It was in 1999 that 17 member nations from the European Union came together to form a powerful economic alliance, known as the Eurozone. The Maastricht Treaty of 1992 laid down stringent criteria to gain a membership in the alliance. Euro became the face of this congregation, standing in direct competition with the strongest currencies, US Dollar and British Pound. Today, years of rampant violation of the fundamental philosophy of the Eurozone and glaring financial realities threaten the very existence of this economic force.
According to the (ECB) European Central Bank President, Mario Draghi, the original objective of Euro was, “To spread price stability and sustainable growth to all European citizens. To reap the gains of the world’s largest single market and make the historic process of European unification irreversible. To raise Europe’s standing – not only economically but also politically – in a globalised world.” Political unification is a far cry, where even the economic fabric of Eurozone has tattered in places. Greece may be at the brink of bankruptcy, but it is not the only one. Spain, Italy, Ireland, and Portugal are also suffering. Grexit is fast becoming a possibility, but Greece is a small economy that may not hurt much if it exits the Eurozone. However, the cost of a bailout for large economies, like Italy (third largest in the region) and Spain (fourth largest) is expected to be huge. If these countries also exit Euro, the currency may be in a trouble. The fears of a contagion are gripping the area, particularly as the climbing borrowing cost for the remaining nations is expected to add to the troubles. If the economic situation worsens and Euro takes a beating, even stalwarts, including Germany and France, will not remain unscathed.
Eurozone has been a classic inter meshing of sustainable & responsible economies with reckless ones. Draghi observes, “The consequences of misguided fiscal policies in a monetary union are too severe to remain self-policed. The euro area is not a nation-state where persistent cross-regional subsidies have sufficient popular support. Therefore, we cannot afford a situation where some regions run permanently large deficits viz-a-viz others.” Price stability and access to cheap credit led these countries to finance their astronomical wage hikes and other expenditures by incurring debt. Efficiency and structural reforms were repeatedly overlooked and the actual sovereign debt position was hidden from records. The Great Recession (2007-09) came as an eye opener, bringing the deficiencies to light and triggering the European crisis as we know today.
Investors, including domestic multinational companies, are pulling out their money from the risky Eurozone countries. There also is a migration towards safer options, such as the Dollar and precious metals. As long as colossal sums are not converted from Euro to other currencies or investments, the position of Euro will not be seriously threatened. The current trend is more towards a flight of capital to stronger economies, like Germany.
The key to saving Euro is to save the large and ailing economies in the Eurozone. ECB is working at the bond-buying plan, the decision on which is expected shortly. Under the new policy, ECB will put a cap on interest rate on borrowings of the distressed countries. Europe being a preferred investment destination, investors are likely to comply with the cap. If the yields rise beyond the stated levels, the ECB will buy the sovereign securities in secondary market operations. However, this plan is currently facing stiff opposition from the German Bundesbank on account of ECB’s direct support to a nation, which is against its basic principles. Also, the plan may be difficult to administer in practice as the question of monitoring and control will crop up.
Whether or not the Eurozone will be able to tide over its differences and adopt widely accepted plans to prevent a complete meltdown, will decide the future of Euro and a once formidable economic group, called the Eurozone.
Learn more about the European crisis at http://www.eurion-finance.blogspot.in/2012/09/is-greece-on-verge-of-bankruptcy.html Eurion Constellation is a research and consulting firm serving businesses in
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