Table of Content - limun.org.uk1).pdf · History of the Eurozone and statement of the problem ... but overall affect the economic, ... Karl Gunnar Persson,“Economic History of Europe”,

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LONDON INTERNATIONAL MODEL UNITED NATIONS 2018

Table of Content

International Monetary Fund London International Model United Nations 19th Session | 2018

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Table of Contents

Introduction Letter ........................................................................................................................ 3

Introduction to Committee ........................................................................................................... 4

Regulation and challenges of digital currencies ........................................................................ 5

History of the problem ................................................................................................................. 5

Statement of the problem ............................................................................................................ 8

Current situation ........................................................................................................................ 10

Bloc positions ............................................................................................................................ 11

Questions working paper should answer ................................................................................... 13

Role of the IMF in the regulation of the Eurozone crisis .......................................................... 15

History of the Eurozone and statement of the problem .............................................................. 17

Current situation ........................................................................................................................ 21

Bloc positions ............................................................................................................................ 23

Questions working paper should answer ................................................................................... 23

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Introduction Letters

Dear Directors,

Congratulations on being selected to partake in the Executive Board of the

International Monetary Fund!

We have decided to challenge you with two topics that are very relevant not

only between the walls of the IMF, but overall affect the economic, financial

and technology space, with cryptocurrencies determining the future of

monetary payment system and the structure of the Eurozone determining the

economic system of 340 million Europeans. Needless to say, it is imperative

for you to pursue additional research outside of this study guide, which should

be perceived only as a springboard for you. We are extremely excited to spend

the weekend with you in the IMF committee!

Please do not hesitate to contact us on [email protected].

mailto:[email protected]

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Introduction to the Committee

The International Monetary Fund (IMF) was established alongside the World

Bank and the General Agreement on Tariffs and Trade (GATT) at Bretton

Woods conference in 1944 and came into being in December 1945, with the

Articles of Agreement being signed by 29 member states1. The system of the

Bretton Woods institutions was the first example of a negotiated monetary

order aiming to manage exchange rates and tackle imbalances of payments.

The mandate of the IMF has been updated in 2012 to include all

macroeconomic and financial sector issues that can impact global stability,

which brings us to the two topics in this guide that fall into the expanded

mandate of the institution. The Executive Board within the IMF oversees the

conduct of its day-to-day business and consists of 24 Directors, who are

elected by the member countries of by a group of countries.

1

Karl Gunnar Persson,“Economic History of Europe”, Chapter 1

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Topic A: Regulation and challenges of

digital currencies

Introduction

Digital currencies, otherwise referred to as cryptocurrencies, are relatively a new

phenomenon available only in digital form – not in physical cash and coin. Some of

their properties are similar to physical currencies; however the main difference lies in

the possibility of instantaneous transactions and a borderless nature. The purchasing

power of the digital currencies, including the most discussed one, Bitcoin, is not

regulated by a central bank of any government (like the usual physical currency), but

by a hard limit of 21 million on the number of coins issued. Therefore, digital

currencies due to their country dis-alignment are currently not bound by the IMF’s

guidelines. Additionally, digital currencies operate directly under user anonymity

umbrella, eliminating the need of banks for storage and transaction activity.

History of the Problem

Digital currencies are ‘defined as a digital representation of value that is

neither issued by a central bank or public authority nor necessarily attached to

a fiat currency, but is used by natural or legal persons as a means of exchange

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and can be transferred, stored or traded electronically’ 2 . Digital

currencies are based on the peer-to-peer transaction system, eliminating the

need for correspondent banking and clearing houses in the middle.

Crypto-currencies are a type of digital currency, and use cryptography to

guarantee its security. In addition, the process of ‘mining’ is undertaken by a

computer of the ‘miner’ or user in order to obtain a certain amount of the

currency, instead of a central authority/firm issuing the currency. Since there is

not a central issuer and registry, crypto-currencies can easily be lost in the case

of a computer crash and an absence of a backup.

Digital currencies3:

Bitcoin – introduced in 2009 as a decentralized currency platform, which

was a shift form the traditional ownership by individuals or firms, as

monetary value is determined by its owners – users. Market cap in

November 2017 was $107Bn with a supply of 16MM Btc4.

Ripple – a real-time gross settlement (RTGS) and currency exchange

enabling secure, instant and cheap global financial transactions based on

a public ledger. Market cap in December was $72Bn with a supply of 39

Bn XRP.

Ethereum – Public and block-chain based distributed computing

platform featuring scripting functionality. Market cap in November 2017

was $30Bn with supply of 97MM ETH5.

Litecoin – based on Bitcoin, however intended to improve Bitcoin’s

inefficiencies – faster block times and different mining algorithm.

2 Eba.europa.eu. (2017). Cite a Website - Cite This For Me. [online] Available at:

https://www.eba.europa.eu/documents/10180/657547/EBA-Op-2014-08+Opinion+on+Virtual+Currencies.pdf

[Accessed 4 Nov. 2017]. 3 Directors are encouraged to dive into addressing digital currencies overall, or take an approach to center the discussion

on only few. 4 Coinmarketcap.com. (2017). Cryptocurrency Market Capitalizations | CoinMarketCap. [online] Available at:

https://coinmarketcap.com/ [Accessed 3 Nov. 2017]. 5 Ibid.

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Market cap in December 2017 was $13Bn with a supply of 54MM

LTC6.

Coinmarketcap.com listed in November 2017 over 1,200 crypto-

currencies with the whole market valuing up to $203Bn7.

So far, we have not experienced digital currencies (even the two most

prominent ones) to pose a direct threat to the established currencies as they are

still considered very volatile, risky and underlying technologies do not allow

for wide-spread application. The challenge that is to be addressed by the

international community, is to prepare for the time, when the short-comings are

addressed and the usage of digital currencies increases. Seeing the recent boom

of investors in digital currencies, and Bitcoin passing the $10,000 mark, the

IMF underscored the need of regulations of cryptocurrencies8.

Digital payments

In order for the digital currencies to flourish and gain its users, consumers have

to have appetite for digital payments and digital wallets. Forms of payments

have evolved over the past decades from cheques, cash and coin, to expensive

payment wires and over-the-counter instructed transactions, to electronic

banking through pre-funded accounts and now to digital payment services

through digital wallets. The movement away from tangible ways of payments

to digital and notional has been accelerating, however for countries to adopt

such measures, it is yet to be determined what levels of education might be

required. It is important to keep in mind that sites such as Paypal or Alipay for

example are only ‘e-money’ providers as they operate in already existing

currencies.

6 Ibid. 7 Ibid. 8 ETCIO.com. (2017). Bitcoin: White House, IMF turn focus on cryptocurrencies - ET CIO. [online] Available at:

https://cio.economictimes.indiatimes.com/news/internet/bitcoin-white-house-imf-turn-focus-on-

cryptocurrencies/61888178 [Accessed 15 Dec. 2017].

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Statement of the Problem

Speculative attack

In the case of ‘speculative attack’, the IMF remains powerless since digital

currencies lack a central regulator, leaving them outside of IMF’s scope of

influence. If digital currencies gain further users and become a form of

international currency, they can represent a major risk to the stability of the

global economy. Speculative attacks on a currency occur when investors aim to

take advantage of a weak currency, and if left without an intervention, the

attack leads to further depreciation, de-stabilizing the foreign exchange market

and economies linked to such currency. According to the Articles of

Agreement9, the IMF can obtain and release holdings of its members’ currency

and therefore influence the supply and flow of that currency in the economy in

order to counter the speculative attack.

Bitcoins are generated by a computer on an on-going basis and are all supposed

to be released by 2025. Due to its finite supply, their value is expected to

increase. If the IMF was to obtain Bitcoin or any other digital currency to

counter such a speculative attack to maintain stability, the potential costs of

such intervention are constantly increasing. However, prior to such

consideration, the Directors have to consider number of central factors

including the decentralization and independence of digital currencies. The

Articles of Agreement allow the IMF to only acquire holdings and influence

flow of currencies of its members or in other words – signatories of the

Articles of Agreement. However, Bitcoin and other digital currencies are not

issued by the sovereigns themselves, but either by individuals or firms or

mined by users themselves. These users cannot become members of the IMF,

and they are not considered official financial institutions of the member states,

which creates a visible gap for the IMF in its mandate.

9 Imf.org. (2017). Articles of Agreement of the International Monetary Fund -- 2016 Edition. [online] Available at:

https://www.imf.org/external/pubs/ft/aa/ [Accessed 1 Nov. 2017].

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Cyber-crime and money laundering

Due to its nature, digital currencies are very prone to money laundering and

cyber-attacks, and a number of them have ceased to exist due to the very

reason – E-gold or Liberty Reserve. The last mentioned has been primarily

used by cyber-criminals to launder illegally obtained funds since transactions

could have been processed anonymously. Users would ‘convert’ cash into the

digital currency for a fee of £1.98, and on the back of that transaction, another

conversion was instantaneously made to convert into real-world currency10.

The anonymity and decentralization are the most attractive features of digital

currencies for avoiding internationally established sanctions, funding drug

trade or human trafficking.

Like security of every currency, security of digital currencies depends on the

cyber-security of the digital wallets and exchanges that holds the currency for

its user. Ether and Bitcoin, even as the most mature digital currencies, are

prone to hacking. Attacks by hackers, such as the incident in July 2017 where

$32.6 MM of Ether was stolen, affect the market and can lead to unpredictable

and un-controllable fluctuations and instability11. Even though we see foreign

exchange markets constantly fluctuating, governments have the toolbox to

intervene in the case of a rapid depreciation of a currency. Digital currencies so

far lack the availability of such toolbox to protect ‘bank runs’.

State-backed digital currencies

China has recently been testing transactions of state-backed digital currencies

that would be ‘treated as cash and used in digital wallets managed by

commercial banks’12. This would constitute a departure from the independent

digital currencies addressed up to this point. However, in addition to the

10 BBC News. (2017). Digital money boss jailed for 20 years. [online] Available at:

http://www.bbc.co.uk/news/technology-36247289 [Accessed 8 Nov. 2017]. 11 Forbes.com. (2017). Forbes Welcome. [online] Available at: https://www.forbes.com/sites/sarahsu/2017/10/19/will-

china-host-the-worlds-biggest-state-backed-digital-currency/#3a2304e51231 [Accessed 8 Nov. 2017]. 12 Forbes.com. (2017). Forbes Welcome. [online] Available at: https://www.forbes.com/sites/sarahsu/2017/10/19/will-

china-host-the-worlds-biggest-state-backed-digital-currency/#3a2304e51231 [Accessed 8 Nov. 2017].

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benefit of reduced transaction costs, greater transparency (due to the

state control) would lower the incidents of money laundering and tax evasion.

In addition, Sweden, UK or Canada have also been considering adoption of

state-backed digital currencies, while some countries have already made the

step such as Ecuador, Tunisia and Senegal13.

Current Situation

Special Drawing Right (SDR) currency

The IMF has been aware of the risks and benefits that digital currencies pose to

the international monetary system, with Christine Lagarde addressing the

challenges on numerous occasions. Most recently, the Managing Director has

stated that ‘we are about to see massive disruptions’14 in the digital currencies

space. At the same occasion, the IMF Director did not rule out the possibility

of incorporating crypto-currency technologies into its own created Special

Drawing Right (SDR) currency to achieve higher efficiency and lower costs.

Current regulation

For the Fund, the challenge is to take necessary precautions without further due

as it appears to be one of the matters that does not age well. So far, no attempt

has been made at establishing international regulatory norm of digital

currencies at the IMF or any other international institution. The New York

State Department of Financial Services has so far presented the only regulatory

document of Bitcoin called BitLicense15.

Reading the Articles of Agreement16, the IMF as mentioned in the introduction,

has the mandate to ‘maintain orderly exchange arrangements among members,

and to avoid competitive exchange depreciation’. As with all international

13 Ibid. 14 Schulze, E. (2017). 'We are about to see massive disruptions': IMF chief on digital currency future. [online] CNBC.

Available at: https://www.cnbc.com/2017/10/13/bitcoin-get-serious-about-digital-currency-imf-christine-lagarde-

says.html [Accessed 3 Nov. 2017]. 15 Dfs.ny.gov. (2017). Cite a Website - Cite This For Me. [online] Available at:

http://www.dfs.ny.gov/legal/regulations/revised_vc_regulation.pdf [Accessed 11 Nov. 2017]. 16 Imf.org. (2017). Articles of Agreement of the International Monetary Fund -- 2016 Edition. [online] Available at:

https://www.imf.org/external/pubs/ft/aa/ [Accessed 1 Nov. 2017].

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institutions, the challenge of enforcement also exists in the digital

currency space. Despite the understanding that due to its wide-spread

membership, IMF is able to conduct a comprehensive international response on

the matter, there are still number of obstacles. The question that needs to be

answered is whether digital currencies are indeed within the scope of this

definition as challenged before.

The Directors are encouraged to research the following possibilities including

the benefits and disadvantages, however should also expand the search for

alternatives:

1. Expanding the interpretation of ‘currencies’ in the Articles of Agreement

and incorporate digital currencies into IMF’s monetary regime,

2. Granting digital currencies a semi-currency membership status,

3. Incorporate non-state actors into the Articles of Agreement of the IMF.

The IMF has always faced criticism for not being able to adapt to changing

economic thinking and financial needs of its member countries. The ability of

the Fund to incorporate digital currencies into its legal framework, would allow

the IMF to remain a relevant regulator within the ever-developing financial

space.

Bloc positions

The Executive Board is made up of 24 Directors – some Directors will

represent a single country and some will represent a grouping of countries with

different allocations of voting rights. Digital currencies operate on a global

nature, making national efforts almost negligible without international co-

operation. Majority of countries have issued national communications or white

papers on their stances towards regulation.

Member states have varying opinions on digital currencies including the

following:

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Despite the government opposing digital currencies such as

Bitcoin, the People’s Bank of China (PBOC) has been working on

introducing a state-backed digital currency17. The Bank of Canada has

also been exploring the possibility of creating its own version of

currency on distributed ledger and a number of central banks, including

the Bank of England have written publications analysing the

implications of Central banks issuing digital currencies – especially

pointing out that due to the absence of a precedent, important questions

remain unanswered18.

The UK has issued warnings reminding the public about the risks of

initial coin offerings (ICOs) with the US Securities and Exchange

Commission hinting it might start regulating ICOs as well19. Kremlin in

the meantime has issued a statement that it will regulate ICOs by July

201820.

Member states facing the issue of un-banked citizens and rural areas

with less access to established banking providers see a future potential in

using digital currencies as a way to provide banking connectivity to

larger population.

Directors have to bear in mind the safety of the international monetary and

financial system, however also be guided by the national interests that may be

influenced by the very subjects of the potential regulation. One might argue

that the entire framework of digital currencies is based on its ability to operate

without its dependency on the nation-states, which Directors should keep in

17 Forbes.com. (2017). Forbes Welcome. [online] Available at: https://www.forbes.com/sites/sarahsu/2017/10/19/will-

china-host-the-worlds-biggest-state-backed-digital-currency/#3a2304e51231 [Accessed 8 Nov. 2017]. 18 Euromoney. (2017). Celent calls on central banks to issue their own digital currencies. [online] Available at:

https://www.euromoney.com/article/b12kpwlr3gtmbb/celent-calls-on-central-banks-to-issue-their-own-digital-

currencies [Accessed 15 Dec. 2017]. 19 South China Morning Post. (2017). Why has China declared war on bitcoin?. [online] Available at:

http://www.scmp.com/news/china/economy/article/2111456/why-has-china-declared-war-bitcoin-and-digital-currencies

[Accessed 11 Nov. 2017]. 20 Cointelegraph. (2017). Putin Confirms Russia Will Regulate ICOs, Mining By July 2018. [online] Available at:

https://cointelegraph.com/news/putin-confirms-russia-will-regulate-icos-mining-by-july-2018 [Accessed 15 Dec. 2017].

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mind. Number of Directors will face the challenge of representing a

group of countries rather than only one, in such instance, the Director should

bear in mind interests and economic rationale applicable to all countries within

the group.

Questions a Working Paper Should Answer

Is IMF the main regulator for digital currencies? (Address from a

number of stand-points)

Should IMF regulate only the mature digital currencies, or focus on all?

Are digital currencies to be incorporated into the IMF regime and dealt

with as fiat currencies, or should the international community establish

different set rules for them?

Should the IMF obtain digital currencies directly or use states as

intermediaries?

Is there a sufficient demand for digital currencies (payments) in the

market to justify the creation of a regulation – in other words, will digital

currencies remain relevant?

In the case of sovereign governments issuing state-backed

cryptocurrencies, how should the approach of the IMF differ?

Sources

BBC News. (2017). Digital money boss jailed for 20 years. [online] Available at:

http://www.bbc.co.uk/news/technology-36247289 [Accessed 8 Nov. 2017].

Coinmarketcap.com. (2017). Cryptocurrency Market Capitalizations | CoinMarketCap. [online]

Available at: https://coinmarketcap.com/ [Accessed 3 Nov. 2017].

Dfs.ny.gov. (2017). [online] Available at:

http://www.dfs.ny.gov/legal/regulations/revised_vc_regulation.pdf [Accessed 13 Nov. 2017].

Eba.europa.eu. (2017). online] Available at:

https://www.eba.europa.eu/documents/10180/657547/EBA-Op-2014-

08+Opinion+on+Virtual+Currencies.pdf [Accessed 4 Nov. 2017].

ETCIO.com. (2017). Bitcoin: White House, IMF turn focus on cryptocurrencies - ET CIO. [online]

Available at: https://cio.economictimes.indiatimes.com/news/internet/bitcoin-white-house-imf-turn-

focus-on-cryptocurrencies/61888178 [Accessed 15 Dec. 2017].

Euromoney. (2017). Celent calls on central banks to issue their own digital currencies. [online]

Available at: https://www.euromoney.com/article/b12kpwlr3gtmbb/celent-calls-on-central-banks-

to-issue-their-own-digital-currencies [Accessed 15 Dec. 2017].

Forbes.com. (2017). Forbes Welcome. [online] Available at:

https://www.forbes.com/sites/sarahsu/2017/10/19/will-china-host-the-worlds-biggest-state-backed-

digital-currency/#3a2304e51231 [Accessed 8 Nov. 2017].

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Imf.org. (2017). Articles of Agreement of the International Monetary Fund -- 2016 Edition.

[online] Available at: https://www.imf.org/external/pubs/ft/aa/ [Accessed 1 Nov. 2017].

Cointelegraph. (2017). Putin Confirms Russia Will Regulate ICOs, Mining By July 2018. [online]

Available at: https://cointelegraph.com/news/putin-confirms-russia-will-regulate-icos-mining-by-

july-2018 [Accessed 15 Dec. 2017].

Schulze, E. (2017). 'We are about to see massive disruptions': IMF chief on digital currency future.

[online] CNBC. Available at: https://www.cnbc.com/2017/10/13/bitcoin-get-serious-about-digital-

currency-imf-christine-lagarde-says.html [Accessed 3 Nov. 2017].

South China Morning Post. (2017). Why has China declared war on bitcoin?. [online] Available at:

http://www.scmp.com/news/china/economy/article/2111456/why-has-china-declared-war-bitcoin-

and-digital-currencies [Accessed 11 Nov. 2017].

Recommended reading:

European Banking Authority: EBA Opinion on ‘virtual currencies’

https://www.eba.europa.eu/documents/10180/657547/EBA-Op-2014-

08+Opinion+on+Virtual+Currencies.pdf

Central Banks considering Bitcoin’s technology:

https://www.nytimes.com/2016/10/12/business/dealbook/central-banks-

consider-bitcoins-technology-if-not-bitcoin.html

Most important currencies other than Bitcoin:

https://www.investopedia.com/tech/6-most-important-cryptocurrencies-

other-bitcoin/

Central banks buying cryptocurrencies as a reserve currency in 2018:

https://www.coindesk.com/2018-year-central-banks-begin-buying-

cryptocurrency/



https://www.nytimes.com/2016/10/12/business/dealbook/central-banks-consider-bitcoins-technology-if-not-bitcoin.html

https://www.nytimes.com/2016/10/12/business/dealbook/central-banks-consider-bitcoins-technology-if-not-bitcoin.html

https://www.investopedia.com/tech/6-most-important-cryptocurrencies-other-bitcoin/

https://www.investopedia.com/tech/6-most-important-cryptocurrencies-other-bitcoin/

https://www.coindesk.com/2018-year-central-banks-begin-buying-cryptocurrency/

https://www.coindesk.com/2018-year-central-banks-begin-buying-cryptocurrency/

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Topic B: Role of the IMF in the

Eurozone financial crisis

Introduction

Roughly a decade after the global financial crisis of 2007-2008, Eurozone growth is

finally returning to pre-crisis levels of 1-2% annual GDP [Eurostat].

Supporters of European policy and decisions taken during the financial crisis and in

the subsequent sovereign debt crisis which hit Greece the hardest laud and commend

these figures as proof of the success of the way the EU and the Eurozone dealt with

these issues.

However, a cursory glance at the figures reveals the following: Germany, the best-

performing member of the Eurozone and the one frequently looked up to as evidence

of its success, has posted an annualised GDP growth figure of only 0.8% a year over

the past decade, an underwhelming figure [Stiglitz]. Spain, the poster-child of

economic recovery following recent quarters of reported annualised 3% GDP growth,

had still not reached its 2008 GDP in 2015, a full seven years after the financial

crisis. Meanwhile, Greek GDP is a full 28% below its pre-crisis level, meaning that it

is likely several decades before Greek citizens will see the same level of prosperity


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they had in 2007 [Eurostat]. Over 1 in 5 Greek workers lost their jobs. Wages

fell an equivalent amount, meaning that a Greek worker in 2008 earning €30,000

would have only earned around €24,000 five years later - in effect, a €6,000 wage

cut, provided the worker was able to retain their job in an era of >65% youth

unemployment and 27% overall unemployment resulting in 3.5 million employed

people support 4.7 million unemployed or inactive Greeks. Comparing this to the

4.9% drop in GDP that the United Kingdom suffered during the Great Depression

puts the suffering of many citizens of the European Union in context and partially

explains the tide of anti-EU sentiment following the sovereign debt crisis.

One might have expected that a financial crisis originating in the United States and

most heavily affecting U.S. companies and consumers would affect the host country

most deeply, and expect some spill over effects onto companies integrated into the

American system such as European banks. However, the U.S. pulled itself out with a

bailout package and returned to growth in a short space of a few years, whereas the

Eurozone has experienced a lost decade, barely climbing to pre-crisis peaks today.

No European can claim that the way the Eurozone dealt with the financial crisis and

the subsequent fallout was successful. The risk that the next financial crisis might

overwhelm the Eurozone and cause its collapse by members exiting (as Greece was

close to doing in 2015) is very high without Eurozone reform, and the consequences

for global financial stability and millions of livelihoods and businesses are dire.

The International Monetary Fund, as the main international body involved with

rescue and bailouts of sovereign nations, has a duty to investigate and produce a

report which stakeholders such as governments can refer to in order to design policy

which will promote global financial stability.

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History of the Eurozone and statement of the problem

The Exchange Rate Mechanism and pegging to the Deutsche Mark

The Eurozone as an entity technically came into being when its founding members

decided to create the Exchange Rate Mechanism (ERM) in 1979, where they pledged

to peg their currency values to each other at fixed rates, not being allowed to fluctuate

within a certain percentage margin of the agreement (a semi-pegged system). The

original participants of the ERM in 1979 included France, Germany, Ireland, Italy,

the Benelux countries (Belgium, the Netherlands, and Luxembourg, Denmark, and

the United Kingdom. The currency of West Germany, the Deutsche Mark, served as a

de facto anchor for the pegs, meaning that to join the ERM a member state had only

to agree a rate to peg their currency against the Deutsche Mark. This was due to the

manufacturing strength (which contributed greatly to the overall strength of its

economy) of West Germany after the United States and other Allies helped rebuild it

after the Second World War.

Interest rates and the arsenal of central bankers

The weapons by which central banks enforced (or attempted to enforce) the peg were

two-fold: fiscal and monetary. The fiscal tool central banks had was the ability to

boost the supply of their currency by issuing more of it. An increased supply would

reduce demand of the currency in the marketplace, decreasing the value of the

currency. Conversely, central banks can use their currency reserves to buy up the

currency, lifting the price.

The monetary tool which central banks used is the ability to change interest rates. A

drop in interest rates would make saving or investing in the currency less attractive,

devaluing the currency, and a rise in interest rates would make saving or investing in

the currency more attractive, increasing its value. However, the adjustments of

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interest rates have macroeconomic side effects - interest rates are also used to

combat inflation (reducing demand by increasing rates) and boost the economy

(encourage spending and consumption by discouraging saving). In other words, if it

is cheap to borrow in a low-interest rate environment, businesses and consumers in

general will do so and invest the money now in order to make profits later,

stimulating the economy. On the other hand, if there is too much currency supply in

the economy, its purchasing power will decrease and prices will rise. Hyperinflation

is the term used to describe when prices rise beyond control - during the Great

Depression in 1930s Germany, an apocryphal anecdote tells the story of a family who

sell their house to move abroad but by the time they reach the port they can no longer

afford the tickets as prices have risen so far in the meantime. Images of citizens

pushing wheelbarrows of currency in order to buy bread are ubiquitous and Germans

used currency as fuel as the paper they were printed on became more valuable than

their purchasing power. Interest rate rises encourage saving and discourage spending

and therefore help keep a lid on price increases. Deflation is another situation to be

avoided at all costs: when prices are falling year on year, consumers and businesses

will hold off purchases as they will be cheaper next year and this will create a vicious

cycle which damages businesses which further decreases wages and demand and

therefore inflation.

To sum up the above, central banks are faced with treading a very fine line between

making sure there is enough money in circulation in the economy to allow for growth

but not too much that prices spiral out of control, or not too little that the country is at

risk of deflation. In a free-market context, a free-floating currency is simply a by-

product of the above policies and allows the currency to be valued and international

importers and exporters to determine the value of the assets and goods produced in

that country. However, adding a certain currency target as a goal of a central bank

adds another dimension which restrains the capability of central banks to react to

economic events: usually they will be able to choose between adapting to current

market circumstances or maintaining a currency peg, but not both.

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Foreign exchange risk

The upside to a currency union is to eliminate foreign exchange (FX) risk from the

markets. In the case of a business, it removes the chance of a destination’s currency

suddenly depreciating and potentially eliminating profits. For example, Mexican car

manufacturers exporting to the United States must deal with the risk of either the

Mexican peso suddenly appreciating against the dollar or the dollar suddenly

depreciating against the peso. A French appliances company who exports to other

members of the Eurozone, however, experiences no FX risk (other than the risk of the

Eurozone breaking up, which has been non-zero in recent years) and can plan ahead

without having foreign exchange fluctuations affect its business. Foreign exchange

risk is related and depends on many factors, but mainly involves changes in political

stability and macroeconomic outlook. Investment banks, inherently risk-taking

organisations, offer companies and governments financial products and services to

help hedge against FX risk where it exists - and therefore, even in the case where

different currencies exist, the specific financial products used to deal with FX risk are

so common and cheap that the cost is not great to the businesses who require them.

Socially, a currency union removes a physical and psychological barrier to trade and

tourism for individual humans although it is difficult to quantify this benefit in

precise economic terms.

The architects of the Eurozone, primarily the French President Francois Mitterand

and the German Chancellor Helmut Kohl, hoped that political union would follow

monetary union and countries’ economies would converge with one another. The

logic goes as follows: with a common currency or currencies fixed to one another

permanently, businesses would be encouraged to invest across the entire currency

union and that this would create a single area across which businesses would compete

with each other and the best products and services for all consumers would emerge.

The freedoms of goods, services, labour, and capital contribute to the competitiveness

of the market and the European Court of Justice would arbitrate disputes between

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companies. Increased tourism and the ease of moving and working between

different countries in the Eurozone would promote diversity and encourage an

inclusiveness unique to Europeans.

Fixing exchange rates had several macroeconomic effects. The primary effect was

that central banks could no longer respond to geopolitical or economic events which

happened to them by using fiscal policy as a tool once the currency peg had

commenced. Events which affected different countries in different manners in ways

which would naturally be balanced out with the alteration of currency levels instead

attacked economies with constrained currency rates relative to one another. Germany,

for example, has a manufacturing sector which has hugely benefited from fixed

exchange rates and has defeated competition across the Eurozone, leading to a large

trade surplus in Germany. Countries stricken by crisis, on the other hand, have been

unable to devalue their currencies when their economies were weakened and have

only two options left to them if they wish to remain in the currency union: have their

deficits covered by other members of the currency union who are currently enjoying

competitive advantages or implement harsh austerity measures in order to reduce

their deficits.

To illustrate this, take the example of England and Scotland, two nations in a

currency union sharing the British pound. The drop in oil prices in 2015 led to

Scotland, heavily dependent on North Sea oil output, with a large fiscal deficit

nearing 10% of GDP - unsustainable in a typical developed economy [Scottish

Government]. However, the political union of the two nations and the willingness of

‘England’ to ‘lend’ money to Scotland until oil prices recover (and vice versa when

oil prices are high and Scotland runs a surplus) erode the potential ill effects of

Scotland’s currency not being able to devalue when its economy is weak in order to

stage a recovery.

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If the rest of the United Kingdom had forced Scotland to cut back its public

spending in areas from health, social security, and education due to a drop in the oil

price, one can only imagine what would have happened to the independence

movement!

The Euro and the Maastricht Treaty

The euro replaced the ERM on 1 January 1999 [ECB]. It is important to note that the

macroeconomic effects of sharing a single currency between many member states

were already in place due to the ERM eliminating almost all foreign exchange risk

between different countries, due to the pegging to the Deutsche Mark. The biggest

impact of the creation of the Euro was the creation of the European Central Bank,

governed by the Maastricht Treaty. The Maastricht Treaty, one of the most important

components of the Eurozone architecture, sets strict limits on member states’ fiscal

policy including the infamous 3% deficit limit, an upper bound of 80% debt of GDP,

and convergence criteria of new potential members of the Eurozone.

Current situation

Global financial crisis and European sovereign debt crisis

The global financial crisis of 2008 was caused by many factors, the most commonly

agreed on being an oversupply of credit. Money being cheap to borrow (relatively

low interest rates) meant that banks lent more and more in order to compete with each

other on profits. In addition, lack of regulation and opaqueness of certain markets,

especially bundled high yield products, meant that there was not enough governance

and risk assessment around these products, causing an eventual crash when investors

discovered that certain products such as bundled subprime mortgages were

overpriced.

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Banks were so overstretched that the lack of liquidity was the main issue -

some banks were lending thirty times their deposits which meant that a bank run

(sudden withdrawal of deposits by creditors) might have meant that the bank may

have to cease operations immediately. A lack of liquidity was the main reason

Lehman Brothers defaulted - no other banks were willing to provide it liquidity at the

time of a crunch.

Providing aid to the ailing banks - whose default would have caused a much worse

recession as the savings of large and small businesses and consumers worldwide

would have been wiped out with no path of recovery - was restricted by the currency

union. Individual finance ministers from different Eurozone countries could not do

much due to the requirement of the European Central Bank and various other

European Institutions to collectively agree and implement a solution.

A series of successive solutions including the European Financial Stability Facility,

European Financial Stability Mechanism and their more permanent successor the

European Stability Mechanism (ESM) eventually contributed to the bailout by

providing cheap funding for European banks. However, the political situation and the

way the Eurozone bailouts were negotiated are widely seen to prolong the crisis and

delay the financial support that member states needed.

Today, the Eurozone has recovered to a ‘good’ rate of growth of annualised 2.5% as

of Q3 2017 [Eurostat]. However, two primary concerns remain: long-term sustainable

growth considering the demographics of the Eurozone as well as the actions of the

Eurozone during another financial crisis or recession.

One has to be careful when looking at growth figures - since they are expressed in

percentages, figures may be misleading in assessing performance after a recession. If

both country A and B have a GDP of 100, a recession brings A down to 90 and B

down to 80, and post-recession both A and B experience 1% annual growth, A will

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grow 0.9 and B will grow 0.8 - the growth rates are not the same and are

dependent on the depth of the recession. The length of the recession also affects

overall GDP, as each additional year of recession is another year of no growth.

Bloc positions

The IMF is grouped into country bloc positions. Information on voting rights may be

found in the addendum. Delegates should note that the IMF is freer than standard GA

committees in terms of country positions as it is supposed to be a board of

economists, not ambassadors of various political ministries. Therefore, although each

country bloc has a rough ‘position’ the role of the IMF was never meant to act as a

political roundtable, but rather as a place where economic agreement could be

reached first.

The overarching goals of most non-Eurozone member states is to, if participating in

an IMF bailout of a European country, make sure that they eventually recover their

taxpayer’s money and keep the global financial system stable. These aims may seem

contradictory at times but middle ground solutions have been proposed by prominent

figures (and it is the responsibility of the individual delegate to research or think

these up herself and present and debate them at the committee)!

Questions a working paper should address

The main issues a working paper should cover, in order of priority, are:

What is the current state of the Eurozone’s financial architecture (ECB, bailout

mechanisms, common debt, banking union, finance minister)? What can be

done to increase its efficacy and stability? (Note: the IMF is able to make

recommendations to the Eurozone and Euro group via its research paper; even

though it cannot effect these changes itself, its research is influential.)

What is the role of the IMF as a bailout negotiator if it happens again in the

context of a monetary union?

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Sovereignty - what role does the IMF have to play in considering

member states’ sovereignty? Is it within the remit of the IMF to consider

democratic pressures from citizens of target states? How far should this go?

Where does the remit of the IMF end when trying to promote global financial

stability?

Politicisation - owing to recent scandals and potential conflicts of interest, how

can the IMF introspectively look at itself and be seen as an impartial arbitrator?

In addition, what recommendations can the IMF make to the Euro group to

make sure that adverse political situations do not affect the efficacy of its

bailout solutions? (Should the IMF offer these recommendations in the first

place?)

Bibliography

[Stiglitz] The Euro and its threat to the future of Europe, Joseph E. Stiglitz

[Varoufakis] Adults in the Room, Yanis Varoufakis

[Scottish Government] http://www.gov.scot/Publications/2017/08/7201

[Eurostat]

http://ec.europa.eu/eurostat/tgm/table.do?tab=table&plugin=1&language=en&

pcode=tec00001

Crisis in the Eurozone, Costas Lapavitsas

Against the Troika: Crisis and Austerity in the Eurozone, Heiner Flassbeck and

Costas Lapavitsas

Integrating Gender: Women, Law and Politics in the European Union,

Catherine Hoskyns

What Does Europe Want?: The Union and Its Discontents, Slavoj Žižek,

Srecko Horvat

The Euro Crisis and Its Aftermath, Jean Pisani-Ferry

Buying Time: The Delayed Crisis of Democratic Capitalism, Wolfgang Streeck

The Crisis of the European Union: A Response, Jurgen Habermas

http://www.gov.scot/Publications/2017/08/7201

http://ec.europa.eu/eurostat/tgm/table.do?tab=table&plugin=1&language=en&pcode=tec00001

http://ec.europa.eu/eurostat/tgm/table.do?tab=table&plugin=1&language=en&pcode=tec00001

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The Battle for Europe: How an Elite Hijacked a Continent and How We

Can Take it Back, Thomas Fazi

Postwar, Tony Judt

The Euro, David Marsh

The Future of the Euro, Matthias Matthijs and Mark Blyth

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Conference Information

When looking for information regarding LIMUN 2018 (and subsequent

editions) your first step should be to visit our website: www.limun.org.uk

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Agenda & Rules of Procedure

The agenda for the 2018 conference is available online at

www.limun.org.uk/agenda

The Rules of Procedure can be accessed here: http://limun.org.uk/rules

Documents

Table of Content - limun.org.uk1).pdf · History of the Eurozone and statement of the problem ... but overall affect the economic, ... Karl Gunnar Persson,“Economic History of Europe”,