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Crisis shows euro currency zone's vulnerability

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Aoife White

Sunday, January 17, 2010

Brussels — The euro is in a rough spot. And it could be there for years.

The economic and financial crisis has ballooned budget deficits in
Greece, Ireland and several other member countries, exposing one of
the underlying vulnerabilities of Europe's decade-old experiment in a
multinational currency.

While few think the 16-country currency zone will actually break up,
holding it together through the unfolding debt crisis will mean painful,
unpopular measures such as budget cutbacks and higher taxes.

German Chancellor Angela Merkel said in a speech Wednesday that “the
euro is in a very difficult phase for the coming years.”

And Daniel Gros, director of the Centre for European Policy Studies in
Brussels, foresees “lean years ahead and there is very little that
European leaders can do about it.”

Jean-Claude Trichet, the head of the European Central Bank, faced several
questions at his monthly press conference last week about the possible
breakup of the euro. He brusquely dismissed them: “I do not comment
myself on absurd hyptheses.”

The problem: The euro zone has one currency and one central bank,
the Frankfurt-based ECB, but 16 governments.

Before the euro, the governments went their own way on spending. But since
big budget gaps can undermine a currency, the euro members agreed deficits
should stay below 3 per cent of a country's economic output every year.

So forecasts that Greece's 2009 deficit was set to hit at least 12.5
per cent of gross domestic product, and Ireland's 11.7 per cent have
spread shock waves. Both countries have announced plans to cut spending
and raise taxes.

More trouble is ahead as the euro states suffer very differently from
the crisis, with Spain's jobless rate hitting 19.4 per cent in November
— the most recent figures available — far ahead of 3.9 per cent in
the Netherlands.

It will be a challenge for the European Central Bank to find one interest
rate to stimulate laggards and, at the same time, prevent inflation in
growing economies.

The pain level is already high enough that a few voices are asking
whether it's worth it.

Irish economist David McWilliams is advocating the end of his country's
“loveless marriage” with the currency.

That would let Dublin instantly devalue its currency to make exports more
competitive. It could also attract jobs to Ireland through comparatively
cheaper wages.

“We need a break. We can't keep cutting expenditure when there is no
offsetting stimulus coming from a cheaper exchange rate, which allows
the trading sector to grow,” Mr. McWilliams wrote in Ireland's Sunday
Business Post newspaper Jan. 10

But the Irish government is adamant that it won't leave — winning
praise from EU officials for massive cutbacks to public spending,
cutting government wages 10 per cent and demanding every worker pay at
least 1 per cent last year to plug the budget gap.

Not all is negative. The euro weathered the first months of the crisis
well. Membership spared Greece and Ireland the currency devaluations
that savaged non-members Hungary, Iceland, and Ukraine.

Indeed, the euro's exchange rate has remained strong, at times rising
in value as investors turned to it when the dollar tumbled. It traded
around $1.44 (U.S.) Friday.

Russia's reserve holdings of euros outweighed dollars for the first time
last year. Ukraine even asked Russia to pay recent gas transit fees in
euros, not dollars.

And quitting would not be pretty, according to Barry Eichengreen, an
economics professor at the University of California, Berkeley. In a
September 2009 paper for the International Monetary Fund he described
a currency devaluation that would scare investors and devastate savings.

“A systemwide bank run would certainly follow,” he wrote. “This
would be the mother of all financial crises. And what sensible government
would willingly court this danger?”

Mr. Gros at the Centre for European Policy Studies said the current
course of making cuts to bend to the EU rules is “the lesser evil.”

He sets little store on frantic plans by EU officials to draw up
a recovery strategy that promises to generate jobs by making labour
markets more flexible, knocking down barriers to business between European
countries and focusing on a green, innovation-based economy.

Down the road, the medicine offered by the EU's executive commission
may work, but the immediate costs may be hard to bear.

Denmark is touted as a model for Europe with a “flexicurity” system
that allows businesses to dismiss workers at short notice, gives generous
welfare benefits to the unemployed and encourages them to retrain for
other jobs.

Following that example and scrapping some labour market rules that make
it expensive for companies to hire and fire workers will likely raise
hackles among trade unions in Spain, Italy and France.

Mr. Gros sees these only as solutions for the long term.

“There's nothing that can really give a boost in the short run to
overcome the effects of this crisis, but that is something that policy
makers cannot accept publicly,” he said. “This is very painful
process which will take a long time.”
 
Ashley Madison
Toronto Escorts