Anderlini, Alan Beattie. 2010. “US delays decision on China currency manipulation.” Financial Times. April 3. (accessed April 3, 2010). Pollard, Patricia S. 2005. “The creation of the euro and the role of the dollar in international markets.” In The Global Economy: Contemporary Debates, ed. Thomas Oatley, New York: Pearson Longman, pp. 259–177. —. 2001. “The creation of the euro and the role of the dollar in international markets.” Federal Reserve Bank of St. Louis Review 83 (September/October): 17–36. At . Pomfret, Richard. 2005. “Currency areas in theory and practice.” Economic Record 81, (June): 166–76. (accessed November 25, 2007). Popper, Helen. 2009. “Argentina’s current account surplus shrinks 66 pct.” Reuters. December 22. (accessed February 10, 2010). Posen, Adam S. 2005. “The euro at five: Ready for a global role?” Peterson Institution for International Economics, Special report 18: 1–212. (accessed November 1, 2007). Prodi, Romano. 2001. “Interviews by the Financial Times.” Financial Times. December 4, 2001. Raines, Philip. 2000. The Impact of European Integration on the Development of the National Labour Markets. Geneva: International Labour Office. (accessed October 23, 2007). Ramírez, Lorenzo. 2010. “La crisis financiera llega a España: la mitad de las cajas, en números rojos.” Libertad Digital. March 25. (accessed March 31, 2010). Ramírez, Luís. 2008. “La entrada de España en el euro infló la burbuja y disparó el precio de los pisos un 177%.” Libertad Digital. October 14. (accessed September 13, 2009).

302

The Euro in the 21st Century

Razin, Assaff, and Efraim Sadka. 2002. “The Stability and Growth Pact as an impediment to privatizing social security.” Cambridge MA: National Bureau of Economic Research Working Paper no. 9278: 1–62. (accessed July 20, 2008). Reinhart, Carmen, and Kenneth Rogoff. 2010. “Why we should expect low growth amid debt.” Financial Times. January 27. (accessed January 28, 2010). Rettman, Andrew. 2010. “EU economic governance inevitable, Belgian PM says.” EUObserver. March 16. (accessed March 17, 2010). Reuters. 2010a. “US job openings rise, hirings steady in December.” February 9. (accessed March 2, 2010). —. 2010b. “S&P cuts Greek debt rating as global crisis bites.” January 14. (accessed January 15, 2010). —. 2009. “Spain unconcerned by rising debt level by markets.” Forbes. October 26. (accessed February 10, 2010). —. 2008. “France’s Sarkozy says euro is too strong.” March 27. (accessed November 4, 2009). —. 2007. “Kuwait drops dollar peg in blow to gulp currency union.” Reuters Business and Finance. May 20. (accessed October 2, 2008). Riese, Hajo. 1986. “Theorie der inflation. Tübingen: Mohr: 45.” Quoted in Stefan Collignon, The Sustainability of Monetary Stability, London: Routledge (2007). Rivera, Alicia. 2009. “Alarma en la comunidad científica por los recortes en investigación.” El País. October 9. (accessed February 2, 2010). Rodríguez Braun, Carlos. 2009. “El Informe Recarte 2009.” El Cultural. March 24. (accessed September 10, 2009). Rose, Andrew K. 2000. “Common currency areas in practice.” Paper prepared for the Bank of Canada conference “Revisiting the Case for Flexible Exchange Rates,” Ottawa, Canada, November 2–3. (accessed April 24, 2008). Rosenberg, Jerry M. 1991. The New Europe. An A to Z Compendium on the European Community. Washington DC: Bureau of National Affairs. Ross, George. 1981. “What is progressive about unions? Reflections on trade unions and economic crisis.” Theory and Society 10, no. 5 (September): 609–

Bibliography

303

643. (accessed November 23, 2007). Ross-Thomas, Emma. 2009. “Spain debt downgraded by S&P as slump swells budget.” Bloomberg. January 19. (accessed September 5, 2009). Roy, Joaquín. 2008. “Reflections on the Treaty of Rome and today’s EU.” In Regional Integration Fifty Years after the Treaty of Rome: The EU, Asia, Africa, and the Americas, ed. Joaquín Roy and Roberto Domínguez, Coral Gables: Miami-Florida European Union Center, pp. 7–23. —. 2007. “A financial and politically symbolic tool.” In The Euro and the Dollar in a Globalized Economy, ed. Joaquín Roy and Pedro Gomis-Porqueras, Burlington VT: Ashgate, pp. 17–28. —. 2005. “The nature of the European Union.” In Public Administration and Public Policy in the European Union, ed. Peter Van Der Hoek, New York: Taylor & Francis, pp. 77–111. Saffire, William. 1998. “On language; with a euro in her pouch.” The New York Times. June 7. (accessed December 8, 2008). Saint-Paul, Gilles, and Samuel Bentolila. 2000. “Will EMU increase eurosclerosis?” Centro de Estudios Monetarios y Financieros Working Paper No. 0004 (March), pp. 1–48. (accessed April 1, 2008). Sánchez, Carlos. 1993. “El déficit del Estado se duplico el ano pasado y asciende ya a mas del 3,77 billones de pesetas.” El Mundo. February 11. (accessed September 12, 2009). Schauble, Wolfgang. 2010. “Why Europe’s monetary union faces its biggest crisis.” Financial Times. March 11. (accessed March 15, 2010). Scheller, Hanspeter. 2006. The European Central Bank: History, Role, and Functions. Frankfurt am Main: European Central Bank. (accessed March 25, 2008). Schimmelfennig, Frank. 2003. The EU, NATO and the Integration of Europe: Rules and Rhetoric. Cambridge: Cambridge University Press. Schmitter, Philippe. 2007. “Neo-neofunctionalism.” In European Integration Theory, ed. Antje Wiener and Thomas Diez, Oxford: Oxford University Press, pp. 36–51. Schroder, Gerhard. 2008. “Q&A with Gerhard Schroder: There’s really no reason to worry about the euro.” Businessweek. June 11. (accessed June 16, 2008).

304

The Euro in the 21st Century

Schuman, Robert. 1950. “The Schuman declaration.” In Pioneers of European Integration and Peace, 1945–1963: A Brief History with Documents, ed. Sherrill Brown Wells, Boston MA: Bedford/St. Martin’s, pp. 98–100. Schwartz, Anna. 1983. “The postwar institutional evolution of the international monetary system.” In The International Transmission of Inflation, ed. Michael R. Darby, James R. Lothian, Arthur E. Gandolfi, Anna J. Schwartz, and Alan C. Stockman, 14–45. Cambridge MA: NBER. (accessed June 5, 2008). Schwartz, Pedro. 2004. The Euro as Politics. Research monograph 58. London: Institute of Economic Affairs. Sennholz, Hans F. 2006. “Hyperinflation in Germany 1914–1929.” Ludwig Von Mises Institute. October 26. (accessed December 1, 2008). Shafer, Jeffrey R. 1988. What the US Current Account Deficit of the 1980s has meant for other OECD Countries. Paris: OECD. (accessed December 2, 2008). Shierholz. Heidi. 2009. “Number of unemployed workers per available job continues to climb.” Economic Policy Institute. September 9. (accessed January 13, 2009). Silbert, Anne, and Alan Sutherland. 2000. “Monetary union and labor market reform.” Journal of International Economics 51, no. 5 (August): 421–35. (accessed May 5, 2008). Skidelsky, Robert. 2001. “The politics of euro economics.” Financial Times. January 23. (accessed May 24, 2008). Slater, Joanna, Brian Blackstone, and Marcus Walker. 2009. “Countries’ debt woes pose risk to upturn.” Wall Street Journal. December 9. (accessed February 10, 2010). Söderbaum, Fredrik. 2003. “Introduction: theories of new regionalism.” In Theories of New Regionalism: A Palgrave Macmillan Reader, ed. Fredrik Söderbaum and Timothy Shaw, Basingstoke: Palgrave Macmillan. Spĭdla, Vladimir. 2008. “Rosy outlook for EU job market.” European Commission. (accessed October 24, 2008). Standard and Poor’s. 2007. “Sovereign ratings in Europe.” June. (accessed October 6, 2008). Stearns, Jonathan, and Maria Petrakis. 2010. “Sarkozy says Euro zone ready to help Greece if needed.” Bloomberg. March 8. (accessed March 10, 2010). Stefano Manzocchi, Pier Carlo Padoan, and Claudio Vicarelli. 2001. “Specialization and flexibility.” In Monetary Union, Employment, and Growth: The Impact of

Bibliography

305

the Euro as a Global Currency, ed. Pier Carlo Padoan, Northampton MA: Edward Elgar, pp. 95–124. Tax Payers Alliance. 2009. “Opinion poll.” CATI Fieldwork, May 1–4. (accessed March 2010). Takayasu, Hideki, Misako Takayasy, Mitsuhiro P. Okazaki, Kpuhei Marumo, and Tokiko Shimizu. “Fractal properties in economics.” Cornell University Library (accessed March 2, 2010). Telegraph.co.uk. 2009. “Russian president Dmitry Medvedev pulls new world currency from his pocket.” July 10. (accessed December 29, 2009). Tempest, Matthew. 2005. “Treasury papers reveal cost of Black Wednesday.” The Guardian. February 9. (accessed April 2, 2010). Thornhill, John. 2010. “Rescue deal boost bond hopes.” Financial Times. March 29. (accessed March 31, 2010). Trichet, Jean-Claude. 2008a. Foreword. In 1998–2008: 10th Anniversary of the ECB, ed. European Central Bank, Frankfurt am Main: European Central Bank, pp. 1– 158. (accessed July 14, 2008). —. 2008b. “European financial integration.” Speech given at the 23 Internationales ZinsFORUM Zinsen 2009. December 11. Frankfurt am Main: European Central Bank. (accessed December 10, 2008). —.2008c. Hearing at the Economic and Monetary Affairs Committee of the European Parliament. December 8. Frankfurt am Main: European Central Bank. . —. 2006. Further Integrating Euro Area Economies: Some Reflections. Frankfurt am Main: European Central Bank. (accessed April 15, 2008). —. 2005. “Reserve currencies.” September 21. Trio Presidency. 2010. “Statement by the Head of State and government of the Euro area.” European Union. March 25. (accessed March 29, 2010). Torrero Manas, Antonio. 2008. “La Crisis de la Economía Española.” Universidad de Alcalá, Instituto Universitario de Análisis Económico y Social. Documento de Trabajo 09/2008. (accessed on September 8, 2009). Tumpel-Gugerell, Gertrude. 2005. “Press briefing: Presentation of indicators of financial integration in the euro area.” September 30. Frankfurt am Main:

306

The Euro in the 21st Century

European Central Bank. (accessed October 1, 2008). Van Oudenaren, John. 1999. Uniting Europe: European Integration and the PostCold War World. Lanham MD: Rowman and Littlefield. Vazza, Diane, and Sudeep Kesh. 2009. “Global corporate default update.” Standard & Poor’s, Global Fixed Income Research, July 31. (accessed January 24, 2010). Verheusen, Gunter. 2006. “Working for growth and jobs: European Commission on Enterprise and Industry.” European Commission, Enterprise and Industry. (accessed September 26, 2008). Vidal-Folch, X., and V. Carvajal. 1995. “La peseta se devalúa un 7% para seguir en el SME.” El País. March 6. (accessed October 25, 2007). Voice of America. 2001. “Argentina’s economic crisis worries Brazilian officials.” January 11. (accessed November 29, 2009). Vucheva, Elitsa. 2008. “Montenegro files EU membership application.” EUObserver. December 15. . Wallis, Allan. n.d. “The new regionalism.” Munimall.com. (accessed April 12, 2010). Wang, J. 2000. “Trading and hedging in S&P 500 spot and futures markets using genetic programming.” Journal of Futures Markets 20, no. 10 (November): 911–972. Whitney, Craig. 1993. “Blaming the Bundesbank.” The New York Times. October 17. (accessed December 2, 2008). Wiener, Antje, and Thomas Díez. 2004. European Integration Theory. Oxford: Oxford University Press. Willis, Andrew. 2010a. “Markets turn on Portugal as EU trade union opposition grows.” EUObserver. February 2. (accessed February 10, 2010). —. 2010b. “Germany says Greece has its ‘full support.’” EU Observer. February 2. (accessed April, 2, 2010)

Bibliography

307

Wise, Peter. 2008. “Lisbon unveils economic boost.” Financial Times. December 13. (accessed January 16, 2009). Wolf, Martin. 2010. “Why Germany cannot be a model for the Eurozone.” Financial Times. March 31. (accessed March 31, 2010). Woodbury, Stephen, and Carl Davidson. 2002. Search Theory and Unemployment. Norwell MA: Kluwer. World Bank. “Gross domestic product.” (accessed September 18, 2009). The World Country. 2010. “France, Germany lead eurozone on Greek rescue plan.” March 27. (accessed March 23, 2010). World Economic Forum. 2009. “Global competitiveness report 2009–2010.” September 8. (accessed September 9, 2009). —. 2008–09. “Global competitiveness report 2008–2009.” (accessed October 28, 2009). Wyplosz, Charles. 1999. “An international role for the euro?” In European Capital Markets with a Single Currency, ed. Jean Dermine and Pierre Hillion, Oxford: Oxford University Press, pp. 73–91. Xiaochuan, Zhou. 2009. “Reform the international monetary system.” The People’s Bank of China. March 23. (accessed November 21, 2009). Zalcova, Zuzana. “European monetarian union.” Center for Strategic and International Studies. (accessed August 31, 2008). Zarlenga, Stephen. 1999. “Germany’s 1923 inflation: A ‘private’ affair.” The Barnes Review (July–August): 61–7. (accessed October 28, 2008).

This page has been left blank intentionally

Index African integration 3, 260 African Union (AU) 35, 277 Andean Community of Nations 38 Arbitrage 220 Ask price 16, 111 Attractor 9, 21, 213, 226–8, 233, 242, 267, 296 Austerity plan 15, 181 Australian index 9, 21, 213, 226, 232–6, 242, 266–7 Austrian school 211 Bailout plan 12, 175 Bancor 28 Basle Agreement 7 Behaviorist approach 21, 213, 221, 224 Behaviorist 211, 213, 218, 220–1, 224, 225 Belgium 3, 29, 88, 96, 132, 172, 259, 263 Benelux 27 Bid price 16, 111 Black Wednesday 124, 193, 197 Brazil 10, 17, 20, 41–4, 47, 112, 115–16, 121, 131–5, 141, 166, 213, 160–1, 264 Brazilian real 115, 121, 132, Bretton Woods 5–7, 9, 27–8, 35, 56, 84, 107, 124, 126, 128, 162, 193, 195, 215, 232 BRIC countries 107, 102, 106, 126, 131,134–5, 232, 264 Brownian motion 218 Brussels Compromise 9 Bundesbank 9, 74, 132, 160, 191–3 Business cycle 14, 23, 31–2, 55, 63, 68, 72, 75–6, 78, 114, 141,163–4, 166, 181, 199, 212, 230, 250, 262, 268, 269, 270–1 Canadian dollar 20, 56, 121, 212–13, 232–3, 243

Capital market theory 218 Chaos 212, 243 Chaos theory 218, 220, 243 Chaotic dynamical system 21, 213 Chartalism 31 China 4, 10, 12, 17, 20, 44, 37, 92, 96, 107, 112–13, 116, 126, 128, 131, 133–5, 138–9, 141, 213, 260–1, 264 Chinese yuan 114–15, 121, 132, 135, 139, 140 Cold War 4, 9, 113, Commodity market 215 Commodities Research Bureau (CRB) 50, 51–2, 68, 69, 70–1, 78, 262 Common currency 3, 8–9, 13–17, 20, 27–9, 30–2, 35–9, 41, 43, 46–7, 49, 50, 58, 62, 77–8, 81–2, 93, 111–14, 116, 141, 158, 168, 191, 193, 207, 211–12, 260–1, 264, 269, 270 Competitive devaluation 82, 161–2, 164, 192, 195–6 Complexity 10, 182, 226–7, 267 Convergence 21, 30, 32, 38, 52–3, 158, 211–12, 226–8, 233, 242–3, 267, 271 Corporate debt 153 Covariance 14, 21, 51–3, 55, 67–9, 71, 139, 211, 213, 221, 242 Critical point 21, 186, 212–13, 227–9, 230, 235, 238, 242–3, 267 Crude oil 14, 68, 71–2 Currency Composition of Official Foreign Exchange Reserves (COFER) 90–1, 129, 234–5 Currency crisis 197 Currency devaluation 17, 19, 113, 143, 184, 265 Currency risk 37, 143

310

The Euro in the 21st Century

Current account 17–18, 41, 143–4, 155–6, 172, 175, 181–2, 190, 197–8, 264–5, 271

Euro-sterling cross rate 16, 112, 121 Eurotop 100 50–1, 68, 78, 221, 262 Excessive Deficit Procedures (EDPs) 159

Default risk 17, 163 Delors Report 13, 30 Democracy Index 42 De-trend 14, 51–2, 54–7, 64–7, 262 Devalued currency 19, 184 D-mark 7, 9, 50–1, 57, 65, 78, 191–2, 195, 261 Dollar trap 138, 264 Dow Jones Industrial Average (DJIA) 50–1, 63, 78, 169, 215, 221–2, 262 Dow Theory 218 Dynamic system 212

Federal Republic of Germany (FRG) 8, 195 Federal Reserve 5, 74–5, 103, 127, 215, 225, 251, 256 Fiat money 31 Financial uproar 3, 8, 11, 15, 18, 22–3, 47, 103, 111, 113, 126, 141, 144, 181, 186, 230, 249, 250–1, 256, 259, 264, 272 Foreign exchange market 14–17, 50–2, 56–7, 85, 107–19, 131, 197, 197, 215, 217, 222, 232, 245, 261–63 Foreign reserves 17, 112, 134–5, 141 Forward 16, 112, 115–20 French Franc 6, 50–1, 57, 60–1, 78, 84, 215, 268

ECOFIN 159, 271–2 Economic and Monetary Union (EMU) 7–8, 13, 27, 30–1, 35–6, 38, 40, 46–7, 158–9, 190, 259, 261 Economic bloc 11, 15, 81, 99, 139, 266 Economic crisis 3, 8, 10–18, 22–3, 47, 87, 103, 109, 11–13, 126, 141–4, 153, 159, 161–4, 175, 181, 186, 199, 230, 249–71 Economic integration 3, 5–10, 35, 38, 42, 44, 46, 259 Efficiency Market Hypothesis 21, 211, 218 Entropy 211, 245 EURIBOR 50, 52, 75–8, 262 Euro index 20–1, 211–13, 226, 229, 231–3, 240–6, 266–7 Eurobarometer 11–12, 121, 268 Eurodollar 50, 52, 73–6, 232–3 Euroization 19, 22, 184, 204 Europa 2020 10 European Central Bank (ECB) 10, 14, 30–1, 50–1, 73, 75, 83, 89, 156, 186, 188, 192–3, 205, 251 European Community 9–10, 19, 184, 193, 201 European Currency Unit (ECU) 30 European Debt Agency (EDA) 207, 209 European Economic Community (EEC) 6, 46, 193 European Monetary System 7–9, 30, 163, 191, 195

German Bund 17, 59, 73, 76–7, 87, 89, 143, 160 German Deutscher Aktien IndeX (DAX) 50, 63 Global common currency 16, 111–16, 141, 264 Global currency 15–16, 25, 81, 93–5, 106–14, 123, 127, 138, 141, 185, 207, 121–3, 232, 263–4 Global international reserve currency 126–7 Great Depression 16, 111, 151, 271 Greece 3, 8, 17–18, 30, 87–90, 116, 143–4, 148, 156, 182–90, 196–9, 206–8, 230, 251, 259, 265–6, 268, 270–2 Heterodox school 211 Hong-Kong dollar 34, 112–14, 121, 135, 139–41, 264 India 12, 17, 20, 47, 85,112, 115–16, 121, 131–4, 141, 202, 213, 261–4 Indian rupee 85, 115, 121, 132–3 Integration process 3, 8, 10, 12–13, 22, 32, 39–40, 43–4, 81, 99, 249, 259, 268

Index International currency 15, 21, 81–3, 93, 106–7, 127, 141, 207, 212, 232, 249, 264 Intor16, 111, 113 Ireland 3, 6–8, 17, 88–9, 143–4, 148, 156, 172, 18607, 198, 251, 259, 265, 271 Italian lira 50–1, 57, 61–2, 78, 261, 268 Italy 3, 7, 9, 17, 29, 87–90, 96, 126, 132, 143, 172, 189, 193, 195–6, 159, 263, 271 iTraxx Europe Index 153–4, 268 Japanese yen 20, 56, 121, 127, 212–13, 232–3 Latin Monetary Union 13, 29, 162 Lender of last resort 19, 93, 95, 131, 138, 184 LIBOR 50, 52, 75–8, 262 Lisbon Agenda 10, 199, 201–2, 272 Lisbon Treaty 8, 10, 22, 204–5, 249 Maastricht Criteria 148, 164, 185, 204, 207 Maastricht Treaty 20, 28–30, 78, 113, 116, 158, 181–6, 204, 261–5, 269 Mainstream economists 211 Market maker 16–17, 111–12, 114, 119–21, 141, 264 Mercosur 3, 10, 38–47, 260–1 Monetary policy 3, 7, 17–18, 20–31, 34, 38, 73–8, 96, 114, 137, 141, 143, 162, 167, 183, 225, 260–1 Money market 14, 51–2, 72–8, 85, 107, 215, 262 Moving average 14, 15, 51–2, 55–7, 64–7, 79, 221, 262 Mundell I 13, 27, 29 Mundell II 29 NAFTA 9 New regionalism 3, 8–10, 259 New Zealand index 21, 213, 226, 229, 232–3, 237–9, 242, 245, 266–7 No-bailout 19, 3, 186, 203–4, 207–8, 266 Object-oriented 212, 233

311

Optimum Currency Area (OCA) 27, 29, 49, 271 Pax Americana 15, 81, 112 Pax Britannica 112, 123, 232 Periodic trajectory 227–8, 233, 267 PIIGS countries 17, 19–20, 143, 148, 156, 184–5, 187, 203, 208, 271 Political integration 15, 21, 31, 40, 44–6, 213 Portugal 3, 17–18, 87–90, 143–4, 148, 156, 185–6, 189, 190, 196, 199, 207–8, 259, 271 Private debt 19, 189 Quantitative analysis 4, 14, 50, 260 Random variables 14, 53 Random walk 21, 211–13, 218–19, 221 Rating agencies 87, 88, 148, 153, 186 Regional monetary integration 13, 27 Regionalism 3–10, 32, 249 Russia 17, 20, 34, 47, 85, 96, 112, 114–16, 121, 126, 131–6, 141, 172, 197, 213, 261, 264 Russian ruble 14, 85, 115, 121, 132, 133 Self-made US dollar index 21, 213, 226, 133, 243, 245, 267 Self-organize 211, 226–7, 233, 243 Sharp jump 212, 226, 229–33, 242–3, 267 Single European Act 46 Single currency 16, 29, 49, 83, 86, 111, 113, 116, 264, 271 Single market 12, 13, 28, 35–9, 46–7, 261 Singularity 226, 229–30 Smithsonian Agreement 6–7 Snake 7, 9, 62, 124 Sovereign debt 17, 19, 87–9, 112, 143, 148, 170, 184, 186, 190, 266 Spain 3, 17–18, 87–90, 143–4, 148, 156, 160–82, 186, 189–90, 195–9, 207–8, 251, 159, 265, 268, 270–1 Spanish peseta 50–1, 57, 61, 78, 161–2, 169–70, 195, 261, 268 Special Drawing Rights (SDR) 16–7, 111–2, 126, 130, 138, 264 Speculative attack 164, 197–8

312

The Euro in the 21st Century

Spot 16, 112–22 Stability and Growth Pact (SGP) 18, 31, 86, 144, 158, 189, 272 Statistical technique 14, 55 Stimulus packages 189 Stock market 14, 49–50, 64, 78, 215, 218, 221, 261 Structural and Cohesion Funds 163, 166–7 Structural reform 10, 18–20, 144, 148, 156, 181–5, 196–7, 199–203, 208, 265, 270 Swaps 16–17, 90, 112–22, Swedish krona 20, 56, 116, 121–3, 233, 243 Swiss franc 20, 34, 56, 115, 121, 134, 212–13, 232–3, 242–3 Trade Weighted US Dollar Index 115, 206, 217 Treaty of Amsterdam 20, 184 Treaty of Maastricht 9, 17, 143, 182 Treaty of Rome 20, 44, 46, 184 Triffin Dilemma 127 UK 3–13, 28, 30, 42, 46, 63, 78, 84–6, 96, 112, 114, 116, 119, 121, 123–4, 131–2, 172, 187, 189, 197–8

UK pound 16, 20, 50–1, 56, 62–3, 73, 76, 92, 112–27, 135, 197, 212–13, 232, 261, 264 Unemployment 18–20, 144, 163–4, 166, 181, 184, 190, 198–201, 151–2, 256, 265 Unitas 28 US Dollar Index (USDX) 20–1, 50–9, 66, 70–1, 78, 212–17, 221, 224–6, 232 Volatility 14, 55, 131 West African Monetary Zone (WAMZ) 35, 38 West African States (ECOWAS) 35–7 White noise 211, 219–20 White plan 28 World Bank 138, 164 World War II 4, 15, 81, 93, 112, 190–1, 250 Yield spread 176, 143 Yuan 112–15, 121, 127, 132–41, 264

The International Political Economy of New Regionalisms Series Other titles in the series

The EU and World Regionalism The Makability of Regions in the 21st Century Edited by Philippe De Lombaerde and Michael Schultz The Role of the European Union in Asia China and India as Strategic Partners Edited by Bart Gaens, Juha Jokela and Eija Limnell China and the Global Politics of Regionalization Edited by Emilian Kavalski Clash or Cooperation of Civilizations? Overlapping Integration and Identities Edited by Wolfgang Zank New Perspectives on Globalization and Antiglobalization: Prospects for a New World Order? Edited by Henry Veltmeyer Governing Regional Integration for Development: Monitoring Experiences, Methods and Prospects Edited by Philippe De Lombaerde, Antoni Estevadeordal and Kati Suominen Europe-Asia Interregional Relations A Decade of ASEM Edited by Bart Gaens Cruising in the Global Economy Profits, Pleasure and Work at Sea Christine B.N. Chin Beyond Regionalism? Regional Cooperation, Regionalism and Regionalization in the Middle East Edited by Cilja Harders and Matteo Legrenzi

The EU-Russian Energy Dialogue Europe’s Future Energy Security Edited by Pami Aalto Regionalism, Globalisation and International Order Europe and Southeast Asia Jens-Uwe Wunderlich EU Development Policy and Poverty Reduction Enhancing Effectiveness Edited by Wil Hout An East Asian Model for Latin American Success The New Path Anil Hira European Union and New Regionalism: Regional Actors and Global Governance in a Post-Hegemonic Era. Second Edition Edited by Mario Telò Regional Integration and Poverty Edited by Dirk Willem te Velde and the Overseas Development Institute Redefining the Pacific? Regionalism Past, Present and Future Edited by Jenny Bryant-Tokalau and Ian Frazer The Limits of Regionalism NAFTA’s Labour Accord Robert G. Finbow Latin America’s Quest for Globalization The Role of Spanish Firms Edited by Félix E. Martín and Pablo Toral

Exchange Rate Crises in Developing Countries The Political Role of the Banking Sector Michael G. Hall Globalization and Antiglobalization Dynamics of Change in the New World Order Edited by Henry Veltmeyer Twisting Arms and Flexing Muscles Humanitarian Intervention and Peacebuilding in Perspective Edited by Natalie Mychajlyszyn and Timothy M. Shaw

The New Political Economy of United States-Caribbean Relations The Apparel Industry and the Politics of NAFTA Parity Tony Heron The Nordic Regions and the European Union Edited by Søren Dosenrode and Henrik Halkier The New Regionalism in Africa Edited by J. Andrew Grant and Fredrik Söderbaum

Asia Pacific and Human Rights A Global Political Economy Perspective Paul Close and David Askew

Comparative Regional Integration Theoretical Perspectives Edited by Finn Laursen

Demilitarisation and Peace-Building in Southern Africa Volume III – The Role of the Military in State Formation and Nation-Building Edited by Peter Batchelor, Kees Kingma and Guy Lamb

Japan and South Africa in a Globalising World A Distant Mirror Edited by Chris Alden and Katsumi Hirano

Demilitarisation and Peace-Building in Southern Africa Volume II – National and Regional Experiences Edited by Peter Batchelor and Kees Kingma Demilitarisation and Peace-Building in Southern Africa Volume I – Concepts and Processes Edited by Peter Batchelor and Kees Kingma Reforging the Weakest Link Global Political Economy and Post-Soviet Change in Russia, Ukraine and Belarus Edited by Neil Robinson Persistent Permeability? Regionalism, Localism, and Globalization in the Middle East Edited by Bassel F. Salloukh and Rex Brynen

Development and Security in Southeast Asia Volume III: Globalization Edited by David B. Dewitt and Carolina G. Hernandez Development and Security in Southeast Asia Volume II: The People Edited by David B. Dewitt and Carolina G. Hernandez Development and Security in Southeast Asia Volume I: The Environment Edited by David B. Dewitt and Carolina G. Hernandez Thailand, Indonesia and Burma in Comparative Perspective Priyambudi Sulistiyanto