Structural Problem with Eurozone (Currency Crisis)

Euro, the official currency of Eurozone, is the second largest reserve currency and the second most traded currency in the world after the United States Dollar. The Euro is managed and administered by the Frankfurt-based European Central Bank (ECB) and the Eurosystem (composed of the central banks of the eurozone countries). As an independent central bank, the ECB has sole authority to set the monetary policy. The Euro has been adopted by 17 out of 27 member states of the European Union (EU) and the rest of the states have chosen to retain/ adopt their independent currencies.

However, despite the huge amount of planning by several economists and financial market experts alongwith the European lawmakers that led to the creation of Euro, Eurozone is now witnessing one of the worst currency crisis that could not have been imagined at its inception. This crisis had its seeds sown way back when the EU was created.

The currency Euro was never intended to be created keeping in mind the different political and social landscape of the countries participating in it. It was created as a facilitator in trade between the nations of the union and also with other countries of the world. In other words, it was a monetary union without a fiscal union (consisting of common taxation, pension benefits and treasury functions). Fiscal related law-making and monetary policies have to go hand in hand to create conducive atmosphere for a stable economic climate in the country. Seeing the situation of Greece and Spain on one hand and Germany and Netherlands on the other hand show us the vast difference in the economic landscape post the introduction of Euro.

Besides above, there is also no banking union to support the troubled banks in downgraded economies or banks owning huge amount of toxic debt from countries like Greece. However, a proposal for the same is under way to create a proper banking union to support the monetary union. Banking union would create an agency or body which would create greater integration among the member states of EU in the sense that the following can be introduced viz. bank deposit insurance, bank oversight, joint means of recapitalisation (injecting funds to meet short term obligations and resume the cycle of lending) or wind down of failing banks. Thus, a failing bank of Cyprus having huge exposure to Greek debt can be recapitalised. This way, the creditors of the bank in Cyprus do not have to worry a great deal and can settle for a minor haircut rather than an all out default. In other words, the financial contagion can be averted greatly. However, inflationary pressures can be a major risk due to excess liquidity.

Furthermore, the 17 nation currency union suffers from a problem of quick response. Every decision making process entails a unanimous agreement and not just a majority vote. This is quite justified also as a majority vote in the favour of easy monetary policy by many troubled EU nations can spell havoc for a current account surplus economy like Germany (which is one of the few nations in the EU at an extremely favourable position with long term interest rates less than 1.5%).

Among the other structural problems with the Eurozone is the inflexible single monetary policy. Individual member states cannot print money independently. In other words, they cannot create excess money supply in the economy leading to devaluation of their currency to make exports competitive and improve trade balance leading to higher and stable tax revenues. This is evident due to 17 nations following one single unit of currency. Though structurally, if the countries had different currencies, the Greek drachma would be trading at less than half the value of the Euro while the German Deutsche Mark would be far higher than Euro considering the stability of the economy and one of the lowest yields on its bonds.

Thus, the above mentioned problems clearly cast a doubt on the stability of the Euro as a currency. However, it is not only in the interest of Greece and Germany but in the interest of the entire world that Euro is not broken and no member nation exits the currency. This is because the exit would not only create huge financial ramifications and uncertainty in the foreign exchange market throughout the globe but also would hamper the confidence of an investor in global financial markets leading to a situation where Lehman collapse would seem like a walk in the park.