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THE CURRENT ECONOMIC
CRISIS AND FINANCIAL
UPROAR IN THE EU
He who blames his failure to a crisis neglects his own
talent and is more interested in problems than in
solutions
A. Einstein
Dr. Maria Lorca-Susino
Dept of Economics and Dept of International Studies
OUTLINE
• The euro: A quick overview
• The euro as a common currency
• The euro and an international and global currency
• The new monetary order
• The EU and the Eurozone:
– The 1st economic crisis
• The current economic crisis and financial turmoil
– Greece and the “bail-out plan”
• Final thoughts
INTRODUCTION
The euro: an overview
The most dramatic change in the international
monetary system since President Nixon tool the dollar
off gold in 1971.
Robert Mundell
The euro: a common currency area
• The adoption of the euro
– The only other successful monetary union:
• The US and the greenback after the Civil War of 1961-65
• Path to the euro:
– Many trials from 1865 to 1971
– An alternative in Europe: • The Union of Soviet Socialist Republics (USSR): from 1922-1991
– The Werner Report the Delors report and its 3 steps to adopt the euro:
• Nominally on January 1999
• Physically on January 2002
The Maastricht Treaty • The set of requirements that must be met to join the euro:
Target Requirement
Inflation Rate No more than 1.5 percentage points higher than the 3 best-performing Member States of the EU.
Public finances The ratio of the annual government deficit to gross domestic product must not exceed 3% at the end of the preceding fiscal year.
Interest rates The nominal long-term interest rate must not be more than 2 percentage points higher than the 3 best-performing Member States.
Exchange rate stability
Applicant countries should have joined the exchange rate mechanism under the European Monetary System for 2 consecutive years and should not have devaluated its currency during the period.
Denmark, Sweden, and the U.K.
• Denmark's national currency, the KROEN linked to the euro through – The government has met the economic convergence criteria for participating
in the third phase of the (EMU), but a September 2000 referendum rejected joining the EMU
• New Referendum: ? • Sweden: rejected the euro in a popular vote maintains its own currency, the
Swedish Krona – The Swedish Riksbank founded in 1668 is the oldest central bank in the world – Convergence problems – Working on inflation
• The U.K. The currency is the pound sterling. – The Bank of England is the Central Bank – The UK chose not to join the euro at the currency's launch. – British Prime Minister, Gordon Brown MP, has ruled out membership for the
foreseeable future. – Former Prime Minister Tony Blair promised to hold a public referendum based
on a number (five) points. – In 2005, more than half (55%) of the UK were against adopting the currency,
while 30% were in favour.
Eurozone Member States: EMU and €
Economic and Monetary Union
(EMU)
1. Monetary Policy: -European Central Bank
- Price stability - 2% inflation rate
2. Economic Policy: •Fiscal Policy: Stability and Growth Pact
• Gov. Deficit to GDP: 3% • Gov. Debt to GDP: 60%
Enlargements: 2004 & 2007
Country EMU entry date Expected Cyprus January 1, 2008 C.Republic 2013 Estonia January 1, 2011 Hungary 2012 Latvia 2013 Lithuania 2013 Malta January 1, 2008 Poland 2012 Slovenia January 1, 2007 Slovakia January 1, 2009 Bulgaria 2012 Romania 2014
Due to economic turmoil these countries will not be making this
deadlines since they are far from complying with the Maastricht
requirements
Non-EU countries and the euro
Country Pegged to Adopted Euro Agreement signed Seeking
Monaco French franc January 1, 1999 December 31, 1998
San Marino Italian lira January 1, 1999 December 31, 1998
Vatican City Italian lira January 1, 1999 December 31, 1998
Andorra French franc
Spanish peseta
January 1, 1999 December 31, 1998 Agreement but not
membership to EU
Montenegro German mark January 1, 2002 Never Membership to EU
Kosovo German mark January 1, 2002 Never Membership to EU
Existing (struggling) Monetary Union
The East Caribbean dollar: in Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, Saint Kitts and Nevis, Saint Lucia, Saint Vincent, and the Grenadines.
The Central and West CFA franc used by currency used in 12 formerly French ruled African countries plus Guinea-Bissau (Portuguese) and Equatorial Guinea (Spanish)
The East African Shilling used in the East African Community (EAC) between the Republics of Kenya, Uganda, the United Republic of Tanzania, Republic of Burundi, and Republic of Rwanda
The Facto Monetary Union
The euro is legal tender in Andorra, Kosovo, and Montenegro.
The Hong Kong Dollar is used in Macau
The Russian rubble is used in Russia and the Georgian Autonomous republics of Abkhazia and South.
The Swiss franc in Liechtenstein
The U.S. 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.
Planned Monetary Union
Name Currency Date
West African Monetary Zone – as part of the Economic
Community of West African States (ECOWAS)
Eco December 2009
Gulf Cooperation Council (GCC) Khaleeji 2010
Caribbean Single Market and Economy (CSME) as part of the
CARICOM
Unknown Due between 2010-
2015
Southern African Development Community Unknown 2016
Alternativa Bolivarianas para los Pueblos de América (ALBA) - Bolivarian Alternative for the Americas Bolivia, Nicaragua, Honduras, Cuba, Venezuela, Dominica, and San Vicente-Granadinas (which have the East Caribbean Dollar) and Ecuador is not sure bc it has the US dollar
SUCRE
(Sistema Unificado de Compensación
Regional)
4th quarter of 2009
(Oct/Nov/Dec)
The euro as an International and
Global currency
A global economy requires a global currency
Paul Volker
The Euro as an International currency
Function Private Sector Official Sector
Unit of account Invoice Exchange rate peg
Store of value Financial Assets Reserves
Medium of Exchange Vehicle/substitution Intervention
Store of value: Financial Assets
• The purchasing power of the euro is measured by the demand of products denominated in euros in the bond, money, and FX market
• Important: the bond market
– Two conflicting patterns
– Since the introduction of the euro growth
– Maastricht criteria forces government to comply with monetary and fiscal requirements
Graph 2. Total Issuing Activity (mill of euros)
750.000 €
1.050.000 €
1.350.000 €
1.650.000 €
1.950.000 €
2.250.000 €
2.550.000 €
2.850.000 €
3.150.000 €
3.450.000 €
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Graph 3. Evolution of Bond Issuing -Central and Local Government (mill of
euros)
500.000 €
600.000 €
700.000 €
800.000 €
900.000 €
1.000.000 €
1.100.000 €
1.200.000 €
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Governments have increased bond issuance to finance national
‘bail-out’ plans and increase government purchases
Sharp increase of Government issuing activity
• Jump from year 2007 to 2009
– Consistent with breaking the requirements
• Consequence: Negative effect on quality & rating of sovereign debt
– PIIGS or Garlic belt countries
– S&P, Moody’s, Fitch
– Spain: August 2008 suspended an aution of 15-year bond woth €3,825 mill for LACK OF DEMAND
– Greece: February 25, 2010 successfully raised €5billion with a 10-year bond issuance offering higher yields
• Yield differential with Bund increased even more
Ratings update (as of March 7, 2010)
Moody’s S&P Fitch
Austria Aaa AAA AAA
Belgium Aa1 AA+ AA+
Cyprus Aa3 A+ AA-
Finland Aaa AAA AAA
France Aaa AAA AAA
Germany Aaa AAA AAA
Greece A2 BBB+ (*-) BBB-
Ireland Aa1 AA AA-
Italy Aa2 A+ AA-
Luxembourg Aaa AAA AAA
Malta A1 A A+
Netherlands Aaa AAA AAA
Portugal Aa2 A+ AA
Slovakia A1 A+ A+
Slovenia Aa2 AA AA
Spain Aaa AA+ AAA
Greece:
March 7, 2011 Moody’s donwgrades
to B1
Ireland:
April 5, 2011 Moody’s donwgrades
to Baa1
Portugal:
April 15, 2011 Moody’s donwgrades
to Baa1
Spain:
March 10, 2011 Moody’s
donwgrades tp Aa1
Corporate and Financial
Graph 5. Evolution of Bond Issuing - Corportate and Financials (mill of
euros)
300.000 €
500.000 €
700.000 €
900.000 €
1.100.000 €
1.300.000 €
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
• The rise in corporate and financial bond issuance proves:
– 1). Euro has facilitated corporations and financial institutions access to market capital
– 2). Before the euro, government enjoyed a “crowding out effect”
– 3). Sharp increase from 2007 to 2008 and 2009 due to financing needs
Official Sector: Reserve currency
1995 1999 2000 2002 2007 2008 2010
Total FX holdings $1,3trill $1,7trill $1,9trill $2,4trill $6,4trill $6,6trill $9.2 tri
US$% 43,92% 54,98%$ 55,77% 50% 40,64% 40,62% 33.96%
€% 6.35% 13,86% 14.35% 17.74% 16.83% 16.79% 14.55%
Industrial countries
US% 44,43% 59,6% 56.1%
€% 9,6% 19,9% 21.5%
Emerging and developing countries
US% 42,91% 29,49% 22.8%
€% 0,36% 14,95% 11.07%
The € has not gained much terrain but the US$ has lost ground
The euro as a global currency to dethrone the US dollar hegemony
• 1. The size of the underlying economy and global trade
Graph 6. Gross Domestic Product
(Based on PPP valuation of country GDP in billions of U.S. dollar)
0
5.000
10.000
15.000
20.000
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
United States Euro area European Union
Rank Exporters Value €bn Rank Importers Value €bn
1 Germany 1461,9 1 US 2169,5
2 China 1428,3 2 Germany 1203,8
3 US 1287,4 3 China 1132,5
4 Japan 783 4 Japan 763,6
5 Netherlands 633 5 France 705,6
6 France 605,4 6 UK 633
7 Italy 538 7 Netherlands 573,2
8 Belgium 475,6 8 Italy 554,9
9 Russian Fed 471,6 9 Belgium 469,5
10 UK 458,6 10 Rep of Korea 435,3
11 Canada 456,5 11 Canada 418,3
12 Rep of Korea 422 12 Spain 401,4
In terms of trade 5 of the Eurozone member states are in the top 10 nets exporters
December 2009 China overtook Germany as the world’s top exporter – in
2009 it reached US1.2tr
March 2011 China hit record high exports in April 2011
The breadth and depth • Breadth of the economy measures the behavior of capital market • Depth of the economy measures by the ration of the financial assets to GDP
Graph 8. Size of the Captial Market, 2007
0
5.000
10.000
15.000
20.000
25.000
30.000
35.000
Debt Securities (Public) Debt Securities (Private) TOTAL Debt
EU Eurozone US
Graph 9. Bond, Equities & Bank Assets (in % of GDP)
(2007)
0
100
200
300
400
500
600
EU Eurozone US
The new monetary order
The stability of the international monetary system can’t hinge on the currency of one single country, even thought that is the
largest economy in the world
Zhou Ziaochuan
The graph of the discord
• Current economic crisis and value of the US$ and US$ index:
– Vulnerability of the current existing international monetary system
– Certain countries are calling for:
• Need to reform the international monetary system and introduce a new global reserve currency
• March 23, 2009 President of the People’s Bank of China, Zhou Ziaochuan:
– Urgent need for “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.”
– Financial and economic war declaration to the US
• President Dmitry Medvedev at the G8 Summit in Aquila (Italy) July 2009 presented a new world currency bearing the words
– “unity in diversity”
• Alternative to the US dollar the SDR by the IMF
Arguments for the SDR and the IMF
• 1). To reduce certain countries’ tendency to accumulate international reserves to respond against account capital crisis
• 2). Stop the “Triffin Dilemma” a reserve currency issuer (the US) chooses a monetary policy and issues currency in response to the national needs and preferences and not to the need of the international monetary payment system and the world economy.
• 3). Change to from a dollar-centric to a more inclusive monetary system
Some problems with the SDRs… • 1). Limited amount of SDR’s and supported by develop
countries
– Only 200bn of SDR available
– In order to cover foreign exchange reserve need there should be a min US$1.1trill in SDR available.
• 2). Allocation based on member quota share
– G7 states have the largest share and least need for SDR
• The US has the largest share (17.816%)
• 3). SDR is a basket of 4 currencies the dollar the highest weight
– Fluctuation on these values will affect value of the SDR
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
7,000,000
8,000,000
9,000,000
10,000,000
1999 2000 2004 2008 2009 2010
Unallocated reserves 2/
Claims in euros
Claims in Swiss francs
Claims in Japanese yen
Claims in pounds sterling
Claims in U.S. dollars
Currency Composition of Official Foreign Exchange Reserves (COFER)
(In mill of US$)
Chinese Government and China’s currency war
Country Rank In US dollar (est. 2008)
China
Russia
India
Brazil
1
3
5
7
$1,955,000,000,000
$427,000,000,000
$254,000,000,000
$193,800,000,000
Figure 4.7. Time Series Data on International Reserves & Foreign
Currency Liquidity (in mill of US$)
$100.000
$150.000
$200.000
$250.000
$300.000
$350.000
$400.000
$450.000
$500.000
nov-08 dic-08 ene-09 feb-09 mar-09 abr-09 may-09 jun-09 jul-09 ago-09 sep-09
Brazil Russia India P.R. China: Hong Kong
The Yuan and the Hong-Kong dollar a picture is worth a thousand words
China: One Country Two systems
• Currency war because:
– China is in a “dollar trap”
– China increase in competitiveness currency dumping
– China running the largest account surplus
• Trade surplus Excess liquidity international creditor to US and other nations (LatAm)
• Undervalued currencies distort the economy trade edge distort prices wrong investment decisions
The EU and the Eurozone:
The first economic crisis
Those who cannot remember the past are
condemned to repeat it
George Santayana
The current situation
• PIIGS countries are not complying with the requirements from boom to bust:
– Ireland in 2009
– Greece in 2010
– Ireland in 2011
– Portugal in 2011
– Spain next??
• WHY?
– They used fiscal policy as a escape valve
• Off-set the rigor of common monetary policy
Graph 1. Government Debt Level
Decomposition of the 2010 gross government debt
0
50
100
150
200
250
AUS
LUX
NZL
CHEDNK
FINSW
ECZE
ESP
IRLPO
LNLD
DEU
AUTCAN
HUNG
BRPR
TFR
AUSA
BEL
ITA
ISL
JPN
All co
untri
es
% o
f 2007 G
DP
2007 Debt Cumm Defic Additional Factors Affecting Debt
`
Graph 3. Government Debt in Eastern EU Countries
0
10
20
30
40
50
60
70
80
Pol C Rep Hung Bul Rom Esto Lat Lith
2005 2006 2007 2008
Graph 2. Euro area Government Debt as % of GDP
60
65
70
75
80
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Graph 5. Euro area 16 Government Deficit
-8
-7
-6
-5
-4
-3
-2
-1
0
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
Graph 6. Deficits and Surplus in Eastern EU Countries
-10,00
-8,00
-6,00
-4,00
-2,00
0,00
2,00
4,00
Pol C Rep Hung Bul Rom Esto Lat Lith
2005 2006 2007 2008
Graph 7. Sovereing Bond Spread with German Yield (% points)
0
0,5
1
1,5
2
2,5
3
Greece Irland Portugal Italy Spain Belgium Netherlands France Finland Denmark
Jyly 07 March 09 may-09 sep-09
This has led to the deterioration of the sovereign and corporate bonds
ratings
But default risk is also affecting • European companies:
– end of 2010 €500,000 bill of rated corporate debt comes to an end corporate default is a spectrum haunting the EU
• In 2009 global corporate default = 260 issuers
– 188 in the US
– 20 in Europe
– 36 in Emerging markets
– 16 in other developed regions
– Reasons: worsening of economic fundamentals, unfavorable economic and financial prospects and recessionary conditions
• The iTraxx Europe Index measures the evolution of the most liquid 125 CDS European investment grade credit corporations distributed in:
– Financial, TMT, Industrial, Energy, Consumer, auto industry
• On February 8, 2010 CDS reached an all time high at 111.8bp
– It costs $118,800 to insure $10 million in corporate bonds of an European corporation
Graph 8. The Markit iTraxx Europe Index
75
80
85
90
95
100
105
110
115
22/0
9/200
9
29/0
9/200
9
06/1
0/200
9
13/1
0/200
9
20/1
0/200
9
27/1
0/200
9
03/1
1/200
9
10/1
1/200
9
17/1
1/200
9
24/1
1/200
9
01/1
2/200
9
08/1
2/200
9
15/1
2/200
9
22/1
2/200
9
29/1
2/200
9
05/0
1/201
0
12/0
1/201
0
19/0
1/201
0
26/0
1/201
0
02/0
2/201
0
09/0
2/201
0
Current account deficit … the forgotten economic data
• Curiously, those countries with economic difficulties all share large current account deficits
• Only the SERVICE component is positive
Graph 9. EU Current Account (in bn euro)
-80
-60
-40
-20
0
20
40
Q3/08 Q4/08 Q1/09 Q2/09 Q3/09
Current Account Goods Services Income Current Transfers
Current account per country
Graph 10. Current Account Balance (mill of US$)
-200.000
-150.000
-100.000
-50.000
0
50.000
100.000
150.000
200.000
250.000
300.000
Germany France Norw ay Sw eden Spain Portugal Greece
2004 2005 2006 2007 2008 2009
In 1999 In 2009
Portugal 8%
Spain 3%
Greece 4%
Portugal 10.7%
Spain 10.5%
Greece 11%
Economic Sentiment Indicator remains low
• Economic sentiment suffered a dip and it seems to be recuperating still:
– All four components are negative
The Current economic crisis and financial turmoil
Eeny, meeny, miny, moe it is time for …
Bail-out yes, bail-out no
Greece
• Main problems:
– No compliance with Maastricht requirements
– Hide real problems Use of derivatives swaps
– €2 bill in debt redemptions in April and May (debt refinance)
• €4.8bn saving package
• Wage increase is a problem:
– If year 2000 is the base year:
» In 2009: Germany 102 while Greece 122
• Long list of wage and pensions cuts for the public sector
– Massive protests and strikes
• Moral dilemma: bail-out or no bail-out
– The Maastricht “no bail-out rule”
• Art 125: The Union shall no be liable for or assume the commitments of central governments, regional, local or other public authorities
The Bail-Out Dilemma If there is NO BAIL-OUT
Pros
Help will increase moral hazard
Spain 2nd in line?
Sets example to force conduct structural reforms
Cons
Speculation against other weak countries
Banking sector in danger:
Most of Greece’s Gov debt is held by EU banks (@€200)
It harms the image of the EU & political
instability
One problem: Greece is threatening we call the IMF for
help
Bail-out plan and Greece calls the IMF
Pros Cons
No bail-out clause is
broken
Other EU member
states do not increase
their exposure
The IMF is not too good
overseeing adjustment
processes
Stop EU integration
process a country
is left behind
Pros Cons Bail-out plan: a mix of bilateral guarantees and loans via EU structural funds,
concerted actions to buy bonds, etc
Strong surveillance mechanisms and further conditionality to the loans
Bail-out plan without the IMF
Pros Cons
Show political strength &
and ‘know-how’ to cope
Enhance EU political
coordination
integration
Harsh measures public
unrest
If the rescue plan fails
the EU is doomed
Pros Cons
Bail-out plan with IMF
Pros Cons Bring technical expertise and
more independence from EU
build ‘know-how’
Conditionality will increase
and will be respected
If fiscal adj is not enough, and
debt restructuring is needed, the
IMF $ might complicate matters
The IMF track record for
overseeing adjustment is
uneven: eg. Argentina
The IMF will take the blame for
unpopular measures
The IMF presence EU &
Eurozone weakness
THE OUTCOME:
A SOUP OF LETTER
Churchill once said:
you can always count on the Americas to do the right
things---after they have tried everything else.
THE BAILOUTS
• Two vehicles to save the Eurozone:
– 1) The European Financial Stability Facility (EFSF) €440 bn in loans from plus the IMF, the European Commission and other $622 bn
– 2) The European Stability Mechanism (ESM) will take effect in 2013 $996bn
• Bailouts so far:
– Greece 110bn
– Ireland 67.5bn
– Portugal 80bn
Final Thoughts
That which does not ‘kill’ us makes us stronger
Friedrich Nietzsche
• The EU and the Eurozone are in serious danger
– Lack of supervision (see no evil, hear no evil, speak no evil)
– This shows negligence EU politicians should be held accountable
• Common fiscal policy not viable
– Budget will be imposed fiscal sovereignty
– Politicians are not longer needed…
• If PIIGS are asked to leave:
– Currency devaluation with lack of comp immediate bankruptcy
• What about Germany leaving the EU?
– Best economy in the area and record high export rate despite euro
– FX vendors still maintain the DEM as a currency
• Solution is not:
– The European Monetary Fund
– Institution to supervise financial activity
Thank you
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