Sample of assignmnet: Influences of the Euro crisis on investments, capital raising and exchange rates

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1.     Rationality of the establishing of European Union (EU)…………………………………. 2

1.1      Introduction of European Union (EU)………………………………………………… 2

1.2      The rise of federalist idealism in Europe……………………………………………… 3

1.3      Benefits of a common currency………………………………………………………….. 3

2.     Euro crisis and its reasons…………………………………………………………………………… 4

2.1      Introduction of Euro crisis………………………………………………………………… 4

2.2      Reasons of Euro crisis………………………………………………………………………. 5

2.2.1     Slow federalization process……………………………………………………… 5

2.2.2     Widespread none compliance with the Maastricht criteria……………. 5

2.2.3     Inflexible state policies……………………………………………………………. 6

2.2.4     Downgrading of debt and fear of default………………………………….. 7

3.     Critical discussion and reflection on the latest measures to contain the crisis…….. 7

3.1      Brussels summit……………………………………………………………………………….. 7

3.2      The bailout fund………………………………………………………………………………. 8

3.3      The European Financial Stability Facility (EFSF)…………………………………. 8

3.4      Enforcement of Maastricht treaty………………………………………………………. 9

4.     Influences of the Euro crisis on investments, capital raising and exchange rates of the major currencies     10

4.1      Influences of the Euro crisis on investments………………………………………. 10

4.1.1     Capitalizing on the Euro Crisis……………………………………………….. 10

4.1.2     Risk avoidance……………………………………………………………………… 10

4.2      Influences of the Euro crisis on capital raising……………………………………. 11

4.2.1     Influences of the Euro crisis on capital raising in private sector…… 11

4.2.2     Influences of the Euro crisis on capital raising in public sector……. 11

4.3      Influences of the Euro crisis on exchange rates of the major currencies…. 12

4.3.1     US dollar……………………………………………………………………………… 12

4.3.2     Chinese RMB……………………………………………………………………….. 13

 

 

1.        Rationality of the establishing of European Union (EU)

 

1.1    Introduction of European Union (EU)

The European Union (EU) is a treaty-based, institutional framework that defines and manages economic and political cooperation among the members states (27 as of today), it represents a unique form of cooperation among sovereign states that has been built through a series of binding treaties. The EU members work together through common institutions that embody the EU’s dual supranational and intergovernmental character (Hostetler 2006, p.2). The economy of the European Union generates a GDP of over €12,279.033 trillion (US$16,242.3 trillion in 2010) based on the data released by International Monetary Fund (IMF), this enable the union to be the largest economy in the world (IMF 2011). The European Union (EU) has a single market and the EU is represented as a unified entity in the World Trade Organization (WTO). Explanations of the rationalities of the establishing of European Union (EU) would be elaborated in the coming paragraphs.

Free movement of capital and other resources
A prominent goal of the EU since its creation by the Maastricht Treaty in 1992 is establishing and maintaining a single market which seeks to guarantee the four basic freedoms, which are related to ensure the free movement of goods, services, capital and people around the EU’s internal market (Barberis, McHugh & Tyldesley 2000). The free movement of these resources is helpful to the healthy growth of the economy of all the member countries. For instance, possible problems of unemployment should not be solved merely by promoting labour mobility, but rather through other means such as the free movement of capital and other inputs and a regional policy (Mei 2003, p.26). Free movement of these inputs according to the economic theories would encourage the labor division and further increase the economy performance because the countries usually have different advantages in doing different business and industries.

1.2    The rise of federalist idealism in Europe

From the 1960through to the early 1980, much early historiography was driven by a strong normative desire to write the history of European integration in a Hegelian perspective as the unstoppable ascendancy of federalist idealism over the nation-states and their integration in a Hegelian perspective as the unstoppable ascendancy of federalist idealism over the nation-states and their internecine wars. For instance, Walter Lipgens, the first holder of the Chair in European Integration History at the European University Institute between 1976 and 1979 was the leading scholar to write in this historiographical tradition (Kaiser, Leucht & Rasmussen 2009, p.2). The ideology development in the federalist idealism in the Europe is a supportive factor to the forming of the European Union historically.

1.3    Benefits of a common currency

Figure 1. Benefits of a common currency and the openness of the country
Source: Grauwe, P. D. 2007, Economics of monetary union. New York: Oxford University Press Inc., p.80

Based on Paul de Grauwe (2007, p.80), the welfare gains of a monetary union are likely to increase with the degree of openness of an economy. As the figure indicates, on the horizontal axis the openness of the country relative to its potential partners in the monetary union measured by the share of the share of their bilateral trade in the GDP of the country considered and on the vertical axis is the benefit obtained in term of a percentage of GDP. With increasing openness towards the other partners in the union, the gains from a monetary union increases. And usually the benefits of adopting a common currency include: reduced transaction cost, controlled price fluctuation and also because of the openness of the economies among the currency union, there would be an increased competition for the companies which promotes the economy of scale and drive down the price of the goods.

2.        Euro crisis and its reasons

 

2.1    Introduction of Euro crisis

From late 2009, fears of a sovereign debt crisis developed among investors concerning rising government debt levels across the globe together with a wave of downgrading of government debt of certain European states. Concerns intensified early 2010 and thereafter making it difficult or impossible for Greece, Ireland and Portugal to re-finance their debts (Reuters.com 2010). There are different views claiming different reasons of the sovereign debt crisis in the Euro area which is an economic and monetary union (EMU) of 17 European Union (EU) member states that have adopted the euro (€) as their common currency and sole legal tender (europa.eu 2011).

 

 

 

 

2.2    Reasons of Euro crisis

 

2.2.1            Slow federalization process

According to Charles Crawford (2011), the change into a monetary fund and economic government will lead to further massive losses of sovereignty for the member states, in favor of a European federal solution. For example, within the monetary union, national budget laws will be subject to a European supervisory body.If the euro is to survive, genuine integration, with further transfers of sovereignty to the European level, will be unavoidable. But the federalization process even inside the European Union is very slow and the evidence could be seen from the recent Brussels summit in which a plan put forward by France and Germany to enforce new austerity measures and budgetary targets across Europe was vetoed by the British Prime Minister David Cameron (Steinberg 2011) rendering it as a plan under the EU treaty. Because of the federalization process, each state is still trying to protect its own interest and does not want to transfer the state interest for the European federal level the crisis has not been contained rapidly.

2.2.2            Widespread none compliance with the Maastricht criteria

The Treaty of Maastricht was negotiated in 1991 on the basis of the Delors Report and was signed in February 1992. With the exception of the United Kingdom and Denmark, which obtained a special “opt out” clause, the signatories committed themselves to start the single currency at an imperatively fixed final date (January 1, 1999). The compliance with the macroeconomic requirements which is so called as Maastricht criteria included convergence toward price stability, sound public finances, exchange rate stability, and low long-term interest rates (Padoa-Schioppa 2004, p.7). The reality is that many current euro zone members do not meet all the Maastricht requirements, and many blame Europe’s current debt problems on a failure to take swift enough action against countries that failed to adhere to the debt and deficit ceilings. The European Commission estimates that the average debt burden for the euro area will be 88 per cent of GDP in 2011 and 90.4 per cent in 2012 — far above the required 60 per cent cap (Stastna 2011). The widespread non compliance with the Treaty of Maastricht and its requirements is an enforcement issue reflecting the loose regulation in the European Union level which contributed to the Euro crisis though it is not an immediate reason.

Slow salvage reaction
Greece is considered as the first country that introduced the sovereign debt crisis, soon after getting elected in autumn 2009, the leftwing Pasok government discovered that the public finances had been fiddled: a budget deficit of 3.7% of national income was in fact touching 14%. This would have been bad at any time, let alone in the wake of the near-collapse of the banking system. Big investors who Athens would normally have approached for a loan, in return for a government bond, would only lend at punitive interest rates – or not at all. After much foot-dragging, the European commission, the IMF and the European Central Bankagreed in May 2010 to lend Greece €110bn (£96bn) (Chakrabortty 2011). One important problem is that the reaction is very slow and therefore the best opportunity to stop the crisis from happening had been missed.

 

2.2.3            Inflexible state policies

Following the fall out of the financial crisis which started in September 2008 a basket of Euro zone countries were considered weakened economically.  The countries: Portugal, Italy, Ireland, Greece and Spain affectionately became known as the PIIGS.  As these countries used the Euro as their currency, they were unable to employ independent monetary policy in order to help battle the economic downturn (Comptonrow.co.uk 2010). And because of the inflexible monetary policies in the state level, the Euro zone members could not approach to some flexible monetary policies such as printing more money like what the United Kingdom (UK) had done. This inflexibility of the policy defers the chance to solve the debt problems in an early stage and also consumed the market confidence and created panic in the market.

2.2.4            Downgrading of debt and fear of default

Take Greece as an example, a number of events eventually led credit rating agency Standard & Poor’s (S&P) to downgrade the Greek sovereign bonds to junk status. On April 27, 2010, S&P reduced Greece’s long-term sovereign debt rating from BBB+ to BB+, the first notch in the junk category. Other credit rating firms such as Moody’s and Fitch Ratings followed and, as a result, yields from government bonds rose. The yield of Greece’s 2-year government bond, for example, jumped from 10% in November 2010 to a whopping 110% one year later (Pinoymoneytalk.com 2011). The dramatical of the yield of the Greece’s 2-year government bond hinted that the market had loss confidence for the Greek government bond and treated it as investment with risks and when risk increases they would require for higher compensations. And apparently the credit rating agency Standard & Poor’s (S&P)’s decision had contributed to the collapse of the investor confidence with the increased fear of default of some of the debts.

 

3.        Critical discussion and reflection on the latest measures to contain the crisis

 

3.1    Brussels summit

In the European Union summit held in December 2011, 26 of the 27 EU member states declared they would go ahead with plans put forward by France and Germany to enforce new austerity measures and budgetary targets across Europe. The only oppositional voice was that of the British Prime Minister David Cameron (Steinberg 2011). Because of the UK’s veto, the new tougher rules on spending and budgets that countries have agreed to will not be held in place by an EU treaty. The new rules are simply a treaty between sovereign states. As Cameron said of the new 23-state pact that he recognised that all countries must do what they have to in order to pursue economic growth, but that he judged it “not in Britain’s best interests” to take part in the treaty (financenews.co.uk 2011). This again confirm the claim that the sovereignty states need to sacrifice their interest for the common good and aim at the long term benefits.

3.2    The bailout fund

In February, euro zone finance ministers set up a permanent bailout fund, called the European Stability Mechanism, worth about 500 billion euros. Now the European Stability Mechanism (ESM) is accelerated into entry as soon as it is ratified by 90 per cent of the member states with capital commitments to it. The objective is now for the ESM to come into operation in June 2012, sooner than what had been planned, January 2013. The increase, in addition to the 500 billion euros already planned for the ESM, will be examined in March 2012 (Triplecrisis.com 2011). But it is widely suggested that this fund would not be sufficient to meet the needs of the borrowing of Italy and Spain if there is such a necessity.

3.3    The European Financial Stability Facility (EFSF)

The European Financial Stability Facility (EFSF) was created by on 9 May 2010 within the framework of the Ecofin Council to provide financial assistance to euro area Member States, backed by guarantee commitments for a total of €780 billion and a lending capacity of €440 billion, EFSF is authorized to use the following instruments linked to appropriate conditionality (efsf.europa.eu 2011):

  1. 1.        Provide loans to countries in financial difficulties
  2. 2.        Intervene in the debt primary and secondary markets.
  3. 3.        Act on the basis of a precautionary program
  4. 4.        Finance recapitalization of financial institutions through loans to governments

As analyzed before, because of the inflexible monetary policies in the state level, the Euro zone members could not approach to some flexible monetary policies such as printing more money like what the United Kingdom (UK) had done, and the building up of the European Financial Stability Facility (EFSF) and other bailout instruments would do some good by offering loans to the members states which could be treated as offering some help in increasing the monetary policy flexibility providing that the states can not increase the issue of currency or make the decision of adjusting the interest rate.

3.4    Enforcement of Maastricht treaty

As the public sector is concerned, Maastricht treaty will get resuscitated, with all euro zone countries except Greece, Ireland and Portugal committing to bring their deficit down to less than 3% of GDP by 2013. Paul Krugman, recipient of the 2008 Nobel Prize in Economics is screaming about this, but this was a central part of the euro zone project from the get-go, and clearly the euro zone needs some kind of fiscal straitjacket for its constituent members to prevent the rest of them from running up enormous deficits and then getting bailed out by Germany (Salmon 2011). Though the enforcement of the Maastricht treaty should have been done long before the Euro crisis, but it would help prevent the further spreading of the debt problems.

 

 

4.        Influences of the Euro crisis on investments, capital raising and exchange rates of the major currencies

 

4.1    Influences of the Euro crisis on investments

 

4.1.1            Capitalizing on the Euro Crisis

Crisis in another way could be understood as opportunities. In order to capitalizing the Euro Crisis, it requires the individual, organizational and even sovereignty state investors to find out the right timing of investment and right industries that worth investments. And investors from the emerging economies are becoming more and more interested in capitalizing the Euro crisis and expand their market and influence in the market. For example, China is seizing on Europe’s debt problems to expand its influence on the continent with large-scale investments and purchases of government bonds issued by highly-indebted states. The strategy could push Europe into the same financial dependency on China that is posing a dilemma for the US (Spiegel.de 2010). Many organizations have followed the political policy of the government to invest in the Euro area which they have been an important export destination of the Chinese companies.

4.1.2            Risk avoidance

With the still undergoing of the Euro crisis, though different methods and techniques have been done or would be done to ensure that there would not be any defaults happen to the debts of the states in the Euro zone some of which have been discussed above, the risk of investment in the Euro zone are generally considered high, under such conditions, not only the foreign investors but now also the local European investors are trying to break their investment customs and search a place for safer investment. For example, Asia is generally a safer place than eastern Europe, where several countries run large current-account deficits, and so rely in part on fresh loans from big European lenders (Economist.com 2011).

4.2    Influences of the Euro crisis on capital raising

 

4.2.1            Influences of the Euro crisis on capital raising in private sector

With the stringent liquidity in the market due to the Euro crisis, some of the frequently used ways of capital raising, mainly referring to the bank loans and stock issuing may encounter setback due to the loss of confidence among the investors and they tend to be more conservative in investment. First of all, more use of short term loan rather than long term corporate loan would receive more attention from the investors who are trying to avoid default of debts and short term debts with a short period of maturity make them feel safer. Also because of the difficulty in maintaining the normal cash flow, more and more companies will choose to retain more profit in the company rather than giving it out in form of dividend paid. In addition, private loan and borrowing from friends could also be used to help the companies to pass the financial difficulties in term of urgent needs of cash.

4.2.2            Influences of the Euro crisis on capital raising in public sector

Besides the building up of the European Financial Stability Facility (EFSF) and other bailout instruments in an Euro area level with the support from the member states, in the state level, economies in the Euro zone should also work hard to facilitate the capital raising in the public sector though expanses in which are expected to the further cut and control, it is necessary to make sure the public sector needs are met before some social problems become evident. For example it is reported that Britain’s banks should build up their capital buffers even further as increased insurance against an “exceptionally threatening” environment still dominated by the euro zone debt crisis.  It needs to maintain lending to the real economy, but should restrain dividends and bonuses — and possibly even issue new shares — to build up these capital levels further according to the Bank’s interim Financial Policy Committee (Jones & Milliken 2011). The state level capital buffers would helpful in ensuring the capital raising in the public sector as well as the private sector.

 

4.3    Influences of the Euro crisis on exchange rates of the major currencies

 

4.3.1            US dollar

In addition to slowing demand in Europe and affected parts of the world, the impact of a European crisis on exchange rates will also hurt the United States. The trade-weighted Euro, which is a weighted average of exchange rates with the weight for each foreign country equal to its share in trade, continues to be about 10 percent weaker than it was in 2009. As the trade-weighted value of the Euro goes down, it means that the currencies of other partners, the U.S. dollar in particular, become worth more and European exports to America become cheaper (Dewan & Weller 2011).  The strong US dollar could also be considered as the result of the outflow of the international hot money into the US market to avoid the possible financial loss.

 

 

4.3.2            Chinese RMB

 

Figure 2. China yuan to 1 EUR
Source: x-rates.com 2012. Chinese Yuans to 1 EUR. accessed on 7 Jan 2012.  
http://www.x-rates.com/d/CNY/EUR/graph120.html

Though the Chinese government has always claimed that it is gradually increasing the Chinese yuan exchange rate flexibility based on the market demand, the government also would not want to see the appreciation that may hurt the export. Because the Chinese yuan exchange rate reform has aimed to adopt a market-based, managed floating exchange rate regime which is tied to a basket of foreign currencies but US dollar is still the priority currency to be referenced, impacted by the current Euro crisis, the Euro depreciates against the United States Dollar forcing the China yuan appreciate again the Euro. In June 2011 the People’s Bank of China (PBOC) announced that it would further the reform of the formation mechanism of the yuan exchange rate to improve its flexibility (chinadaily.com.cn 2010), this can be understand as the government’s attempt to keep the value of the yuan low against the Euro though so far this target has not been hit. The changes of the Chinese Yuan in the future against the European Euro could be very uncertain because of the central government influential role in affecting the Chinese Yuan exchange rate formation mechanism. Though such political interference in the currency market has been widely criticized, it shows to be effective during the crisis which a free market could not compared like that the government could write off the bad debts in the banking systems.

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