Lessons from the Euro zone debt crisis: Part III

Management of the euro crisis has exposed the complexity of a monetary union and thus a single currency in diversified economies with different cultural (languages) settings ranging from Anglo-Saxony to Roman, and reformed socialist economies of Eastern Europe. The various cultural settings as expected happen to espouse equally different monetary and fiscal cultures as well as political values that are so dear to their livelihood which bodes heavily on the mechanics and thus identity of the currency. These are issues beyond economics and not easy to fix using the conventional economic models that are known in book today. More so, the political elite as well as monetary authorities of these economies (true to other global economies), have been conditioned by international financial markets whose assessment of the underlying economies, and their real time reaction to economic mismanagement, receives severe penalties from financial markets. No political pressure can tame these global markets, no matter the might. It is a new global development. And one that has changed the entire global financial panorama and an indirect but effective means of monitoring economic management by political elite not only in the west but of late in Africa too. That global financial markets monitor the manner, in which political elite manage their economies, has its positive sides as well as negative. On the lighter side, this monitoring is quite transparent, fast and effective, especially in the manner in which it penalises economic mismanagement by freeing funds from these economies and or make such finance too expensive to use in public investments. On the other hand, these markets can literally stagnate economies with hardship yet can not address the damage thereafter.Political elite can only adjust this reality by changing the economic management in their countries. In light to the above, Hans Timmer, Director of Development Prospects at the World Bank says that; “Global capital market and investor sentiment are likely to remain volatile over the medium term – making economic policy setting difficult”. Thus for instance, the Greek contagion effect has caught up with Spain, and this could infect Portugal, Ireland and Italy. This is true, for as pointed in the earlier article, international financial markets and players have no boarders and their behavior impacts across boarders to determine the value and price of financial instruments traded on international financial markets. This fact therefore means that, their risk perception over a given country financial/economic stability cannot be wished or washed away by political rhetoric not even the real-politik. These are markets which are highly information efficient, where the action of one major investor is shared among others across board in real time. Central banks and other monetary authorities have their hands tied up in such environment for their traditional monetary or fiscal tools cannot mitigate by any measure the behavior of international investors/International financial markets. Like the impact of social media on all spheres of life in the western world, the impact of information efficiency of these international financial markets is an irreversible development to monetary systems world over and one we can only manage by through prudent economic management of our economies. Thus, recent Spanish bank €100 billion bailout ostensibly to recapitalize one of its largest banks which was under severe financial distress, has been perceived by global capital markets as a bailout for Spain, out pricing its debt to an all time high of 8.5 per cent cost of finance. The European Central Bank (ECB) has had its hands tied up by these financial markets without any option for recourse.Now, many economists and indeed euro-skeptics have adopted a “told-you-so” attitude in their analysis of the current crisis citing their earlier held view that some euro zone economies did not satisfy the classic conditions for a successful monetary union (i.e Optimum Currency Area - OCA Plus). If they did not, then the entire euro zone, did not meet this criteria either. It is these classic conditions among others that should inform the EA monetary project authorities to put measures in place that would avoid euro crisis in our region in the future. Among the essential conditions for a monetary union include: High degree of economic interdependency and opennessThis factor has been referred to as the ‘endogeneity of the OCA model. Substantial inter-trade among economies is one of the major conditions for a monetary union. Thus, if intra-trade among member countries accounts for most of the trade within a monetary union and as such partner countries are all affected by the same major external shocks (e.g oil shocks), the business cycles will be more synchronised and the members of the monetary union will certify the OCA model. The major reason for a monetary union is as argued in earlier articles, a reduction in transaction costs of intra-trade by eliminating foreign exchange risks and regional price harmonization. Nevertheless, trade among the EA member states is relatively too small to reap the benefits of low transaction costs and foreign exchange stability. According to available figures (2008) gross intra-EAC trade was 7.8 per cent of member’s total gross trade, and 3.1 per cent of their GDP (EAC, 2010). On contrary, in EU the value of trade was 26 per cent of GDP in 1998 and increased to 33 per cent in 2010. Even with the customs union in 2005, intra-regional trade represents only 17.5 per cent of total EAC exports and 7 per cent of imports.In contrast intra-euro-zone trade amounts to considerable more than half (60%) of total trade of euro zone countries. Thus, European Monetary Union (EMU) did fulfill OCA of high trade integration than currently is the case with EAC. Despite this however, studies indicate that, even with higher trade integration in EMU, benefits from reduction in transaction costs due to a common currency were estimated to be small, and this would even negligible for EAC.Furthermore, EAC currently trades more with outside world (than intra-trade), where close to 80 per cent of her trade is transacted by way of imports of finished or intermediate goods and exports mainly of primary products to external markets. Under these conditions, a common currency is irrelevant as it does not reduce transaction costs accruing to such high volumes and values of foreign trade. Rather, it is in the interest of member countries to peg their currencies to currencies of countries with which they have high volumes of trade, and US Dollar becomes a natural anchor as most payments are effected through US dollar. This is even more pertinent for terms of trade and relatives productivity are the main drivers of real exchange rate in EAC, which further questions the rational for a common currency at least in the short run under these trade structures. Thus, EAC countries are naturally more concerned with currency stability against major international currencies than among themselves, given their dismal intra-trade. Even then, trade among the EAC partner States happen to be of intermediate goods imported for re-export to the region thus minimizing the benefits/usage of the common currency in such trade. Besides, most of EAC economies are agro based to the extent to which up to more than 70 per cent of the production is agro products, which are either consumed locally, or traded a cross boarders in inconsequential values that a common currency would not benefit such small scale trade. If 70 per cent of our economies are agro based, this signalizes concentrated production void of diversification, a prerequisite to a currency unionThe latest discovery of oil in Uganda and Kenya, has also introduced another risk of divergence in natural resources that is structural change in EAC economies. Export boom of oil in these countries would fuel not only inflation, but also appreciation of real exchange rate across board undermining the exports of other non-oil producer partners in a monetary union. As pointed earlier, before another phase of integration is implemented, the previous phases should be at their optimality efficiency. In the case of EAC, Customs Union which was implemented in 2005, and a common market put in place in 2010, are yet to meet the conditions of optimality efficiency according to recent studies. These have to be optimally efficient for a common currency to make sense, for it serves to enhance their operations. This (as will be pointed out later in the series) therefore means that, the road map to EAC monetary union, will be much longer than politicians would want the same to be. To be continued…

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Lessons from the Euro zone debt crisis: Part III