That Other Issue

The euro. Hamish McRae talks a lot of sense in the Independent today:

So was the euro a terrible mistake? Will Germany, Italy and France go back to the mark, the lira and the franc? A string of stories have hit the streets hinting that this may be the outcome following the failure of France and the Netherlands to ratify the European constitution.

It is easy to see why there should be such speculation, but the eurozone is not going to collapse in the near future. I may be wrong, but my instinct is that while it will eventually unravel, such an event is almost certainly at least a decade away. That said, the debate matters because what was once a no-go subject is now being talked about, and this changes things.”

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

11 thoughts on “That Other Issue

  1. So his instinct tells him the Euro will unravel. My instinct tells me he’s wrong.

    Who’s right then?

    In a decade nobody will talk about the price rises due to the Euro any more. Who knows, in a decade the UK might be in a crisis and desperate to join the Euro. The dollar might have unravelled because the one size fits all didn’t work in the US any more and the Californian economy felt stifled by a monetary policy decided in Washington. Or Scotland decided to leave the Pound because the interest rates set in London didn’t help economic development north of the border.

    All makes sense to me.

  2. There’s a difference. You would get an overwhelming majority in a popular vote for the dollar or the pound. The Euro would go down in flames. Unless that changes, and at present things are going the other way, the Euro is in trouble.

  3. In the UK’s Sunday Times today:

    ” .. Stuart Thomson, an economist with Charles Stanley Sutherlands, the stockbroker, says in a paper that the French referendum was the beginning of the end for the euro. The collapse of monetary union is inevitable by 2020, he writes, as the European economy comes under increasing pressure, not least from its ageing population. But he also sees a 50% probability of a partial break-up by 2008, with one or more member states withdrawing, partly as a consequence of the currency-market backlash as China and Japan abandon their policy of supporting the dollar through large-scale purchases of US government bonds. History is on his side. Every previous monetary union in Europe, such as the Latin Monetary Union of 1865-1927, ended in failure. . . ”
    http://www.timesonline.co.uk/article/0,,2095-1641196,00.html

  4. The currency union of the UK and Ireland from 1922 to the end of the seventies, such as it was, didn’t really end in failure.

  5. Ah, from the Werner plan to the Euro, a currency union would never ahve survived a popular vote. That’s why there aren’t popular votes on these matters… what’s the alternative? Back to free floating for an ever more integrated European economy? Dirty pegs? Please. The 1992 disaster happened precisely because there was no Euro back then. I hate to revisit this 1990s debate.

    And above all with theses like the above… “in a decade there won’t be Euro”. Please. A decade. Or in 2025? Remember Dow 36,000. Exactly. Here’s a prediction that’s going to stay: in the long run we’re all dead.

    I’m just very surprised about the extent to which these speculation get printed… I mean all of them are saying… “nothing is going to happen now… or in the future that I can oversee… but after that… things could turn ugly”. It will dry up quickly enough I hope.

  6. Back to free floating for an ever more integrated European economy?

    Yes. If the Euro collapses now, for some time the currencies will float. Immediately reestablishing a stabilisation system will not work.

    It will dry up quickly enough I hope.

    Hope is not enough to make a currency. You need to show that it is an advantage to those taking part. If the fundamentals of the union are discussed, you cannot really hope that the Euro won’t.

  7. “The dollar might have unravelled”

    Now the dollar unravelling story is a really interesting one. I’ve been having quite a time over at Brad Setser’s weblog on this one. It could be that the *size* of the US CA deficit simply gets too big for even the US to handle (Brad is arguing that it could even hit 10% of GDP next year), and if this were to happen obviously our worst fears would be realised and the euro would be pushed through the roof.

    This would effectively break the neck of the eurozone economies. I mean this would then really be akin to the 1930’s: I sincerely hope it doesn’t happen, and at this stage I don’t imagine it will.

    I don’t imagine it will, because the system will buckle first under its weaker leg, the eurozone one. This, of course, will drive the dollar up, and we could repeat the same scenario backwards, but again this is unclear.

    All of this is a neat inversion of the usual Darwinian process, since what we may have here is survival of the weakest.

    The reason some people are suggesting the euro won’t hold, is that there are sound economic reasons for thinking that this will be the case. It isn’t simply a fad.

    McRae’s point is that before the odds were put at 0-100, now people say there’s a 5% chance, so we are at 5 – 100. The next time it wobbles (which might even be as early as next week) it will move to 10 – 100. At some stage the probabilities will hit a critical number, everyone will decide its about to go, and there’ll be some sort of rush for the door that will make what might be reality.

    Meanwhile the worlds major central banks quietly, and without fuss, start lowering the proportion of their reserves they hold in euros, even while we speak.

    “But he also sees a 50% probability of a partial break-up by 2008, with one or more member states withdrawing,”

    I will buy this, Italy simply cannot recover using the defationary medicine which is about to be administered, and five years from now the political pressures that this produces will be too much for the National politicians to bear 2008 – 2010, that’s my guess.

    “as the European economy comes under increasing pressure, not least from its ageing population.”

    This to me is obvious, but I guess everyone already new that :).

    “partly as a consequence of the currency-market backlash as China and Japan abandon their policy of supporting the dollar through large-scale purchases of US government bonds.”

    This part, IMHO, is absolute tosh. The Chinese and the Japanese are not going to bring the US economy crashing down. The Japanese, for the sound reason that it would bring their’s crashing down behind it, and the Chinese because they need more time (they are not going to bring the US economy crashing down yet). Of course when they are fully industrialised and produce a much more competitive version of the airbus for themselves, then all bets are off. But this needs ten years, minimum.

    What the US needs to do is stop looking at China, and reform itself, get competitive so it can export, make the necessary structural reforms etc, to try and stop this happening.

  8. The Chinese and the Japanese are not going to bring the US economy crashing down.

    They will not want to. But neither their willingness nor their ability is absolute. Next month a big earthquake might hit the Tokio plane or Taiwan might declare independance. Of course all of this is unlikely, but fundamentally he’s right that a currency that has such a deficit is weaker.

  9. The Chinees need more time but 2008 is that time. After that they can use their own population to supply the demand they need.

    The Biggest export market of Japan is, or will be very soon, China. The rest of East Asia is another big Japanese export market so claiming that Japan would crash and burn without the US market is IMHO an exaggeration

    USA can not devalue too much because the industries in which the USA is strong (Science and Amusment) are the industries in which global labour arbitrage works. If they devalue than those people will go to Europe and make their films and toys there and not in the USA.

    Eurozone has a problem with a small US devaluation but not with a large devaluation because in that case the East Asian economies would leave the common US peg (though they would keep an internal peg)

  10. “Japan would crash and burn without the US market is IMHO an exaggeration”

    I prefer to leave Japan out of most of this because I think it is a real special case – look at the continuing deflation – and I think it needs more detailed treatment, but….

    Lets just look at this the other way round. Japan (and Germany) sells lots of machinery and equipment to China, with this machinery and equipment China produces manufactured products which go to the US (and Increasingly europe). So if the US market for consumer goods turns sour on China (and of course Japan) then China won’t be buying from Japan either.

    “After that they can use their own population to supply the demand they need.”

    This remains to be seen, at present there is still a huge savings surplus, one day that will turn, but when will that day be? We need some evidence.

  11. There are policy methodes to spend those savings (if nothing works then you can always inflate them away by goverment expenditure) But it is at this moment in time not in the interrest of the Chinese to fire up their economy even more. They are already near their maximum growth rate. They will use those methodes when export growth slows down to keep the Chinese economy growing, especially if they only have 15 years or so left if you believe your theories.

    It is also not like the US is the biggest export market of China. Add to that that they just opened a new, potentially very large market for Chinese industry (India, but they need to find a Chinese import market for India to let it grow)

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