Ten years the euro Celebration or deception?
Introduction: A retrospective
Ten years ago twelve countries of the European Union replaced their national banknotes and coins with the euro. Today that number has risen to seventeen, with several more countries planning to switch to the euro in the next few years. A lot has happened during these past ten years, from the initial introduction to surviving the financial crisis to the global debt crisis that in Europe originated with Greece.
Looking at the beginning of the euro, we can see that several expectations existed. Countries joining the common currency had to satisfy the criteria of the treaty of Maastricht, which among other things stated that countries cannot have a deficit to GDP ratio of more than 3% or a debt to GDP ratio of more than 60%. Naturally it is assumed that any country that adopts the euro as its currency meets these criteria and thus has its finances straightened out. However, several years later people discovered that, thanks to creative accounting, this was not always the case. It was also thought that when confronted with high interest rates on their loans of, say, 7% or more, countries would make cutbacks in order to regain the trust of investors. As it turns out now, countries like Greece are more likely to default than to cut their spending. There is another side to a country?s debt problem. Where countries would simply devalue their currency in the past, they now find themselves restricted in doing so that area. This leads to a change in the level of competition with for example Germany or the Netherlands, which are major exporters. Usually when a country devalues its currency, that country becomes more interesting to trade with. With the euro this is no longer the case, in turn resulting in a loss of potential income.
The introduction of the euro was accompanied by promises of a lower inflation rate. EU residents, however, initially experienced the opposite. Yet, in the first 10 years of the euro, the inflation rate has been 1.97%, which is lower than in any other period in any euro area country and in accordance with the price stability objective of the ECB. For the Netherlands, the introduction of the euro has been particularly advantageous, since the exchange rate risks with its major trading partners had disappeared.
Effects on businesses and investments
It is hardly a surprise when we state that the euro has had its impact on both businesses and investments in EMU and as well as non-EMU countries. Apart from having to change accounting systems to work with the new currency, several other important changes occurred.
Let us begin by looking at the changes that companies witnessed over the past few years. First of all there is a change in cash positions within businesses that operate in multiple countries. Multinationals keep cash as a buffer for future uncertainties, such as exchange rates for example. Von Eije and Westerman concluded in their research (2002) that cash positions had lessened due to a decrease in the necessity of holding foreign currencies. However, a study conducted by Ramirez and Tadesse in 2009 contradicted these findings; they discovered that cash holdings had, in fact, gone up. One explanation might be the increase in competition a company experienced after the introduction of the euro. The increase in competition between European companies has benefited consumers in a large way but had an impact on businesses as well. One of the first noticeable effects of increased competition is the reduced profit margin, resulting in lower prices for consumers as well as lower profits for companies themselves. These price cuts do have advantages for businesses as well, that is, companies themselves also fill the role of buyer and thus benefit from lower prices. An advantage for both consumers and businesses is the higher amount of innovation the increased competition brings about. In addition to the competition caused by the euro itself, the European procurement law aims to increase competition between European companies. This law entails that purchases made by governments above a certain threshold value, have to go through a European procurement.
In the investment sector the effects of the euro are noticeable as well. A clear example of these effects is presented in the research of Pavlos Petroulas who, in 2006, examined the effect of the euro on foreign direct investments (FDI). Petroulas found that in the period between 1999 and 2001 the FDI from countries within the EMU went up with by 16%, the FDI from member countries to non-member countries increased by 11% and the FDI from non-member countries to member countries were augmented by 8%. One reason for an increase in investments could be the decreased risk of exchange rate fluctuations; the euro is a lot more stable than, for example, the lira or the drachma were. It is, however, very likely that the investments declined due to the financial crisis. One of the reasons for this is the exchange rate between the euro and the dollar, with the latter decreasing in value. Furthermore, the European debt crisis diminished trust among investors, resulting in a near standstill in investments in Southern European countries in particular.
The euro and politics
In essence, politics are involved in most, if not all, aspects of the euro. We can, however, distinguish different levels of political involvement over the past years. During the heyday of the euro the involvement of politicians was mainly to decide which countries they would let into the EMU. The currency itself was largely managed the ECB and by market influences. Indeed, we could remark that politics might not have been involved as much as it they should have been. A clear example is the entry of a country like Greece, which, in retrospect, never met the entry conditions. Another illustration is the fact that several countries were beginning to failed to meet comply with the Maastricht treaty?s criteria after only just a couple of years and faced little or no consequences. Even Germany breached the 3% budget deficit ceiling as early as 2004, only two years into the euro. It is at least slightly ironic that it was Germany which demanded the 3% ceiling to be integrated into the treaty in the first place.
As of the past few years, political engagement has significantly increased. It started with the subprime mortgages crisis in the US, after which banks needed a bail out and local economies had to be stimulated, and continues today with the debt crisis. Discussions arose about turning in sovereignty in favor of the common currency and even about disbanding the euro. The biggest discussion perhaps was about whether or not to bail out countries that were on the brink of bankruptcy. The treaty of Maastricht has a no bail out clause, meaning that member countries do not vouch for one another when it comes to paying off debt.
The question emerges whether or not it is desirable to get politics involved with the euro. It has proven to be hard for member countries to be in unison, not to mention the citizens of individual countries. Then there is the question of which nation?s voice should be the strongest. Should it be the Northern European countries because of their tight financial management? Or should it be Germany and France for being the largest economies? The political tug-of-war impedes fast decision making, which, in turn, results in diminishing trust among investors. However, should we decide to let the free market run its course without political intervention, it is very likely that a country like Greece will either default or go bankrupt, which would almost certainly trigger an immediate contagion to other countries.
What can we expect for the future?
When looking at the future, only assumptions about what is next can be made. Currently there is a crisis because of high deficits in Greece, Ireland and Portugal and problems starting are arising in Italy and Spain as well. The current situation is not tenable and action needs to be taken. It is hard to determine the right course of action as opinions on what to do next differ. Interests of several stakeholders need to be taken into account. Looking at the current public opinions a couple of possible solutions can be considered.
The first option is to save the current model with a series of measures. The rules concerning budgets and deficits as well as the supervision on the compliance of these rules need to be intensified, enforcing sanctions when needed. The implementation of a so-called euro economic government should facilitate this. The introduction of eurobonds could provide a safety net for weaker member countries when it comes to attracting capital. The idea behind these bonds is that all member countries stand surety for the repayment. The downside of these eurobonds is the possible increase in interest for stronger member countries such as Germany and The Netherlands. Despite the extra costs for the stronger member countries, eurobonds could be a way to help save the euro in the long run, if they coincide with a strong economic governance framework, allowing for correction of any unsustainable fiscal policies in Member States.
A second possibility is to dissolve the euro and to quit the EU altogether, going back to different currencies such as the Deutsche mark, the Dutch guilder, the French franc et cetera. This opens up possibilities, such as the devaluation of a country?s currency, and its deficit, by printing extra money. The biggest drawback when taking this path are the associated costs. First of all, costs have been made to introduce the euro, now costs have to be made again by switching everything back to the old currencies. Furthermore, all advantages of the last decades would be lost since protectionism would immediately resurrect.
For a third solution we could take a look at the possibility of creating a common currency in which only the strongest countries participate. This option seems attractive but creates enormous drawbacks for all parties involved. The countries participating in the new currency continue receiving the known benefits of the euro, but there would be constant attacks on the members of the “core” area that are perceived to be weaker (e.g. France) and in addition the successful exporters of this core area (e.g. Germany and the Netherlands) would lose a lot of market share in the countries that would leave the euro area. Finally their financial sectors would incur enormous losses if the leaving countries are defaulting on their (euro) debts. For the countries that are not allowed to participate the debts (which are in euros), would become unbearable after a significant devaluation of their new currency. Moreover, the “„benefit?” of being able to once again devaluate their currency in order to respond to their deficit would soon dissipate because of higher inflation. All in all the current debts will not magically disappear, the weaker countries still need to pay off what they owe the other countries. Should the weaker countries go bankrupt and decide to default the financial institutions in other countries would be confronted with major losses, which in turn would disrupt the economies of the affected countries.
Looking at some of the possibilities of what the EU could do, it becomes clear that the right answer should be found urgently.
