The Euro and the Great Currency War

The Euro countries are sitting like clay pigeons while the Great Currency War unfolds.  This is a war to position each country’s currency value as low as possible against each other for competitive advantage.

China currently seems to be winning the battles by taking advantage of the many options available in fiat currencies.  One significant advantage is exploiting their self positioned peg against other currencies.

Options for the USA are more limited as the dollar IS the international trade currency.  The dollar sets the international bar so it cannot battle a single currency like the Chinese (RMB).  Whatever monetary policy is for the dollar – it effects the world equally.  If the dollar offers money cheaply – the world gets money cheaply.

The beauty of a fiat currency is that there are few rules for a currency as powerful as the dollar.  As an example- if the debt is monetized (simply issue dollars to the holders of the debt), the whole world would pay for America’s overspending.   Would the dollar revalue? – this is a Great Currency War and all currencies are fiat – we can only speculate.

The Euro was born in 1999.  Many countries in Europe share the Euro as a common currency – even though each have significantly different government fiscal approaches. It requires consensus to adjust to what is happening internally within the Euro  countries, or globally.  There is no consensus, so the currency is just floating around the internal and global economic currents.

For a short period this was the largest currency in the world (as denominated in dollars).  Now many pundits speculate the end of the Euro is near.

Not likely.

The Euro by design is a “good times” currency – it requires members to budget with the ability for deficit spending limited.  This limitation severely restricts monetary flexibility in bad times.  This limitation was put in place to protect the position of the largest or strongest member – Germany.

Most believe the primary purpose of a currency is a storehouse of value.  I believe the primary purpose for a currency is an economic tool.  If you want to store value – buy an asset, buy gold or other commodities.

The primary purpose of a currency is for trade of physical things or services.   Currency or money is worthless until it is used. [I am ignoring borrowing and lending to allow this article to get to a conclusion.]

The primary value of a currency lies in its economic value – and a much lesser degree in its ability to store value.  Having said that, a currency which revalues quickly has lost its economic value – there is a loose relationship between a currency’s economic value and its storage of value.

Each Euro country is effectively using the rules of a backed currency for a fiat currency.  They cannot re-peg (devalue) their currency.  The individual countries cannot expand their money supply.  In essence, the Euro countries have given up economic control of their country for a stable currency.

Still, the Euro is a fiat currency – and fiat options exist IF the main currency backer Germany agrees.  To date, Germany is resistant to modern monetary theory.

This is not a wise move in a world of fiat currencies where some major fiat currencies are exploiting options available.

The time for the weaker members – specifically the PIIGS (Portugal, Ireland, Italy, Greece and Spain) to get out of the Euro was in 2007.  Today with deteriorating economies and rising debt – any currency the PIIGS would issue would be worthless.  The basic concept of a fiat currency is that the user in the currency must have faith in the paper.

So the PIIGS have only have two options: 1) do nothing while praying to some deity for help; or 2) default on their debt.  I see no viable door #3.

The Euro itself is functioning as a backed currency in a fiat world.  The currency is operating primarily as a storehouse of value – and doing little to benefit the economies.  The Euro is the odd man in a fiat world.

The Europeans have set up a Maginot Line in the Great Currency Wars.  As a result, the Euro is inflexible in meeting the changing strategies of the fiat world.

Fixed fortifications did not work in World War II – and are likely to meet the same fate in the Great Currency Wars.  Instead of the weaker members plights improving to those of the stronger members, the results may be the erosion of the stronger members.

It is interesting to speculate it might be the stronger members who leave the Euro to optimize their economies.

So the Great Economic War continues with outcomes uncertain.

Economic News this Week:

Econintersect economic forecast for December 2010 estimated level or slightly negative economic growth.   This week the Weekly Leading Index (WLI) from ECRI improved from a revised -1.4% to -0.1% implying the business conditions six months from now will be roughly the same as today.

Initial unemployment claims this week continued to decline, and are below levels where jobs growth is possible.

No data released this week was inconsistent with Econintersect’s November forecast of slow growth.   The table below itemizes the major events and analysis this week (click here for interactive table).

Bankruptcy Filed this Week: RHI Entertainment, InSight Health Services Holdings, Molecular Insight Pharmaceuticals, The Great Atlantic & Pacific Tea Company

Bank Failures this Week:

5 replies on “The Euro and the Great Currency War”

  1. Good observation that the euro is acting like a backed currency, a fixed supply currency designed to preserve the value of money, in contradiction of the more economically beneficial options available in an adjustable supply fiat money system. John Lounsbury recently came up with the insight that the two main functions of money, a medium of exchange and a stable store of value, are in conflict. Gold or any fixed supply money functions well as a store of value but chokes off economic growth due to a dearth of money or an over concentration of ownership of the money supply. An expanding supply fiat money encourages the economy by motivating workers and businesses to get out there and earn some of the money, but fiat is a notorious failure as a store of value. We can use both kinds of money so it’s not an either-or choice. We can buy and hold gold and silver to preserve the value of our cash savings, and we can use fiat as a monetary medium in our productive trading economy. In light of John’s insight it is irrational to demand that a single form of money serve both the value storage and economic exchange functions.

  2. As the EU (ECB?) puts packages together to bail-out the PIIGS, is bond issuance the only financing method available?

  3. Each Euro country issues bonds to support their respective funding needs – the Euro countries have no agreement to issue a common bond. The ECB, like the USA’s Fed – has been buying debt of the respective Euro governments. This basically puts a big buyer in the market to try to keep bond rates down.

    The question is whether there are other options. If the goal is to keep the Euro intact and the bond holders whole – the ECB could simply print money and hand it to the individual countries. I believe there are moral hazards which belong to this solution.

    One solution is to let the individual Euro default on their debt – and the bond holders take a haircut. This is Sophia’s choice as it sets up contagion throughout Europe. I can envision scenarios to limit the damage.

    I believe it is better to suffer damage today and move on – like Iceland. This puts your economy in a immediate recovery cycle. Right now both the USA states and the PIIGS are only kicking the problems down the road by issuing bonds which must be repaid from future growth. This actually puts your economy into a stall.

    The first step in problem solving is defining the problem. The problem is debt growth in a world economy which is not growing fast enough to absorb it. Debt issuance only kicks the problem down the road hoping that a better solution presents tomorrow. Tomorrow may also narrow the solutions available, and make the solutions more painful.

  4. it is irrational to demand that a single form of money serve both the value storage and economic exchange functions as the currency will do neither function well. specifically the dollar has painted itself into the corner of being the world’s reserve currency which implies it is a store house of value – and this limits the options available to the Fed.

    the Asian countries seem to have a better handle on using their currencies as an economic tool – forcing cash into assets for storage of value. The worst record to date comes from South America (although better recently).

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