The debut of the euro was one of the greatest events that have occurred after World War II. The individual European currency was introduced in 1999, by replacing the natural currencies of 11 states in Europe including Belgium, Germany, Spain, Ireland, France, Italy Luxemburg, Finland, Austria, Portugal and Netherlands. Today, 16 states have replaced their natural currency with the euro and 27 states in Europe are members of the euro. ( Ash, 2009 ) The euro has made a extremist alteration to Europe and reached a milepost in the European brotherhood economic integrating procedure.
Furthermore, the launch of the euro has besides contributed to great transmutation to the international pecuniary system. The dollar has been the dominant currency of the universe economic system with no competition and challengers for about a century. McCauley ( 1997 ) states that, ‘the debut of the euro, will dispute the position of the dollar in the international pecuniary system and alter the power constellation ‘ . In add-on, Portes ( 1998 ) have stated that assorted factors and indexs have suggested that, if the euro ‘s demand increases with clip, the euro might excel the dollar as the universe ‘s prima international modesty currency.
In the yesteryear, the US dollar had been the universe modesty currency and accounted for approximately two-thirds of all the official exchange militias. ( Salvatore, 2002 ) . However, today, the euro is the 2nd largest modesty currency after the US dollar. From October 2009, more than a‚¬790 billion euro bank notes and coins are go arounding in the universe economic system which has surpassed the sum of the US dollar. ( Salvatore, 2002 )
There are three major motions in the value of the US dollar against the Euro since the debut of the euro. ( See Appendix 1 ) . For the first three old ages from 1999 to 2002, the euro lost land against the US dollar. During this stage, the euro depreciated which weakened the brotherhood of the euro country members. The euro-dollar exchange rate depreciated in 1999, from $ 1.17 to $ 0.82 on October 2000. This was a depreciation of about 30 per centum. Therefore it led to a financial shortage in the euro zone, and triggered assorted hazards similar to the Greek autonomous debt crisis. ( Salvatore, 2002 ) . Therefore, the depreciation from 1999 to 2002 weakened the foundation of the euro zone members enormously and many members wanted to go forth. However, fortunately the euro picked up and appreciated in 2003. ( Salvatore, 2002 )
The ground that the euro depreciated and lost land was because economic growing in US was stronger than economic growing Euro during that period. Therefore, because of greater economic and productiveness growing in US, investings were more profitable in the US so there were a larger sum of investings. Salvatore ( 2002 ) stated that ‘the weak euro reflected investors explanation that America ‘s productiveness growing would outpace the euro country ‘s in the old ages in front ‘ . Therefore because of this, the euro depreciated.
Furthermore, the investors had more assurance and religion in the US Federal Reserve than in the European Central Bank ( ECB ) at that clip. This is because the ECB ignored growing and focused on monetary value stableness excessively much. During that period, many perceivers besides believed that ECB lacked transparence about their policy ends and the manner they made their involvement rate determinations. Another ground was because the US dollar was a safe oasis. Hence, when the investors became more hazard averse, they would keep dollar-denominated assets. As a consequence, the investors would be secured by roll uping dollar balances even when U.S.A goes into recession. The statement buttocks is that if US enters a recession, the remainder of the universe will be hurt and so investors would ensue in stacking dollars to avoid hazard. The euro was overvalued against the dollar and take downing the value was a natural consequence to a more sensible degree of the euro.
On the other manus, during the 2nd stage from 2003 to 2008, the euro appreciated unusually. From January 2003, the euro appreciated up to 20 % and invariably appreciated boulder clay July 2008. ( Ash, 2009 ) The euro in 2003, was undervalued in comparing to the dollar and is now overvalued as compared to what it used to be. The euro managed to derive much strength during this period against the dollar. There are assorted ways in which the Euro managed to develop its strength against the dollar.
First, the euro strongly advanced both economic and political integrating between the euro zone members by leting the members to fall in if they meet the pecuniary demands. The euro is managed and administered by the ECB ( European Central Bank ) . Furthermore, outside Europe, the euro has managed to increase its supply of euro denominated assets outside Europe than within the European Union. ‘The euro portion ‘s in international debt securities rose to 30 per centum ‘ ( Smaghi, 2009 ) . By 2003, the Euro managed to be involved in 37 % of all minutess which is behind the dollar ‘s 89 % . Furthermore, because many European states joined the EMU by 2004, the euro land exceeds the U.S in income and trade. However, because Britain decided non to fall in the euro, existent growing has been slower in Europe than United States for some old ages due to low population growing. ( Smaghi, 2009 ) . All of the developments stated above contribute to how the euro became a challenging and future leading of the U.S dollar as a planetary currency.
On the other manus, there are two chief economic factors responsible for the rise of the euro, which are the high involvement rates that were maintained by the European Central Bank while in contrast, the US Federal Reserve seeks to maintain their involvement rates low. Another major ground to the rise of the euro is that the euro regained most of its losingss against the dollar because US went into recession and the dollar weakened. Many economic experts such as Ash ( 2009 ) believe is that the euro strengthened because of the intrinsic failing of the dollar. Therefore, the ECB ‘s effort at maintaining high involvement rates could hold attributed to a healthy European economic system.
The euro-dollar exchange rate reached up to $ 1.62 in April 2008 from $ .80 in 2000 against the USD and has since been worsening against major currencies at a rapid rate of diminution. ( See Appendix 2 ) By the terminal of 2009, the euro-dollar exchange rate was around $ 1.4. There are two chief grounds, which contribute, to Euros ‘ currency diminution which are the pecuniary crisis and secondly the integrity job between the 15-euro zone members that use the euro currency. The euro zone members ‘ came together get downing 1998 to happen strength and integrity and to construct a common currency in order to derive strength in their ability to vie against other major currencies such as the dollar and the hankering. However, although the euro value appreciated and the value increased, the harmoniousness of the euro zone members still remained impaired. Recently, it has become apparent that the attitude of the euro currency members being ‘all for one, one for all ‘ ( Spurr,2008 ) has diminished. The chief cause for this is because if any single state ‘s bank faces jobs, the ECB is expected to financially back up the state. This consequences in jobs, because many states with strong financial balances are n’t willing to back up the states with weaker financial balances. Therefore, the relationship between the strong states and weak state is one of the root jobs for the euro. Speculators suggest that the euro will go on to fall and might come to an terminal if states prefer to be in control of their ain state alternatively of being portion of the brotherhood. The weakening of the currency has led to a crisp impairment in economic activity and mentality, particularly a reversal of capital flows that was caused from a consequence of heightened planetary hazard antipathy and increased place prejudice.
Furthermore, due to the pecuniary crisis, the euro suffered a significant sum in 2008. One of the exchange rate jobs that the euro currency faced was that the US dollar support demands resulted in a batch of tenseness in planetary money markets and forced many establishments to change over euro into dollars through FX barters. Until summer 2008, the US dollar weakened against the euro nevertheless after summer 2008 and the Lehman prostration, the euro weakened against the USD. ( Fieldstein, 2008 ) This resulted in the dollar profiting organize the increased hazard antipathy worldwide and other factors such as widespread deficit of dollar liquidness in fiscal markets. All these factors led a batch of states wind offing of the carry trade places that had been established when the euro encompassed a low volatility environment before summer 2007. It is said that the dollar appreciated against the dollar though after the 2008 crisis because of the market ‘s perceptual experience of the international position of the dollar, the function of safe oasis in periods of heighted hazard antipathy. . ( Eichengreen, 2008 )
In add-on, apart from the exchange rate policy, the crisis has besides affected facets of international pecuniary coordination. The ECB ( European cardinal bank ) have engaged in joint actins to supply liquidness, cut down fiscal market strains and counter negative spillover effects on the existent economic system. Such as on 8th Octoboer 2008, ECB cut involvement rates at the same time with other cardinal Bankss against a background caused by rising prices. ( Fieldstein, 2008 )
Although many economic experts such as Spurr ( 2008 ) and Fieldstein ( 2008 ) believe that the outgrowth of the euro would stop up weakening the US dollar as international currency, the US dollar still has n’t been undermined and is improbable will be in the hereafter. ( Spurr 2008 ) Despite the appreciated of the euro, 60 % of cardinal bank militias worldwide still remain in US dollars. ( Fieldstein, 2008 ) The euro still remains a figure two international currency, still far behind the dollar, which still remains comfortably at the figure one slot. ( Fieldstein,2008 )
In 1983, Hong Kong adopted a fixed exchange rate from the Currency Board Arrangement ( CBA ) and pegged the Hong Kong dollar to the USD at a rate of $ 7.80. The chief ground for following this nog was to forestall the Hong Kong dollar from fall ining during a political difference between China and Britain over the hereafter of the district. Due to the political row, there was no times to neither scientifically determine the pegged rate nor argument whether a fixed exchange rate was optimum for the Hong Kong economic system. In 1997, a political passage occurred, as Hong Kong was no longer colonized by Britain but alternatively became a particular administrative part under Chinese sovereignty. ( Charles, 1997 ) . Hence, for that ground many inquiries were raised whether a fixed exchange rate was optimum for the economic system.
Hong Kong has experienced many advantages from 1983 due to holding a fixed exchange rate. One of chief advantages of Hong Kong holding a fixed exchange rate is that it suits Hong Kong ‘s extremely external and flexible economic system. Hong Kong is outstanding for flexibleness in the ‘production responses of its endeavors and in the labour market. ‘ ( Tsang, 1999 ) Harmonizing to the CBA, the more flexible an economic system is the more suited will a fixed exchange rate be because the existent sector will set rapidly. This is because a fixed exchange rate has the benefit of airting force per unit area off from the exchange rate to as other facets of the economic system and provides greater stableness in the economic system. Furthermore, holding a fixed exchange rate is good because nominal monetary values do non hold to be changed through exchange rate motions in instance of external dazes. Hong Kong has managed to stay stable during assorted dazes such as it was unaffected by the 1987 stock market clang. Therefore, it enables the economic system to set to floor without harm and volatility of an disconnected currency prostration because the existent sector will rapidly set it alternatively. Therefore, a fixed exchange rate can be advantageous as it can move as a house pecuniary ground tackle for Hong Kong. ( Tsang, 1999 )
Furthermore, a fixed exchange rate would accommodate a little unfastened economic system like Hong Kong because a floating exchange rate may non convey much pecuniary autonomy. This is because, local involvement rates can non divert from foreign 1s a big sum in instance there are exchange rate rotations. A floating exchange rate would hold greater volatility hence a fixed exchange rate would accommodate Hong Kong ‘s economic system more. Milton Friedman, the celebrated American economic expert favored Hong Kong ‘s fixed exchange rate system in 1994 as he stated, ‘ The currency board system that was introduced in 1983 has worked really good for Hong Kong and I believe it is desirable that it be continued ” ( Hanke, 2008 )
However, there are many disadvantages Hong Kong faces from utilizing a fixed exchange rates system. First, for a fixed exchange rate, external dazes might be excessively large to manage, for a existent economic system to make all the adjusting, such as the Hong Kong being effected by the Asiatic fiscal crisis. For illustration, Hong Kong was affected by the current fiscal tsunami after the Lehman Brothers filed for bankruptcy protection and this led to the domestic stock market falling enormously and interbank liquidness was tightened. ( Parisis, 2008 ) Therefore, the Lehman ‘s Brother ‘s act as an external daze and can impact serious existent economic activities.
Furthermore, a fixed exchange rate is besides a less barometer to altering market conditions as it would be harder to cover with structural divergency and deep-seated economic instabilities that do n’t ‘ demo up easy. Another factor is the cost of discontinuing the nog in Hong Kong. ‘If more is invested in constructing assurance in the system, more has to be forgone when it is eventually deemed necessary to alter path ‘ . ( Parisis, 2009 ) . Abandoning the nog can ensue in high involvement rates, which leads to a lessening in tourers, belongings collapsing and other side effects.
Furthermore, Hong Kong is affected by the pecuniary policy of the US dollar and after the fiscal crisis, this nexus with the dollar has led to depression and high unemployment rate. As the US dollar appreciates, the Hong Kong authorities is restricted to alter the money supply because the authorities surrenders its power to set Hong Kong ‘s pecuniary policy to the US Federal Reserve. This hinders the velocity of retrieving for the economic system. Although, the nog gave Hong Kong US flat nominal involvement rates for 15 old ages, Hong Kong faced enormous rising prices as it benefited organize the expletive of existent involvement rates. ( Tsang,1999 )
On the other manus, another exchange rate system would be the floating exchange rate system. A floating exchange rate would be more good to the economic system for assorted grounds. A floating exchange rate system, during a daze would give more utile information about blossoming the instabilities in the economic system. Many economic systems run successfully under a floating exchange rate system such as New York, and Tokyo. ( Schwartz, 1993 ) A drifting exchange rate would be a better barometer of economic instabilities.
Another advantage of a floating exchange rate system is that it can acquire back the independency of pecuniary policy. Hong Kong would be able to utilize appropriate pecuniary constabularies to stabilise and retrieve the economic system more quickly. This resolves the job of the US dollar pecuniary policy impeding the recovery of the economic system. A floating exchange rate would besides decide the jobs of plus rising prices to an extent because local assets will look more attractive to foreign invest. ( Charles,1997 )
After the crisis, most Asiatic states have chosen to follow a flexible exchange rate system in reaction to the dollar nog system they adopted before the crisis. In economic theory, a floating exchange rate would be more good during these times because it avoids overestimate and undervaluation. ( Tsang, 1999 ) Furthermore, it discourages speculators, as there is no mark that needs to be protected by the authorities. Hence, a floating exchange rate system encourages market subject, therefore cut downing the chances of a currency crisis happening.
However, a floating exchange rate system exposes little economic systems to interchange rate volatility. Most states in Asia after following the exchange rate system, faced volatility, nevertheless, little economic systems had the most trouble in covering with incorporating bad capital motions and onslaughts on their currency. This can take to interrupting growing and development of their economic systems while Asiatic economic systems grew quickly when they had a fixed exchange rate with less volatility. This is caused by a lessening in investings, which a flexible exchange rate system incurs. Hong Kong is a little economic system, therefore a floating exchange rate for that ground might non be optimum. Furthermore, with a floating exchange rate, the economic system may greatly fluctuate such as it did in the 1970s and 1980s. ( Charles, 1997 ) The volatility in fiscal assets that a free float would make is a future statement against the system.
In add-on, a floating exchange rate incurs an instability hazard particularly for a state like Hong Kong that is sing a well delicate period of political passage. There would be more volatility and it would be harder to command onslaughts on the currency and manage bad capital motions in a floating exchange government. Besides, Hong Kong might non hold the necessary instruments to command the money supply. The fiscal governments do n’t hold the substructure or tools to command involvement rate and does non embrace bank modesty demands. Last, a floating exchange rate system can decline the rising prices Hong Kong already every bit because it encourages rising prices. This occurs when import monetary values rise as the exchange rate falls. Therefore, a floating exchange rate might non be optimum as Hong Kong already faces a significant sum of rising prices around 4.0 % in 2007. ( Brender,2007 )
Another option for Hong Kong would be to re-peg the currency with the Chinese Renminebe ( CNY ) . Re-pegging the currency would take to markets theorizing on future re-pegging which causes a higher hazard premium in fiscal assets monetary values and consequences in a sustained addition in volatility. Re-pegging would profit more as a short-boost. There are many factors, which need to be considered with re-pegging to the Hong Kong dollar. First, the renminibi is still non a to the full exchangeable currency while the Hong Dollar is one, hence, its makes the peg rather impractical. Furthermore, it would take a long clip for the renminibi to develop into a modesty currency, which necessitates the presence of deep and liquid capital markets. However, even if the renminibi was to the full exchangeable there are many economic statements against making so. In malice of the economic ties between Hong Kong and China, both conutries are at different phases of economic develop hence they are both can confront different types of dazes. For illustration, China faces more internal dazes while Hong Kong faces both internal and external dazes outside the state, as it is an international fiscal centre. Most of Hong Kong ‘s international trade in goods and services is transacted in U.S. dollars. Additionally, there is no free motion of labour between China and Hong Kong. Hence, nail downing the currency might non be optimum.
However, Hong Kong today faces a misanthropic occasion that is out of sync with the US economic system and faces effects of the US pecuniary policy. Hong Kong has been faces an addition in rising prices over the old ages because the nominal involvement rates in Hong Kong must follow the U.S involvement rates. ( Charles,2007 ) Interest rates in U.S may still non lift any clip shortly and low involvement rates in Hong Kong would hike disbursement and increase belongings monetary values, which leads to farther rising prices.
Overall, the options to the fixed exchange rate system do hold its benefits nevertheless do n’t outweigh the fixed exchange rate system. Nail downing the Hong Kong Dollar to the reniminibi could be optimum but the job is the currency is non executable at the minute, so it could be an option after a twosome of old ages. On the other manus, a flexible exchange rate system would profit in footings of crisis but addition volatility and uncertainness. However, the fixed exchange rate system has long-run benefits that outweigh the short-run costs associated with misanthropic fluctuations that lead to high volatility and exchange rate rigidness. The fixed exchange rate has been a basis of pecuniary and fiscal stableness for Hong Kong and has anchored investor and consumer assurance. ( Tsang, 1999 ) Furthermore, Hong Kong has illustrated their flexibleness to dazes, which depicts a solid foundation for the hereafter. Hence, I believe that the fixed exchange rate pegged with the USD is yet optimum for Hong Kong dollar.
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