Accounting

ACCOUNTING CONCEPTS AND APPLICATIONS ACTG – 500 RESEARCH PAPER ON FUTURE OF THE EORO AS A RESULT OF THE EUROPEAN DEBT PROBLEM EUROPEAN UNION The European Union is an economic and political union of 27 member states which are located primarily in Europe. The European Union traces its origins from the European Coal and Steel Community and the European Economic Community formed by six countries(Belgium, France, West Germany, Italy, Luxembourg, Netherlands) in 1958. The European Union operates through a hybrid system of supranational independent institutions and intergovernmentally made decisions negotiated by the member states. Important institutions of the European Union include the European Commission, the Council of the European Union, the European Council, the Court of Justice of the European Union and the European Central Bank. The European Parliament is elected every five years by European Union citizens. The European Union developed a single market through a standardized system of laws which apply in all member states including the abolition of passport controls within the Schengen area. A monetary union, the Euro zone, was established in 1999 and is currently composed of seventeen member states. Through Common Foreign and Security Policy the European Union has developed a limited role in external relations and defense. Permanent diplomatic missions have been established around the world and the European Union is represented at the United Nations, the WTO, the G8 and the G-20. With a total population of over 500 million inhabitants in 2010 the European Union generated an estimated 26% (US $ 16.28 trillion) of the global economy. EURO The euro is the official currency of the euro zone. 17 of the 27 member states of the European Union. It is also the currency used by the European Union institutions. The euro zone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. The currency is also used in a further 6 European countries ( Montenegro, Andorra ,San Marino, Kosovo and the Vatican) and is consequently used daily by some 327 million Europeans. The euro is the second largest reserve currency as well as the second most traded currency in the world after the US dollar. The euro was introduced to world financial markets as an accounting currency on 1 January 1999, replacing the former European currency Unit at a ratio of 1:1. Euro coins and banknotes entered circulation on 1 January 2002. EUROPEAN DEBT CRISIS Emerging market economies are not the epicenter of the financial crisis. Having entered the crises either a relatively strong fiscal position, they emerge from it relatively unscathed. Hence, their aggregate public debt ratio at around 35% of GDP at the end of 2009, remains low compared with that of the advanced economies and seems unlikely to rise sharply. By contrast, the combination of large scale fiscal stimulus plans, financial rescue packages and falling tax revenues has led to historically large government budget deficits and record levels of actual and projected public debt in most industries. The aggregate public debt of the advanced economies is projected by the BIS to rise from 76% of GDP in 2007 to more than 100% in 2011 – a record high in recent decades. Following the quasi-collapse and public rescue of the private sphere and given this extraordinary convergence of factors, the sustainability of fiscal policy could only turn out to be a major financial concern. Public debt/GDP ratios are rapidly increasing in every industrial country, this increase being particularly high for countries hard hit by the financial crisis. The cumulative public deficit between 2007 and 2011 is less than 30% for all Euro zone countries, except Greece. Between 2008 and 2010, several things went wrong in Europe, the biggest of which was Greece’s financial crisis. For years, Greek fiscal policy had been unsound. Although private debt had been rising, the country’s overall debt to GDP ratio had not ballooned, because the Greek economy was growing. But the growth turned out to be unsustainable. When the global economic crisis hit, Greece’s deficit more than doubled. The problem was compounded by revelations that the government had grossly falsified and padded its budget in the run up to the 2009 parliamentary elections. Economic crisis exposed problems in the Greek economy; it also exposed weakness in the euro’s institutional framework. Restoring confidence will require strengthening that framework. The ECB released its own recommendations: stronger independent surveillance of the budgetary policies of the member states with more automatic implementation of sanctions, improved surveillance of country competitiveness to ensure that member states continue to converge economically, and a crisis management structure with strong conditionality to support countries that implement adjustment program. As far as the euro’s architects were concerned, this kind of problem should never have arisen. European financial market should have put pressure on countries with excessive debt-to-GDP ratios, such as Greece, by charging them higher interest rates for loans. The European Central Bank prohibits loaning money to service national debts, and its no- bail-out clause should similarly have discouraged overspending. Additionally, the euro zone’s stability and growth pact, which was meant to enforce fiscal discipline in member countries through rules against running high deficits and debt, should have constrained Greek politicians. The plan was accompanied by financing from the IMF and loans from the rest of the euro zone worth €110 billion -- or 46 percent of Greece’s 2010 GDP. Because the Greek crisis spread to other countries -- Portugal and Spain, in particular -- member states agreed to create a special European Financial Stability Fund to support any euro zone country that decides to undertake economic reform. In such an economically integrated area as the euro zone, leaving the currency union would not solve Greece’s economic problems either. After Italy left the European Exchange Rate Mechanism (ERM) and devalued its currency in 1992, for example, it suffered from volatile swings in interest rates due to a lack of investor confidence. Inflation rapidly reappeared, and Italy had to tighten its monetary policy further than would have been necessary if it had stayed in the ERM. Just as the economic crisis exposed problems in the Greek economy, it also exposed weaknesses in the euro’s institutional framework. Restoring confidence will require strengthening that framework. A task force headed by EU President Herman Van Rompuy is scheduled to offer concrete proposals to do so by the end of this year. And in June, the ECB released its own recommendations: stronger independent surveillance of the budgetary policies of the member states with more automatic implementation of sanctions; improved surveillance of country competitiveness to ensure that member states continue to converge economically; and a crisis management structure with strong conditionality to support countries that implement adjustment programs. We acknowledge that it will not be possible to expel member states that fail to comply with EU budgetary guidelines, so such a threat would ultimately not be credible.  The EC and the European Parliament have also called for the creation of three financial supervisory authorities (the European Banking Authority, the European Insurance and Occupational Pensions Authority, and the European Securities and Markets Authority) and a regulatory authority (the European Systemic Risk Board). Because the economies of the euro zone are so interconnected, euro zone-wide supervisory and regulatory authorities are necessary. They would have the discretion to press national governments to remedy problems and would be independent enough to act preemptively, without having to wait for a crisis to galvanize politicians to action. Some may dislike the idea of giving international bodies the power to constrain national economic policy. But financial contagion spreads too quickly, and European taxpayers have had to pay for the failures of other countries too often, for the current system to remain.  Forecasting the euro’s demise was premature. The EU and euro zone countries were able to respond to the financial crisis with appropriate corrective measures: many countries adopted strong fiscal adjustment packages; euro zone countries have announced, and in some cases already implemented, unprecedented structural reforms, not least of which was their joint decision to coordinate and publish the results of their bank stress tests; the new European Financial Stability Fund has been established and can be used to support other euro zone countries in distress, and a task force on reform will offer and approve concrete proposals to strengthen euro zone governance by the end of the year.  One might criticize these measures for having been taken only after a crisis was eminent, but this is ultimately how democracies work in the face of difficulties. Problems in the economies of euro zone countries and in the framework of the monetary union will need to be addressed, but all the constituent countries will emerge stronger if they continue to pursue the right adjustment policies. Europe will need to find the right mix of cooperation, in defending its common interests at the global level, and competition in incentivizing growth. It will need to rely both on the center, which must ensure strong fiscal policy, and on the member states, which control much of the rest of economic policy. But one should take inspiration from the EU’s history. Finding these balances has historically been one of Europe’s key strengths. FUTURE OF THE EORO AS A RESULT OF THE EUROPEAN DEBT PROBLEM When the euro was conceived two decades ago, few people expected it to have to weather a storm as great as the recent global economic and financial crisis. And many observers now think the entire European construct -- its institutions and currency -- has been so damaged by the crisis that it might not survive. A careful analysis of the problems within individual euro zone economies, particularly Greece’s, and in the architecture of the monetary union among them reveals what went wrong, how the EU has responded, and what the prospects of the euro really are. Between 2008 and 2010, several things went wrong in Europe, the biggest of which was Greece’s financial crisis. For years, Greek fiscal policy had been unsound. Although private debt had been rising, the country’s overall debt-to-GDP ratio had not ballooned, because the Greek economy was growing. But that growth turned out to be unsustainable. When the global economic crisis hit, Greece’s deficit more than doubled. The problem was compounded by revelations that the government had grossly falsified and padded its budget in the run up to the 2009 parliamentary elections. The euro has become an international currency because it is used by non-residents for commercial and financial transactions. Indeed the European currency represents 22% of the foreign currency assets of non-resident banks and 27% of Central Banks’ official foreign exchange reserves. in addition to this the euro is one of the most frequently used currencies in currency exchange transactions. its market share has grown since the reduction in the use of the dollar has benefited the European currency which gained two points between 2007 and 2010 to reach a 39% market share against 85% for the dollar; the sum being 200% since the transaction implies two currencies simultaneously. Further to this with the dollar, the euro is the privileged currency employed in the issuance of debt: in the fourth quarter of 2009 29.8% of international debt instruments were issued in Euros and 38.2% in dollars. in short the European currency is used as a peg by 48 countries or territories against 51 for the dollar Although economic theories show that the European alternative boils down to continued economic integration or a more federal management of the euro area we must not forget that the future of the single currency depends above all on economic dynamism. However the recent crisis has shown that certain Governments have benefited from European integration to implement growth strategies which are open to criticism to say the least. For example creation of the euro led to a reduction in financing costs particularly in Spain, Portugal and Greece. Between 1999 and 2007 the average real key rate of the Central European Bank per year was -0.2% in Greece, -0.1% in Spain and -0.1% in Portugal against 1.2% in France and 1.5% in Germany. Moreover the real yield in 10 years lay at 1.3% in Spain and 1.6% in Portugal and Greece per year on average whilst it lay at 2.6% in France and 2.8% in Germany. Nothing prevented the Governments of these countries from using these lower real interest rates to apply the Lisbon programme put forward in 2000 and to invest in research, development and training. But some, like the successive governments in Spain, preferred to help economic distortion in support of the real estate sector which is more sensitive to interest rates. The free distribution of profits associated with the creation of the euro area was more or less successful but it led to national growth strategies. Hence the European crisis is not just The result of a problem of European governance but also of the democratic process. For the time being European governance has been responsive and strong enough to compensate for national inadequacies by pooling the sovereign risks. But this is time for the main European governments to really improve the sustainability of their public finance and change the source of GDP growth. Greater European integration cannot solve divergence in national growth strategies or prohibit GDP growth by debt strategies this is why it is now urgent to define the framework to limit choices in terms of budgetary policy. it is likely that the proposals put forward by the Task Force led by president of the European Council, Herman van Rompuy will take this direction. Achieving a balance between public spending growth rates and GDP Growth would undeniably be a major step forward since it would help towards improved coherence of active growth support policies. But in the first half of 2010 GDP growth was higher than expected in the euro area and with the purchase of sovereign bonds by the European Central Bank the budgetary vice has slackened its grip somewhat. Governments were therefore able to find a less restrictive compromise. Greater awareness and the differential in the monetary policy of the euro area and the use lend promise to the future of the euro because the European currency “stability-predictability” has improved. Therefore, its international nature as its reserve currency status could be strengthen However we should not deceive ourselves, the European union still has to cross some areas of turbulence since most of its governments are postponing the moment when they will have to choose a sustainable, coherent growth model not only based on private or / and public debt.