Economic Insight The turn of the Euro next ?

THE Euro was being seen as alternative global currency to the dollar during the last two years of American economic crisis. Many investors withdrew their monies from the dollar and shifted it to the Euro zone. It seemed then that problems of America were mainly due to irresponsible lending by American banks and had no connection with Europe. But the truth is that European economies are equally in trouble. Difference is that the misdeeds of the American banks have been exposed quickly while similar misdeeds of European banks continue to be hidden.

Economic advisory company Stratfor tells us that European companies and banks have deep connections: “Bank executives often sat on the boards of the most important industries, and industrial executives also sat on the boards of the most important banks, making sure that capital was readily available for steady growth. The most famous example of this type of cozy link is the ties between Siemens AG and Deutsche Bank, a relationship which has existed for more than 100 years. An overlapping and intermingling of interests results from this type of arrangement, insulating the system from many minor shocks like strikes or changes in government, but making the system less flexible in the face of major shocks like serious recessions or credit crises.”

Say, a company’s exports are under pressure. An American company will have to approach the banks for assistance. The bank will scrutinise the situation and assess whether the company will be able to come out of its troubles. If not, finance will not be forthcoming. Such scrutiny need not take place in Europe. The cozy relationship enables the companies to raise monies easily and to hide deeper problems. The boats of companies and banks in Europe are tied with a strong rope. The stronger boat can pull the weaker for a while. But if one should sink, it will pull down the other with it.

Many indications of deeper problems of Europe are visible. Six months ago the fiscal deficit of Greece was 3.7 per cent of the GDP. It has since risen to 12.7 per cent because Greek companies are unable to face global competition and are paying fewer taxes. Unemployment is increasing leading to higher payouts of unemployment compensation. This is imposing greater burden on the already stressed government finances. The Government is borrowing heavily to meet the deficit but does not have funds to redeem the bonds issued earlier. The Government unveiled an austerity plan to tide over these difficulties. Salaries of government employees were cut, new appointments were frozen and strict action was taken against tax evaders. The government employees consequently went on strike.

The rate of unemployment in Spain has increased from 8.3 per cent in 2007 to 19.4 per cent presently. The Government has increased the number of years of service required to qualify for receiving state pensions. Iceland has nationalised the entire banking system. The British government has pumped in money in all major banks including Barclays, HSBC, Lloyds, Royal Bank of Scotland and Standard Chartered to help them avoid potential crisis.

Europe is burning. According to a report from Reuters, British workers held a series of protests at power plants, demonstrating against the employment of foreign contractors to work on critical energy sites. 2.5 million protesters took to the streets of France on January 29 in a day of strikes and rallies to denounce the economic crisis. Thousands of Opel workers from around Germany took part in a mass rally at the company’s headquarters, demanding that parent General Motors scrap plans for plant closures in Europe. Prime Minister Geir Haarde of Ireland resigned on January 26 after protests-the first leader in the world to fall as a direct result of the financial crisis. Nearly 100,000 people marched through Dublin, Ireland on Feb 21 to protest at government cutbacks in the face of a deepening recession.

Main point is that European businesses are not able to face competition from Asia any more than the United States. They are paying fewer taxes and government finances are under stress in nearly all countries. Governments are being forced to cut social sector expenditures leading to public unrest.

Such crises have occurred in the past as well. But there was no Euro then. Each country was free to allow its currency to devalue and regain global competitiveness without adopting harsh measures like wage cuts. Say cost of production of olive oil in Greece is $ 10 per liter while that produced in Asia is $ 8. Previously Greece had two options to regain competitiveness. It could reduce the wages of olive workers or it could allow its currency to devalue. The impact of wage reduction is direct and harsh because the price of goods in the market remains high as previously. The burden falls wholly on the workers of the affected industry. The impact of devaluation is relatively soft. It takes time for the price rise to spread through the economy. Moreover, the burden is borne by the entire population, not just the workers of affected industry. Remember, we had devalued our rupee immediately after initiation of the economic reforms in 1991. It was not followed by Europe-type unrest because the impact was slow and spread thinly all over.

European Governments no longer have the softer option of devaluation available to them. A member country of the European Union cannot singly devalue its currency because it no longer has its own currency. And all countries are unwilling to devalue because devaluation will impose uncalled for costs on their people even if they occur in the long run. They have not borrowed huge amounts like Greece and see no reason why they should devalue their common currency for the errors of one member. The only option available to the troubled members is to impose harsh measures such as salary cuts and tax raises. This is the reason for the burning of Europe today.

I reckon that the people of the European countries will not be able to bear these harsh measures. The political situation will explode. Weaker countries like Greece will demand that stronger countries like Germany either devalue the Euro or provide them with huge subsidies to tide over their difficulties. Neither of these will be practical for Germany. In the result, weak crisis-stricken countries will seriously consider walking out of the common currency. There is already talk in media that the European Union should allow Greece to quietly walk out of the Euro and set its house in order. Same situation is likely to occur with respect to other weak countries like Spain, Portugal, Ireland and Iceland. This may be the end of the Euro!

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