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Boon or Bust? Sizing Up the Euro at Age 10

January 09, 2009 07:25 AM
by Anne Szustek
The euro turned 10 years old on Jan. 1. How has the regional currency fared in its first decade, and what’s next for the European Union’s tool of trade?

The Euro: Easy Does It

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Over the first decade of its existence, the euro has weathered the dot-com boom and bust, the market tribulations following Sept. 11, 2001, and skyrocketing oil prices.

Countries party to its currency, such as Ireland; as well as those on its periphery, such as Iceland, have risen from relative international financial obscurity to become tiger economies, only to recently tumble back into the red.

But by and large the euro has emerged as a bulwark against the roller-coaster markets of the past 10 years. Its status as an international reserve currency is now entrenched; Eastern European economies are working to tighten their fiscal and monetary policies with the aspirations of joining the Eurozone, and the diversity of the economies falling under the auspices of the European Central Bank has lent the multinational currency cushioning against external shocks.

“Perhaps the euro has proved too safe a haven,” writes The Economist. “The run-up to currency union and most of the euro’s first decade coincided with the Great Moderation, a period of economic stability and low inflation—and hence low interest rates—in the rich world.”

Currently, however, the global economy is far from stable, yet low interest rates are prevailing all around. Last month, the U.S. Federal Reserve cut the benchmark federal funds interest rates to a range of between 0 and 0.25 percent.

In the Eurozone, consumer price inflation dipped to 1.6 percent in December, well below the target interest rate of 2 percent. This has sparked speculation that the European Central Bank is cutting interest rates next week, according to Forbes.

In countries where wages have outpaced productivity, as has been the case in Italy and Spain, it may take longer to bounce back from public debt or current account deficits, as they are not able to lower their exchange rate, the usual go-to in that situation.

London School of Economics economist Francesco Caselli told The Economist that “in 1992, the last time Europe lived through such currency-market squalls, both Britain and Italy were forced to devalue their currencies against other EU nations. Neither country regretted it.”

For its part, the United Kingdom, which has stuck with the pound sterling, has fared worse than the EU and the United States during this economic downturn, however the fact that it has the opportunity to wield its own monetary policy finesse has its benefits. And the Centre for European Reform surmised in a 2006 report that Italy may leave the Eurozone in a bid to avail itself of its economic woes.

Yet the “safety in numbers” accorded by the euro can not be underestimated. Poland is pushing to join the Eurozone in 2012, and European countries whose economies were heavily exposed to the euro without having it as its currency, such as Iceland and Hungary, have been the worse for wear.

The euro’s diversified stability has also made it a sound investment during these economic times among foreign investors; however the U.S. dollar looks to remain on top. For one, the dollar remains the first fallback currency when other central banks struggle. Plus, the euro is backed by 16 bond markets, some of which are at a risk of default, compared to the U.S. Treasury, the singular lender behind dollar bonds.

Morgan Stanley currency analyst Stephen Jen told The Economist, “It is only in bad times that the mettle of a reserve currency is tested and the dollar met that test better than the euro.”

Key Player: The euro (1999–)

The euro is the official currency of 15 member countries of the European Union, as well as six other European nations, and is used as a foreign-exchange reserve currency around the world. It was instituted as an accounting currency in 1999 and in paper form on Jan. 1, 2002, according to the European Commission.

Among the raisons d’être for the regional currency were to help cross-border trade, eliminate exchange fees and, by way of having a broader frame of management than did the member-state currencies, such as the French franc or German mark, offer greater stability against inflation and external shocks such as oil price rises.

Some EU states, including the United Kingdom and Denmark, have opted not to sign on to the euro, while some newer member states are implementing economic reforms with a view to adopting it in the future.

Related Topic: Regional currencies considered elsewhere

Columbia University economist Robert Mundell, considered the “father of the euro,” believes a regional Asian currency could work—“if it could be arranged properly, and that would take agreement between Japan and China.”

The 33 percent depreciation of the Chinese renminbi versus the U.S. dollar in 1994 and the Japanese yen’s three-year decline from 1995 to 1998 played heavily into the Asian financial crisis of the late 1990s.

A shock to either of those two currencies could devastate smaller Asian markets such as Malaysia or Indonesia. This is one of the reasons that China, Japan, South Korean and ASEAN—an association of 10 Southeast Asian countries—are considering the “Asian currency unit” (ACU) as a way to restrain inflation, eliminate currency trading fees and make those countries more resistant to external currency shocks.

Not quite a currency in and of itself, but rather a basket of weighted national monetary units, the ACU, Asian Development Bank adviser Alfred Steinherr was quoted as saying by findingDulcinea in May, would help Asian countries “cooperate within Asia and become less dependent on … multilateral institutions.”

One obstacle for the ACU is the member countries’ wildly disparate rates of economic growth.

Similar concerns cloud the scheduled 2010 implementation of the khaleeji, a currency that would comprise most of the oil economies of the Persian Gulf. “Saudi Arabia’s inflation rate was only 2.3 per cent in 2006 while Qatar’s was 9.2 per cent,” according to Gulf News.

Reference: Investing guide

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