The Euro, Past, Present and Future

“Our role as central banks is to guarantee price stability in the Eurozone. I’m convinced that the future of the euro is fundamentally linked to the support of the population, and that this support depends on the confidence Europeans have in the stability of their money.”  

“The mandate is deeply rooted and stems from the lessons learned during the seventies and eighties," he said. "It’s when a central bank ensures price stability that it contributes the most to durable growth.”  

“Governments must take on their responsibilities and not subcontract them out to monetary policy.” 

Jens Weidmann, Bundesbank President (article)

The persistent Euro crisis has garnered much media attention in the aftermath of the credit crunch. With benefit of hindsight many have concluded that the Euro was always doomed to fail from the start, with both sides of the political spectrum fervently believing they were correct all along. In Britain, right wing thinkers always believed that 'Brussels' never had a solution and should stay out of Individual Nations affairs. The left initially thought the Euro to be a good thing, seeing old currencies as symbols of Imperialism, but would later object to the Austerity imposed on member States. The left during the seventies were opposed to the common market, while the right were in favour. When the European Exchange Rate Mechanism was in use it was the right who were generally in favour. After the pound was ejected the left could claim it was a disaster made by the Tories; after the event had occurred.

You can see the confusion and schizophrenic nature from both ends of the political spectrum. History has shown both camps to support one form of monetary union, but then to oppose another. There has never been a thorough discussion on the Euro in mainstream politics with either end of the spectrum unable to rationally determine what the real issues are. 

Claims have been made that "You can't have monetary union without political union" or "A Nation and its Government should always have control of its own money supply", to "You need the power to devalue in order to regain competitiveness". All are stabs in the dark, as these were never raised as issues back when the currency was created. Only when catastrophic events have transpired do these so called shortcomings come forth. Like all events in history, it is never a simple yes or no, and requires a rational look of what caused the current situation to arise.

During Bretton Woods I, when the US was on it's quasi Gold Standard, they pegged the dollar to gold allowing only foreign central banks to redeem their dollars for gold. With increased deficits by Kennedy and then by Lyndon Johnson this spending had to be paid by someone, therefore the government does what it usually does, it printed money to pay the difference. When the Bretton Woods agreement was created the Keynesian's proclaimed that redeemability of the dollar for gold would cause no issues as institutions would never need to claim. Unfortunately for them they didn't count on Jacques Ruff advisor to former French president Charles De Gaulle. 'They run deficits without tears', thus Ruff advised De Gaulle to call the Americans bluff and trade in the paper promises for something that the American Administration couldn't create out of thin air. Others followed suit.

The rest as they say was history. Bretton Woods I was abandoned, in which we moved to the current global monetary system we still have now. The erratic fluctuations of the currency markets during the seventies accompanied with widespread financial turmoil prompted many European nations to look for solutions to stabilise trade, thus the chaos became one of the prime reasons for the single monetary currency created two decades later. (Taken from a previous post)

After the post war era Western Europe progressively moved towards economic integration. Many reasons exist, to combat American dominance, to unify against Eastern Europe, to enable greater trade - it was always a strength in numbers philosophy. 

Prior to the Euro, Europe had the ERM which attempted to tie the various currencies on the continent to the German D-mark; which at the time was one of the hardest currencies in Europe. It was doomed from the start as fixing currency exchange rates is a foolhardy scheme. It was price fixing and like any attempt to fix market prices it fell apart in the end. The principle however was to maintain low inflation among member nations and to stop political pressure to devalue in a race to the bottom. The right wing in Britain joined the ERM under Majors Government, despite the Majority Conservative Euroscepticism we see now. 

When the Euro was created nations who had an association with soft currencies clamoured to obtain membership. Its easy for complaints to be made towards the Euro now when austerity is imposed, but when the single currency was introduced it was seen as an economic boon by such countries.  Nations such as Spain, Greece and Ireland benefited greatly from the introduction of the Euro. Inflation fell, interest rates stabilised, capital investment spending increased. The whole point of the Euro is to ensure inflation is kept low by borrowing inflation credibility from the old Bundesbank who had a long history of doing just that. Interest rates fell across Europe in part due to this factor. Bond markets could therefore ask for a lower rate of interest on Greek or Italian bonds as Monetary Policy had been handed over to the more competent Germans. Historically Mediterranean countries would erode the value of their bonds with expansive monetary policy, but when these powers were absolved to the ECB, markets lowered prices for such Government debts.

A similar mechanism happened here the United Kingdom, whereby monetary automonoy was taken out of political hands. In 1997 the new Labour Government gave interest rate decisions to the Bank of England, a supposed neutral organisation. The idea was to take such decisions away from politicians who had in the past set interest rates to create inflation, and/or economic booms during election times. Both sides of Parliament, agreed that this was a good policy. The rest of Europe did something similar to the above, it handed monetary policy over to the Bundesbank. Another example of the contradictive nature of mainstream thinking.

The principle in keeping inflation low is a good thing. This spurs capital investment and production so that citizens can obtain better living standards. The more stable a moneys purchasing power is, the better off its people will be. The faster a currency devalues over time, the poorer its economy and people will be.

Many of the countries however still worked under the spend now, act later mentality. Government and consumer debts kept rising along with off the record liabilities. The European Welfare state was supported by this illusion, along with heavy Government corruption, rigid regulation or absurd employment traditions. The Credit Crunch was just the spark to highlight all these underlying issues to the market that has since demanded the bankrupt countries get their house in order. Markets have been trying to do this by asking for higher rates of interest on bonds; increased risk means the return an investor requires should be higher. This is the markets price mechanism trying to force bankruptcy/spending reform upon the political system. Without this dynamic the old political system tricks people to believe that an easy fix is within sight, allowing Government spending to get out of control. The problem is whenever these prices have been raised, a bailout fund is announced in an attempt to bring these prices back down. Initially the markets predictably put money on the new policy but not for long as markets know the underlying issues are only compounding.

The quotes taken from the Bundesbank President are exactly the reason the Germans have such a strong reputation in financial markets for running a sound currency during the Post War Period. It also highlights cultural differences between the Germans and the Mediterranean countries, who historically had Governments that pursued high inflation for their political failings. The periphery countries want all the benefits that accompany the common currency, low inflation, low interest rates, real terms capital investment, while at the same time oppose the fiscal constraints that help foster such benefits.

The simple problem with the Euro, or any money controlled in a monopolistic manner, is its openness to abuse. Money should be provided, like all goods and services, by a free market, competition, consumer sovereignty and choice. Thats the real issue behind the Euro and the solution not just to its ills but all problems that will arise with Government controlled money. 

We are witnessing the end of the Euro as many analysts/pundits/commentators are proclaiming, who state it should never have been created (usually these were the same people who were saying the UK should have joined, or were selling their Dollars and buying Euros a few years back). It is impossible for any commentator to predict what Governments will do, however I believe the Euro has the potential to prosper from recent events, only if the Germans maintain a hard line. This will entail Government defaults, bank collapses, members leaving, but if they decouple the currency away from political pursuits it will be a sound currency relative to others.

The real crisis will be if the Germans do not uphold a hard line. Many are distracted at the crisis occurring in Europe but are unaware of the crisis building up in nations who are overstretched, but still have monetary autonomy. Countries like Japan, the UK and the US are the ones who will have real problems. Their spending is also out of control, but the politicians are just using monetary tools to mask their problems. Interest rates for Government bonds are low in such countries because the market knows they will just monetise their debts if there are no buyers. Its certainly not because they are any more creditworthy. However this postpones any reforms that need to occur, with the situation getting worse. Look at Japan. Its debts are astronomical and will no doubt have great problems during the decade.

The Euro, if it is managed correctly, will be a strong contender to challenge the Dollars world reserve currency status. If this occurs, contrary to popular opinion, I believe the UK will eventually join as we continue to mismanage pound sterling. 

As mentioned in previous posts, I believe the 21st Century will be a great Century for liberty, individual freedom and human innovation. Statism, Monarchies, dictators have all had their time in the West. Such nations will increase individual freedoms as the states role diminishes over time. It will be an evolutionary process, not revolutionary. I also believe that the Euro may be a step towards the abolition of Government control over money. Its a pseudo gold standard that has the potential to stop endless devaluations for political means. As the state shrinks, people will realise the state is not required to help run our lives with money also falling under a similar observation, we don't need our Government to issue money. The Euro may well be run by Government officials, but its not tied to a single nation or a unified political system. Therefore the Euro, to some extent, decouples political affairs from monetary policy. We are a long way from free market money, but the Euro could be the start of a long path towards such a goal.