Will the European Union Come Through Crisis?

by zikipediq

Sunday, September 20, 2009 at 07:58 AM EDT

Spain has passed from rating ‘AAA’ ‘to rating ‘AA’, after Standard & Poor’s, the 1st international rating agency (IRA), lowered its assessment of long-term debt; so she did with Greece, Ireland and Portugal. This is the first time that the S&P financial rating drops for Spain in 30 years.

What is under consideration?

From the French side, on the one hand, what is at issue is the structural weakness of these economies. Beyond a snide comparison with the food and the stars of the Michelin guide, this decision might have serious consequences for the countries concerned and for the future of the European Union. Because the differences between European states today are so important that each country acts without consulting others, and in addition, the principle of subsidiarity seems more often invoked than solidarity.
However, the shock wave of the financial crisis has reached the credit of the States themselves. To put it clearly, some countries cannot afford to borrow financing their reflation plan.
During the first half of 2009, in addition to the degradation in rating of several countries by the IRA, Ireland has appealed the intervention of the IMF, the Eastern countries have called for help to historical Member States, and the pound sterling fell on the foreign exchange market.

Alternatively, many well-informed specialists consider that the announced downturn due to the financial crisis is greatly exaggerated [1]. Most of banking operators have dealt with serenity and the European Commission forced restructuring of banks that received state aid to encourage further integration of the sector within the EU single market.

A Special Report on the Euro Area [2] published in The Economist pointed how the Euro has brought however, an irrelevant achievement.

“The ECB has fulfilled its remit to maintain the purchasing power of the Euro. Since the currency’s creation, the average inflation rate in the Euro area has been just over 2%. Fears that the Euro would be a “soft” currency have proved unfounded. It is unquestioningly accepted at home and widely used beyond the Euro area’s borders.”

Even if the Euro has not made possible significant gains in productivity or GDP, it has unquestionably engendered greater stability.

What can the Europe Union do to face this?

Despite the bad omens of some analysts, the current crisis shows how the Euro area is not at a critical stage of its existence yet.

Then again and despite of a single currency, there is no economic policy, no budget, no solidarity. Spanish government on top and, to a lesser extent French as well, believe that, to be able to attest its usefulness, the EU might directly help the most vulnerable States by financing reflation plans mutually beneficial.

Oddly, countries that are now complaining of the burden of the Euro are those that once mainly benefited from their membership to it. Thus:

“[The Spanish economy] grew at an average annual rate of 3.9% between 1999 and 2007, almost twice the Euro-zone average and much faster than in any of the currency area’s other big countries…Unemployment fell from close to 20% in the mid-1990s to just 7.9% in 2007.”

Too much at once, as the prosperity met with prices and unit wage costs getting higher, both of which are now particularly painful in the context of recession. Aided by a strong currency, its current account deficit has risen to 10% of GDP. Same for Greece, Italy, Ireland and Portugal. As the report [2] explains

“The main hazard for investors in high-inflation countries—that a steady loss of domestic purchasing power will drag the currency down—is eliminated in a fixed-exchange-rate zone.”

The consolidation of the Euro area needs to move up a gear in terms of political ambition and economic governance. Economic governance, the word is dropped, and it is on everyone’s lips.
Does the 10th anniversary of the European single currency will be marked by the bursting of the Euro area, as some economists fear?
What is involved in crisis management by Europe: politics or money? The lack of economic government, or the absence of a common currency?
In other words, will the EU survive to the crisis?

As indicated earlier, prestigious analysts point that the consequences of the so-called recession are important, but that its context has been exaggerated too. [1].

Alternatively, for The Economist, leaving the Euro zone is inconceivable:

“The costs of backing out of the Euro are hard to calculate but would certainly be heavy. The mere whiff of devaluation would cause a bank run: people would scramble to deposit their euros with foreign banks to avoid forced conversion to the new, weaker currency. Bondholders would shun the debt of the departing country, and funding of budget deficits and maturing debt would be suspended.” [2]

Therefore, borrowing costs would increase considerably, which could induce a wage-price spiral. Inflation and currency stability would be precarious at best. Thus, it is not surprising that in most European member states, citizens surveyed remain strongly in favor of the euro. Additionally, those who are about to join, remain more convinced to do so:

“As emerging economies they are prone to sudden shifts in foreign-investor sentiment, which makes for volatile currencies, so exchange-rate stability holds considerable appeal for them.” [2]