Thursday, July 21, 2011

Why the Euro must not be allowed to fail

While Britain has been focused on the potential collapse of the Murdoch empire, there has been a building financial crisis within the European Union which threatens to bring down the entire house of cards.

With Greece running up massive debts and other member states running into financial problems, there has been much talk of abandoning the Euro and with it the Eurozone.

But while eauro-sceptics might be happy at such a prospect, the president of the European Commission Jose Manuel Barroso has warned that the collapse of the Euro would have widespread repercucussions. "Nobody should be under any illusion: the situation is very serious. It requires a response. Otherwise the negative consequences will be felt in all the corners of Europe and beyond," Barroso said.

Last night Angela Merkel and Nicolas Sarkozy were holding crisis talks in Berlin amid warnings that a failure to break the debt crisis deadlock within 24 hours would send shockwaves around the global economy.

The euro climbed a third day on Thursday as a deal between France and Germany over a bailout of Greece raised hopes ahead of a major European summit, though investors barely moved from government bonds and precious metals.
But the rise was small and traders around the world are waiting nervously to see what the outcome of the talks are.

But what would happen if the Euro did collapse? No exit process was written into European rules but it is technically possible. The future of the Euro lies in the hands of its members, especially Germany, the richest and strongest member of the Eurozone.

Simply put, the Eurozone would revert to what it was before the Euro existed. The European Central Bank would be obliged to return all of its gold to the member states in proportion to their initial contributions. Their old currencies would have to be resurrected and Euro reserves converted back to the mix passed to the European Central banks from the beginning of the Eurozone.

Dollar reserves would be built up again to replace the lost Euro reserves. The world's Foreign Exchange Markets would be in chaos. Confidence in most if not all currencies would almost disappear. By extension the ripple effect through the economies of the world and business in general, would be destructive. There would be a huge scramble for all hard assets, but particularly precious metals such as gold which has already hit a record high of record high of $1.609.51 this week. The US Dollar would become the main trading currency if only briefly.

Resource producing currencies would soar. In an attempt to lower their exchange rates they would turn to lowering their interest rates in the hope of maintaining the export competitiveness of their locally manufactured goods. With resources having an international market price, outside their own currency, such nations would drive down their exchange rates, provided local inflation allowed it.

The overall result would be a volatile and damaging use of currencies as part of trade wars. Should that happen, protectionism and exchange controls would become commonplace, particularly in smaller economies.

As China grows in international importance over the next decade, the Yuan could quickly become of equal importance to the US Dollar and move into center stage as a global reserve currency. This would accompany pricing of goods [imports] in Yuan and exports from China in the currency of each importer's currencies. China may well be aware of such prospects and may already be making plans to internationalize the Yuan.

With Foreign Exchanges becoming increasingly volatile, confidence mercurial and uncertainty hanging over both the present and the future, assets, particularly internationally-mobile assets, such as precious metals would be increasingly sought after as a counter to all currencies.

This of course is a worst case scenario. There may be only a partial collapse; allowing nations such as Greece and other defaulting countries to fall into the quagmire, abandoning them to the wolves.

But even casting out the poorer member states may not stem the tide of long term economic stability for the remaining Eurozone. The exchange rate of the exiting countries would initially fall heavily then take a long time to recover, if they managed to recover economically at all. By leaving the zone, these countries, would likely suffer at least one, if not more, decades of growing poverty. Having such countries on the Eurozone borders would not be good for social stability. Economic migrants would flow across borders and create problems for countries bordering the cast out member states.

General stability might see the exchange rate of the Euro soar, but this would reduce its global trade competitiveness, though it might attract the world's capital.

The only choice open to Europe is to help the weaker member states through the current economic crisis. The solution is as yet unclear. Propping up a failed or failing economy seems like suicide. The ECB and politicians might proposes wiping the slate clean for Greece, though other struggling countries such as Spain and Portugal may well cry foul. Greece may be forced to take its medicine and pay its debts as well as imposing more unpopular austerity measures. Perhaps Greece should take note of the great Greek philosopher Socrates, who in his dying words to Crito was "We owe a rooster to Asclepius. Please, don't forget to pay the debt." If Greece were to fail and be cast asunder, it would not only be a Greek tragedy but a tragedy for the whole of Europe [Telegraph / WSJ / Reuters / Bloomberg / FT / BBC].    

tvnewswatch, Beijing, China

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