European Finance

The United States of Europe: A Work in Progress

by David R. Kenerson, Jr. and Niklas K. Oskarsson

In 1993, when the European Union was formed between 12 countries, much was made of the possibility that the countries of Europe might become one unified government.  When – six years later – the Euro was introduced as common currency between 11 of those countries, those speculations gained new energy.

Now, Europe is working on centralizing the oversight of banking and the provision of a European wide guarantee of bank deposits, and institutions have been created to bail out governments that may suffer debt crises in the future. Thus, we – now in 2014 – see a gradual trend toward the creation of European-wide institutions that suggest ultimately the formation of a United States of Europe, a trend many people would say has been ongoing for over 20 years.

The Benefits and Challenges of the EU and the Euro

In forming the European Union, Europe agreed to facilitate cross border travel, employment, and transfer of goods. It also began setting common standards for construction and the manufacture of certain goods such as electrical equipment. As a result manufacturers could manufacture one version of a product instead of many.

Then, the formation of a currency union in the Euro reduced transaction costs from converting various currencies and simplified cross border accounting.

The strength of a country’s currency is a function primarily of four things:

·         its relative economic growth rate,

·         its relative inflation rate,

·         its financial soundness,

·         and its relative political stability when compared with other countries.

The Euro’s value is a balance between the values of the currencies of the “weaker currency countries” (e.g. Italy, Portugal, Greece, etc.) and the “stronger currency countries” (e.g. Germany and the Netherlands), and as such, it has had major benefits for all concerned: the weaker currency countries have had a stronger currency in the Euro – which has allowed them to import goods more cheaply than they could otherwise. It has also helped reduce inflation.

The stronger currency countries, who now have a “weaker currency” in the Euro, have also benefited from having more competitive exports from a price standpoint.  For example, Germany benefited significantly by it sales of equipment to Greece: German goods cost less than they would have (because most believe the Euro is “cheaper” than the old Deutschmark), and the Greeks could buy more than they otherwise had been able to do.

The disadvantage of the common currency is that the economies and cultures of the various countries vary greatly and labor flexibility differs widely. Therefore, some of the weaker currency countries can no longer compete effectively with Germany, for example.  However, in the Euro system, they are unable to devalue their currency in order to compete on a relative price/cost basis. Therefore, the market place can only express its dismay with the policies of a government by selling its country’s bonds – which we saw in the European debt crisis of 2010-2012.

Europe’s Response to the Challenges

To address these disadvantages, the European Union is taking steps –  centralizing banking oversight, providing a European wide guarantee of bank deposits, and the creation of bail-out systems to help governments in trouble.

These steps continue the gradual trend toward the creation and unification of European institutions that suggest ultimately the formation of a United States of Europe.

 

 

The information based here represents the judgments and opinions of the management of Virginia Global Asset Management and not intended as financial advice.