Saving The Euro

Do you want to save the Euro? Well one idea for how to do it has been proposed by University of Missouri-St Louis history professor John Gillingham: reissuing the 12 national currencies that were replaced with just one, while at the same time retaining the euro as a parallel currency that finds its market value in competition to reissued national currencies (podcast here).
Continue reading

More On Exchange Rates and Policy Rate Differentials

Morgan Stanley’s Stephen Len is obviously on the same page as I am about how the rising interest rate differential between Europe and the US is likely to drive short term currency movements:

Policy rate differentials are especially important now for the currency markets, and it pays to focus on central banks these days.

Reason 1. Global monetary paths are diverging, not converging. Among the major economies, only the US has an output gap small enough to support tightening. I doubt either the ECB or BOE will be in a position to tighten rates this year. Many now understand quantitative easing must be terminated by early next year, but no one has proposed actually raising interest rates from zero. Therefore, monetary paths are diverging, with the rest of the world having trouble keeping up with the Fed. This makes the Fed much more important for the USD than in ‘normal’ times.

Reason 2. Global equity portfolios are likely to be out of balance. Since 2003, there have been massive equity flows into Euroland and Japan. Since much of these flows occurred when the USD was still in structural decline, and some of the outflows reflected fears of a USD crash, it makes sense to suspect hedge ratios are quite low on these equity outflows. With the rise in the FFR and resilient dollar, the cost of running these currency exposures is increasingly unjustifiable. The equity market cap-weighted short-term interest rate differential between the US and the major markets is now around 180 bp, and still rising. If the Fed takes the FFR to 5.0% by end-2006, the differential will reach levels last seen in 2000.

The Italian Government Has A New Crisis

Germany isn’t the only EU country where serious ongoing economic problems are leading to political gridlock. Italy’s situation is no better, and arguably worse. This ‘worse’ aspect was pushed into the headlines yesterday by the resignation of Economy Minister Domenico Siniscalco. This is sending shock waves throughout the entire Italian political system. It still isn’t clear at the time of writing whether the Berlusconi government can survive, especially given the gravity of the underlying problem which is the need to make severe budget cuts when Italy is in a prolonged recession and elections loom sometime next spring.

Essentially Siniscalco quit because of continuing government infighting over the 2006 budget and over the administration�s failure to force the resignation of Bank of Italy Governor Antonio Fazio following the scandal produced by accusations that he showed bias against Dutch bank ABN AMRO during a takeover battle for the Italian Banca Antonveneta SpA.
Continue reading

Something Worries Me About Peter Bofinger

Really I realise I have been remiss in another important sense. I have long assumed that in fact the decision to reduce deficits was taken due to the coming fiscal pressure from ageing. This certainly was the background to the discussion. However now I look at the details of the SPG this area is not mentioned (as far as I can see) and the other – the free rider and associated – is the principal consideration.

So those who criticize the bureaucratic and infexible nature of the ECB are in the right to this extent. Of course the underlying demographics *should* be part of the pact, but that is another story.

I find myself in a tricky situation, since I am deeply sceptical that the euro can work, and now after the French vote even more so, but since it has been set in motion, the best thing is obviously to try and make it work (even while doubting). So I am thinking about all this. Obviously I should try and write a longer post making this clearer.

The SGP was adopted at the Amsterdam Council 1997. A history of the implementation of the pact, and a summary of the debate over the new pact can be found here. The Stability and Growth Pact was designed as a framework to prevent inflationary processes at the national level. For this purpose it obliges national governments to follow the simple rule of a balanced budget or a slight surplus.

Now if we go back to the origins of the pact, to the communication of the European Commission on 3 September 2004, you will find the following:

“As regards the debt criterion, the revised Stability and Growth Pact could clarify the basis for assessing the “satisfactory pace” of debt reduction provided for in Article 104(2)(b) of the Treaty. In defining this “satisfactory pace”, account should be taken of the need to bring debt levels back down to prudent levels before demographic ageing has an impact on economic and social developments in Member States. Member States’ initial debt levels and their potential growth levels should also be considered. Annual assessments could be made relative to this reference pace of reduction, taking into account country-specific growth conditions.”

Now curiously I have found nothing in Bofingers argument which seems even to vaguely recognise this background.

A good starting point for this topic would be the conference “Economic and Budgetary Implications of Global Ageing held by the Commission in March 2003.

The European Council in Stockholm of March 2001
agreed that ?the Council should regularly review the
long-term sustainability of public finances, including the
expected strains caused by the demographic changes
ahead. This should be done both under the guidelines
(BEPGs) and in the context of the stability and
convergence programmes.?

This document on the history of EU thinking on ageing and sustainability is incredible.
Continue reading

The Euro Also Rises

The euro is trading this morning at around $1.2150. The big issue seems to be the US trade deficit, which is currently outweighing all other considerations. Still what goes down can come up, and what goes up……

The dollar fell to the lowest in two weeks against the euro, the biggest move of any currency, on expectations a government report tomorrow will show the U.S. trade deficit was near a record.

The U.S. currency has retreated 2.3 percent against its European counterpart since reaching a 14-month high on July 5. A rising deficit means more dollars are leaving the country to pay for imports. The dollar also weakened against the yen after Japan’s Nikkei 225 Stock Average rose to a three-month high.

“The dollar all of a sudden looks shaky; the deficit will be significant,” said Callum Henderson, head of global currency strategy in Singapore at Standard Chartered Plc. At the same time, “stock inflows are undoubtedly helping the yen. It makes sense for the dollar to weaken.”

Christian Noyer: Much Ado About Nothing?

The euro fell briefly below $1.19 yesterday. There is nothing surprising or exceptional about that, the common currency has been drifting steadily downwards against the dollar for a number of, by-now, pretty well known reasons – better economic performance in the US, a growing interest rate differential between the ECB and the Fed, political issues following the referendum noes, and an incapacity to decide what to do with the SGP. Yesterday however, an apparently new element was introduced: Christian Noyer, and his appearance before the Foreign Affairs Committee of the French National Assembly.

That this should have caused a stir surprises me. Christian Noyer is Governor of the French national bank (and not simply, as much of the press report, an ECB governing council member). It is therefore perfectly logical that when asked whether any country could leave the eurozone, he should reply in the affirmative. EU member states are, as Noyer says, still sovereign nations. He would therefore have been lying to answer ‘no, it is impossible’. Curiously, the other part of M. Noyer’s recorded testimony, that any exit would put in question continued membership of the EU is far more debateable, yet seems to have attracted far less attention.

Membership of a currency union is (or should be) an economic, not a political decision. Decisions on entry or exit should therefore be taken on economic grounds, and discussions of the issues involved should be possible without an atmosphere of emotional hysteria. Of course, if your currency falls simply because someone states the obvious (I mean the information content *is* zero), then this may indicate that there is a rather deeper problem knocking around somewhere or other.

Update: Jean-Claude Trichet yesterday defended the current ECB TWIRP stance (two per cent interest rate policy) before the European parliament?s monetary affairs committee and understandably rejected a call for an annual evaluation of the benefits of the common currency for zone-member citizens.
Continue reading

You’d Better Move On

The papers this morning seem to be all full of ‘gloomy’ articles whose principal theme is that Europe has finally been plunged into a grave crisis by this weeks summit.

“People will tell you next that Europe is not in a crisis,” Luxembourg Prime Minister Jean-Claude Juncker, who holds the EU presidency, said after a two-day summit ended in acrimony. “It is in a deep crisis.”

As someone who is ‘crisis prone’ I would have imagined I would share that feeling. Somehow I don’t.

Some reasons why.
Continue reading

French Franc Naustalgia

Well I’ve been reading about the Germans, the Italians, now apparently it is the turn of the French to feel naustalgic:

Three out of five French people miss their old currency, replaced by the euro in 2002, a survey for Valeurs Actuelles magazine showed on Wednesday. In February 2002 that figure was just 39 percent.

While the rising tide of nostalgia seemed to chime with French voters’ rejection last month of theEuropean Union constitution, a breakdown showed longing for the franc was widespread even among those who support the EU project.

I like that bit, “longing was widespread even among those who support the EU project”. This highlights the fact that it is perfectly consistent to feel pro EU and yet not want the common currency. Out of the wardrobe everyone.

Update: The Financial Times this morning also mentions the emergence of Philippe de Villiers, the leader of the nationalist Movement for France, as the champion of a referendum in France on continued use of the euro. According to the FT de Villiers, who is a leading anti-constitution campaigner, said a debate about Europe’s single currency was already under way in Germany, the Netherlands and Italy but had not properly started in France. ?Everybody notes today that the adoption of the euro was a technical success but its economic, political, and human toll is incontestable,?. Now much of the recent ‘ referendum euro’ talk comes from those who would predictably say what they are saying. They are normally not people with any special knowledge of the economics behind it, and I think no great significance should be attached, except the fact that these kind of comments are becoming commonplace, where they weren’t before. My guess is that debate about the euro will increase with time.

US Trade Numbers Are In

So are the China trade surplus ones. Dave at MacroBlog has the details on China. I’m waiting for Brad Setser to post, but he must be either doing his sums, or having a late breakfast :). Before we get some blog analysis (even Brad Delong is quiet today) you can get the basics here. In fact the rise in the April CA deficit to $57bn, from $53.6bn in March, is supposed to be good news, since the increase wasn’t as big as expected.

Essentially I am outside the Atlantic blog consensus here, since I think the US dollar will hold, and that it is the euro which is in trouble. I have a little post on this here. Logically if the other major alternative as a reserve currency is in trouble under Bretton Woods Mark I, everyone goes home to Daddy. I think that is how it will be.

Update: Well Brad still isn’t there but Stephen Roach is. I think his view is the dominant one on the US blogging scene, and shared by non-blogging economists like Paul Krugman. I’m sorry, I think it’s wrong, and by a long way.

Update 2 I’m getting a little tired of waiting (incidentally General Glut has just passed by in comments, and he *does* have a post on the topic). Now the politically sensitive US trade gap with China widened $14.0 percent in April to $14.7 billion. This means it was $12 billion in March, or that it rose $2.7 billion. Now China’s surplus widened to $8.99 billion from $4.59 billion. Doing the arithmetic the surplus rose $4.4 billion. $4.4 billion minus $2.7 billion gives $1.7 billion, a hell of a big chunk of which was probably with Europe. I wish someone who really knew about this would write something, but my educated guess is that Chinese import penetration in Europe is now big and getting bigger by the month. Hence the row about globalisation in the French referendum. Basically what I am saying is that having this kind of issue in the Free Trade US of A is one thing, having it in the more anti-globalisation European core is going to be quite another. China the global imbalance to end all (im)balances.

Now if you want to understand something about China:
Continue reading

Hungary: New President & Debt Downgrade

This week Hungary has a new President. The election of Laszlo Solyom as Hungary’s new President was a major setback for the governing Socialist Party (MSZP), at the same time as it was widely lauded as a victory by the right wing opposition Fidesz party. The outcome was largely the result of the behaviour of the MSZP?s junior coalition partner, the liberal leaning Free Democrats, who abstained. Katalin Szili, the MSZP choice, was regarded by Free Democrats as being far too involved with the MSZP. Only 3 votes separated the two candidates, and this reflects the current balance within the Hungarian parliament between Fidesz and MSZP ? a handful of independents and the Free Democrats in fact have the deciding votes.
Continue reading