The Euro Zone, is probably fighting the gravest battle since the time it was conceived by members of the European Union (EU). Euro was introduced around 1999 as a currency that could be used across all the EU member countries. Soon it was proposed to replace the local currency of each of the member country. Over a span of 10 years,  17 of the 27 EU countries changed their local currency to the Euro. The rationale behind such a dramatic move was to

  • Increase trade collaboration within the EU member countries
  • Reduce dependency on US $ to influence the exchange rate fluctuation
  • Increased cross border employment opportunity
  • Better cost parity across countries
  • Opportunity for, the developing economies in the EU to restructure their economic fundamentals and pave way for growth

Euro today is only second to the US $ in terms of net worth and the currency in which global trade is being carried out. Also to a large extent it has managed to make itself immune from the number of $ in circulation, ofcourse a 100% immunity is neither possible nor desired. So all the 17 countries that agreed to convert to Euro soon came to be known as The Euro-Zone. Interestingly though, UK is not among the 17 countries, though Euro is accepted as a currency for trade but the Pound still remains their local currency.

Whatever limited success that Euro has enjoyed till date, it is quite interesting to note that there was one key inherent flaw. The flaw was that, there was a common monetary policy across the Euro-zone countries but there was no common fiscal policy across them. This meant that while it was understood by the Governments what currency they are dealing with and how much of it, there was no understanding about how each Government was spending them. It isn’t like the United States or India where, while each state makes their own independent decision on State Government expenditure but it is still within the framework of the Central Government. With the lack of such over-viewing body, each country had it’s own fiscal policy and went ahead and did whatever they thought was best for their people without realising that how it would affect other countries.

Governments in most countries, tend to spend on infrastructure to generate jobs in public sector, provide unemployment benefits and some of them offer pensions and other social benefits. These expenditures are to be funded.  
A. You could print money to fund them (at the risk of inflation) 
B. You could increase taxes (income/sales/service/excise/customs) and increase revenue (to the dissatisfaction of people) 
C. You could borrow money against Government bonds (with risk of higher fiscal deficit).

All said and done the option that least impacted people immediately was borrowing money, hence lot of countries like Greece were known to have large fiscal deficit and used to borrow heavily to fund their social benefits programs. Individual countries making their own decision to provide benefit to their own people in the Euro Zone was interestingly coming at the expense of every other country also part of the same Euro Zone. Amidst this came the economic slow down of 2008 and what was worse was that banks were failing and falling like dry leaves. Even central banks of some countries lost their stability. There was only two option – allow the banks to fail or recapitalise the banks by injecting genuine (and not speculative) funds into them. The vote was in favor of injecting funds and billions of Euro’s were offered as bail out packages to these banks as they were seen as a the back bone of the economy and their failing or falling could lead to horrible bloodbath.This sort of paved way for more such stimulus funds or packages which has only made the matter worse.

With a linked currency, what it meant now was a country’s exports or imports could become expensive or cheap depending upon the exchange rate of the Euro. Greece suffered the consequences of this and suddenly found themselves in a position where their exports became expensive to buy and imports became expensive to sustain, thus further fueling their debt levels. Most countries like Greece or Spain, in order to raise money sold Government bonds to other countries and borrowed heavily, which meant that all the countries that bought these bonds became dependent directly on the well being of these countries. It is a catch 22 situation all the way. Let me explain.

  • Countries like Greece or Spain have borrowed so heavily that they can continue to sustain only if they can still borrow; even if it means that their bonds are of no value. Which means the other countries have to suffer losses to sustain Greece
  • There is a need to politically influence countries like Greece or Spain to reduce their respective public spending
  • Reduced public spending would mean loss of jobs and incomes for households which would mean either higher unemployment benefit cost again leading to debt or reduced collection of tax and a shrinking GDP
  • One could ask why not let Greece drop out of the Euro Zone and revert back to it’s old currency, well what about the bonds they sold to other countries? What worth would they be? What value will they get, indirectly it influences the financial stability of countries who bought these bonds

Not an easy decision to make, however what the Euro-zone Political leaders have agreed upon is inline with the problem we highlighted above

  • Write off some part of Debts (non-repayment of loans), especially Greece
  • Offer bailout package to sustain the countries
  • Resort to AUSTERITY – a move popularised and strongly voiced by German Chancellor Angela Merkel – basically means reduced Government spending on social benefits and other activities to ensure the debts don’t increase dramatically.

It looks to be a fair decision provided, saving the Euro-Zone is a predetermined objective. Hence I said at the beginning it is the gravest battle that Euro-zone is fighting for it’s own survival. The  country that could probably be smiling with a ‘ I told you So’ smile is UK, who have remained relatively immune to this turmoil and ofcouse so have been the 9 other EU members who decided to stay out of the Euro-Zone. The Political and Economic big-wigs of Europe are definitely making an all out effort to keep alive their baby (the Euro Zone) however, it is coming at an expense of competitiveness of individual countries to sustain and earn their way out of crisis.

If Greece is allowed to fall out of the Euro Zone they could devalue their currency which would make their exports cheaper and imports sustainable. This would aid them to earn greater returns from exports helping to minimise fiscal deficit. It would give them the opportunity to revive their economic health and rejoin Euro-Zone when in a better shape. Holding other countries contingent to Greece is like telling me that, how much I can spend today is dependent on how much my neighbor  already spent yesterday. Because of Greece all other countries which are part of Euro Zone are now in the AUSTERITY mode which means reduced public spending. This has led to public outcry, loss of jobs, emotional turmoil, depression, suicides and many other repercussions of it. If Euro Zone has to be sustained the turmoil and disturbance is inevitable, infact leaders would like us to believe that the turmoil is only a trade-off for a long term benefit. However there are other options that could be explored if so desired.

This is the thing about Globalization, today nobody is entirely immune from what goes on in the other parts of the world. So if global economy has to recover, EU and Euro Zone play a crucial role in it. Hence their well being is as important as any.