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Euro and the Global Financial Crisis

Introduction

Today, the world is regaining from the world economic crisis that started in 2007. Every economy is trying to position itself to effectively recover. The crisis has already affected economies with a large number of them having a negative economic growth. There is hope that recovery will be attained. The global financial crisis is thought to have been as a result of the collapse of the mortgage industries in the United States of America. The two major mortgage companies were the Freddie Mac and Fannie Mac. By the end of 2007 the two corporations had owned and guaranteed over 50% of the United States mortgage market. During this time the low earning people were unable to finance their mortgages (Ambachtshee, Beartty and Booth, 2008). They claimed that the mortgages were expensive to service alongside other basic necessities and many decided to take the option of foreclosure of the contract. This led to an increased number of homes to mortgage. The banks’ lending rates were strict and thus an increased supply of mortgages but no corresponding demand. In respect to the law of demand, the cost of houses reduced drastically and bank default rate was high. The mortgage corporations and banks suffered hefty losses. United States of America being a major player in the world economy suffered its own problems that spread to the entire world. This was the start of world economic crisis (Park, Cona and Fingess, 2008). There was the effect of trade among countries all over the world (international trade); different countries and regional markets adopted different mechanisms to successfully come out of the crisis.

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The strength of a currency is dependent on the demand and the supply of the currency. If the demand is high, then the currency gains value and it is thus a strong currency. The demand and supply on the other side are affected by various factors and consequently the value of the currency. To get a deeper analysis of how the euro has been affected by the global crisis, we will expound on the factors that affected the demand of euro, and how the global crisis have affected the factors.

Inflation

When the inflation rate of a country is high, it means that the amount of money that is in circulation in the country is high, and thus the cost of good is high.

If the inflation in the United Kingdom is lower than the trading partners, then it means that then the U.K. exports will become cheaper and thus more competitive. The value of the euro will thus increase since its demand has increased. On the other hand, the U.K. citizens will need less value of the euro to buy foreign goods. According to the office of national statistics April 2010 analysis, there has been a steady increase in the inflation at the country. The rate that was recorded was for the RPI annual inflation rate was 5.3 in the month of April which was up from 4.4 recorded in the month of March. This was the highest rate since 1991, with this it means that the currency of the country lost value with the increased inflation rate. The value of the imports was increased.

Interest Rate

If the interest rate of governmental securities in a country is high, then there will be more demand for the currency as investors aim to gain from the high interest rates. This demand makes the value of the currency increase. The opposite of the same case is true. This though is a short run effect of the value of the currency. The global financial crisis has not been a short term but it has now past three years. There are some measures that had been put by the governments to ensure that the euro did not lose value in such a great way. One of the ways was to make the interest rates high in the beginning, but this did not last for long. As the economies deteriorated, financing these rates was hard and had to be revised downwards. This revision meant that the euro lost value. The interest rate had fallen from 5% in the year 2007, to a 1% by the end of 2009, this had a negative effect to the economy and thus the currency value depreciated (Pretcher, 2009). The reduced interest rate meant that the banks were able to give loans at a reduced rate. This rate leads to an increased inflation in the country, subsequently the inflation affect the value of the currency.

Balance of Payment

Europe is one of the major international trades. Balance of payment is achieved when the value of the imports, in terms of money, is equal the value of exports. When the value of imports is higher than the exports, then the balance of payment is not good (negative balance of payment), at this point the value of the currency will be reduced. If the export is higher than the imports, then there is a positive balance of payment and the value of the currency increases. The above means that a small change on imports and exports will affect the value of the currency. The general effect for the trade was that the purchasing power was reduced and thus demand of imports was reduced all over the world. This led to reduced gross domestic earning of the world. Companies closed down and trade suffered greatly. The major trade partners of Europe are the African countries and United States. They had their problems to handle and thus the trade with the world was reduced. The exports from Europe were reduced and thus the currency value reduced. As much as the imports on their part also reduced, the effect on the currency value was negative since trade can only have a positive effect on the value of a currency if the trade is well enhanced (Flynn, 2008).

Relative Growth of the Other Countries

The effect of the financial crisis gave a negative growth in the economies of the world. This was the same case with Europe. When the rate of the Economic growth rate was reduced the value of the currency reduced. Even if the other countries of the world had their economies shrunk more than in Europe, the fact that the world today is dependent on the trade among them meant that Europe had to feel the negative flow. The value of the currency dropped, as the demand of the euro was reduced (Anon, 2010).

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Change of Competitiveness

The more competitive a country’s products are, the better the economy of the country. In the last ten years, trade in many countries especially the developing countries has shifted to the east. China has emerged as a major player in this. The goods that come from China are cheaper than those from the European countries. The above has even been made even more severe by the reduced purchasing power of the consumers in the world. The attractiveness of the good from Europe was largely reduced. The effect of this was a reduction in the value of the currency.

Speculation

When the value of a currency is expected to increase, speculators buy the currency with the aim of benefiting in future, this leads to currency demand increase. On the other hand speculators hold the currency as they wait for it to appraise and get the money; as they are holding this, then the supply of the currency is reduced when the demand is increased. This leads to an increase in the value of the currency. The opposite was happening in Europe, the euro was expected to deteriorate on value, and thus no one was holding currency. They were selling the ones that they were having. This led to an increased supply of the currency in the diminishing demand. This meant that the value of the currency depreciated. There are the other factors that the governments have been using to ensure that the economy gets into track. One of this ways was bailing out of some companies. This has led to increased amounts of money in the economy and thus the value of the euro reduced accordingly.

Will the Crisis Affect the Use of the Euro?

One of the ways that the world has put in place to enable that it recovers from the global crisis, is enhancing trade among the countries. The individual countries in Europe have the mandate to protect their individual currency, but the reason that led to the development of a common currency was to enhance trade among the countries and the world in general. This still holds and it is given more preference since trade is seen as the way forward. The use of the Euro can only strengthen but not cease to be used. On the other hand, there is hope of recovery (Dullien, 2010).

Conclusion

The world global crisis should be seen as a learning era where by each country should be always staying aware of its symptoms. The value of Euro currency has deteriorated over time although there is hope of recovery. The effect is as a resultant of the factors that affect the value of the currency that include international trade, inflation, relative growth of the other countries, the change of competitiveness of a countries products among others. The euro, which have been in operation for over one year is likely to survive the global crisis although its value is reduced. There should be no economic giants that are so strong that their collapse paralyses the whole world. Trade as the backbone of any economy should be enhanced globally and regionally.

Reference List

Ambachtshee, K., Beartty, D. and Booth, L. (2008). The financial crisis and rescue. What went wrong? Why? What lesson can be learnt? Toronto: university of Toronto

Anon (2010). COMMODITIES: Gold drops sharply; prices still vulnerable. (2010). Business line.

Dullien, S. (2010). Euro revisions. New Statesman, 139 (4983), 10.

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Flynn, S. (2008). Balance of Payments. Great Neck Publishing.

Office of national statistics (2010). Inflation. CPI 3.7%, RPI 5.3%. Web.

Park, R. Cona, K. and Fingess, M. (2008). The crisis of global environment governance: towards a new political economy of sustainability. New York: Macmillan

Pretcher, R. (2009). UK Interest Rates Forecast to Crash to 1%. 

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