The Unique Form of Currency Unity: Euro

Prepared for: Md. Al Mamun Senior Lecturer East West University Prepared by : Khondokar Kamran Bin Khaled 2008-1-10-152 Tasnima Azam 2008-2-10-279

Assignment on Problems & Prospects of EURO Course: International Financial Management (Fin 465)

Contents
Introduction ..................................................................................... 2 The Euro Symbol- .......................................................................... 2 Early History of Euro ..................................................................... 2 Modern history of Euro.................................................................... 3 German Mark and other currencies in Euro history ........................ 3 Euro Countries ................................................................................. 4 Recent and Future Euro Countries ................................................... 5 Implied Contracts of Euro ................................................................ 6 Problems inherent in Euro ............................................................... 6 Prospects for Euro ........................................................................... 7 Bibliography ..................................................................................... 9
EURO: PROSPECTS AND PROBLEMS

Introduction

On January 1, 1999 one of the largest steps toward European unification took place with the introduction of the euro as the official currency in eleven countries (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain).However, residents of the first European Union countries that adopted the euro didn't begin using euro banknotes and coins until January 1, 2002.

The Euro Symbol-

The symbol for the euro is a rounded "E" with one or two cross lines - . You can see a larger image on this page. Euros are divided into eurocents, each eurocent being one one-hundredth of a euro. A one-euro coin is shown. The euro is used throughout Europe as an international currency. The symbol of the euro is , the letter "E" with one or two cross lines.

Early History of Euro

The Euro currency was launched or introduced as an accounting currency on EURO: PROSPECTS AND PROBLEMS January 1, 1999. The Euro became the single currency of 12 European states in 2002. Other states joined the currency later. The history of Euro started with the acceptance of the Maastricht Treaty. The history of Euro begun with participating countries fixing their domestic currencies to the Euro. This event in the history of Euro meant that local currencies were not allowed to fluctuate against the Euro and against each other. When the history of Euro was started, Euro was launched merely as an electronic currency. Euro as a cash currency did not become a legal tender until later, on January 1, 2002. The roots of the euro currency originated in the European Monetary System in 1979 which involved creation of the European Currency Unit. Per history of Euro, originally twelve (12) of the 15 EU countries (Germany, France, Austria, Spain, Portugal, Italy, Belgium, Luxembourg, the Netherlands, Finland,

Greece and Ireland) were members of the so-called Eurozone. Euro history tells us that these states were joined later by Slovenia (2007), Cyprus (2008), Malta (2008), and Slovakia (2009).

Modern history of Euro

The picture illustrates the modern history of Euro.

The history of euro timeline shows a number of important euro history events. The history has started in 1999 with the Euro adoption. The Greek and Irish crises in 2010 were very important events in the history of euro.

German Mark and other currencies in Euro history

The German Mark, French Franc, Italian Lira, and other local currencies ceased to exist on July 1, 2002. This date was important not only as the history of Euro in its cash form, but this date was also important in the history of Euro as the beginning of centralized monetary policy. With the introduction of Euro, the

EURO: PROSPECTS AND PROBLEMS

European Central Bank started implementing monetary policy of the countries which were using the common currency. When looking at the history of Euro, we can see that attempts to create a single currency go back some 20 years. The chart below shows the value of the Euro against the US dollar. Before 1999, history of Euro is shown as a basket of the 11 legacy currencies.

Euro Countries
Today, the euro is one of the world's most powerful currencies, used by more than 320 million Europeans in twenty-three countries. The countries currently using the euro are: 1) Andorra 3) Belgium 5) Estonia 7) France 9) Greece 11) Italy 13) Luxembourg 15) Monaco 17) Netherlands 19) San Marino 21) Slovenia 23) Vatican City 2) Austria 4) Cyprus 6) Finland 8) Germany 10) Ireland 12) Kosovo 14) Malta 16) Montenegro 18) Portugal 20) Slovakia 22) Spain Eurozone as of 2011 EURO: PROSPECTS AND PROBLEMS

Non-eurozone areas using the euro

Recent and Future Euro Countries

On January 1, 2009, Slovakia started using the euro. Estonia began using the euro on January 1, 2011. Lithuania and Latvia are expected to join the Eurozone in the next few years and thus become countries using the euro. Only 17 of the 27 members of the European Union (EU) are part of the Eurozone, the name for the collection of EU countries that utilize the euro. Notably, the United Kingdom, Denmark, and Sweden have thus far decided not to convert to the euro. Other new EU member countries are working toward becoming part of the Eurozone.

EU Eurozone (17) EU state with an opt-out on Eurozone participation (UK) abolished by a future referendum (Denmark) States outside the EU with issuing rights (3)

EU states obliged to join the Eurozone (8) EU state with an opt-out which may be

Other non-EU users of euro (4)

On the other hand, Andorra, Kosovo, Montenegro, Monaco, San Marino, and the Vatican City are not EU members but do officially use the euro as their currencies.

EURO: PROSPECTS AND PROBLEMS

Implied Contracts of Euro

The Euro is a bold experiment to create the largest currency area in the World. The Eurozone is a diverse area and whether it is an optimal currency area is a matter of debate. The Euro involves: 1. A single currency within the Eurozone area. 2. A Common Monetary Policy. Interest Rates are set by the ECB for the whole Eurozone area. 3. Growth and stability Pact. Limits on government borrowing, national debt and fiscal policy. However, in practice member countries have often violated the strict limits on government borrowing.

Problems inherent in Euro

In this section we will elucidate the problems faced due to the implementation of EURO in various countries1. A common monetary policy involves a common interest rate for the whole eurozone area. However, the interest rate set by the ECB may be inappropriate for regions which are growing much faster or much slower than the Eurozone average. For example, if the French economy was in a recession, it would benefit from lower interest rates to boost demand. However, France no longer has the flexibility to be able to cut rates. Therefore, it could be stuck in a recession and not able to cut rates. 2. Not an Optimal Currency Area. If a state in the US like New York was in recession, it is argued that people in New York could move to New England and get a job. However, in the Eurozone this is much more difficult; it involves moving country and possibly learning a new language. There are more barriers to the movement of labour and capital within a diverse region like Europe. 3. Limits Fiscal Policy. With a common monetary policy it is important to have similar levels of national debt, otherwise countries may struggle to attract enough buyers of national debt. This is a growing problem for many Mediterranean countries like Italy, Greece and Spain who have large national debts. For example Italy's national debt is over 100% of GDP. EURO: PROSPECTS AND PROBLEMS

4. Insulation against Currency Crisis. It is argued that being a member of the Euro protects a country from a currency crisis. Therefore, there is less incentive for countries to implement structural reform and fiscal responsibility. This is even more important given the fact that devaluation is not an option. 5. No Scope for Devaluation. Euro countries are locked into the fortunes of the Euro. The Euro has been appreciating sharply in recent months because it has become an alternative to the dollar. If the Euro became the World's reserve currency its value could appreciate even more. However, the strength of the Euro is creating problems for European exporters and the European tourist industry. The appreciation in the Euro could start to harm prospects for economic growth in the Euro Zone. The main problem is that there is no flexibility for depreciating. This is also a problem for countries with large current account deficit. Traditionally, devaluation is a solution to current account deficit because it makes exports cheaper, but European countries have lost this as a possibility.

Prospects for Euro

The Euro has been strengthened as investors look for an alternative to the dollar. (Dollar as reserve currency) But, with the EU economy facing recession, the Euro looks painfully overvalued. I would suggest this is a good time to sell the Euro According to the Big Mac Index, the Euro is 50% overvalued compared to the US dollar on purchasing power parity. There are increasing concerns that the Euro economy is heading towards recession. Although, the Euro economy is less affected by the global credit crunch, there are still many factors contributing to a deteriorating economy. 1. High value of Euro, making it difficult for Euro-Exporters, especially in Germany and France. EURO: PROSPECTS AND PROBLEMS

2. Housing Boom and Busts: With most attention focused on the US housing market, not many know that European house prices, in many countries have increased much more than US house prices. For example, French house prices have increased 140% since 1999 (only 80% increase in US). In Spain and Ireland, the housing bust is more pronounced leading to a loss of jobs in the construction sector. (overvalued housing markets)

3. Slowdown in export partners. The UK and US economies are slowing down reducing demand for Euro exports. 4. Rising Oil prices: Most euro economies are net oil importers. Rising prices are squeezing living standards and reducing spending power. 5. Inflation and higher interest rates: rising cost push inflation has caused the hawkish ECB to increase interest rates( currently 4.25%) this has further reduced demand and spending 6. Signs of rising unemployment and decreasing output.

EURO: PROSPECTS AND PROBLEMS

Bibliography

http://econ.economicshelp.org/2008/04/problem-with-euro.html http://www.en.wikipedia.org/wiki/Euro http://www.econ.economicshelp.org/2008/04/problem-with-euro.html

http:/www.econ.kuleuven.be/eng/ew/PDF%2050%20jaar%20CES/De%20Grauwe.pdf

http://www.intereconomics.eu/downloads/getfile.php?id=18 http://www.regional-studies-assoc.ac.uk/events/2008/may-rague/papers/budd2.pdf http://www.huffingtonpost.com/nathan-lewis/the-problem-with-theeuro_b_469365.html http://www.econ.economicshelp.org/2008/07/prospects-for-euro-economy.html http://www.weekly.ahram.org.eg/2006/805/cu2.htm http://www.economist.com/node/18713850 http://www.economist.com/blogs/charlemagne/2011/07/euro-crisis http://www.eecon.economicshelp.org/2008/04/problem-with-euro.html http://www.seekingalpha.com/article/280176-ignore-the-eurozone-s-problems

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http://www.dailyreckoning.co.uk Economic Forecasts http://www.monies.cc/publications/euro.htm