Likelihood and implications of giving up the Euro?

[Arwin]

@pantom

I’m going to need a cite for that, first of all.

So far I only found a Dutch one, and that one is pre-introduction.

Secondly, for the sake of argument, I’ll assume that this has something to do with things like fired FX traders, both in banks and in large companies that had to deal with exchange-rate fluctuations and hire people to administer that, and who thought of it as a cost.

As pointed out, its the banks that made money there and now don’t. Just like they made money from the exchange rates and such.

Just one example of where costs were saved: companies have to keep financial reserves or provide other means as a reserve against currency fluctuations. An interview of companies before the introduction revealed these to be around half a billion euro alone.

Small concerns are the ones responsible for economic development, not big ones, and they are most likely to do most of their business locally, first within the city/town and then the region in which they were founded, and then only after that initial success will they do business elsewhere, which, depending on the size of the nation in question, may or may not involve having to get concerned with exchange-rate fluctuations.

You’d be surprised how many smaller business still get their materials from abroad. In the article I just read from the Dutch bank, pre-introduction, the smaller companies themselves believed to start making a profit from the introduction of the euro after about 5 years.

Getting back to fx trading as a cost, there is a benefit: a currency, like anything else, can and should be valued on the open market. The benefit to having it valued thusly is that it gives instant, real-time feedback on how a country’s economy is doing.

It does, but you don’t need it. Lowering your currency also makes your imports more expensive, so that the benefits only really exist if your export is much larger than your import. The Dutch bank believes that there are no real benefits to using the instrument of currency fluctuation, and has locked the guilder to the D-Mark a long time ago, as I said.

Before the euro and the ERM, Europe had the benefit of a multiplicity of currencies giving precise, real-time feedback to a large number of nations. With the euro, all that feedback has been suppressed.

If you think that economists need a currency to tell how an economy is doing, you’re mad. In reality, they can tell how an economy is doing despite the currency. For instance China is keeping its currency way below how its economy is doing, and so, it seems, does the U.S. Otherwise, how would you explain the weakness of the dollar against the euro, versus your argument that the U.S. is doing so much better than Europe?

I at first thought this would lead to a boom followed by a long stagnation, but I was wrong: the boom never came. To quote from an article on the last global economic update from the OECD:

There are a number of factors preventing (a number of big countries in) the euro region from booming. The external factors are a definite influence - regardless of what some articles say, oil prices are a very strong economic factor right now. The mere factor alone that many economists, investors and traders believe so, makes it so. That’s how the economy works, to a great extent. If people believe the economy will surge, they buy, and if they buy, it surges. It is partly a self-fulfilling prophecy. The strong euro, by the way, is mitigating the oil price factor for euro countries - it would have been much worse for us if the euro had been weak.

At the same time, I would add that due to the prolonged uncertainty the consumer confidence rate, seen as one of the primary indicators of local economic potential, remains low. After a long period of eoconomic uncertainty, people start changing their behavior and concentrate more on savings, which inhibits consumer spending, which is one important factor in the local economy. Of course, they also have to have the money.

I think, in short, that there are plenty of reasons, but the euro isn’t really one of them.

I would call all of your arguments about what happened to the Dutch economy previous and post the euro circumstantial. Anecdotal, even. We have the eurozone, wherein aggregate growth has been insignificant for 5 years, coincident with the life of the euro. And we have the UK acting as a control on this experiment, doing quite nicely. Indeed, in the above-cited article, projected growth in the US was revised upwards by the OECD, which flatly contradicts your assertions about the US having a bad economy relative to Europe. Note well that the previously projected level was already 50% faster than the aggregate of eurozone growth in any of the past 5 years. That’s not doing badly relative to Europe; a more reasonable description would be “way better”.

Your UK issue has been addressed already, so I won’t go into that much further. But I would like to add that the social system and no minimum wage (and now still a very low one) are important factors. Like the U.S., the U.K. had a significant percentage of real poverty. By the time Blair was elected into office, Britain was in a dismal state. The U.S. has one of the highest poverty rates in the Western world. The benefits of which are that there is more economic flexibility, but the downside is that especially in combination with its health-care system, economic malaise can hit terribly hard and sudden for a great number of individuals. In the U.K. there was at least the NHS, which, although it could be much, much improved, was still relatively cheap compared to most other European countries.

Again, countries like Germany and France are on the other side of this scale. Germany used to be one of the strongest economies in the world, but after the ‘Wende’ it needed to strip itself of a lot of luxury, to be able to rebuild East-Germany. This it has failed to do to a great extent, for which it is now paying the price. Countries that have a lot of trade with Germany, like the Netherlands, Sweden, and so on, pay a price. I won’t even go into France, and Italy is … well. We’re all dealing with issues here that have little to do with the euro. And the countries that are experiencing growth, like Portugal, Spain, and as mentioned Ireland, were extremely poor when entering the euro.

[max_power]

In some ways, I’m reluctant to get further involved in this. Suffice it to say, pantom believes the euro is responsible for the malaise in the larger euro economies, I don’t believe it to be. As it often goes in economics, one can find evidence to back either position, but it is all necessarily circumstantial, since there are a million and one factors that have a bearing on economic performance.

Pantom may have a point, but one thing i certainly disagree with him on is the time period. 5 years is a very short period on which to draw conclusions about a project such as the euro…

A couple of other things, we hear a lot of similar arguments, particularly in the british press, which may explain my irrational sensitivity, since it isn’t even something i feel particularly strongly about… I thought, another knee-jerk euro sceptic, I concede that pantom is just objecting to monetary union and not the yurpeen project in general.
Also, personal factors as always come into play. My mortgage rates are very low… if ireland hadn’t joined the euro, i’d be out of pocket

Oh yeah, one other thing.

@pantom

Because if everyone knew those reforms, whatever they may be, were needed in order for the euro to work, why do the euro before you do the reforms? And what, exactly, is the euro supposed to do for you if it can’t work absent these reforms?

I don’t think anyone said that the reforms were required for the euro to “work”. The euro does work. It is just a currency, all commodities, stocks, bonds etc are priced in it. People use it to buy and sell goods and services… what else do you mean by work?

Ok, that’s about it…

[clairobscur]

Any thing, concept, idea that’s supported by the Italian North League (they’re the party advancing the "get rid of the Euro agenda) is immediatly classified in my mind as highly suspect.

I saw yesterday a footage of one of their gatherings, and their “green shirt” outfits, with badges and stripes on them didn’t help much. I classify them in the “semi-fascist” category.

[pantom]

@max power

I don’t think anyone said that the reforms were required for the euro to “work”. The euro does work. It is just a currency, all commodities, stocks, bonds etc are priced in it. People use it to buy and sell goods and services… what else do you mean by work?

Somewhere up there someone pointed out that the OECD was calling for reforms when it said circumstantial arguments were no longer sufficient to explain the persistent stagnation of the eurozone. That was directed at that, since the OECD seems, basically, to be saying that either the reforms get done or the euro fails. The euro doesn’t “work”, in the sense that if reforms are needed in order to get out from under the persistent stagnation of the eurozone, then that means that either the euro isn’t helping or that it is in fact hurting. Either way, it means that a huge project that scrapped the economic status quo ante is at best useless.
I’d say it’s a utopian scheme that’s gone belly up.

[Arwin]

@pantom

Somewhere up there someone pointed out that the OECD was calling for reforms when it said circumstantial arguments were no longer sufficient to explain the persistent stagnation of the eurozone. That was directed at that, since the OECD seems, basically, to be saying that either the reforms get done or the euro fails. The euro doesn’t “work”, in the sense that if reforms are needed in order to get out from under the persistent stagnation of the eurozone, then that means that either the euro isn’t helping or that it is in fact hurting. Either way, it means that a huge project that scrapped the economic status quo ante is at best useless.
I’d say it’s a utopian scheme that’s gone belly up.

Nice twisting of what they are really saying, and that is that these companies need to reform. By and far from saying that the euro contributes to the (relative) economic malaise in the eurozone, the point was that the benefits of the euro cannot fully make up for structural deficiencies like heavy social security systems that badly need reform.

[Arwin]

@Arwin

that these companies

sorry, that should be countries, not companies

[ColonelDax]

@Arwin

the benefits of the euro

Heh heh, that’s quite good, I like dry humor. Seriously, though, the euro zone’s one-size-fits-all interest-rate policy has created the absurd situation we have now in which the countries with the worst-performing economies, and so the lowest inflation rates, have the highest real interest rates, while countries where inflation is higher because growth is stronger have lower or even negative real interest rates. This is, of course, the exact opposite of what would prevail in a sane world, where interest rates would be lower in countries whose economies were weak and higher in states with stronger growth.

For those Dopers wondering what I’m talking about, a real interest rate is one that’s been adjusted for inflation. For example, the Federal Reserve’s target for the Fed Funds rate is 3% (the nominal, or un-inflation-adjusted, interest rate) and U.S. consumer-price inflation is running at an annual rate of 2.8% (all figures in this post are from Bloomberg), so the real interest rate is 0.2% - they’re practically giving money away after taking inflation into account. If inflation exceeds a nominal interest rate - for example, if inflation were 3.5% and the Fed Funds target were still at 3% - the real interest rate is negative.

The European Central Bank’s refinancing rate (the nominal rate) stands at 2%. That’s great for companies based in Spain, where CPI is rising at an annual rate of 3.1%, but their competitors in France, where CPI is at 1.5%, are at a big relative disadvantage. Needless to say, this stems directly from the idiocy of having national interest rates set by a supra-national body - the Banque de France would be perfectly free to set French interest rates wherever it thought appropriate if the country weren’t bound by the euro straitjacket.

So Ireland’s been having a party? I should hope so if people there can borrow money at no cost after inflation (2.4% CPI).

The one area in which the euro has been an unqualified success, I would argue, is in the borrowing (bonds and loans) market, where the single currency has helped to create a regional pool of liquidity that dwarfs anything available beforehand. In particular, Olivetti’s takeover of Telecom Italia in 1999 and Banque Nationale de Paris’ attempt that year to take over Societe Generale and Groupe Paribas - both of which really changed the map in terms of making clear that any company was takeover bait, no matter what old-boy networks or governments might think - would have been extremely difficult at best to finance without the euro, I’d say.

Ultimately the euro will fail because it’s completely lacking in democratic legitimacy, not unlike the European Union itself, in my view.

[Arwin]

@ColonelDax

Heh heh, that’s quite good, I like dry humor. Seriously, though, the euro zone’s one-size-fits-all interest-rate policy has created the absurd situation we have now in which the countries with the worst-performing economies, and so the lowest inflation rates, have the highest real interest rates, while countries where inflation is higher because growth is stronger have lower or even negative real interest rates. This is, of course, the exact opposite of what would prevail in a sane world, where interest rates would be lower in countries whose economies were weak and higher in states with stronger growth.

But completely irradicated by the fact that countries like China or the U.S. work in exactly the same way, even if, say, Ohio is vastly outperforming California. They still both have the dollar.

For those Dopers wondering what I’m talking about, a real interest rate is one that’s been adjusted for inflation. For example, the Federal Reserve’s target for the Fed Funds rate is 3% (the nominal, or un-inflation-adjusted, interest rate) and U.S. consumer-price inflation is running at an annual rate of 2.8% (all figures in this post are from Bloomberg), so the real interest rate is 0.2% - they’re practically giving money away after taking inflation into account. If inflation exceeds a nominal interest rate - for example, if inflation were 3.5% and the Fed Funds target were still at 3% - the real interest rate is negative.

And yet again, you say this makes perfect sense for a country consisting of 50 states and nearing 300.000.000 inhabitants, but for the individual countries that chose to take part in the eurozone it apparently is a bad idea.

The thing is, the downsides of such policy, one big one of which is provisions international companies need to make against sudden currency fluctuations, and the possibility for currency traders to influence the value of a coin against economic reality, or countries being able to undervalue their currency (as China is doing now, and partly as a result of that, the U.S. too*), make the old interest rate policy outdated, especially on the tiny scales of individual nation states in Europe.

The one area in which the euro has been an unqualified success, I would argue, is in the borrowing (bonds and loans) market, where the single currency has helped to create a regional pool of liquidity that dwarfs anything available beforehand. In particular, Olivetti’s takeover of Telecom Italia in 1999 and Banque Nationale de Paris’ attempt that year to take over Societe Generale and Groupe Paribas - both of which really changed the map in terms of making clear that any company was takeover bait, no matter what old-boy networks or governments might think - would have been extremely difficult at best to finance without the euro, I’d say.

No, that’s just one area.

Ultimately the euro will fail because it’s completely lacking in democratic legitimacy, not unlike the European Union itself, in my view.

So what your elected leaders do is lacking in democratic legitimacy? In my country, the EU is still considered a good thing. Economic advantages of the EU are without question for most people I talked to that voted against the constitution. They were just worried about the implications of further political integration, which they hadn’t previously thought about and weren’t ready to accept on face-value. That’s ok, because *that * is the democratic process in action too.

• If you don’t believe me, then just read up on recent analysis of the world economy by the worldwide institute of national central banks.

[Neurotik]

@pantom

Well, as I said when I started: five years of below 2% growth should be enough for any reasonable person who isn’t wedded to an ideology.
Do you need ten years? Twenty? How long before YOU give up?

Again, you have yet to prove that the euro is reponsible for any of this. It’s not like France was a booming economy prior to adopting the euro.

The economic stagnation in France (possibly Germany, but I don’t know as much about that) has little to do with the euro vs. the franc. It has to do with an extremely inflexible labor market that makes it nearly impossible to let someone go if needed. This prevents staff cutting during business downturns. French businesses are, of course, aware of this so they become reluctant to hire more people in boom times knowing that if things start to go sour, they’ll be stuck with them.

That’s not to say that the euro hasn’t had its downside for countries. Everything has tradeoffs. The tradeoff with the euro is that while you get lower barriers to trade and lower transaction costs between countries, along with better bond ratings and lower debt servicing costs because of the spread of the currency, you also lose local control of interests rates. This is part of the problem in Germany, where even though exports are pretty good, domestic demand hasn’t increased in part because interest rates couldn’t be lowered.

Or take Italy: they greatly lowered their debt servicing due to the switch from the lira to the euro, but they’ve also seen in increase in labor costs. While the euro isn’t the root cause of the cost increase, it didn’t really help. Italy used to deal with labor costs by devaluing the lira - it can’t very well do that with the euro.

That said, the idea of a single currency isn’t a bad one. But a lot of European countries have failed to make the structural changes necessary to make it work. The ECB doesn’t have nearly the flexibility to fiddle with interest rates as the Fed does, meaning that they are often slow to deal with changing economic realities. That’s not the fault of the euro, it’s the fault of the general structure.

[Arwin]

[QUOTE=Neurotik]
Again, you have yet to prove that the euro is reponsible for any of this. It’s not like France was a booming economy prior to adopting the euro.

The economic stagnation in France (possibly Germany, but I don’t know as much about that) has little to do with the euro vs. the franc. It has to do with an extremely inflexible labor market that makes it nearly impossible to let someone go if needed. This prevents staff cutting during business downturns. French businesses are, of course, aware of this so they become reluctant to hire more people in boom times knowing that if things start to go sour, they’ll be stuck with them.

That’s not to say that the euro hasn’t had its downside for countries. Everything has tradeoffs. The tradeoff with the euro is that while you get lower barriers to trade and lower transaction costs between countries, along with better bond ratings and lower debt servicing costs because of the spread of the currency, you also lose local control of interests rates. This is part of the problem in Germany, where even though exports are pretty good, domestic demand hasn’t increased in part because interest rates couldn’t be lowered.

Or take Italy: they greatly lowered their debt servicing due to the switch from the lira to the euro, but they’ve also seen in increase in labor costs. While the euro isn’t the root cause of the cost increase, it didn’t really help. Italy used to deal with labor costs by devaluing the lira - it can’t very well do that with the euro.

Yes, but don’t forget, each time they did that (and they did it a lot!) they decreased the value of savings and pensions too. I remember the days that liras came by the thousands. It wasn’t pretty, and their constant devaluation was a result of failing to find a permanent solution for economic problems. Not that that was easy, with each government lasting an average of say 2 years.

That said, the idea of a single currency isn’t a bad one. But a lot of European countries have failed to make the structural changes necessary to make it work. The ECB doesn’t have nearly the flexibility to fiddle with interest rates as the Fed does, meaning that they are often slow to deal with changing economic realities. That’s not the fault of the euro, it’s the fault of the general structure.

But if the Euro hadn’t come, those structural changes would still have been necessary. I’m not sure why you believe the ECB hasn’t the same flexibility. I believe it is a matter of choice, rather.

I maintain that there are a number of issues that need to be dealt with to upgrade the economy, and that the Euro is but one of the steps required to move the economy in the right direction. Germany’s main problem is by and large not having adjusted itself to deal with the Wende properly. It needs to trim down. It hasn’t. Period.

[Neurotik]

@Arwin

Yes, but don’t forget, each time they did that (and they did it a lot!) they decreased the value of savings and pensions too. I remember the days that liras came by the thousands.

I didn’t say it was a great idea without downside, I’m just saying that the Italian government lost its main method of dealing with labor costs and I’m not sure they know what to do now. Compare to Germany, which dealt with things intelligently and it shows in their exports.

But if the Euro hadn’t come, those structural changes would still have been necessary.

Some of them would have. Labor market liberalization is necessary whether or not they switch currency, for instance. Other things in the banking and financial world wouldn’t have. Like I said, it’s a trade off.

I’m not sure why you believe the ECB hasn’t the same flexibility. I believe it is a matter of choice, rather.

Yeah, that was poor phrasing on my part. I meant that the slowness of some of the financial integration necessary, along with the “two pillar” strategy the ECB has followed due to the process (needing to both keep inflation in check and keep monetary growth stable and consistent), has reduced its room to maneuver as compared to countries, like the US, that aren’t going through that restructuring.

Germany’s main problem is by and large not having adjusted itself to deal with the Wende properly. It needs to trim down. It hasn’t. Period.

Germany’s biggest problem isn’t its welfare state, it’s high unemployment that’s largely kept that way by rigid labor markets. This cycles down into a lack of domestic consumer demand. The problems that were caused by re-unification made things difficult a while back, but I don’t think they’re really what’s holding things back now. Germany is having similar problems as France, for largely the same reasons and I don’t think that re-unification really affected that much over the long-term.

That said, a looser domestic money supply would have helped spur things domestically. It likely would have given the property market a bit of a kick in the pants and gotten it to move a bit out of the stagnation its currently in. Remember that the housing market is what is driving a lot of the economic gains in the UK, US, Australia, etc.

[Arwin]

@Neurotik

Germany’s biggest problem isn’t its welfare state, it’s high unemployment that’s largely kept that way by rigid labor markets. This cycles down into a lack of domestic consumer demand. The problems that were caused by re-unification made things difficult a while back, but I don’t think they’re really what’s holding things back now. Germany is having similar problems as France, for largely the same reasons and I don’t think that re-unification really affected that much over the long-term.

No, I have to disagree. The weight of its welfare system in its current form, which by the way includes rigid labor markets, at least in my view (but IANAE ), was barely supportable by Western Germany itself, but with Eastern Germany being in much worse shape now drawing from that same welfare supply, the already fragile system breaks down and grinds to a halt. The only way I agree with you in the sense that re-unification really affected that much, is that it would have happened anyway without reform, maybe just a little later as they’d have had a lot of reserves.

The power of their economy still has to be admired to this day, if you see the amount of money that went into the re-unification, but at the same time that would have meant, without the Wende, that the DMark might have remained comparatively expensive as well, maybe even more so in the context of other European countries. And the situation with China keeping its currency grossly undervalued, and the Dollar in its wake, I highly doubt that Germany would be gauranteed to have been better off without the Euro. I also highly doubt they believe they would have been themselves.

[ColonelDax]

@Arwin

But completely irradicated by the fact that countries like China or the U.S. work in exactly the same way, even if, say, Ohio is vastly outperforming California. They still both have the dollar.

Eradicated in what way? A Spanish borrower has a 1.5-percentage-point advantage over his French counterpart at the moment in real terms - that is a factual statement. U.S. states don’t calculate their own inflation rates, as far as I’m aware, so there’s only going to be one real interest rate across the country. I’m not intimately familiar with local levels of interest rates in the U.S., but I can’t imagine that a businessman in Dayton would have to pay 1.5 percentage points more in real terms to borrow than one in Fresno. (Please correct me if I’m wrong, of course.)

@Arwin

And yet again, you say this makes perfect sense for a country consisting of 50 states and nearing 300.000.000 inhabitants, but for the individual countries that chose to take part in the eurozone it apparently is a bad idea.

It makes sense for the country of 50 states precisely because it is a single country. The dollar is the product of 200+ years of evolution that have taken place under a single and agreed-upon form of national government, which is to say simply that political union came before monetary union. The euro is the opposite - monetary union without political union. It’s an artificial creation that was backed by the political and financial elites of the member states and imposed by a supra-national body, hence my earlier remark about its lack of democratic legitimacy.

@Arwin

They were just worried about the implications of further political integration, which they hadn’t previously thought about and weren’t ready to accept on face-value.

Perhaps they should devote some more thought to that question in the context of the euro. In my view, the single currency ultimately will fail unless it’s supported by a true federal system. In turn, I infer that for the euro to work, political integration must follow monetary integration. In light of the vote on the constitution, what do you think the chances are that this would happen anytime in the near future?

@Arwin

the possibility for currency traders to influence the value of a coin against economic reality

Would I be correct in interpreting this as evidence that in the monetary debate your view is government good, nasty ol’ traders bad?

@Arwin

countries being able to undervalue their currency (as China is doing now, and partly as a result of that, the U.S. too*)

I disagree with your seeming conviction that countries can influence their own currencies’ exchange rates, absent formal arrangements such as currency boards or pegs such as China’s peg of the yuan to the dollar. In any case, currencies are only over- or undervalued relative to each other. If a U.S. businessman had complained to you about the undervalued euro at the end of 2001 - when a euro was worth about 90 cents, rather than the $1.20 or so it fetches now - may I ask what your response would have been?

[Arwin]

@ColonelDax

Eradicated in what way? A Spanish borrower has a 1.5-percentage-point advantage over his French counterpart at the moment in real terms - that is a factual statement.

But not for long, because there is little barrier left for a Frenchman to open an account in Spain. But seriously, I don’t get this argument of yours at all. I have a Visa card. That’s an international company. Credit on that card costs me. I have another card from another company. Credit on that card costs me a lot more. I can go to a great number of banks, and many offer completely different rates. So what, precisely, is your ‘factual statement’ trying to tell me here? I can’t figure it out.

U.S. states don’t calculate their own inflation rates, as far as I’m aware, so there’s only going to be one real interest rate across the country. I’m not intimately familiar with local levels of interest rates in the U.S., but I can’t imagine that a businessman in Dayton would have to pay 1.5 percentage points more in real terms to borrow than one in Fresno. (Please correct me if I’m wrong, of course.)

Sure, please fill up the discussion with imaginative arguments.

It makes sense for the country of 50 states precisely because it is a single country. The dollar is the product of 200+ years of evolution that have taken place under a single and agreed-upon form of national government, which is to say simply that political union came before monetary union. The euro is the opposite - monetary union without political union. It’s an artificial creation that was backed by the political and financial elites of the member states and imposed by a supra-national body, hence my earlier remark about its lack of democratic legitimacy.

200+ years of evolution, single and agreed-upon form of national government, pff. There are more similarities than differences. The european economic integration started just after the second world war. The dollars purpose was not political, but economical. If multiple currencies had been more effective, for instance to allow individual states to represent their relative performace correctly, they would at this day still have had their own currencies. But it doesn’t work that way. And China knows this. Let’s throw in a little link here:

Why China adopted a fixed-currency regime:

• To promote cross-border social and political integration.
• Using the same currency stimulates two-way trade and investment, helping to turn two separate economies into one integrated whole. This is the reasoning behind the euro.
• Could China be doing something similar? Barron’s thinks so. China 's decision to link its currency to the dollar was motivated by a desire to maximize trade and investment with Hong Kong and Taiwan as part of its long-term strategy to integrate those entities into greater China.

Why a fixed currency is consistent with American interests:

• Integrated economies reduce the likelihood of military conflict between China and Taiwan, and should facilitate China 's gradual evolution from a belligerent communist state into a benign and prosperous democracy.
• By choosing the dollar peg as a vehicle for facilitating political integration of Taiwan and Hong Kong, China has assured that the US will enjoy a more or less permanent advantage over Europe and Japan in forging closer economic relations with China and Southeast Asia.
• Given current trends, this will greatly facilitate America’s efforts to remain a prosperous global superpower.

As for the economic dislocations caused by the yuan’s undervaluation:

• The US need not worry. China is printing yuan furiously, in order to buy up US dollars and defend its peg. The M-1 money supply rose by 19% over the past year. As a result, inflationary pressure is building in China. And inflation is just as effective a remedy for undervaluation as currency appreciation.

That last underlined sentence is key. Inflation is replacing the economic currency appreciation, and is superior because it gets rid of most of the risks and costs that economic currency appreciation brings along with it.

Perhaps they should devote some more thought to that question in the context of the euro. In my view, the single currency ultimately will fail unless it’s supported by a true federal system. In turn, I infer that for the euro to work, political integration must follow monetary integration. In light of the vote on the constitution, what do you think the chances are that this would happen anytime in the near future?

Pure nonsense. This would imply that China’s strategy pegging the Yuan to the Dollar would only work if China and the U.S. political integration should follow. Please.

Would I be correct in interpreting this as evidence that in the monetary debate your view is government good, nasty ol’ traders bad?

No. I’m just saying that traders do not necessarily have a large interest in how well a country is doing, but rather how much money they can make off changing currency values. Like stock values, they don’t necessarily match real economic performance, and at the same time they largely undercut the options countries have to influence their own exchange rates to increase performance. What, for example, is happening in Japan? The Yen is expensive, yet the Japanese economy isn’t doing all that well. Please explain.

I disagree with your seeming conviction that countries can influence their own currencies’ exchange rates, absent formal arrangements such as currency boards or pegs such as China’s peg of the yuan to the dollar.

You disagree with my seeming conviction? First of all, I am fully convinced. But I have to admit, I only echo what all sorts of economists say, often with very different interests as a background. “Absent formal arrangements such as currency boards or pegs such as China’s peg of the yuan to the dollar.” So China pegged the yuan to the dollar. The Netherlands pegged the guilder to the Deutschmark 15 years before the EMU. Men can’t walk on the moon except when they fly there in a spaceship and wear special suits.

In any case, currencies are only over- or undervalued relative to each other. If a U.S. businessman had complained to you about the undervalued euro at the end of 2001 - when a euro was worth about 90 cents, rather than the $1.20 or so it fetches now - may I ask what your response would have been?

I would echo the president of the European bank who was faced with journalistic criticism for the same. His answer: “You complain about the low value of the Euro now, but in only a few years time you’ll be back complaining that the Euro is too expensive.”

[Arwin]

Sorry, forgot to include cite for my quote in the above post:

http://www.chinastockblog.com/2005/02/barrons_ony_why.html

[pantom]

Arwin: I read that article in Barron’s; it was a pretty clever thesis. It might even be right. What it has to do with this argument is unclear, to say the least.
China’s peg to the dollar works for the simple reason that it opens up the US market to China’s goods, thereby giving China a cheap, easy route to providing jobs to the vast numbers of people it will need to employ in order for the current regime to stay in power. That regime, because it lacks the legitimacy of the ballot box, must instead buy its legitimacy with economic growth. The peg to the dollar does this.
Japan, meantime, pegs its currency to the dollar just as effectively, (if you don’t believe this is so, see this 5 year chart comparing the exchange rates over the last five years between the EUR/USD, Canadian dollar/USD, and the Yen/USD. Notice that the yen, over the last five years, is virtually unchanged against the dollar.) and just as effectively gets good export earnings out of it. But while in China we see the benefit, a seemingly endless boom, in Japan we see the curse: a seemingly endless stagnation.
Why? Because if you mess with the value of your currency, you mess with your cycle. Pegging your currency to a strong country to gain export earnings by selling to that strong country will give you, first, an exaggerated boom if you’re a poor country coming up, and then a nice, long, endless bust, because when it’s all over you will continue, as Japan has done, to peg the currency because you will have become addicted to those export earnings. This kills any chance you may have to provide the proper feedback, via both exchange rate fluctuations and interest-rate fluctuations, to your economy.
The eurozone suffers from what now looks like a seemingly endless bust because, secondarily, if Trichet had a brain he’d be an idiot, and primarily because, within the eurozone, the effect of the euro is extraordinarily distortive. As Colonel Dax pointed out, it does wacky things to interest rates. As Barron’s pointed out a few months ago, the ECB must depress the economy of Germany at least, and I’d throw in France too, if smaller countries within the eurozone are growing rapidly, as many of them are, because in order to keep within its inflation target of 2% it must keep the large countries from ever rising much above the average inflation rate. Thus, if German inflation goes above 2%, this will be far more likely to cause the ECB to tighten than if Greek inflation goes above 2%. The effect is to permanently depress the large economies, which will, of course, have a permanently debilitating effect on the eurozone economy.
That’s another particular economic distortion, an effect that is caused by the fact that the euro is a huge currency peg within that zone, between those economies, that introduces the same cycle-killing effect as the Japanese peg to the dollar does.
Kill the feedback that currency fluctuations provide, and you kill the cycle. Kill the cycle, and you wind up with endless stagnation. Japan and the eurozone are already providing ample proof of this thesis. Japan’s interest rates have been at zero forever; the eurozone’s interest rate has been at 2% since seemingly forever, anyway. Meantime, Sweden (big welfare state, but somehow they manage. Hmm.), the UK, the US, and so on have recognizable cycles and far better overall growth because they have independent currency and interest rate policies that respond to the actual conditions prevailing in their countries.
Or to put it simply and bluntly: those currency traders may not have cared about the welfare of the countries whose currencies they were trading, but they still fulfilled a vital function. The markets aren’t an eleemosynary pursuit, nor were they ever meant to be any such thing. That doesn’t mean they don’t serve a good purpose.
One day, Japan and the eurozone may finally get off the dime. The bad part of it is that if they ever do, they will probably wind up booming for a really long time because of the cycle-killing effects of these currency fixing policies, and this will provide the politicians and clueless central bankers with all the excuse they need to continue doing stupid things. Then, when the next endless bust comes, they’ll probably spend a couple of decades coming up with excuses.
Pretty depressing, when you think about it.

[Arwin]

As an update, China finally decided to revaluate their currency after muchos pressure. 'nuff said.

[Arwin]

Or perhaps not 'nuff said, in light of your post:

@pantom

Arwin: I read that article in Barron’s; it was a pretty clever thesis. It might even be right. What it has to do with this argument is unclear, to say the least.
China’s peg to the dollar works for the simple reason that it opens up the US market to China’s goods, thereby giving China a cheap, easy route to providing jobs to the vast numbers of people it will need to employ in order for the current regime to stay in power. That regime, because it lacks the legitimacy of the ballot box, must instead buy its legitimacy with economic growth. The peg to the dollar does this.

Your point being?

Japan, meantime, pegs its currency to the dollar just as effectively, (if you don’t believe this is so, see this 5 year chart comparing the exchange rates over the last five years between the EUR/USD, Canadian dollar/USD, and the Yen/USD. Notice that the yen, over the last five years, is virtually unchanged against the dollar.) and just as effectively gets good export earnings out of it. But while in China we see the benefit, a seemingly endless boom, in Japan we see the curse: a seemingly endless stagnation.

Japan has been working hard to prevent the expensive Yen from ruining their economy, by any means they could. They bought heaps of currency to influence the market, but no success. It is debatable wether Japan kept its currency lockstep to the dollar, or whether in fact the US kept their dollar in lock-step to the Yen. Make of it what you will, but the EU and Japan have put a decent case about the undervalued dollar with the WTO. Now that China upgraded their currency.

Why? Because if you mess with the value of your currency, you mess with your cycle. Pegging your currency to a strong country to gain export earnings by selling to that strong country will give you, first, an exaggerated boom if you’re a poor country coming up, and then a nice, long, endless bust, because when it’s all over you will continue, as Japan has done, to peg the currency because you will have become addicted to those export earnings. This kills any chance you may have to provide the proper feedback, via both exchange rate fluctuations and interest-rate fluctuations, to your economy.

We’ve been here. Old fashioned. It’s just a matter of moving stuff around, and the extra costs outweigh the benefits almost always. Except when, like China, you’re at the bottom of the market, then you might benefit for a while, until you start earning enough money to make your import rise to a comparable level of your export.

The eurozone suffers from what now looks like a seemingly endless bust because, secondarily, if Trichet had a brain he’d be an idiot, and primarily because, within the eurozone, the effect of the euro is extraordinarily distortive. As Colonel Dax pointed out, it does wacky things to interest rates. As Barron’s pointed out a few months ago, the ECB must depress the economy of Germany at least, and I’d throw in France too, if smaller countries within the eurozone are growing rapidly, as many of them are, because in order to keep within its inflation target of 2% it must keep the large countries from ever rising much above the average inflation rate. Thus, if German inflation goes above 2%, this will be far more likely to cause the ECB to tighten than if Greek inflation goes above 2%. The effect is to permanently depress the large economies, which will, of course, have a permanently debilitating effect on the eurozone economy.
That’s another particular economic distortion, an effect that is caused by the fact that the euro is a huge currency peg within that zone, between those economies, that introduces the same cycle-killing effect as the Japanese peg to the dollar does.

Listen, you can keep on arguing this, but I will keep on arguing that the difference between the poorest U.S. state and the richest U.S. state might be bigger than the differences between the E.U. states, and as long as you can’t come up with a better argument than that the U.S. is more a political union than the E.U., this argument is going nowhere.

Kill the feedback that currency fluctuations provide, and you kill the cycle. Kill the cycle, and you wind up with endless stagnation. Japan and the eurozone are already providing ample proof of this thesis. Japan’s interest rates have been at zero forever;

The only problem being that since practically nobody is playing by the rules anymore, Japan can’t get anywhere. Japans problems are older than 5 years, and they suffer most from the competition from other Asian countries, already having stagnated before that time, they haven’t had a chance to change their economy to adjust, probably they were too slow to make sure they’d ride the new wave, and probably also would find that very hard because PR with the other nations there aren’t all that.

the eurozone’s interest rate has been at 2% since seemingly forever, anyway. Meantime, Sweden (big welfare state, but somehow they manage. Hmm.), the UK, the US, and so on have recognizable cycles and far better overall growth because they have independent currency and interest rate policies that respond to the actual conditions prevailing in their countries.
Or to put it simply and bluntly: those currency traders may not have cared about the welfare of the countries whose currencies they were trading, but they still fulfilled a vital function. The markets aren’t an eleemosynary pursuit, nor were they ever meant to be any such thing. That doesn’t mean they don’t serve a good purpose.

For every Sweden I have a Norway.

One day, Japan and the eurozone may finally get off the dime. The bad part of it is that if they ever do, they will probably wind up booming for a really long time because of the cycle-killing effects of these currency fixing policies, and this will provide the politicians and clueless central bankers with all the excuse they need to continue doing stupid things. Then, when the next endless bust comes, they’ll probably spend a couple of decades coming up with excuses.
Pretty depressing, when you think about it.

I agree about the excuses, but it’s all about adjusting the economies. The cycle-theory is really outdated. The EU will do better if they can manage to reform, compete and more importantly, ride the economic wave that China produces - after all, China creates a larger world economy - so in theory, although in lower levels cheap labor competition threatens parts of the economies of other countries, the overal moneyflow grows. And so economies have to adjust.

Face it, hardly any amount of devaluation is going to help you compete with third world countries, unless you are willing to also significantly lower your standard of living (or become completely self reliant, independant of imports - not easy for a first world country). So the only thing to do is shift your economy more to stuff that suit higher living standards, like services.

[pantom]

The US has a lot of OTHER problems, but currency intervention isn’t one of them. The suggestion that the US currency is undervalued because of US intervention or something when we’re looking at a 6% balance of payments deficit is so laughable that I’m genuinely surprised you would even introduce the thought. Its rises and falls pretty much mirror the cycles in the American economy, even now, with that amazing deficit. Those cycles still exist, regardless of whether the poorest US state is poorer than the richest by a wider margin than the poorest EU state. Such a statistic proves nothing. The simple fact is, the US is much much farther along in being integrated in every way you can possibly think of than the EU is.
It DOES have the problem that, being the world’s reserve currency, it has a very hard time falling to a level that reflects the actual performance of the US vis-a-vis the world. This is a known cost of having the reserve currency. The balance of payments deficit that we have is a direct result of its having become an extremely popular reserve currency. This is a problem, but it’s not the same one as the euro’s.
Getting back to the issue for the euro: whereas in the US there is no such thing as a “state champion”, in the EU you still have France promoting its “state champions”, and Italy throwing up obstacles to a bank takeover from outside the country, and of course instead of a uniform standard for labor laws with some variation state-to-state, you have far different codes for different countries. This would be thought by any normal person as the normal differences that happen between countries with non-integrated economies. Imposing a currency on a set of non-integrated economies is daft.
Now let’s get to the cycle. Japan has been stagnant for 15 years, and there are a lot of reasons for that besides its constant intervention in the currency markets, but that intervention is one of the reasons, as it constitutes an attempt to short-circuit a market price signal. They’ve succeeded in short-circuiting that signal, and their inability to climb out of the hole they climbed into 15 years ago is proof of that success. As I’m sure you’ve heard, one of the things you do when you’ve put yourself in a hole is to stop digging. Japan hasn’t stopped digging yet. So, this shows that messing with the price signals that go into making the cycle turn will, strangely enough, mess up the cycle. Odd, that.
Over to China. They are finding it very very hard to slow their economy down, and one of the reasons for their upward revaluation was to give themselves another way of doing so. 2.1% isn’t going to do it, but at least they’ve introduced the principle to their economy. The trouble they’re having slowing their economy shows that messing with the cycle will, amazingly enough, mess up the cycle. Who knew?
Now, finally over to the EU, which has the opposite problem. The point I made was that both Sweden and the UK have stayed out of the system, and both have had far less trouble with their cycle than the EU has. That remains the case. I’m quite confident that, five years from now, we’ll either be dealing with continuing stagnation or an unstoppable boom, with the ECB bewildered at its powerlessness to stop inflation. This would be merely the flip side of the current problem, as shown by the current example of China. Neither Sweden nor the UK will be dealing with this; they’ll be dealing with something else because in those countries the cycle continues to function (It is possible that the euro will succeed in dragging these two economies down with it, which would be bad. One hopes this will not be the case). Why am I so confident in making that prediction? Because, well, if you mess with the cycle you mess up the cycle.
Bicycles are a bit old-fashioned. Economic cycles, not so much. Their absence is not a good sign.
Utopianists always try to go around the obvious problem by saying “No, it’s this.” Or “No, it’s really that.” But the problem isn’t with France’s labor laws per se, or Germany’s subsidies to its eastern half, or any of the rest of the particular things that are brought up. The problem is that the euro is an attempt to impose a single currency on multiple economies.
To quote from a certain Paul Einzig, in a book called Destiny of the Dollar, written in 1972 shortly after the fall of Bretton Woods (the subject was whether any currency was ready yet to replace the dollar as the reserve currency of the world):

It has been widely suggested that a composite European currency might be able to become a successful rival to the dollar, especially after Britain joined the Common Market. Some minor degree of integration is not outside the realm of possibilities, but the creation of a European currency would only be possible following on the economic and even political integration. But a unified European currency is a Utopian dream…

The simple fact of the matter is that the necessary integration still hasn’t taken place, even if it is much further along than anything Einzig would have envisioned at that time, and this is shown by the actual fact of the Eurozone’s economic performance, the actual fact of the resistance of some member states to takeovers of local companies by companies from other member states, and by the continuing resistance to syncing up such things as labor laws. The euro is here, and it still isn’t ready to replace the dollar as a reserve currency, even as the dollar goes through a crisis similar to that experienced at that time, and it’s not ready to replace the dollar because of the exact same reason that was cited by Einzig more than thirty years ago. Of course, the dollar is also going through similar problems to thirty years ago, because of its continuing reserve currency status. Plus ca change and all that.
Must be some kind of a cycle.

[ColonelDax]

@Arwin

But seriously, I don’t get this argument of yours at all.

A great deal of information on real interest rates is available with a quick Google. In a nutshell, while you and I as individual consumers don’t often have cause to think in terms of real rates, companies plan in terms of real interest and exchange rates all the time so they can make international comparisons that have been adjusted for inflation. As for real interest rates’ application to the euro, here (third paragraph), here (page nine) and here (page eight) are some quick citations.

@Arwin

The dollars purpose was not political, but economical.

Politics and economics are indissolubly linked, and the dollar’s purpose was every bit as much political as economic. The political relationship between Thomas Jefferson and Alexander Hamilton, Andrew Jackson’s assault on the Bank of the United States and the Free Silver movement are just a few instances of the interplay between politics and economics in U.S. history.

@Arwin

Pure nonsense. This would imply that China’s strategy pegging the Yuan to the Dollar would only work if China and the U.S. political integration should follow. Please.

My comment implied nothing of the sort; rather, your inference overlooks the difference between a currency peg and a currency union. As I have stated elsewhere in the thread, I feel that politics and economics are inseparable and therefore the European currency union cannot succeed without political union. Unlike the euro-12, China did not unify its currency with that of the U.S., which is why I have not made any suggestion of a political union in this case.

@Arwin

as long as you can’t come up with a better argument than that the U.S. is more a political union than the E.U., this argument is going nowhere

Again, the tight links between economics and politics mean that the U.S.'s development as a single political unit is a key reason the country makes a much better optimal currency area than the euro-12.

@Arwin

The EU will do better if they can manage to reform, compete

Do you have any particular basis for optimism that this will happen? In my opinion, many European governments - notably that of Italy - have viewed the euro as some kind of economic panacea that would enable them to stave off the kind of tough acts needed to remain competitive, such as working to encourage wage moderation. Because Italy is now cut off from “the oxygen of constant devaluation,” labor costs are rising faster than euro-zone economic growth and so boosting the real exchange rate, making the economy uncompetitive, as this article notes about two-thirds of the way through.

For anyone who isn’t aware, Italy’s economy entered its second recession in two years in the first quarter of 2005. Tellingly, between 2000 and 2003, the country was one of the worst performers in terms of unit labor costs among the six euro members included in this U.S. government report. (See the second table on page 11, last three columns on the right. Not perfect, as it doesn’t have all of the euro-12, but i think it’ll do.) Is there a connection between the country’s worsening economic peformance and some politicians’ recent proposals to consider re-establishing the lira? Absolutely, in my view. And again, an example of the interplay between economics and politics.

Finally, I note that the other euro-zone country which stands out in the table cited above as a poor performer in terms of labor costs is the Netherlands. I also note that the Dutch economy shrank by the most in almost 12 years in this year’s first quarter. While we won’t know until second-quarter figures are available, Arwin and his countrymen may have been enjoying the benefits of a euro-induced recession since the end of March, though I certainly hope that’s not the case.