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A

Project report

On

Can EURO Replace USD as the Global Currency?

In partial fulfillment of the requirements of

The Summer Internship of

Post Graduate Diploma in Business Management

Through

Rizvi Academy of Management

Under the guidance of

Prof. Imran Kazi

Submitted by

Ronak M Thakkar

PGDBM

Batch: 20112013.

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CERTIFICATE

This is to certify that Mr. Ronak M Thakkar, a student of Rizvi Academy of

Management, of PGDBM III bearing Roll No. 68 and specializing in Finance has

successfully completed the project titled

Can EURO Replace USD as the Global Currency?

under the guidance of Prof. Imran Kazi in partial fulfillment of the requirement of Post

Graduate Diploma in Business Management by Rizvi Academy of Management for the

academic year 20112013.

_______________

Prof. Imran Kazi

Project Guide

_______________ _______________

Prof. Umar Farooq Dr. Kalim Khan

Academic Co-ordinator Director

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ACKNOWLEDGEMENT

I take this opportunity with much pleasure to thank all the people who have helped me

through the course of my journey towards producing this report. I sincerely thank my

project guide, Prof. Imran Kazi, for his guidance, help and motivation. Apart from the

subject of my report, I learnt a lot from him, which I am sure, will be useful in different

stages of my life.

I would like to thank our director Dr. Kalim Khan for providing the necessary

infrastructure and guidance in the course of the project. Also I would like to take this

opportunity and be grateful to all the teaching as well as non-teaching staff for their

continuous help and support.

______________

Ronak M Thakkar

PG-Finance

Roll No.68

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Table of Contents

Chp-1 Overview Of foreign Exchange market ................................................................... 1

1.1 Introduction ............................................................................................................... 1

1.2 World currency .......................................................................................................... 2

1.3 Major currencies ........................................................................................................ 2

The US dollar (USD)........................................................................................... 3 The EURO (EUR) ............................................................................................... 3 The pound sterling (GBP) ................................................................................... 4 The Japanese yen (JPY) ...................................................................................... 4 Swiss franc .......................................................................................................... 5 The Canadian dollar (CAD) ................................................................................ 5

Objective of the project ....................................................................................................... 6

Scope of study ..................................................................................................................... 7

Chp-2-Dominance of USD ................................................................................................. 8

2.1 Significance of USD as a global currency .............................................................. 12

2.2 Factors responsible for USD dominance- ............................................................... 14

2.2.1Quantitative factors ....................................................................................... 14

2.2.2 Qualitative factors ........................................................................................ 18

Chp-3 Emergence of EURO ............................................................................................. 19

3.1-Why EURO as a hard currency ............................................................................... 20

3.2- Significance Of Euro In World .............................................................................. 23

CHP -4 EUROS vs. USD .................................................................................................. 29

4.1 GDP Growth ............................................................................................................ 29

4.2 Trading Position in world trade ( 2011) ................................................................. 31

4.3 Debt to GDP ............................................................................................................ 32

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4.4 Inflation ................................................................................................................... 33

4.5 Unemployement Rate .............................................................................................. 35

4.6 Rating By top agencies ........................................................................................... 36

4.7 Currency composition of Foreign exchange reserve ............................................... 37

4.8 Global institution Dominance ................................................................................. 38

4.9 Business Confidence ............................................................................................... 40

4.10 Fiscal balance ........................................................................................................ 41

Chp-5 Subprime &European Debt crisis .......................................................................... 42

5.1. Subprime crisis ....................................................................................................... 42

5.2 EU crisis & PIGGS ................................................................................................. 46

Chp-6 Who wins? ............................................................................................................. 59

6.1. Scenario-1............................................................................................................... 60

6.2. Scenario-2............................................................................................................... 60

6.3. Scenario-3............................................................................................................... 61

Chp-7 Findings.................................................................................................................. 63

Chp-8 Conclusion ............................................................................................................. 65

Bibliography............................................................................................... ...................67

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Rizvi Academy Of Management Ronak Thakkar

Can EURO Replace USD as the Global Currency Page 2

no central market place for the exchange of currency, but instead the trading is conducted

over-the-counter. Unlike the stock market, this decentralization of the market allows

traders to choose from a number of different dealers to make trades with and allows for

comparison of prices. Typically, the larger a dealer is the better access they have to

pricing at the largest banks in the world, and are able to pass that on to their clients. The

spot currency market is open twenty-four hours a day, five days a week, with currencies

being traded around the world in all of the major financial centers.

The Foreign Exchange market, originally only accessible to large corporate banks and

international corporations, is now available to speculators traders large and small. When

trading Foreign exchange market, investors are betting that one currency will appreciate

against another one, and they will collect the change when they return to the original

currency in which the position was established.

1.2- World currency

In theforeign exchange market andinternational finance, a world currency, or global

currency refers to a currency in which the vast majority of international transactions take

place and which serves as the world's primaryreserve currency. In March 2009, as a

result of theglobal economic crisis,China pressed for urgent consideration of a global

currency. A UN panel of expert economists has proposed replacing the current US dollar-

based system by greatly expanding the Funds special(SDRs).

1.3Major currencies

Fundamental Factors Behind 6 Major Currencies

Every Foreign exchange market-traded currency is influenced by a range ofinternal macroeconomic conditions in its country of origin, as well as by and the

global market situation.

Economic Indicators (GDP growth, import/export trade accounts), social factors(unemployment rate, real estate market conditions) and the countryscentral bank

policy are the factors that determine the currency value in the foreign exchange

market.
http://en.wikipedia.org/wiki/Foreign_exchange_markethttp://en.wikipedia.org/wiki/International_financehttp://en.wikipedia.org/wiki/Reserve_currencyhttp://en.wikipedia.org/wiki/Global_financial_crisis_of_2008%E2%80%932009http://en.wikipedia.org/wiki/Global_financial_crisis_of_2008%E2%80%932009http://en.wikipedia.org/wiki/Reserve_currencyhttp://en.wikipedia.org/wiki/International_financehttp://en.wikipedia.org/wiki/Foreign_exchange_market

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Each one of the six major currencies has its particularities, and we are goingto analyze the fundamentals that drive the currencies individually.

1.3.1- The US dollar (USD)is the most traded

currency in the Foreign exchange market. It is also

used as a measure to evaluate other currencies and

commodities. The USD dominates the foreign

reserves held by all nations it composes about

64% of the world reserves. Globally speaking, there

are several fundamentals that drive the U. S. dollar.

Since the largest amount of metallic commodities

and the oil are mostly traded with prices

denominated in USD, significant supply/demand

fluctuations in these markets will have an immediate impact on the currency value,

as it has happened in 2008 when, largely due to the oil prices collapse, the EUR/USD

reached 1.60 rate. The dollar also benefits from its status as a safe haven, as investors run

to it when economic conditions deteriorate. As a result of a reserve currency status

sometimes, USD sometimes profits from problems in the US itself. As for domestic

factors, theFederal Reserve and its main interest rate has a tremendous influence on the

currency. Decisions of the Fed about the benchmark rate are influenced by inflation,

employment and GDP, thus the dollar is also influenced by these factors. Other important

factors for USD are the trade balance and the national debt of the US. Usually, a higher

trade balance deficit and a growing national debt reduce attractiveness of the US

currency. Yet sometimes the opposite can happen as high trade deficit and debt may drive

investors to the perceived safety of the dollar.

1.3.2- The EURO (EUR)is by far the newest currency traded among the major pairs

on Foreign exchange market markets. It is used by 17 members of the European Union.

The fundamental factors that move the EURO are often based on the strongest economies

using the new common currency, such as: France, Italy and, mainly, Germany. The main
http://www.federalreserve.gov/http://www.federalreserve.gov/

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factors for performance of EURO are inflation of consumer prices and the target lending

rate set by theEuropean Central Bank.The countries indicators of the export trade and

the unemployment rate also tend to have a high impact performance of the shared

currency, considering that countries such as Germany are large exporters of

manufacturing goods and technology. EUROPE still remains an energy dependant from

the Russian gas and the Middle Eastern oil, making higher demands for these

commodities to have a negative reflect on the EU currency. Another problem for the

EURO is the difference between its economies, made apparent by the debt crisis in 2011.

Its hard for the EU leaders in times of troubles to find solutions that are equally

benefiting to the major economies and the weaker ones

1.3.3- The pound sterling (GBP), The Great British pound, also known asthepound sterling is the Third most traded currency in the Foreign exchange market. It

also acts as a large reserve currency due to its relative value compared to other global

currencies. Although the U.K. is an official member of the European Union, it chooses

not to adopt the EURO as its official currency for a variety of reasons, namely historic

pride in the pound and maintaining control of domestic interest rates. For this reason, the

pound can be viewed as apure play on the United Kingdom. Foreign exchange market

traders will often base its value on the overall strength of the British economy and

political stability of its government. Due to its high value relative to its peers, the pound

is also an important currency benchmark for many nations and acts as a very liquid

component in the Foreign exchange market.

1.3.4- The Japanese yen (JPY)is the strongest and by far the most traded currency

in the Asian market. Japans economy is mainly geared towards industrial exports. JPY is

greatly valued by traders as a safer currency in periods when risk aversion sentiment hits.

The yen is also well known in Foreign exchange market circles for its role in the carry

trade.With Japan having basically a zero interest rate policy for much of the 1990s and

2000s, traders have borrowed the yen at next to no cost and used it to invest in other

higher yielding currencies around the world, pocketing the rate differentials in the

process. With the carry trade being such a large part of yen's presence on the international
http://www.ecb.int/http://www.ecb.int/http://www.investopedia.com/terms/g/gbp.asphttp://www.investopedia.com/terms/p/pureplay.asphttp://www.investopedia.com/terms/c/currencycarrytrade.asphttp://www.investopedia.com/terms/c/currencycarrytrade.asphttp://www.investopedia.com/terms/c/currencycarrytrade.asphttp://www.investopedia.com/terms/c/currencycarrytrade.asphttp://www.investopedia.com/terms/p/pureplay.asphttp://www.investopedia.com/terms/g/gbp.asphttp://www.ecb.int/

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stage, the constant borrowing of the Japanese currency has made appreciation a difficult

task. Though the yen still trades with the same fundamentals as any other currency, its

relationship to international interest rates, especially with the more heavily traded

currencies such as thegreenback and the EURO is a large determinant of the yen's value.

1.3.5- Swiss francThe Swiss franc, much like Switzerland, is viewed by many as a

"neutral" currency. More correctly, the Swiss franc is considered a safe haven within the

Foreign exchange market, primarily due to the fact that the franc tends to move in a

negativecorrelation to more volatilecommodity currencies such as the Canadian and

Australian dollars, along with U.S. Treasury yields. The Swiss National Bank has

actually been known to be quite active in the Foreign exchange market to ensure that the

franc trades with a relatively-tight range, to reducevolatility and keep interest rates inline, yet, its strong international trade and money influx, made the Swiss franc (CHF),

one of the main currencies traded on Foreign exchange market. CHF is another currency

that is preferred during risk aversion as Switzerlands robust economy and huge gold

reserves (the countrys reserves is seventh biggest in the world, despite Switzerlands

small size) add to credibility of the currency

1.3.6- The Canadian dollar (CAD)is considered a commodity currency as

Canadas economy is export-driven. Most of its exports Canada sell to the USA, making

the Canadas economy and the currency dependent on the nations southern neighbor.

The main export commodity is crude oil and CAD depends on the price moves of crude

as well. The global economic growth and resulting advance of commodities tend to make

CAD attractive to investors. On the other hand, problems with the global and the

domestic economy can hurt CAD.
http://www.investopedia.com/terms/g/greenback.asphttp://www.investopedia.com/terms/c/correlation.asphttp://www.investopedia.com/terms/c/commodityblockcurrency.asphttp://www.investopedia.com/terms/v/volatility.asphttp://www.investopedia.com/terms/v/volatility.asphttp://www.investopedia.com/terms/c/commodityblockcurrency.asphttp://www.investopedia.com/terms/c/correlation.asphttp://www.investopedia.com/terms/g/greenback.asp

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Objective of the project

To understand the basics of foreign exchange markets To know the major currencies of the world. To know the important position of USD &EURO in world To understand the factors which are responsible for USD s global currencies To understand the growing importance of EURO To find whether EURO can replace USD as a global currencies using various

factors.

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Scope of study

My scope of study is limited to comparison of USD &EURO currency. Comparison is done on selected parameters only.

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Chp-2-Dominance of USD

How USD Became Global Currency

In the 19th and early 20th centuries gold played a

key role in international monetary transactions.

The gold standard was used to back currencies; the

international value of currency was determined by

its fixed relationship to gold; gold was used to

settle international accounts. The gold standard

maintained fixed exchange rates that were seen as

desirable because they reduced the risk when trading with other countries. Imbalances in

international trade were theoretically rectified automatically by the gold standard. A

country with a deficit would have depleted gold reserves and would thus have to reduce

its money supply. The resulting fall in demand would reduce imports and the lowering of

prices would boost exports; thus the deficit would be rectified. Any country experiencing

inflation would lose gold and therefore would have a decrease in the amount of money

available to spend. This decrease in the amount of money would act to reduce the

inflationary pressure. Supplementing the use of gold in this period was the British pound.

Based on the dominant British economy, the pound became a reserve, transaction, and

intervention currency. But the pound was not up to the challenge of serving as the

primary world currency, given the weakness of the British economy after the Second

World War.

Breton Woodsssystem:

The Breton Woods system of monetary management established the rules for commercial

and financial relations among the world's major industrial states in the mid-20th century.

The Breton Woods system was the first example of a fully negotiated monetary order

intended to govern monetary relations among independent nation-states.

Preparing to rebuild the international economic system as World War II was still raging,

730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in

Breton Woods, New Hampshire, United States, for the United Nations Monetary and

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Financial Conference. The delegates deliberated upon and signed the Breton Woods

Agreements during the first three weeks of July 1944.

Setting up a system of rules, institutions, and procedures to regulate the international

monetary system, the planners at Breton Woods established the International Monetary

Fund (IMF) and the International Bank for Reconstruction and Development (IBRD),

which today is part of the World Bank Group. These organizations became operational in

1945 after a sufficient number of countries had ratified the agreement.

The chief features of the Breton Woods system were an obligation for each country to

adopt a monetary policy that maintained the exchange rate by tying its currency to the

U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments.

On August 15, 1971, the United States unilaterally terminated convertibility of the dollar

to gold. As a result, "the Breton Woods system officially ended and the dollar became

fully 'fiat currency,' backed by nothing but the promise of the federal government." This

action, referred to as the Nixon shock, created the situation in which the United States

dollar became the sole backing of currencies and a reserve currency for the member

states.

Fixed exchange rates:

The rules of Breton Woods, set forth in the articles of agreement of the International

Monetary Fund (IMF) and the International Bank for Reconstruction and Development

(IBRD), provided for a system of fixed exchange rates. The rules further sought to

encourage an open system by committing members to the convertibility of their

respective currencies into other currencies and to free trade.

What emerged was the "pegged rate" currency regime. Members were required to

establish a parity of their national currencies in terms of the reserve currency (a "peg")

and to maintain exchange rates within plus or minus 1% of parity (a "band") by

intervening in their foreign exchange markets (that is, buying or selling foreign money).

In theory, the reserve currency would be the bancor (a World Currency Unit that was

never implemented), suggested by John Maynard Keynes; however, the United States

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the U.S. dollar lost faith in the U.S. governments ability to cut its budget and trade

deficits.

By 1971, the money supply had increased by 10%. In the first six months of 1971, $22

billion in assets left the U.S. In May 1971, inflation-wary West Germany was the first

member country to unilaterally leave the Breton Woods system unwilling to devalue

the Deutsche Mark in order to prop up the dollar. To preempt dumping of the Deutsche

Mark on the open market, West Germany did not consult with the international monetary

community before making the change. In the next three months, West Germanys move

strengthened their economy; simultaneously, the dollar dropped 7.5% against the

Deutsche Mark.

Due to the excess printed dollars, and the negative U.S. trade balance, other nations

began demanding fulfillment of Americas promise to pay that is, the redemption of

their dollars for gold. Switzerland redeemed $50 million of paper for gold in July. France,

in particular, repeatedly made aggressive demands, and acquired $191 million in gold,

further depleting the gold reserves of the U.S. On August 5, 1971, Congress released a

report recommending devaluation of the dollar, in an effort to protectthe dollar against

foreign price-gougers. Still, on August 9, 1971, as the dollar dropped in value against

European currencies, Switzerland unilaterally withdrew the Swiss franc from the Breton

Woods system

To stabilize the economy and combat the 1970 inflation rate of 5.84%, on August 15,

1971, President Nixon imposed a 90-day wage and price freeze, a 10 percent import

surcharge, and, most importantly, closed the gold window, ending convertibility

between US dollars and gold. The President and fifteen advisors made that decision

without consulting the members of the international monetary system, so the international

community informally named it the Nixon shock. Given the importance of theannouncementand its impact upon foreign currencies presidential advisors recalled

that they spent more time deciding when to publicly announce the controversial plan than

they spent creating the plan. He was advised that the practical decision was to make an

announcement before the stock markets opened on Monday (and just when Asian markets

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also were opening trading for the day). On August 15, 1971, that speech and the price-

control plans proved very popular and raised the public's spirit.

By March 1976, the worlds major currencies were floating in other words, the

currency exchange rates no longer were governments' principal means of administering

monetary policy.

2.1- Significance of USD as a global currency

An evaluation of this question must begin with an understanding of why the U.S. dollar is

so well regarded globally in the first place.

According to me there are four main reasons for this.

It has, at least until now, been a reliable store of value. it is the most widely accepted means of international payment for goods and services Third, large, deep, and liquid dollar financial markets exist for savers to invest their

money in. And finally,

A long period of dominance has allowed the currency to become a part of theinternational financial trading infrastructure.

The U.S. dollar is the most frequently used currency in international trade today. The fact

that the U.S. is the world's largest trading nation is only part of the reason. The value of

international trade that is invoiced in dollars is much larger than the total trade conducted

by the U.S. and countries with currencies linked to the greenback. This is particularly true

in Asia, where many countries bill more than 80% of their exports in dollars.

Large international savers such as the Persian Gulf states and East Asian exporters also

find U.S. financial markets most attractive. Partly, this is because Gulf oil exports are

paid for in dollars and because it is the most convenient currency with which to intervene

in foreign exchange markets for Asian central banks. But more importantly, the U.S.

financial markets remain the most efficient place to intermediate global funds. In these

markets, particularly the U.S. Treasury market, large amounts of financial assets can be

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bought and sold without causing large movements in market price. Moreover, due to the

narrow differences between buying and selling prices, the costs of transacting in these

assets are lower than in any other market. Investing in U.S. financial markets, and also

through the dollar in other financial markets, therefore, lowers costs and increases the

flexibility of portfolio decisions.

The previous two reasons also give rise to a third factor that keeps the U.S. dollar as the

world's currency. The dollar has become an integral part of international financial and

commodity markets because it is so frequently used in international trade and investment.

In quoting exchange rates, the value of a currency is most commonly stated in terms of

the U.S. dollar. Even in actual exchange, the dollar's role is important. A company

wishing to exchange Thai baht for New Zealand dollars typically buys U.S. dollars first,

before converting them into New Zealand dollars. As a result, the U.S. dollar is involved

in one leg in close to 90% of all foreign exchange transactions, compared with less than

40% for the EURO and 16% for the Japanese yen.

Similarly, commodities, such as oil and copper, usually have their quotes and their trades

executed in U.S. dollars. This prevalence also means that the dollar derivative markets

are the most developed for anyone wishing to hedge currency and commodity price risks.

The common factor crucial for the continued validity of the above support for the dollar's

international status is confidence in the stability of its purchasing power and confidence

in the government to honor its debts. Whether one is a trader or an investor, there is a

need to hold the currency on an ongoing basis. People have to believe that it is a good

store of value, in that the real effective exchange rate of the dollar is not expected to see

large declines over the short to medium term.

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Figure 2(B) Countries reporting dollar-based exchange rate arrangements

The dollar remains prominent in exchange rate arrangements. While the dollarwas the central currency in the Breton Woods period, today there are alternative

choices available. Nevertheless, many countries have dollar-based exchange rate

arrangements.

With exchange-rate regimes defined according to the Reinhart and Rogoff (2004)approach, seven countries currently are dollarized or have currency boards using

the dollar and eighty-nine have a pegged exchange rate against the dollar (Figure

2 (B). The share of countries linking their currency to the dollar in some manner

has been stable since 1995, and this group represents more than a third of world

GDP (excluding the US)

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Figure 2(C).Foreign currency reserve holdings

Source: International Monetary Fund, Currency Composition of Official Foreign

Exchange Reserves (CCFER) data

The dollar remains the dominant currency in foreign exchange reserve accounts.Foreign governments foreign exchange reserve accounts, essentially the

governments foreign currency savings, can be large.

In 2009, dollar assets accounted for about two-thirds of the reserve assets ofindustrialized and developing countries (Figure 2 (C).

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Figure 2(D).Turnover in traditional foreign exchange markets (percent)

The dollar is a leading transaction currency in the foreign exchange markets. With an86% share in the volume of international trade and financial markets more than

twice the share of the EUROthe dollar continues to dominate these markets (figure

2(D). Turnover volumes in the foreign exchange markets have more than doubled in

the past decade, implying large numbers of transactions measured in reference to, or

involving, the dollar.

The dollar also serves as a prominent currency in the international debt markets(European Central Bank 2009, Couerdacier and Martin 2007, and Thimann 2008).

One measure is the share of all outstanding debt securities, issued anywhere in the

world, denominated in dollars. According to this measure, the dollars share stands at

approximately 39%, down only slightly from a high of 42% in 1999. The dollar

remains the primary financing currency for issuers in the Middle East, Latin America,

Asia, and the Pacific area.

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Chp-3 Emergence of EURO

The EURO (Greek:, Evr) (sign:;code:EUR) is the official currency of

theEURO zone,which consists of 17 of the 27member states of the European Union.It

is also the currency used by theInstitutions of the European Union.

Austria,Belgium,Cyprus,Estonia,Finland,France,Germany,Greece,Ireland,Italy,Lux

embourg,Malta, the Netherlands,Portugal,Slovakia,Slovenia, and Spain. The currency

is also used in a furtherfive European countries

The EURO is the second largest reserve currency as well as the second most traded

currency in the world after theUnited States dollar.As of February 2012, huge amount of

EURO are in circulation, the EURO has the highest combined value of banknotes and

coins incirculation in the world, having surpassed the US dollar. Based onInternational

Monetary Fund estimates of 2008 GDP andpurchasing power parity among the various

currencies, the EURO ZONE is the second largest economy in the world.

Outside the EURO ZONE, a total of 23 countries and territories that do not belong to the

EU have currencies that are directly pegged to the EURO.
http://en.wikipedia.org/wiki/Greek_languagehttp://en.wikipedia.org/wiki/Currency_signhttp://en.wikipedia.org/wiki/Euro_signhttp://en.wikipedia.org/wiki/Euro_signhttp://en.wikipedia.org/wiki/Euro_signhttp://en.wikipedia.org/wiki/ISO_4217http://en.wikipedia.org/wiki/Eurozonehttp://en.wikipedia.org/wiki/Member_states_of_the_European_Unionhttp://en.wikipedia.org/wiki/Institutions_of_the_European_Unionhttp://en.wikipedia.org/wiki/Austriahttp://en.wikipedia.org/wiki/Belgiumhttp://en.wikipedia.org/wiki/Cyprushttp://en.wikipedia.org/wiki/Estoniahttp://en.wikipedia.org/wiki/Finlandhttp://en.wikipedia.org/wiki/Francehttp://en.wikipedia.org/wiki/Germanyhttp://en.wikipedia.org/wiki/Greecehttp://en.wikipedia.org/wiki/Republic_of_Irelandhttp://en.wikipedia.org/wiki/Italyhttp://en.wikipedia.org/wiki/Luxembourghttp://en.wikipedia.org/wiki/Luxembourghttp://en.wikipedia.org/wiki/Maltahttp://en.wikipedia.org/wiki/Portugalhttp://en.wikipedia.org/wiki/Slovakiahttp://en.wikipedia.org/wiki/Sloveniahttp://en.wikipedia.org/wiki/International_status_and_usage_of_the_eurohttp://en.wikipedia.org/wiki/Reserve_currencyhttp://en.wikipedia.org/wiki/United_States_dollarhttp://en.wikipedia.org/wiki/Circulation_(currency)http://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/Purchasing_power_parityhttp://en.wikipedia.org/wiki/Purchasing_power_parityhttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/Circulation_(currency)http://en.wikipedia.org/wiki/United_States_dollarhttp://en.wikipedia.org/wiki/Reserve_currencyhttp://en.wikipedia.org/wiki/International_status_and_usage_of_the_eurohttp://en.wikipedia.org/wiki/Sloveniahttp://en.wikipedia.org/wiki/Slovakiahttp://en.wikipedia.org/wiki/Portugalhttp://en.wikipedia.org/wiki/Maltahttp://en.wikipedia.org/wiki/Luxembourghttp://en.wikipedia.org/wiki/Luxembourghttp://en.wikipedia.org/wiki/Italyhttp://en.wikipedia.org/wiki/Republic_of_Irelandhttp://en.wikipedia.org/wiki/Greecehttp://en.wikipedia.org/wiki/Germanyhttp://en.wikipedia.org/wiki/Francehttp://en.wikipedia.org/wiki/Finlandhttp://en.wikipedia.org/wiki/Estoniahttp://en.wikipedia.org/wiki/Cyprushttp://en.wikipedia.org/wiki/Belgiumhttp://en.wikipedia.org/wiki/Austriahttp://en.wikipedia.org/wiki/Institutions_of_the_European_Unionhttp://en.wikipedia.org/wiki/Member_states_of_the_European_Unionhttp://en.wikipedia.org/wiki/Eurozonehttp://en.wikipedia.org/wiki/ISO_4217http://en.wikipedia.org/wiki/Euro_signhttp://en.wikipedia.org/wiki/Currency_signhttp://en.wikipedia.org/wiki/Greek_language

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The Criteria for World Money

According to me there are five key factors that determine whether a currency will play a

global role:

The size of its underlying economy and global trade; The economy's independence from external constraints; Avoidance of exchange controls; The breadth, depth and liquidity of its capital markets; and The strength and stability of the economy and its external position.

The unified Europe is slightly superior to the United States on the first twostructural criteria. Thegross domestic product of the European Union was $8.4

trillion in 1996 compared with $7.2 trillion for the United States. Growth of

potential output in the two regions is similar so their rough parity in terms of

economic weight is likely to continue.

The European Union also has a modestly larger volume ofglobal trade flows.

Excluding intra-EU trade, EU trade (exports plus imports) totaled $1.9 trillion in

1996. The comparable number for the United States was $1.7 trillion.

In terms of openness, the share of exports plus imports of goods and services isnow about 23 percent in both the EU and the US. This ratio has doubled for the

United States over the past twenty-five years while rising only modestly in

Europe but is also likely to remain broadly similar. Both regions are thus fairly

independent of external constraints and can manage their policies without being

thrown off course by any but the most severe exogenous shocks.

It is virtually inconceivable that either the EU or United states would unilaterallyresort to exchange or capital controls. Globalization of capital markets has

reached the point where all major financial centers, including many in the

developing world, would have to act together to effectively alter international

capital flows. Hence the two regions will remain. The total value of government

bond markets in the EU is 2.1 trillion EURO as compared with 1.6 trillion EURO

in the United States. The issuance of international bonds and equities is

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considerably higher in the current European markets, taken together, than in the

United States. Futures trading in German and French government bonds, taken

together, exceeded that in US notes and bonds.

The final criterion is thestrength and stability of the European economy. There isobviously no risk of hyperinflation or any of the other extreme instabilities that

could disqualify the EURO from international status. To the contrary, the ECB as

noted is virtually certain to run a responsible monetary policy and achieve rapid

credibility. On the other hand, it is true that Europe may not carry out the

structural reforms needed to restore dynamic economic growth. But markets prize

stability more than growth, as indicated by the continued dominance of the dollar

through extended periods of sluggish American economic performance. Hence the

EURO is sure to qualify on these grounds as well.

In addition, America's external economic positionwill continue to pose doubts about the

future stability and value of the dollar. The United States has run current account deficits

for the last fifteen years. Its net foreign debt exceeds $1 trillion and is rising annually by

15 to 20 percent. The EU, by contrast, has a roughly balanced international asset position

and has run modest surpluses in its international accounts in recent years.

On this important criterion, the EU is decidedly superior to the United States.

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3.2- Significance Of EURO In World

This chapter shows the significance of EURO in the current world...

It builds on a comprehensive set of indicators, covering transactions and outstanding

amounts in various market segments.

The share of the EURO in global foreign exchange reservesincreased slightly to26.3% at the end of 2010 when adjusted for valuation effects (from 26.0% at end-

2009, at constant end-2010 exchange rates). During the same period the share of

US dollar-denominated assets in global foreign exchange reserves decreased

somewhat to 61.4% from 63.2% at end-2009 (at constant end-2010 exchange

rates). In line with anecdotal evidence indicating that interest in non-traditional

reserve currencies was increasing somewhat among central banks, the share of

other currencies in global foreign exchange reserves rose by around 1

percentage

Figure 3(A) - currency composition of foreign exchange reserve

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The weight of the EURO in the IMFs special drawing right (SDR)basket hasrisen from 34% in 2005 to 37.4%, following the last five-yearly review of the

SDR basket in November 2010. Its rise has partly displaced the Japanese yen

(down from 11% to 9.4%), and the US dollar (down from 44% to 41.9%). The

increase in the share of the EURO is due predominantly to an increase in the share

of reserves denominated in EURO over the past five years and, to a lesser extent,

to the increase in the same period in the EURO AREAs share in the exports of

the four economies issuing the currencies in the basket.

This is shown in figure 3(B)

Figure 3(B)

SDR basket

European Union generates aGDPof over 10.729trillion (US$15.390 trillion in2011) according to theInternational Monetary Fund (IMF), making it the largest

economy in the world.
http://en.wikipedia.org/wiki/GDPhttp://en.wikipedia.org/wiki/GDPhttp://en.wikipedia.org/wiki/GDPhttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/GDP

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Figure 3(E)-Global foreign exchange market turnover (currency breakdown)

European Union is the largest exporter in the world and as of 2010 the 2ndlargestimporter & exporter in the world.

Figure 3(F)Total exports Figure 3(G) -Total imports

Note- excluding intra EU- Trade

Source-

http://www.theodora.com/wfbcurrent/European_union/European_union_economy.html
http://www.theodora.com/wfbcurrent/european_union/european_union_economy.htmlhttp://www.theodora.com/wfbcurrent/european_union/european_union_economy.html

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Figure 3(G). The EURO and the dollars projected international reserve shares

Source: Chinn and Frankel (2008).

Figure 3(E) shows one of our simulations. In this scenario, the UK does not join the

EURO, but 20% of London turnover counts toward EURO AREA financial depth, and

currencies depreciate at the 20-year rates experienced up to 2007. The result is that the

EURO overtakes the dollar by 2015.

Looking at the few factors which are shown above we can see that the

strength of the EURO has increase significantly in last few years. And after the subprime

crisis the US dominance has also decreased in the world. So we can say that the EURO

has a power to challenge USD in near future.

In next chapter we will compare USD &EURO on certain parameters & try to find their

strengths & weakness.

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CHP -4 EUROS vs. USD

4.1 GDP Growth-

The annual growth rate in Gross Domestic Product measures the increase in value of the

goods and services produced by an economy over the period of a year.

USA

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USA GDP Growth rate is stable in last 10 years. Since the Economy is matured it is very

tuff to grow at a faster face like India & china. But the SUBPRIME CRISIS has hit them

hard which you can see in above graph.

EURO AREA GDP Annual Growth Rate averaged 1.8000 Percent reaching an all time

high of 5.0000 Percent in March of 1995 and a record low of -5.2000 Percent in March of

2009. Since its a mixture of countries & current crisis in most of European countries it

will grow at a slow pace.

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4.2 Trading Position in world trade (2011)

Exports Imports

Source-

http://www.theodora.com/wfbcurrent/European_union/European_union_economy.html

USA-

EXPORTS-United States exports were worth 151 Billion USD in DEC of 2011. United

States is the world's third largest exporter.Main exports are: machinery and equipment,

industrial supplies, non-auto consumer goods, motor vehicles and parts, aircraft and parts,

food, feed and beverages. Main exports partners are: Canada, European Union, Mexico,

China and Japan.

IMPORTS - United States imports were worth 231.4 Billion USD in DEC of

2011. United States is the world's larger importer. Its main imports are: non-auto

consumer goods, fuels, production machinery and equipment, non-fuel industrial

supplies, motor vehicles and parts, food, feed and beverages. Main imports partners are:

European Union, China, Canada, Mexico and Japan.

EURO AREA-

EXPORTS-EURO AREA exports were worth 157.6 Billion EUR in May of 2012. The

EURO AREA refers to a currency union among the seventeen European Union member

states that have adopted the EURO as their sole official currency. EURO AREA main

exports partners are United Kingdom, United States, China, Switzerland and Turkey. The

biggest exporters within the EURO AREA are Germany, France, Italy and Netherlands.
http://www.theodora.com/wfbcurrent/european_union/european_union_economy.htmlhttp://www.theodora.com/wfbcurrent/european_union/european_union_economy.html

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IMPORTS-EURO AREA imports were worth 200. Billion USD in DEC of 2011. EURO

AREA main imports partners are China, United Kingdom, United States, Russia and

Japan.

4.3 Debt to GDP

Government debt as a percent of GDP, also known as debt-to-GDP ratio, is the amount of

national debt a country has in percentage of its Gross Domestic Product. Basically,

Government debt is the money owed by the central government to its creditors. There are

two types of government debt: net and gross. Gross debt is the accumulation of

outstanding government debt which may be in the form of government bonds, credit

default swaps, currency swaps, special drawing rights, loans, insurance and pensions. Net

debt is the difference between gross debt and the financial assets that government holds.

The higher the debt-to-GDP ratio, the less likely the country will pay its debt back, and

more likely the country is to default on its debt obligations.

The United States recorded a Government Debt to GDP of 103.00 percent of the

country's Gross Domestic Product in 2011. Historically, from 1940 until 2011, the United

States Government Debt to GDP averaged 60.2900 Percent reaching an all time high of

121.7000 Percent in September of 1946 and a record low of 32.5000 Percent in

September of 1981.

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EURO AREA recorded a Government Debt to GDP of 87.20 percent of the country's

Gross Domestic Product in 2011. Historically, from 1999 until 2011, EURO AREAGovernment Debt to GDP averaged 72.4800 Percent reaching an all-time high of 87.2000

Percent in December of 2011 and a record low of 66.2000 Percent in December of 2007.

4.4 Inflation

The inflation rate in the EURO AREAwas recorded at 2.80 percent in January 2012.

Historically, from 1999 until 2012, EURO AREA Inflation Rate averaged 2.3 Percent

reaching high of 4.0 Percent in July of 1999 and low of -0.7 Percent in July of 2009.

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4.5 Unemployment Rate

The unemployment rate in the United Stateswas last reported at 8.2 percent in May of

2012. Historically, from 1948 until 2012, the United States Unemployment Rate averaged

5.7800 Percent reaching an all-time high of 10.8000 Percent in November of 1982 and a

record low of 2.5000 Percent in May of 1953.

The unemployment rate in the EURO AREA was last reported at 11 percent in May of

2012. Historically, from 1995 until 2012, EURO AREA Unemployment Rate averaged

9.1800 Percent reaching an all-time high of 11.0000 Percent in April of 2012 and a

record low of 7.2000 Percent in February of 2008.

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4.6 Rating By top agencies -

A sovereign credit ratingis the credit rating of asovereign entity, i.e., a national

government. The sovereign credit rating indicates the risk level of the investing

environment of a country and is used by investors looking to invest abroad. It takes

political risk into account

EURO ZONE countries rating & outlook by top agencies

If you see here most of the countries are struggling to get AAA rating, & their future

outlook is also not good. Only 6 countries have got AAA ratings from Moodys & Fitch.

& only 4 from S&P. & recent negative outlook to Germany & France have hit the EURO

zone.
http://en.wikipedia.org/wiki/Sovereigntyhttp://en.wikipedia.org/wiki/Sovereignty

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USA-

Where as USA has got AAA rating from fitch & Moody. But S&P has AA+ rating.

Future outlook is also negative from all 3 rating agencies.

4.7 Currency composition of Foreign exchange reserve

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A 2011 study about the current dominant reserve currency in central banks shows that

dollar may not be the obvious dominant currency,

4.8 Global institution Dominance

WTO-

The World Trade Organization (WTO) is an organization that intends to supervise

and liberalize international.

Headquarters- Geneva, Switzerland. Out of 5 previous director generals 3 have been from EU.

IMF- The International Monetary Fund(IMF) is aninternational organization that

was created on July 22, 1944 at the Breton and came into existence on December 27,

1945 when 29 countries signed the Articles of Agreement. It originally had 45 members.

The IMF's stated goal was to stabilize exchange rates and assist the reconstruction of the

worlds international payment system post-World War II.Countries contribute money to

a pool through a quota system from which countries with payment imbalances can

borrow funds on a temporary basis. Through this activity and others such as surveillance

of its members' economies and policies, the IMF works to improve the economies of its

member countries. The IMF describes itself as an organization of 188 countries (as of

April 2012)
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In the United States, business confidence also known as The Purchasing Managers Index

(PMI) improved to 60.1% in January 2012.according to the Institute of Supply

Management (ISM). Historically, from 1999 until 2012, the United States Business

Confidence averaged 52.7700 reaching a high of 63.5 in January 2011 and a record low

of 32 in September 2009.

4.10 Fiscal balance-

Amount ofmoneygovernment has from tax revenues and the amount from asset sold

minus any government spending when negative government has fiscal deficit, when

positive has fiscal surplus.

USA is the region always have struggle for its fiscal balance. Both the region spends

same amount of money on their social sectors. & after 2008 SUBPRIME CRISIS the

problem is getting worse.

EUROZONE also have negative fiscal imbalances because of Countries like Greece

whose are struggling with their fiscal balance in last 10 years but since there are countries

like Germany &France who are the major players in world trade, are able to cover that.
http://www.businessdictionary.com/definition/amount.htmlhttp://www.businessdictionary.com/definition/money.htmlhttp://www.businessdictionary.com/definition/government.htmlhttp://en.wikipedia.org/wiki/File:Goverment_surplus_or_deficit_(EU-USA-OECD).pnghttp://www.businessdictionary.com/definition/government.htmlhttp://www.businessdictionary.com/definition/money.htmlhttp://www.businessdictionary.com/definition/amount.html

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Chp-5 Subprime &European Debt crisis

5.1. Subprime crisis

Introduction

The subprime mortgage crisis is an economic problem manifesting itself through

liquidity issues in the global banking system owing toforeclosures which accelerated in

theUnited States in late 2006 and triggered a global financial crisis through 2007 and

2008. The crisis began with the bursting of theUS housing bubble and high default rates

on "subprime" and otheradjustable rate mortgages (ARM) made to higher-riskborrowers

with lower income or lessercredit history than "prime" borrowers. Loan incentives and a

long-term trend of rising housing prices encouraged borrowers to assume mortgages,believing they would be able to refinance at more favorable terms later. However, once

housing prices started to drop moderately in 20062007 in many parts of the U.S.,

refinancing became more difficult. Defaults and foreclosure activity increased

dramatically as ARM interest rates reset higher. During 2007, nearly 1.3 million U.S.

housing properties were subject to foreclosure activity, up 79% from 2006.

The mortgage lenders that retainedcredit risk (the risk of payment default) were the first

to be affected, as borrowers became unable or unwilling to make payments. Major Banks

and other financial institutions around the world have reported losses of approximately

U.S. $435 billion as of July 17, 2008. Owing to a form of financial engineering called

securitization,many mortgage lenders had passed the rights to the mortgage payments

and related credit/default risk to third-party investors via mortgage-backed securities

(MBS) andcollateralized debt obligations (CDO). Corporate, individual andinstitutional

investors holding MBS or CDO faced significant losses, as the value of the underlying

mortgage assets declined.Stock markets in many countries declined significantly.

The widespread dispersion of credit risk and the unclear effect on financial institutions

caused lenders to reduce lending activity or to make loans at higher interest rates.

Similarly, the ability of corporations to obtain funds through the issuance of commercial

paper was affected. This aspect of the crisis is consistent with a credit crunch. The
http://en.wikipedia.org/wiki/Liquidityhttp://en.wikipedia.org/wiki/Foreclosurehttp://en.wikipedia.org/wiki/United_Stateshttp://en.wikipedia.org/wiki/Financial_crisishttp://en.wikipedia.org/wiki/United_States_housing_bubblehttp://en.wikipedia.org/wiki/Subprime_lendinghttp://en.wikipedia.org/wiki/Adjustable_rate_mortgagehttp://en.wikipedia.org/wiki/Borrowerhttp://en.wikipedia.org/wiki/Credit_historyhttp://en.wikipedia.org/wiki/Default_%28finance%29http://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Mortgage-backed_securitieshttp://en.wikipedia.org/wiki/Collateralized_debt_obligationshttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Stock_markethttp://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/Credit_crunchhttp://en.wikipedia.org/wiki/Credit_crunchhttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Stock_markethttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Institutional_investorhttp://en.wikipedia.org/wiki/Collateralized_debt_obligationshttp://en.wikipedia.org/wiki/Mortgage-backed_securitieshttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Default_%28finance%29http://en.wikipedia.org/wiki/Credit_historyhttp://en.wikipedia.org/wiki/Borrowerhttp://en.wikipedia.org/wiki/Adjustable_rate_mortgagehttp://en.wikipedia.org/wiki/Subprime_lendinghttp://en.wikipedia.org/wiki/United_States_housing_bubblehttp://en.wikipedia.org/wiki/Financial_crisishttp://en.wikipedia.org/wiki/United_Stateshttp://en.wikipedia.org/wiki/Foreclosurehttp://en.wikipedia.org/wiki/Liquidity

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Understanding the causes of the subprime crisis

Causes of the crisis

The housing downturn

Subprime borrowing was a major contributor to an increase in home ownership rates and

the demand for housing. The overall U.S. homeownership rate increased from 64 percent

in 1994 (about where it was since 1980) to a peak in 2004 with an all time high of

69.2 percent.

This demand helped fuel housing price increases and consumer spending. Between 1997

and 2006, American home prices increased by 124%. Some homeowners used the

increased property value experienced in thehousing bubble to refinance their homes with

lower interest rates and take out second mortgages against the added value to use the

funds for consumer spending. U.S. household debt as a percentage of income rose to

130% during 2007, versus 100% earlier in the decade.

A culture of consumerism is a factor. In the early 2000s recession that began in early

2001 and which was exacerbated by theSeptember 11, 2001 terrorist attacks,Americans

were asked by the current President, George W. Bush, to spend their way out of

economic decline and "Get down to Disney World in Florida." This call linking

patriotism to shopping echoed the urging of former PresidentBill Clinton to "get out and

shop", and corporations likeGeneral Motorsproduced commercials with the same theme.

Existing Homes Sales, Inventory, and Months Supply, By Quarter

Overbuilding during the boom period, increasing foreclosure rates and unwillingness of

many homeowners to sell their homes at reduced market prices have significantly

increased the supply of housing inventory available. Sales dropped by 26.4% in 2007. By

January 2008, the inventory of unsold new homes stood at 9.8 months based on

December 2007 sales volume, the highest level since 1981. Further, a record of nearly

four million unsold existing homes was for sale, including nearly 2.9 million that were

vacant.
http://en.wikipedia.org/wiki/Housing_bubblehttp://en.wikipedia.org/wiki/Second_mortgagehttp://en.wikipedia.org/wiki/Early_2000s_recessionhttp://en.wikipedia.org/wiki/September_11%2C_2001_terrorist_attackshttp://en.wikipedia.org/wiki/Presidenthttp://en.wikipedia.org/wiki/George_W._Bushhttp://en.wikipedia.org/wiki/Bill_Clintonhttp://en.wikipedia.org/wiki/General_Motorshttp://en.wikipedia.org/wiki/General_Motorshttp://en.wikipedia.org/wiki/Bill_Clintonhttp://en.wikipedia.org/wiki/George_W._Bushhttp://en.wikipedia.org/wiki/Presidenthttp://en.wikipedia.org/wiki/September_11%2C_2001_terrorist_attackshttp://en.wikipedia.org/wiki/Early_2000s_recessionhttp://en.wikipedia.org/wiki/Second_mortgagehttp://en.wikipedia.org/wiki/Housing_bubble

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This excess supply of home inventory places significant downward pressure on prices. As

prices decline, more homeowners are at risk of default and foreclosure. According to the

S&P/Case-Shiller housing price index, by November 2007, average U.S. housing prices

had fallen approximately 8% from their 2006 peak. However, there was significant

variation in price changes across U.S. markets, with many appreciating and others

depreciating. The price decline in December 2007 versus the year-ago period was 10.4%.

As of February 2008, housing prices are expected to continue declining until this

inventory of surplus homes (excess supply) is reduced to more typical levels

Figure 5 (B)causes of crisis

Figure 5(C)Size of US Debt

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5.2 EU crisis & PIGGS

The European sovereign debt crisis is an ongoing financial crisis that has made it

difficult or impossible for some countries in theEURO AREA tore-finance their

government debt without the assistance of third parties.

From late 2009, fears of asovereign debt crisis developed among investors as a result of

the rising private andgovernment debt levels around the world together with a wave of

downgrading of government debt in someEuropean states.Concerns intensified inearly

2010 and thereafter, leading Europe's finance ministers on 9 May 2010 to approve a

rescue package worth 750billion aimed at ensuring financial stability across Europe by

creating theEuropean Financial Stability Facility (EFSF).

In October 2011 and February 2012, theEURO zone leaders agreed on more measures

designed to prevent the collapse of member economies. This included an agreement

whereby banks would accept a 53.5% write-off ofGreek debt owed to private creditors,

increasing the EFSF to about 1 trillion, and requiring European banks to achieve 9%

capitalization.Restore confidence in Europe, EU leaders also agreed to create a European

Fiscal Compact including the commitment of each participating country to introduce

abalanced budget amendment.

While sovereign debt has risen substantially in only a few EURO ZONE countries, it has

become a perceived problem for the area as a whole. Prior to May, 2012, theEuropean

currency remained stable. As of mid-November 2011, the EURO was even trading

slightly higher against the bloc's major trading partners than at the beginning of the

crisis. The three countries most affected,Greece,Ireland andPortugal, collectively

account for 6% of the EURO ZONEs gross domestic product (GDP).

Cause

The European sovereign debt crisis resulted from a combination of complex factors,

including theglobalization of finance; easy credit conditions during the 20022008

period that encouraged high-risk lending and borrowing practices; the20072012 global

financial crisis; international trade imbalances;real-estate bubbles that have since burst;
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the20082012 global recession;fiscal policy choices related to government revenues and

expenses; and approaches used by nations to bail out troubled banking industries and

private bondholders, assuming private debt burdens or socializing losses.

One narrative describing the causes of the crisis begins with the significant increase insavings available for investment during the 20002007 periods when the global pool of

fixed-income securities increased from approximately $36 trillion in 2000 to $70 trillion

by 2007. This "Giant Pool of Money" increased as savings from high-growth developing

nations entered global capital markets. Investors searching for higher yields than those

offered by bonds sought alternatives globally.

The temptation offered by such readily available savings overwhelmed the policy and

regulatory control mechanisms in country after country as global fixed-income investors

searched for yield, generatingbubble after bubble across the globe. While these bubbles

have burst, causing asset prices (e.g., housing and commercial property) to decline, the

liabilities owed to global investors remain at full price, generating questions regarding

thesolvency of governments and their banking systems.

The interconnection in the global financial system means that if one nation defaults on its

sovereign debt or enters into recession putting some of the external private debt at risk,

the banking systems of creditor nations face losses. For example, in October 2011, Italian

borrowers owed French banks $366 billion (net). Should Italy be unable to finance itself,

the French banking system and economy could come under significant pressure, which in

turn would affect France's creditors and so on. This is referred to asfinancial

contagion.Another factor contributing to interconnection is the concept of debt

protection. Institutions entered into contracts calledcredit default swaps (CDS) that result

in payment should default occur on a particular debt instrument (including government

issued bonds). But, since multiple CDSs can be purchased on the same security, it is

unclear what exposure each country's banking system now has to CDS.

Greece hid its growing debt and deceived EU officials with the help of derivatives

designed by major banks Although some financial institutions clearly profited from the

growing Greek government debt in the short run, there was a long lead-up to the crisis.
http://en.wikipedia.org/wiki/2008%E2%80%932012_global_recessionhttp://en.wikipedia.org/wiki/2008%E2%80%932012_global_recessionhttp://en.wikipedia.org/wiki/2008%E2%80%932012_global_recessionhttp://en.wikipedia.org/wiki/Economic_bubblehttp://en.wikipedia.org/wiki/Solvencyhttp://en.wikipedia.org/wiki/Financial_contagionhttp://en.wikipedia.org/wiki/Financial_contagionhttp://en.wikipedia.org/wiki/Credit_default_swapshttp://en.wikipedia.org/wiki/Credit_default_swapshttp://en.wikipedia.org/wiki/Financial_contagionhttp://en.wikipedia.org/wiki/Financial_contagionhttp://en.wikipedia.org/wiki/Solvencyhttp://en.wikipedia.org/wiki/Economic_bubblehttp://en.wikipedia.org/wiki/2008%E2%80%932012_global_recession

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Figure- 5.2 (A)

Public debt $ and %GDP (2010) for selected European countries

Source-www.Eurostate.com(May- 2012)

Public debt relative to GDP (2010), Germany, Estonia had a considerably betterpublic debt and fiscal deficit relative to GDP than the most affected EURO ZONE

members. In the same period, these countries (Portugal, Ireland, Italy and Spain)

had far worse balance of payments positions. Whereas German trade surpluses

increased as a percentage of GDP after 1999, the deficits of Italy, France and

Spain all worsened.
http://www.eurostate.com/http://www.eurostate.com/

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Figure 5.2 (B)

Note- SovereignCDSprices of selected European countries (20102012). The left axis is

inbasis points;a level of 1,000 means it costs $1 million to protect $10 million of debt

for five years.

Prior to development of the crisis it was assumed by both regulators and banksthat sovereign debt from the EURO ZONE was safe. Banks had substantial

holdings of bonds from weaker economies such as Greece which offered a small

premium and seemingly were equally sound. As the crisis developed it became

obvious that Greek, and possibly other countries', bonds offered substantially

more risk. Contributing to lack of information about the risk of European

sovereign debt was conflict of interestby banks that were earning substantial

sums underwriting the bonds. The loss of confidence is marked by rising

sovereign CDS prices, indicating market expectations about countries'

creditworthiness
http://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Basis_pointshttp://en.wikipedia.org/wiki/Conflict_of_interesthttp://en.wikipedia.org/wiki/Conflict_of_interesthttp://en.wikipedia.org/wiki/Basis_pointshttp://en.wikipedia.org/wiki/Credit_default_swap

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Figure 5.2 (C)

This Figure shows that investor doesnt have confidence in most of the EUROZONE countries. But Greece is the country which gives highest interest rate.Ever since world has came to know about the crisis the interest rates are going up

, this shows that investor lacks confidence in most of EURO ZONE countries.

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PIIGS

An acronym used to refer to the five EURO ZONE nations considered weaker

economically often in regard to matters relating to sovereign debt markets

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1. GreeceIn the early mid-2000s, Greece's economy was one of the fastest growing in the EURO

ZONE and was associated with a largestructural deficit growing in the EURO ZONE

during the 2000s at an annual rate of 4.2%. The government spent heavily to keep the

economy functioning and the country's debt increased accordingly which increased by

87% & is 50% of GDP Lot of these lenders (bondholders) were foreign - pension funds,

banks of EURO region, American banks, investors etc. As the world economy was hit by

theglobal financial crisis in the late 2000s, Greece was hit especially hard because its

main industriesshipping andtourism & revenues fell by 15.Greece is a member of the

EURO zone, and its health affects everyone else's too as there is a common currency, and

many banks of EURO ZONE are invested in Greek bonds. So a default is a dangerous

thing for all markets involved, and hence the EURO zones authorities, the ECB and the

big ones - Germany and France - bailed Greece out.

Figure 5.2 (D)
http://en.wikipedia.org/wiki/Structural_deficithttp://en.wikipedia.org/wiki/Global_financial_crisishttp://en.wikipedia.org/wiki/Greek_Merchant_Navyhttp://en.wikipedia.org/wiki/Tourism_in_Greecehttp://en.wikipedia.org/wiki/Tourism_in_Greecehttp://en.wikipedia.org/wiki/Greek_Merchant_Navyhttp://en.wikipedia.org/wiki/Global_financial_crisishttp://en.wikipedia.org/wiki/Structural_deficit

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Figure-5.2(E)

2. IrelandThe Irish sovereign debt crisis was not based on government over-spending, but from the

state guaranteeing the six main Irish-based banks who had financed aproperty bubble.

The case of Ireland has been marked by an almost whole sale nationalization of the

banking sector that translated into severe fiscal stress. But not long back, the Ireland was

hailed as the Celtic tiger for its economic dynamism. The economy expanded rapidly

during 19972007 with investment stimulated, in part, due to a low corporate tax rates.

With low interest rates, there was rapid expansion of credit and property valuations from

2002 to 2007. The rise in mortgages was accompanied by banks relying heavily on whole

sale external borrowing. As property prices showed a downward movement from 2007

Irish banks stood exposed and came under severe pressure. The property price crash by

the first half of 2009 broadly coincided with the tightening of credit control.

The case of Ireland has been marked by an almost whole sale nationalization of the

banking sector that translated into severe fiscal stress. But not long back, the Ireland was

hailed as the Celtic tiger for its economic dynamism. The economy expanded rapidly
http://en.wikipedia.org/wiki/Property_bubblehttp://en.wikipedia.org/wiki/Property_bubble

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during 19972007 with investment stimulated, in part, due to a low corporate tax rates.

With low interest rates, there was rapid expansion of credit and property valuations from

2002 to 2007. The rise in mortgages was accompanied by banks relying heavily on whole

sale external borrowing. As property prices showed a downward movement from 2007

Irish banks stood exposed and came under severe pressure. The property price crash by

the first half of 2009 broadly coincided with the tightening of credit control.

3. PortugalWhile the Financial Crisis affected the Portuguese economy on account of which its

fiscal deficit and public debt deteriorated from -3.1 per cent and 68 per cent of GDP (in

2007) to -10 per cent and 83 percent in 2009, the down turn in GDP growth for Portugalwas one of the mildest (only -2.5 %) compared to a sharper decline in the rest of the

EURO zone. Public debt and deficit is also lower than Greece. In that respect, the

situation of Portugal is unlike the other peripheral economies that witnessed a boom-bust

situation. Portugal, however, has a significantly large external current account deficit and

external debt fuelled largely by private sector borrowing.

In terms of other social indicators that are critical for productivity, Portugal ranks low.

For instance, as per the OECD surveys, Portugal has one of the lowest percentage of

population with at least upper secondary education in the age group of 25 to 64 as

compared to the EU average. Alongside, Portugal has also shown an increase in the

structural rate of unemployment right from 2000. In other words, Portugal faces a

somewhat different problem from some of the other peripheral economies, that is - of

chronic low rate of growth.

On 16 May 2011, the EURO ZONE leaders officially approved a78 billionbailout

package for Portugal, which became the third EURO ZONE country, after Ireland and

Greece, to receive emergency funds.

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4. SpainThe 20082012 Spanish financial crises began as part of the worldLate-2000s financial

crisis and continued as part of the European sovereign debt crisis, which has affected

primarily the southern European states and Ireland. In Spain, the crisis was generated bylong-term loans (commonly issued for 40 years), the building market crash, which

included the bankruptcy of major companies, and a particularly severe increase in

unemployment, which rose to 22.9% by December 2011. It should be noted that Spain's

public debt (60.1% of GDP in 2010) is significantly lower than that of

Greece (142.8%)

Italy (119%)

Portugal (93%)

Ireland (96.2)

The provision of 100bn of rescue loans from EURO ZONE funds was agreed by EURO

ZONE finance ministers on 9 June 2012.

5. ItalyItaly's deficit of 4.6 percent of GDP in 2010 was similar to Germanys at 4.3 percent and

less than that of the U.K. and France. Italy even has a surplus in its primary budget,

which excludes debt interest payments. However, its debt has increased to almost 120

percent of GDP (U.S. $2.4 trillion in 2010) and economic growth was lower than the EU

average for over a decade this has led investors to view Italian bonds more and more as a

risky asset. Other hand, the public debt of Italy has a longer maturity and a substantial

share of it is held domestically. Overall this makes the country more resilient to financial

shocks, ranking better than France and Belgium. About 300 billion EUROs of Italy's 1.9

trillion EURO debt matures in 2012. It will therefore have to go to the capital markets for

significant refinancing in the near-term.
http://en.wikipedia.org/wiki/Late-2000s_financial_crisishttp://en.wikipedia.org/wiki/Late-2000s_financial_crisishttp://en.wikipedia.org/wiki/European_sovereign_debt_crisishttp://en.wikipedia.org/wiki/European_sovereign_debt_crisishttp://en.wikipedia.org/wiki/Late-2000s_financial_crisishttp://en.wikipedia.org/wiki/Late-2000s_financial_crisis

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Comparing the PIIGS Nations

In the European Union Portugal ranks 17th in size. Although the debt of thecountry is less than that of the United States, its level of indebtedness has risen to

nearly 20 percent in the past years. In addition, its unemployment stands at the

alarming 10.4 percent.

While the Italianeconomy ranks fourth within the EU, in 2009, it went down byabout 4.8 percent. The debt to GDP ratio of the country stands at 115.5 percent

and its unemployment rate exceeds 7.5 percent.

Although Ireland used to be on the 15th place in terms of economic size, itsindicators suddenly dropped down by 7.5 percent in 2009. In the past 3 years, its

debt has tripled from 25.4 percent while unemployment rate reached 13.3 percent.Thus, the country joined the team of PIIGS nations.

Greeceis the most controversial case of all. Although its economy ranks 13th interms of economic size, its debt-to-GDP ratio is at the startling 125 percent. Since

2010, the government of Greece has started making budget cuts equaling 10

percent of its GDP.

Finally, Spainis the fifth largest economy in the European Union, with the lowestdebt-to-GDP ratio of all PIIGS countries. However, its gross domestic product is

at the low 66.3 percent, while unemployment stands at 20 percent. At present, the

authorities in the country are about to implement some tough fiscal restraint.

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5.2 (F) - percentage of debt held abroad

5.2 (G) - Rapidly expanding expenditure of PIIGS countries

EFFECT OF CRISIS

The U.S. and EURO ZONE economies play major roles in the world economy and are

crucially important for each others prosperity. The two sides combined account for

around 40% of world GDP, 25% of world trade, 60% of world foreign direct investment

flows, and 60%-70% of world banking assets and financial services. They also remain

each others most important market for exports of goods and services, and are each

others primary source for foreign direct investment. U.S. companies operating in Europe

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and European companies operating in the United States employ up to 15 million workers

on both sides of the Atlantic.

Given these strong economic linkages, it is not surprising that the U.S. economy can be

Negatively impacted by the EURO ZONE crisis via both financial and trade linkages&

vice-a- versa.

.

In terms of international trade, the U.S. and EURO ZONE countries have one of the

largest bilateral relationships in the world. If the EURO ZONE economy stagnates this

year or slips into recession, demand for U.S. exports and the sales and profits of U.S.

multinationals operating in Europe will be depressed. If the EURO begins to depreciate

more steeply against the dollar due to slower growth and loss of confidence in the EURO,

these adverse impacts on the U.S. economy could be amplified.

A stronger dollar/weaker EURO would also likely have some effects on U.S.-EURO

ZONE foreign direct investment flows. Currently, EURO ZONE countries account for

26% of all U.S. direct investment abroad and for 44% of all foreign direct investment in

the United States.

Based on slower growth in Europe, U.S. investors may look towards emerging markets

for additional investments, particularly since profits generated in EUROs would translate

into fewer dollars, hurting the bottom line of U.S. parent companies. An offsetting factor

could be that European stocks and assets with a weaker EURO would look cheaper and

more attractive, attracting U.S. capital to Europe.

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Chp 6 - Who wins?

Comparing the economic performance of the Europe and the USA does not leadone to conclude that America has the more dynamic economy, or that it has

performed better in the pas

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