An important article to understand currencies

I totally agree with this article. There is more to currencies than just interest rates differentials. They reflect productivity differentials, government regulations, concentration of power. 
Currency areas hide many currencies. It is a fine point explained in great detail by the author. It is a difficult subject but you owe it to yourself to try to understand it. This is a great introduction.

Greece is already paying the price for being inefficient. Its “currency” keeps devaluing reflecting the huge loss of purchasing power of the Greek people. That Greece is in the EU or not is a matter of semantics. They are paying the price right now for their disastrous way of running their economy. No doubt about it.

Get Over It Pundits, Greece Is Not Leaving The Euro Even If It 'Leaves' The Euro by John Tamny

About Greece and the euro, a conservative U.S. magazine recently opined that “A common currency for the European Union was always a bad idea, because it required a common monetary policy for very different economies.” Books can and will be written on all that’s wrong with the previous statement.

If one were to take the passage seriously the only conclusion would be that just as a common currency is supposedly a bad idea for EU countries, so has a common dollar been a disaster for most of our 50 U.S. states, along with the various countries around the world that have essentially dollarized their economies.   The economies of New York, California and Texas are nothing like those of West Virginia and Mississippi, not to mention that economic activity in Manhattan, Beverly Hills and Highland Park in no way resembles what’s taking place in Buffalo, San Bernardino and Denton, yet the dollar is the accepted medium of exchange without much in the way of protest in all the locales mentioned despite their “very different economies.”  Implicit in the assertion about the alleged horrors of a common currency is that the relatively weak economies of Arthurdale (WV) and Oxford (MS) are held back by the dollar such that each state should issue a currency of its own.  Hello WV Ringgit and MS Peso.  About the economic productivity that would vanish under such a scenario, many books could be written.

In the magazine’s defense, what it presumes about money is not uncommon on both the left and right, and that’s the problem.  While many on the right pay lip service to the tautology that there’s no free lunch, alongside their reliably emotional opponents on the left who act as though lunch can be free (government spending seemingly just happens, with no one fleeced to pay for it…), each subscribes to the falsehood that “money” is magical, and can be played around with by wise minds to achieve all manner of wondrous economic outcomes.

In truth, money is solely a measure.  I have bread, I want your wine, but you don’t want my bread.  Money makes a transaction possible between a baker and vintner with differing wants simply because it’s historically been viewed as a stable “ticket” that allows producers of actual wealth to measure what they produce on the way to trade.  Money facilitates exchange, and that’s why a common dollar has long made so much sense.  That’s why the euro still makes sense.

To simplify what is truly basic, but almost totally misunderstood by those deep in thought on the right and left, money is not wealth.  Instead, money is how we exchange actual wealth.  Money is also not investment.  Repeat the latter over and over again.  Instead, money is what we use to direct the economy’s actual resources to their highest use.  Money facilitates investment. That’s why gold has historically been used as the definer of money.  Known throughout history as the most constant commodity from a value standpoint in the marketplace, it was logically used to define money that achieves its greatest utility when it’s stable.

Economies grow thanks to investment, and when investors invest, they are buying future dollar, euro, yen (name your currency) income streams.  So while money itself isn’t wealth, stable money makes the investment that leads to wealth creation far more constant, patient, intrepid, etc.  England was a very poor country until it tied the pound to gold in the 18th century (after which investment into the country soared), while the U.S. would most certainly not be the world’s richest country today if the dollar hadn’t been a stable measure of wealth for most of our existence.

That’s what was so puzzling about the conservative magazine’s added assertion to the one from above that the problem with the European Central Bank vis-à-vis Greece is that it’s conducting a monetary policy “appropriate for Germany,” but not one that makes sense for Greece and other EU laggards.  This gets things 100% backwards.  Explicit in such a viewpoint is that there are free lunches, that money can be used to distort actual reality.  Too short? Devalue the foot.  Too impatient to eat that Pop Tart that is taking 30 seconds to cook in the microwave? Strengthen the second.  Unable to compete, devalue the currency.

Missed here is that at least 50 countries around the world have their currencies pegged to the euro, and many others  have their currencies pegged to the dollar.  Yet not all of them are imploding as Greece is.  To blame the euro for Greece’s troubles is to miss the point, or at the very least miss the actual demerits of the euro since the early 2000s.

Furthermore, those still deluded by the notion that monetary policy for rich countries is not appropriate for poorer countries might ask themselves what things would look like for the euro itself had Greek monetary authorities not just designed it, but if Greece’s economic situation were the driving force behind the ECB’s conduct of monetary policy.  If so, as in if Greece managed the euro, would those 50+ countries have their currencies pegged to it, let alone all the European countries that have adopted it? Obviously not.  That a rich country like Germany runs the euro currency show is what makes the measure so attractive to begin with.

The belief underlying the idea that relative economic laggards need a “separate” monetary policy is the equivalent of Tennessee issuing a TN Lira because its economy doesn’t resemble New York’s. It presumes that Greece could be more flexible with the Drachma, that it could issue more debt to “stimulate” the economy, that it could devalue (more on that in a bit) the Drachma during periods of weakness….Again, books could be written about all that’s wrong with this monetary mysticism, and in my upcoming book Popular Economics, I devote many chapters to all the mythology surrounding money.

But for now, let it be said that even if the Drachma were to replace the euro, Greece’s government and Greek businesses would still be issuing debt in euros.  If this is doubted, readers need only consider how often Argentina’s government leaders float debt in Argentine pesos.  It’s been done, but it’s rare.  Argentine government and business debt is most often issued in dollars simply because the interest rate on a currency that lacks credibility (the peso) would be nosebleed high.  Does any serious person think the situation would be different for Greece’s finance ministry or its businesses assuming the country were to “leave” the euro? Not very likely.  Of course, assuming a “Grexit” and the desire to issue debt in Drachma, this would only be possible insofar as the revived currency were pegged to the dollar, yen, and yes, you guessed it, the euro.  There’s no escaping economic reality despite what politicians and pundits want you to believe.

It’s then argued that the acceptance of the euro as “money” is what got Greece into trouble in the first place.  They say Greece was essentially borrowing with a German credit card.  It’s a nice assumption, there’s a small amount of truth to it considering the credibility that German monetary views brought to the currency, but overall it’s nonsense.  If true then it would also be true that Mississippi and Louisiana could run up debt in the way that California and Texas can.  The problem is they can’t.  Markets are wise, while currency pundits are generally confused.

What the above hides is that Greece’s problem was never debt, rather it was and is government barriers that strangled growth, along with an overly weak euro that deterred investment.  Regarding the latter, most of the blame lies with the U.S. and its dollar policy. The reality is that the world remains on a dollar standard of sorts, so when we devalue in the U.S. it’s a global event.  A weak dollar since 2001 fostered a run on paper currencies of all shapes and sizes on the way to slower global growth.  The euro’s “strength” against the dollar in the 2000s masked the actual truth revealing a very weak euro made to look “strong” by a much weaker dollar.  In that case it can’t be repeated enough that investment comes first, growth second.  Investors are buying future dollars, euros and yen when they invest, but over the last fourteen years broad currency weakness made investment far more risky, and as such, less common.  It’s very simple.  Absent weak U.S. dollar policies in the 2000s that took down the euro too, Greece is not insolvent in the first place.

All of which leads to the most brain dead commentary of all about Greece, that its struggles stem from an inability to devalue its way out of its troubles.  This bit of illogic excites liberals and conservatives alike, and speaks once again to a bipartisan belief that reality can be obscured by magic.  Too corpulent? Strengthen the pound.  Do you blanch at an hour on the treadmill each morning?  It’s simple, devalue the minute.  Don’t like your slow rate of growth? Issue a new currency meant to “trick” investors and the electorate into believing that economic activity is actually abundant.

Yet missed by the fabulists on the left and right is that there are second and third stage market responses to currency devaluation.  To devalue the currency is to tautologically raise production and labor costs, all the while devaluing earnings that attract investors in the first place.  That no country in the history of the world has ever devalued its way to prosperity doesn’t deter the mystics across the ideological spectrum who think diluting the proverbial ticket will alter reality.  That devaluation would scare away the very investors essential to growth doesn’t seem to interest the astrologists either.

Fair enough, there’s no law against confusion, but with West Virginia and Mississippi constantly fighting it out for the distinction of being the poorest state in the U.S., does anyone want to guess how long it would take West Virginia to firmly wrest control of #50 if it were to exit the dollar in favor of the WV Ringgit?  Just the same, does anyone want to contemplate the wealth result of Greece leaving a mostly credible currency for one that would quickly be a global joke?

Of course, that’s ultimately not the point. The reality, as I wrote back in 2011, is that no matter what Greece does, it will always be on the euro, or the dollar, the yen, or some other credible currency.  This won’t change even if the country’s hopeless leaders follow the advice of an even more clueless commentariat such that Greece “leaves” the euro.  It will do no such thing.  Reality bites.  Deal with it.
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George Dagnino, PhD
The Peter Dag portfolio
Since 1977

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1 comment:

Anna Willson said...

Yes, good example with Greece. Financial crisis is never an easy thing to go through. In most of occasions the consequences of it affect as social as political life. Even before the crisis there was an unemployment problem in Greece but now the situation has changes into the worse. Lots of Greeks are looking for ways to stay afloat and need to find a steady source of income but it’s easier for those who already have some job experience. For youth it’s much harder to get a decent job because in most of occasions they lack required experience and employees don’t want to hire them. Because of financial crisis many consumers find best short term payday loan here or other lending services to stay afloat and cover at least basic expenses.