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 Richmans' Trade and Taxes Blog

After the Euro, Fluctuating Currencies
Raymond Richman, 6/10/2010

Edmund Conway reported in London’s The Sunday Telegraph June 5, 2010 that, in a survey he conducted of 25 leading “City” (the English equivalent of Wall Street) economists, “12 predicted that the euro would not survive in its current form this Parliamentary term, compared with eight who suspected it would. Five declared themselves undecided.” Our view is that the euro cannot be sustained any more than any system of fixed exchange rates can be sustained. Historically, no countries were able to maintain a fixed rate to gold so the Gold Standard had to give way to the gold exchange standard based on the U.S. dollar, which itself was revalued from $20 per ounce to $35, and then to no standard at all, the current system of relatively flexible exchange rates. We believe that the EU’s attempted Greek bailout may delay the demise of the euro but when and how the euro will be abandoned is uncertain. But it won’t be long. Even a fund twice or three times greater than the three-fourths of a trillion euros contemplated will not save the Euro. It will only bail out the banks that made foolish loans to “sovereign” countries expressed in unsovereign euros. The Royal Bank of Scotland Group issued a statement that the fund, while “Herculean,” might fail to save the euro and could usher in an extended period of market stress and disorder. We agree.

The fund, called The European Financial Stability Facility is being created backed by €440 billion in national guarantees, seeking to halt the spread of Greece’s debt crisis. The fund would sell bonds backed by ECB guarantees and use the money it raises to make loans to euro-area nations in need. The fund is part of a €750 billion aid package designed to combat sovereign debt crises like the one Greece is experiencing. Another 60 billion euros will come from the European Commission -- the EU’s executive arm -- and €250 billion from the International Monetary Fund to which the U.S. is the chief contributor. What business does the U.S. have to bail Europe out of its mistakes? Were it not for the fact that U.S. debt is expressed in U.S. dollars which the U.S. can print at will, the U.S. would long ago been forced into bankruptcy.  

We have criticized Obama’s economic stimulus plan because it does not address the causes of our recession and as a consequence will not end the recession. The European plan has the same fatal error. It does not address the cause of Greece’s problem, its chronic trade deficits. It assumes that Greece by balancing its fiscal budget will earn enough Euros to service any future debt. Economists for no sound theoretical reasons embrace free trade. All that economic theory supports is the benefits to all trading partners of balanced trade. The media share this bias. A news story in the WSJ, 6--8-10, informs its readers that exports surged 57.9 percent in Taiwan in May compared to the year earlier. Not a word about imports. The US Council of Economic Advisers in its annual reports over the past twenty years took pride in the fact that US exports rose in each of the last ten years without mentioning the dramatic increase in our trade deficits in goods which reached $800 billion in 2008. Germany, until recently the world’s leading trade surplus country, is not likely to seek aid from the fund.

The EU leaders hope that  the “sheer size” of the fund  will help to stabilize markets for each country’s debts. This is known as throwing money at a problem and if that doesn’t work, throw a lot more. Any loans from the fund would be accompanied by the kinds of budget- austerity conditions placed on  Greece as part of  the current agreement.  Not satisfied with protests in the streets, the EU is likely to cause blood to flow in the streets. How much better it would be if Greece’s debt were expressed in drachmas and the drachma was simply allowed to fluctuate freely.

Some mechanism must be found to allow Greece, Portugal, Spain, Italy and Ireland and others likely to get into trouble to reduce the value of their currencies relative to the euro. The simplest way would be to restore national currencies and let them float.