On the Trading of Currencies as
Commodities
The value of international currency is defined as the faith or
speculation that the value of currency will increase. When the Western European
countries maintained their own currency, usually indexing them to either a
solid material, such as gold or silver, or to other currencies, their central
banking policy was focused on domestic growth, as well as protecting against
inflation and deflation. The consolidation of the various European currencies
has resulted in the fate of one nation, such as France, becoming associated with
that of a much poorer nation, such as Bulgaria.
The recent economic
crisis, beginning in 2007 and continuing through 2010, has been at least
partially attributed to the values of currency. Jörg Bibow, in the article Europe’s Quest for Economic Stability, discusses key decision
points of the European Central Bank (ECB). Bibow, writing in 2006, explains
both strengths and weaknesses of the Eurozone banking model. The primary
objective of the ECB, according to its founding charter, is to maintain price
stability across the Eurozone.[1]
Price stability, Bibow states, is “essentially a piece of Bundesbank
nostalgia,” referring to the former German bank charged with maintaining price
parity, and coordinating the now defunct erratic European Monetary System, from
which the ECB’s framework is largely derived.[2]
As a matter of general policy, the ECB does not
attempt any other ends aside from their primary mandate, only fostering
interest in economic development and employment when the ECB views that
engaging these ends will not interfere with price stability.[3]
On the Harm Caused by A Centralized
Currency
Bibow accurately predicts the contention
between the ECB and national central banks (“NCB”).[4]
Bibow discusses the issue of self-interested national banks acting in their own
interests as an issue that the ECB and NCB’s have yet to reconcile. The
provisions of the founding treaties and charters allowed the NCB’s to stay open
to regulate domestic affairs, being allowed to act as lenders of last resort;
however, the ECB’s role is to make policy decisions on a high level. The effect,
however, is that the ECB and NCB’s do not act as a unified actor, with goals
that can be in opposition. Kathryn Dominguez, in the article The European Central Bank, the Euro, and
Global Financial Markets (2006), cites the loss of NCB’s ability to control
inflationary or deflationary pressures. Because the euro is not attached to a
single NCB, countries in the Eurozone lack the ability to revalue their
currencies, allowing the market to correct for imbalances. Using Germany as an
example, Dominguez writes, “nominal exchange rates are fixed within Europe,
differences in inflation across countries can still affect real exchange rates.
For example, Germany’s low domestic inflation has made the country’s exports
relatively cheap, while higher rates of domestic inflation in Greece and Spain
make their exports relatively expensive”.[5]
Dominguez supports Biblow’s conclusion that the ECB’s increased scope of
membership is detrimental because the ECB’s policies may diverge from those of
the individual member countries. Further,
Dominguez cites a study by Meade and Sheets (2002, in Dominguez, 2006) in
writing, “Meade and Sheets argue that monetary policy decisions of the European
Central Bank from 1999 to 2001 are consistent with national central bank
governors voting in line with their national interests”.[6]
Bibow’s point of contention on this issue is
that the ECB is, essentially, an independent institution. The ECB only answers
to a board if bankers, and the “ECB refuses to publish minutes and voting
records”.[7]
Bibow comments that, “there are no effective checks and no real accountability
on performance”.[8]
Bibow (2006), cites the
ECB’s policy of “price stability above all else,” a mantra Bibow attributes to
Otmar Issing, as being actively anti-growth.[9]
Bibow attributes this unwavering commitment, despite new information, as being
causal to the early decline of the value of the euro, effectively forcing
inflationary pressures on the value of the Euro. Bibow writes,
As to the euro’s plunge, the ECB’s role was one
of acting as a twofold propogation mechanism as the bank’s words and deeds provoked
market opposition. [...] So when the ECB backed up its confusing words with all
to clear actions, that is, aggressive interest rate hikes, the market simply
took flight, preferring policy makers that were perceived as more growth
friendly.[10]
Bibow further discusses
the effects of perceived anti-growth policies, and the effects they have on the
Eurozone members. Specifically, Bibow mentions that the contingencies required
in accession to the European Union “imposes austerity especially on those who are
crippled already, whereas stronger members may even have room to cut taxes.”[11]
The inequitable treatment of the poorer Eastern European nations, compared to
the largely stable Western European nations, has, Bibow states, caused the very
condition the euro was designed to avoid: a “beggar-thy-neighbor” situation
that allows an unacceptable amount of risk into the banking system.[12]
Dominguez contributes to this thought by noting that “five out of the eleven
countries in the euro-zone (Greece joined the euro zone in 2002) were in
violation of the public debt rule. A strict interpretation of the [Stability
and Growth] pact is clearly not being imposed; in 2005, the three largest
euro-zone economies – France, Germany, and Italy – were out of compliance with
both the budget deficit and public debt rules”.[13]
Bigger, Western European economies are being treated preferentially – allowed
to break rules when it is convenient – further increasing the probability of
inflation, which further hinders growth in Eastern Europe.
Living standards in Germany, for example, are
undoubtedly better than Romania; however, inflation in Germany keeps exports
relatively high. What the euro has done, by standardizing currencies across
Europe, is allow comparisons to be made in the same unit. The ECB, when
admitting new countries into the Eurozone, uses a fixed exchange at the time of
accession, leaving the same amount of currency buying the same amount of goods.
Despite the equality of currency, one euro in Germany has the same value as in Romania,
the disparity in economic output between the two separates developed and
developing nations into almost separate regions. In Romania, since the
potential output of the economy, and relative inability to garner interests in
Romanian exports, limits the money supply, the Romanian population is still
chasing after a limited amount of purchasing power; in Romania, demand for
money outpaces the supply, and ability of the Romanian economy to get euros
from international sources is limited. Without a population full of euros,
government income from both personal and business tax revenue is likewise
limited. With a limited income, and mounting expenses, countries act in the
same way as individuals: they borrow money, spending income they haven’t yet
earned in order to pay for things they want or need at the time, on the promise
that in the future, when payments are due, the money will be there. When the
bills are due, and the money is not there, speculation forces a country’s bond
yields up, increasing the costs associated with lending, and trigging a
liquidity trap. Because the euro in the failing country is now saddled by debt,
the value depreciates across the zone.
When It Rains, It Pours…
The last issue that Bibow examines is the
potential for the Euro and the Eurozone to invoke a liquidity trap: “cutting
short term rates would only undermine confidence and drive up bond yields”.[14]
Bibow’s words ring true, especially when considering the system level of
analysis that induced the Greek, Irish, and Portuguese debt crises.
Ireland, according to an article disseminated
by Reuters, and published on CNBC.com, Worst
of Times, Best if Times: Tale of Two Irelands, is undergoing a financial
crisis as well. The article discusses the state of the Irish economy,
contrasting Northern Ireland, in union with the United Kingdom as stable and
continuing on a path to prosperity with an ever increasing trade surplus, with
the Republic of Ireland, hampered by recession and job losses equal to one
tenth of its population. Northern Ireland, as a member of the UK, does not use
the euro as its currency – preferring the British pound, and has been ever
increasing its self-rule. The difference in monetary control may seem to be
unimportant, until the realization that The UK has a vested interest in the
strength of the pound internationally, while the ECB has a plurality of
national interests, ready undermine foreign competitors. The Republic of Ireland joined the European
Union, uses the euro, and recently enjoyed economic prosperity, is now faced
with “a sudden fall in [domestic] output [that] has blown apart what were once exemplary
public finances”.[15]
The article further discusses the job vacuum left in the wake of a housing
bubble, increasing unemployment to 14% from four, and renewed emigration to
countries with jobs. The article mentions that firms from the United States
“have invested more in Ireland than in Brazil, China, India, and Russia
combined”.[16]
The significance is only realized when combined with the information that
foreign firms are only taxed at a rate of 12.5%, a decision made to entice
foreign investment.[17]
EU members, however, are less than thrilled, and the article suggests outrage
that EU members now must fund a bailout of the Irish economy, while accusing
Ireland of competing unfairly with the lowest tax rates on foreign firms in
Europe.[18]
Traditionally, as has happened to every economy, currency would have been devalued,
the market allowed to readjust, cheapening Irish goods, spurring global demand
for Irish goods at a now lower price, which will infuse new capital into the economy,
leading to recovery. Lacking effective controls over their currency of use, the
euro, the Republic of Ireland must now pay a value that it cannot afford, with
a currency it does not have, with trade partners who seek to maintain their
national interests – for their goods.
According to an article by Antonia Van de
Velde, published on CNBC.com, titled Think
BIIGS: There’s One Euro Country Under the Radar, Belgium is also facing a
currency crisis. Belgium is unique among the troubled euro states today for two
reasons: the first, that Belgium currently lacks a national government;
secondly, that Belgian “public debt is just under 100 percent of gross domestic
product”.[19]
Essentially, Belgium is indebted to the world the entire sum of one year’s
economic production, having spent money that has not been earned yet. In a
traditional “one nation-one bank” system, Belgian currency would fall in value
to a level that is sustainable in the market, or short term interest rates might
be lowered to decrease the costs
associated with moving capital from the central bank though the entire banking
system. However, because Belgium is part of the euro zone, the harshest
consequence is the increase in the spread of Belgian credit default swaps.[20]
Further, despite a debt load that would be considered in most other
circumstances as technical insolvency, “Standard and Poor’s wrote that it’s AA+
rating on the country’s long term debt – the second highest rating at the
agency – could come under downward pressure if a continued political
stalemate were to diminish the
authorities’ capacity to address the ‘outstanding challenges’”.[21]
The only positive factor, according to Van de Velde, is that the perception in
Belgium is that if there is no government, there can be no spending.[22]
Despite Belgium’s inability to decide whether it is German or French or Dutch, for
a country, about the size of Maryland, it may have acted and spent differently
would the true cost of Belgian debt not spread amongst its European neighbors.[23]
While the risk of a country, especially a
modern economy, defaulting on its debt has fallen since the turbulence of the
70’s and 80’s, the fact that these conditions are perceived as consequence free
encourages countries to spend more money than they have, to buy things they
cannot afford (and as Suze Orman would add, to impress people they don’t know).
The moral hazard, of removing consequences from bad decisions, has the effect
of enticing other countries to engage in similar reckless spending practices –
knowing that they would be shielded from their actions.
Dominguez further believes that limiting a
government’s ability to control its own currency can not only affect the
individual country, but can bleed over and poison healthy economies within the
same currency market.[24]
Stripping monetary policy from a country, and handing over that power to an
outside power, further disrupts a nation’s ability to pursue the goals demanded
by their population. Dominguez writes that the euro and the ECB, “was sold to
Europeans as the means by which they could achieve political and economic
stability”.[25]
The euro, a common currency for all of the Eurozone, necessarily is contingent
upon the member states’ values; Dominguez questions the ability of the Eurozone
to stay together should Germany or France go into recession.[26]
Dominguez asks, “If Germany or France go into recession and badly need monetary
stimulus, how will the European Central Bank balance their needs against the
rest of the euro zone?”[27]
Quantitative easing serves to decrease the value of a currency, but with
twenty-two member states’ economies crucially dependent on a newly-lowered
value euro, the rest of the euro zone is poorly equipped to absorb such
capacity.
Conclusions
While the goals of a
pan-European currency are admirable, and greatly benefit countries during boon
times, the methods that the European Central Bank have chosen to use is of
greater harm. Lacking the ability to make independent decisions on monetary policy,
relative inflation can occur even between Eurozone countries. Rather than
achieving the stated goal of price stability, the euro serves only to increase
the amount of countries affected by an economic downturn; the amount of risk is
just more broadly distributed. While diversification of a portfolio is,
unquestionably, an important aspect of investing, incorporating toxic assets,
even while packaged with healthy assets, is not. Not only do Eastern Europeans
suffer as a result of unequal inflation, the Eurozone is unnecessarily liable
for the debts and deficits of their neighbors that engage in reckless
behaviors: Germany, France, and Spain – otherwise first-world countries that
have debts beyond the allowances of EU and ECB regulations.
The model of Adam
Smith, who clearly describes the relationship and origins of division of labor
and the development of market economies, can be applied to states. If the state
is the individual in a state of nature, as Smith postulates our origins, then
comparative advantage and trade of each nation is the same as the barter
economy of individuals before the development of currencies as proxies for
labor. The labor of a country is the amount of wealth contained in the country,
which itself is related to the capacity of the economy for growth. While
unionization into the European Union has proven to be beneficial, with regards
to the lowering of trade barriers and establishing mutual trade and peace, the
consolidation of currencies cannot be so readily lauded. Decoupling the growth
of each economy for the value the country provides invites unnecessary risk
into the global financial system. No longer is a country defaulting limited to
the debtor countries; the shockwave will be sent throughout the zone, with a
collective devaluation of currency. In Smith’s model, the loss of an individual
will remove just one operation from the pin-making business – should a
significant number of euro countries crash, it may result in the loss of the
entire factory.
References
Bibow, Jörg. 2006. "Europe's Quest for Monetary
Stability." International Journal of Political Economy 35, no. 1: 24-43.
Business Source Premier, EBSCOhost (accessed November 22, 2010).
Central Intelligence Agency. 17 Nov 2010. CIA – The World Fact Book: Belgium. Published on https://www.cia.gov/library/publications/the-world-factbook/geos/be.html.
Dominguez, Kathryn M. E. 2006. "The European Central Bank, the
Euro, and Global Financial Markets." Journal of Economic Perspectives 20,
no. 4: 67-88. Business Source Premier, EBSCOhost (accessed November 22, 2010).
Reuters News Agency. 26 Nov 2010. Worst of Times, Best of Times: Take of Two Irelands. Published on http://www.cnbc.com/id/40377778
Smith, Adam. The Wealth of Nations.
Edited by Alan B Kreuger. Translated by Edwin Cannan. Vols. Based on Cannan,
5th Edition, 1904. New York, NY: Bantam Books Publishing: Random House, Inc.,
2003 (1776).
Van de Velde, Antonia. 26 Nov 2010. Think BIIGS: There's One Euro Country Under
the Radar. Published on http://www.cnbc.com/id/40379099
[1]
Bibow, 1996, pp. 32-33
[2]
Bibow, 1996, pp. 32, 24
[3]
Bibow, 1996, p. 34
[4]
Bibow, 1996, pp. 24-25
[5]
Dominguez, 1996, p. 79
[6]
Dominguez, 2006, p. 73
[7]
Bibow, 1996, p. 30
[8]
Bibow, 1996, p. 29
[9]
Bibow, 2006, p. 37
[10]
Bibow, 2006, p. 37
[11]
Bibow, 2006, p. 38
[12]
Bibow, 2006, p. 38
[13]
Dominguez, 2006, p. 76
[14]
Bibow, 2006, p. 39
[15]
Reuters, CNBC, 2010
[16]
Reuters, CNBC, 2010
[17]
Reuters, CNBC, 2010
[18]
Reuters, CNBC, 2010
[19]
Van de Velde, 2010
[20]
Van de Velde, 2010
[21]
Van de Velde, 2010
[22]
Van de Velde, 2010
[23]
Information about Belgium’s size compared to the state of Maryland, CIA World
Fact Book Online
[24]
Dominguez, 2006, p. 81
[25]
Dominguez, 2006, p. 86
[26]
Dominguez, 2006, p. 86
[27]
Dominguez, 2006, p. 86
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