Can the Euro Really Fail?
Beginning with government debt struggles in Greece and Ireland last year, it’s become sport among the economic commentariat to predict the euro’s inevitable demise. In the past two weeks alone, headlines about the euro have included “The Coming Crackup Of the Euro”, “The Euro Is Running Out of Time”, and of great curiosity to this writer, “IMF chief’s departure is another nail in the euro’s coffin.”
The problem with all of these bombastic headlines is that underlying them is a misunderstanding of currencies more broadly. To paraphrase Adam Smith, the sole purpose of money is to facilitate the exchange of goods. That being the case, there’s no reason that debt problems within certain euro countries should lead to the extinction of what is merely a “unit”, or a concept meant to put a money price on goods and investments.
Money is once again a concept, so if the euro’s survival or viability is the goal, then the ECB should make the currency viable in the markets. One way to do so, though it wouldn’t work very well given the dollar’s weakness, would be to peg the euro to the world’s currency.
Even better would be to define the euro in terms of gold (NYSE:GLD), and make euros redeemable in the yellow metal. If so, the euro’s staying power and eventual rise to preeminence among currencies would almost be assured. Strong money that is stable in value is much demanded as a ticket used to exchange real wealth, and if the euro had a stable definition, it would quickly trump the dollar.
Of course the mythmakers predicting the euro’s demise would argue that a gold-defined euro would lead to certain debt default by Greece and Ireland (to name but two struggling countries), and that both would quickly exit the euro under such a scenario. The thinking here is wildly incorrect.
For one, if the ECB were to give the euro a gold definition, the cost of servicing euro-denominated debt for Greece and Ireland would decline. With markets suddenly aware of the euro’s extreme credibility, investors would demand lower interest rates due to greater certainty about the value of the money being paid back. This on its own would reduce the pressure presently placed on the governments in Greece and Ireland. Right now the euro’s weakness serves as a stealth default on euro-denominated debt, so a stronger currency would reduce the cost of a potential “haircut” for holders of Greek/Irish debt. The other argument that would be made against a gold-defined euro (the commentariat almost to man say that the euro must be devalued to keep Greece and Ireland in the fold) is that a strong euro would make exporting from the euro bloc’s sagging countries extraordinarily difficult on the way to a certain collapse.
The above is false on many counts. For one, further devaluation of the euro almost certainly ensures higher interest rates on euro debt. For two, considering the producers in Greece and Ireland, a stronger euro would in fact reduce wage pressures, the cost of imported inputs necessary to produce what they manufacture, plus it would reduce shipping costs. Any euro strength that would make euro-denominated goods more expensive on world markets would be mitigated by commensurately reduced production, labor and shipping prices.
After that, it should be noted that the governments of Greece and Ireland are having trouble with their debts to some degree because economic growth has withered alongside tax receipts. If so, far from a weight on growth, a strong, stable euro would attract the investment that would drive company formation and job creation that would bolster the ability of both governments to remain current on interest payments. For good or bad, economic growth is always the best fix for governments in arrears to creditors.
Considering a popular option among the commentariat that Greece ditch the euro in favor of the drachma, it would be hard to think of a more dangerous idea. The move speaks to stiffing euro creditors, after which any government debt denominated in drachma would require astronomical rates of interest to float. And then the greater problem would be the one for private sector Greek companies suddenly forced to suffer a new/old currency lacking any credibility. If interested in raising growth capital in the private markets, they too would face difficult creditors on the way to subpar growth, which would ultimately make government debt in drachma even less attractive in a vicious cycle.
The answer, always and everywhere, is stable, credible money, though it’s hard to find a commentator making such an argument.
Of course, the greatest myth is the one promoted by the Wall Street Journal’s Mark Whithehouse last week. In an article pregnant with falsehoods about the nature of currencies and economic growth, Whitehouse observed that “Differences in economic cycles, languages, rules and competitiveness can make the costs of a common currency outweigh the benefits.”
Lost on Whitehouse is the simple truth that what he describes is the United States. Indeed, no one would mistake the growth cycle of West Virginia for that of New York, yet the fifty different states (different tax policies, regulations, laws, etc.) in our Union thrive precisely because there’s a common currency. Absent a common currency in the form of the dollar, the U.S. would still be a rich country, but far less vibrant for all the wasted effort necessary to facilitate interstate trade given 50 different floating money concepts.
If we then say that West Virginia and Mississippi are the Greece and Ireland of the United States, poor as they both are we must ask how much worse off they would be if both states had their own currencies; arguably severely compromised monetary systems. If so, the poverty that defines each would be even greater for them lacking an historically credible currency that investors could trust. As always, there’s no company formation and no job creation without investment, and that’s why credible currencies are so essential.
So while the economic commentariat will continue to blindly promote currency devaluation as the fix for every economic ill, those in favor of what’s never worked might ask if any country in history has ever devalued its way to prosperity. The answer is no, and because it is, the economies (and ultimately governments) of Greece and Ireland will suffer if they leave the euro.
As for the European currency’s presumed demise, this won’t occur if the ECB strengthens and stabilizes the euro unit over which it has control. That’s the pro-growth maneuver, and it’s the only one that will stave off looming default for the euro bloc’s weakest countries.
John Tamny is a senior economic advisor to Toreador Research & Trading, a senior economist with H.C. Wainwright Economics, and editor of RealClearMarkets and Forbes.