Stabilizing the European Currency Union and Implications for Private Investment

Stabilizing the European Currency Union and Implications for Private Investment

The financial crisis that started 2006 had dramatic impact on every country. Nevertheless, it has to be seen as an opportunity to improve ongoing failures in economy and economic policies. It made markets more aware of risks. Although many countries are recovering faster from the crisis than expected, it showed the vulnerability of the financial market and revealed the problem of many Western countries to support economic growth through debt making. Especially the success of the euro was questioned. In this essay we attempt to explain the reasons for the struggle of the euro and possible ways of its stabilization. Furthermore, we will indicate the future of private investment within the European Union, since it is strongly connected to the position of the euro.

The first attempt to establish euro occurred in the 1970's. The European Currency Union was created as a logical step resolving from the European Economic Community. The final plan of the Community and its currency, euro, was made in 1988 in the Delors report. On January 1st 1999 the establishment of European currency union ended with the foundation of the European Central Bank. Euro rapidly established itself as the second most important currency in the world and was a guarantor for stability and economic growth in the region (European Central Bank, 2007).

Nevertheless, the euro was and still is an ambitious but unfinished project with many unanswered problems. For example, major problem because of euro was the existence of bonds with low interest rates, which lead countries like Spain and Ireland into enormous investment bubbles. A similar problem with a different outcome became obvious in 2008 in countries like Greece, Portugal and Italy. They were released from the high pressure of responsible debt making, since it seemed possible to sell an infinite number of bonds with low interest rates on the market. This behavior is now a threat for euro (Soros, 2010).

Another major problem of the economy of the European Union was the financial crisis of the banking sector in 2006. It was very cost intensive for the European countries, but also made the sector more aware of risks (Dorn, 2009). In 2008 Greece was the first country within the European Currency Union which could not serve its debts (Gloede & Menkhoff, 2010). The problem was to find a fast solution in order to stabilize the market and restore trust in euro. Nevertheless it turned out to be difficult since bail outs, one of the strategies that could be applied to solve the crisis, were explicitly forbidden in the Lisbon treaty, which defines the basic principles of the European Union (The Economist, 2010). A temporary solution was found with the creation of the European Stabilization Fund, which European Union member state and the International Monetary Fund established together. However, this will probably not be able to provide economic relief for a long time. Moreover, many prominent economists believe that Greece will not be able to repay its debts in the long run at all (The Economist, 2010).

The crisis of euro has different country-specific causes. For instance, in Ireland and Spain the major problem was the rescue of the banking sector. However, in Greece and Portugal the issue lies on the much deeper level (Gloede & Menkhoff, 2010). There, it is not only the banking sector with costly banking rescue programs that causes euro instability, but the mismanagement of many other areas, such as industries, infrastructure, retirement policies, and so on. Moreover, Greek economy is not very competitive on the international level. The extent of the economic hardships that this country is experiences is visible from the figures about the trade components in the last several years represented below.

2004 2005 2006 2007 2008 2009 2010

Current Account Balance (% of GDP) -5.8 -7.5 -11.3 -14.4 -14.6 -10.9 -

Trade Balance (USD bn) -32 -34 -44 -57 -65 -43 -

Exports (USD bn) 16 18 20 24 29 21 -

Imports (USD bn) 47 52 65 81 94 64 -

(Focus Economics, 2010)

Therefore, the solution of crisis in Greece is possible only with the improvement of the entire economy. The substantial growth of GDP can be the deciding factor in repayment of the national debt of Greece. The solution of crisis in Greece is even more complicated than might seems, since the policy of national savings, required by the European stabilization fund, might even lead to a deflation and thus worsen the crisis (Soros, 2010).

Therefore, in order to stabilize the European Currency in the long run other solutions have to be found. The first steps of the European Currency Union were to establish a permanent European Stabilization Fund and a common European Economic policy from 2013 (ARD , 2010). This policy aims at adjusting the different economic policies of the member states. As a result of that, the