Why the Euro Hasn't Depreciated

Recently, The Economist had an article where it intended to explain why the Euro had not depreciated by as much as most believed, given the developments in Eurozone (Greek/Spanish/Irish bailouts, too much Italian debt, the Cyprus haircut, and so on). Without trying to come off as critical, the article did not really explain much about the Euro's endurance in the markets. In fact, the article did not really mention that in most cases not only the euro hasn't been depreciating, but appreciating for more than a year, with a slight fall in March 2013 (Cyprus haircut anyone?). Have a look at the following 2-year courses of the Euro compared to other currencies (Source: Yahoo!Finance):

USD/EUR

EUR/Canadian Dollar

EUR/Swiss Franc

EUR/Sterling Pound

In every one of the above charts the Euro has been appreciating from a low just before September 2012 (for what you see in the USD/EUR graph think of the reverse). Thus the question is what happened in September 2012? The answer is not something most would really believe: the Outright Monetary Transactions (OMT) scheme. This was presented by the ECB in early September 2012, even though the decision was announced in August. As you may recall, there have been many critics of the ECB's stance on the subject (amongst them was Yanis Varoufakis), claiming that the "bazooka" could never be used and the threat was not credible. 

Yet, as stated at the time both the timing and the actions were much more than the markets anticipated; this showed clearly that the ECB was willing to take some action on the subject. The point of the policy was that it was better that it was never used since there could be potential caveats (Paul De Grauwe and Yuemei Ji have an excellent post on the subject). Still, just affirming that the ECB was willing to act like a real Central Bank and prevent a meltdown did the trick. 

Although the OMT could account for the spike in markets, it wouldn't be sufficient for the longer trend. There are two additional reasons why the euro has been appreciating over time:

1. Increased trade surpluses Eurozone countries have been running for the past year

2. Very low inflation

The first reason is as obvious as it can get: when a country has massive exports then its currency appreciates. As the trade surplus has been on the rise, led by Germany and following by almost every other country in the EZ wishing to gain from exports or reduce their deficit, the Euro has been steadily increasing in value relative to other currencies.

The second reason is again obvious: the higher the inflation rate, the lower the deterioration of a currency's value. Thus, as inflation falls, as the next graph (originally posted on BritMouse's blog) shows, the value of the currency increases.

The trend is obvious as inflation has been steadily falling since 2012, but the interesting question here is why. The answer lies to something rather simple: bank loans. As banks have been deleveraging over the past year, the amount of money in the system is decreased, making inflation fall with it. The extend of this decrease in loans can be seen in the following graph (Hat Tip to the brilliant Frances Coppola for bringing it to my attention)

If the former graph is not descriptive enough, then the next, showing the M3 evolution over time in the Eurozone, will almost certainly be sufficient to convince most of those who are unwilling to believe that banks assist in inflation:

In essence, the Euro appreciation can be summarized in three simple points: commitment to "do what it takes" (raises trust and causes the original spike), a decrease in trade deficit and its conversion to trade surplus within a year (inflow of cash increases the value of the currency) and a fall in the inflation rate caused by bank deleveraging (makes the currency more valuable). Add to this the instability of several of the Eurozone's countrerparties (the UK and US for example) and the whole "mystery" of the appreciation is unveiled.

Is the Euro appreciation a good thing? Not really to be honest. First of all, the Eurozone needs inflation, for reasons explained in other posts. To get that, we need good banks. We do not have them at the moment. Thus, the whole appreciation issue masks the main problem the Eurozone is trying to hide at the moment, something which is even more important than the sovereign debt issues; the banking crisis. Why is it more important than sovereigns? Simply put, it's because sovereigns cannot issue money. Only the ECB can, and the banks are the only others which can increase that quantity.

Thus, their significance in a region which shares the same currency cannot be overstated. The banking system really requires reforms; yet, these should not come at the cost of growth. It makes no sense to start combing your hair before you can even stand on your feet.

The Economic Consequences of a CY-Exit

Ever since the latest Cyprus fiasco, many have been wondering whether a country exiting the Eurozone could be a possibility. The fact is that the Eurozone cannot evacuate a country as it will set a precedent (not that setting a precedent seems to bother them a lot, given that lately we have learned that every deposit over €100,000 is not safe). For the sake of argument we can assume that the Eurozone leaders can understand that if one country exits then it is only a matter of time before more leave; thus it is to their better interest to keep every country in the monetary union.

In addition to the assumption that leaders do understand the consequences of their actions, we will also assume that the exiting the Eurozone will allow the exiting country to remain in the EU which means that forcing it out will not forbade it from the common market (details on the subject will be discussed later).

To make things more specific, Cyprus will serve the cause of a case study. 

We know that Cyprus has an 87% debt-to-GDP ratio, a ratio slightly more than the EU average of 81%. As stated in a previous post, Cyprus currently has €9bn of her debt held by domestic creditors. Thus, even under the English law (which does not allow for any changes in the bond structure) if more than 75% of creditors are in agreement then the bond terms can by altered. One can only assume that the Cyprus Central Bank can excess some kind of pressure to the state creditors making them agree on longer duration and lower interest rates (from the creditors' point of view this would not be a bad deal; the alternative would be default and losing all the invested funds). Thus, if this can happen in Cyprus then it is not irrational to assume that it can happen in every other EU nation.

Re-structuring the domestic debt means less expense for the government for the next 10-20 years; the excess could be employed to boost the economy. Then, according to Alex Apostolides an additional €3.9bn would be remain (the rest was bank recapitalization needs which after the fall of Laiki bank are no longer needed), in addition to approximately €5-6bn of ELA money. Then the matter of which issue has more seniority arises. According to Megan Green:

@alexapostolides So defaulting on ELA same as defaulting on anyone else unless want to stay in euro (in which case it's de facto senior)
— Megan Greene (@economistmeg) April 7, 2013

Thus, in the case of an exit, ELA debt and any other European debt (such as Target2 balances) would be equal to every other issue. Then, if Cyprus (or any other country for that matter) chooses to partially default on debt repayments the ECB cannot do anything more than seize assets (which I doubt since it is not senior to any other debt and no actual assets are being on mortgage when a bond is issued-unlike bank loans). Under those terms the ECB would be forced to re-structure any loans it has made to Cyprus (again, the other alternative would be default).

Then we move to the trickier parts of the equation and first of all how will the new currency be introduced. An award-winning paper on Euro-exit states that at the time of the exit, the new currency and the euro should be at a 1-to-1 parity and that euros should be allowed for small transactions for a further 6 months. The first issue that has to be made clear here is that in the case of a euro exit, the new currency and the euro cannot co-exist for more than a week. Many have been arguing for parallel currencies yet, as history has shown and common economic sense dictates, this will cause much trouble.

The reason is simple: assume that on the first day the new currency will have a 1-to-1 parity with the euro. Nevertheless, the new currency will suffer a severe devaluation within the first hours (minutes?) of trading. Thus, if we assume a 40% devaluation as the most popular scenarios do, it would make 1 unit of the new currency equal to €0.60, which would mean that prices would have to be altered again as it would mean that now what cost €1 should cost 1.4 units of the new currency, just to make up for the exchange rate losses. Making matters even worse, the rate would not be at all stable during the transition period. 

A possible solution would be either to peg the new currency to the euro at 1-to-1 parity. However, this would never hold as the George Soros pointed out to the Bank of England in the 1990's. In addition, the willingness of Brussels to do that for a "traitor" is highly questionable. The only remaining alternative is a short transition period and capital controls through it. In order for the transition period to go without any severe effects on the economy (the two-week bank "holiday" is expected to cost approximately 2% to the country's GDP) it has to be fast and swift, with capital controls loosening significantly after it (unlike the very slow steps taken now). 

The only real problem faced by any nation who wishes to exit the Eurozone is inflation. The award-winning paper suggested that:

"The exiting country would immediately announce a regime of inflation targeting, adopt a set of tough fiscal rules, monitored by a body of independent experts, outlaw wage indexation, and announce the issue of inflation-linked government bonds.It also recommends that government should redenominate its debt in the new national currency and make clear its intention to renegotiate the terms of this debt."

The only trouble with the above is that inflation targeting does not assist in the short-run, where the economy will face harsh problems through increased energy prices. In addition, all of the proposed measures are more for the sake of credibility than actual good (in the short-run that is). Although inflation would be needed as a means to boost the economy, too much of it will prove to be disastrous, especially with regards to imports (it has been suggested that deposits will lose their value. This is not an issue per se for residents as everything will be evaluated in the new currency. This is only an issue with hyperinflation and increased import prices).

Economic theory (and practice) indicates that there are the following determinants of an exchange rate:
1. Domestic Money Supply/Inflation and Interest Rates
2. Import demand and Export Demand
3. Productivity (with respect to other countries)
4. Current Account balance and the Trade Balance
5. Domestic Reserves in Gold and other currencies

Another issue which cannot be measured is investor/speculator sentiment. For example, although the US has employed three rounds of monetary expansion (commonly known as QE) the euro continues to depreciate against the dollar because of the Eurozone uncertainty. We will return to that later.

The following data are before Cyprus's entry in the Eurozone (in 2008) and shall assist us in determining the needs of the country for a stable currency (click on the image for enlargement):

Source

The above graph indicates the exchange rate between USD and CYP (the reason for not choosing EUR/CYP is of less history and the fact that energy prices are quoted in dollars). The exchange band of the currencies fluctuated from a low of $1.44 per CYP (in late 2000, after Cyprus's stock market bubble crashed) and $2.5414 (in late 2007, perhaps due to the sub-prime lending crisis). In the meantime, Cyprus's other indicators were:

 

 In contrast to the views of many, it appears that from 2001 until 2007, when the CYP/USD rate was increased by 76%, money supply rose by 191% and foreign reserves by 112% (at their all time high). Inflation was rising during the period, with an approximate increase of 21.4% (or approximately 3% per year).

In addition, the current account was not doing any better either. The data show that as it reached its all-time low (by then) in 2001, the exchange rate did not resume its fall (it moved within the same band for about a year), and the year-end CYP/USD rate was actually increased. In addition, CYP continued its appreciation (reaching the all-time high) regardless of the fact that its current account reached new depths in 2007.

The Import/Export data do not show any significant difference over time either. Their average was pretty much zero until 2004, when the Trade Balance fell continuously until 2007. Yet, however, the CYP increased in value.

Oil prices are always important in an economy.Yet, although oil price rose from 1996 to late 2000 by 70% and the exchange rate fell to approximately $1.50, thus forcing the price of oil to rise more than 130%, real GDP rose by approximately 0.94% per quarter.

The last part of economic theory is interest rates: if interest rates are high, the investors/speculators will want to hold on to the currency; if they are low they do not wish to hold any of it. Yet, as interest rates are higher in a country, higher inflation appears and growth is supposed to be less than it could potentially be if the rates had been lower. 

Having an extremely high interest rate in 1999 did nothing to stop currency deterioration. As the reader may recall, the lowest point of the USD/CYP pair was in late 2000, just before the interest rate was lowered. As interest rates dropped to an average of 3.5% (which again is very high compared to other nations), the currency started appreciating.

In comparison, Cyprus today (as of 2012Q3) stands at:

- minus 990m on the current account (48% less than 2007 but 10% more than 2006 although the full year total will probably be less than 2006)

-341m of reserves (less than any period since 1995)

-101m of forex reserves (again an all-time low)

-563m in gold (an all-time high due to the increased price of gold)

-Deposit rates at about 3-3.5% for term deposits

-The least Balance of Trade (-1bn) it had over the past 8 years (since 2005)

-A slowing inflation (up just 1.2% in 2012 and expected to be near zero in 2013)

The only problems in Cyprus's position are foreign reserves and general reserves. The catch here is what Paul Krugman has been stating and many (including many Cypriots) ignore: 

-Income from tourism in 2012: €1.927bn or approximately 11% of GDP. (The income was actually higher in 2001 when the CYP was in place)

Such an influx of money (which will be even more if the depreciating currency brings more tourists than 2012) will increase the country's foreign reserves and help stabilize her currency. That is the reason why a euro exit should occur either before the summer season or just after it (if the island can survive until then that is). A devaluation of the new currency would in fact assist Cyprus to gain more tourists thus increasing that income.

The main cause of worry for the Cypriots should be oil prices. Yet, as the graphs have shown, rising oil prices is not the end of the world. Real estate, tourism and business services (which comprise approximately 60% of GDP) would be benefited from a devaluation of the currency, which means that more money would be pouring in Cyprus than before. This will again help stabilize the currency thus making prices less susceptible to oil shocks.

In addition, the other worry would be that of money supply. At its highest, M1 supply in Cyprus was approximately 36% of real GDP. Thus, according to data on 2012Q2, the amount of money supply would have to be roughly the same as it was in 2007 to compensate for that (i.e. €4.5bn). The amount of money used to recapitalize banks would not affect M1 as bank reserves are not included in its definition (nor are they included in the M2 definition). (This justification obviously assumes that money needed for recapitalization purposes will be treated as cash/reserves by the banks and not directly used for lending purposes).

A few paragraphs above, there was mention of investor/speculator sentiment. Imagine this: a country exits the Eurozone. Which that country is, does not really matter since once a country is out everybody else will start thinking about their own exit. Consequence: the euro depreciates. Sharply. With fears of a euro break-up, speculators will start shorting the currency driving its price down. Simultaneously, the CYP will itself depreciate, yet not such a fast pace as the euro, leaving it stronger than assumed. In addition, the USD will itself depreciate with regards to the CYP as the effects of the three rounds of QE will once again be visible. What economists seem to be forgetting in their analyses is that an exchange pair does not really count on just one currency but on both: if both deteriorate the same then the exchange rate is unaltered. 

Should the new CYP parity be 1-to-1 with the euro? Not in my opinion. The island would be better off in setting the parity a 0.5CYP to a euro to compensate for any potential currency depreciation. In addition, having the above-suggested parity would need less money supply to support it, making it both easier to create in shorter notice and simultaneously having the reverse effects of exchange rate overshooting in the short run (i.e. currency appreciation instead of depreciation).

Hugo Dixon presented the idea that Cyprus could lose competitiveness if the CYP depreciated because foreign labour will no longer be cheap. Yet, in a country with the largest increase in unemployment over the past year this will not be an issue. If cheap foreign labour force turned expensive it could easily be replaced with cheap domestic labour (unemployment is currently at 15% and rising). As for the current account having a deficit of 5% of GDP, the country never really had a strong current account balance (the least current account deficit was back in 1999 and it was approximately 4.95%).

What can be seen above is that if Cyprus wants to exit the Eurozone it is to its benefit. Although I would not strongly suggest that it does, the island has a very strong negotiating position now: it can request (or threaten) a euro-exit. Most commentators fail to see that if the country exits (or any country exits for that matter) consequences will be severe both for those who left as well as for those who are left behind. Cyprus has nothing to lose at the moment: she is facing at least a 15% decline in GDP in 2013 with no idea when growth will return. If she exits then a significant decline in GDP will also occur. The benefit though, is that it can control both its monetary as well as its fiscal policy which is much more than those which will be left in the Euro can brag about. 

If one country chooses to exit the Eurozone, either with the others' consent or without, the rest will have to live forever with the ghost of uncertainty lurking above them. Any austerity measures taken until now will appear to in vain. Which country will be the next? Will Italy, without a government and eager to relieve its citizens from the perils of austerity exit next? Will Greece? Or will mighty Germany decide to give up the throne of the Queen of Europe? Uncertainty will reign and the euro rate will collapse. Bond spreads will rise and the ECB will have to either use the OMT it has proudly presented in summer or watch it all fall like a tower of cards.

There is also another issue: whoever exits first, gains the most. Less depreciation, less uncertainty, less bond yields and more time to control its finances if (or until) someone else also leaves. As Megan Greece comments, in another example of a half-baked union "There is no mechanism through which Cyprus could be pushed out of the European Union in retaliation." In addition, there should be no country willing to kick another out of the EU just because they wish to exit the Eurozone since they can understand that their time may come soon enough. 

Thus, it can be safe to assume that Cyprus will not be etched out of the EU if it decides to return to the pound. The consequences of that are not as harsh as most people believe; yet they are not to be taken lightly. However, the island has more to lose if it remains in the Euro than if it exits in both the medium- as well as the long-run and it would be wise to use the exit scenario as a bargaining card.

Schäuble

I have to admit that I have not been the greatest follower of Wolfgang Schäuble. Especially when his ideas of more austerity, harsh measures and reforms are still echoing in my ears. But I have to admit that ever since he, Angela Merkel and the majority of European leaders have changed their attitude towards Greece and the austerity measures undertaken there, I have grown fonder of them. (Up to a point that is!) Nevertheless, one has to recognize that the man has some guts. In a recent trip to Singapore discussion, he has stated the following: 

"If we are not fast enough for markets, sorry, but markets have to wait"

Well, he is right on this one. As it is known, markets are handled by people who are more than eager to see action, rapid movements and fast decisions. Unfortunately, in the real world, fast decisions seldom make good decisions. This is a fact that markets have to live with. I would be much happier if it took 2 months to make a decision which would restore prosperity in the region than if a decision was agreed upon in 2 weeks and its results were mediocre. 

Wolfgang Schäuble, winner of the 2012 Charlemagne Prize. Source: Wikimedia Commons

In another interview, Schäuble has commented that "I think there will be no government bankruptcy in Greece.". I think German and (most) European politicians have come to understand that you can gain much more by supporting someone than by constantly criticizing and degrading. His recent trip to Singapore was primarily focused on convincing investors in the booming Southeast little giant to invest in European bonds. Truth be told, it will be an extremely difficult task. Investors will be hard to agree in investing at a region where fiscal stability is far from achieved. Nevertheless, if things work out in the end, returns of Greek, Spanish, Italian and Cypriot bonds will be much higher than those in most nations in the world.

European Exuberance

After the Euro introduction, the EU research departments had stated that no major inflationary pressures had been made to the Member-States economies. Any discrepancies which may have been observed during the transitional period were eliminated very soon. However, if one looks at the HICP (Harmonized Index of Consumer Prices) data that Eurostat regularly publishes one may observe something different.

Take a look at the following. The graphs illustrate the monthly average inflation rate in the now crisis-ridden countries as well as Finland, Germany, Sweden and the UK (the latter two for comparison with nations which have not introduced the Euro to their economies) both before as well as after the introduction of the Euro in their economies. 

As you may observe the differences in average monthly inflation are significant. Germany, with a somewhat stabler transition than most other nations saw its average inflation rise from 0.1% to 0.17%. This would mean an average yearly inflation of 0.95% greater than before the introduction of the Euro. The same holds for all other nations, with the largest change occurring in Spain and France where on average they experienced increased inflation by 1.21% yearly. The lowest has been in Ireland where -0.98% was experienced, mainly due to the sub-prime lending crisis which brought the Celtic tiger to its knees. 

In addition to higher inflation, property prices had been rising rapidly until 2008 throughout the EA17, when the sub-prime debt crisis occurred. This led to a higher cost of living than the one experienced before the introduction of the Euro, when at the same time, in order to compensate for this increase, labor costs were rising as well, making the EU nations less competitive.

What we are witnessing now is that, as labor costs, pensions and other benefits are decreasing making the South more competitive than ever before, the cost of living and property prices will decline substantially, making way for more sustainable growth in the following 2-3 years.

Investor Pessimism

Lately, I have been reading a lot about investors, banks and nations preparing for the worst case scenario. It seems that the definition for "worst case scenario" differs from time to time: a Greek exit, a Euro collapse, a banking collapse, a Eurozone collapse and so on. Obviously one has to prepare for such events. What I always thought to be weird is that people always prepare for "worst case scenarios" only after recessions or severe economic blows occur. One should never be worried by pessimism or optimism in the markets. Although they may last long in many cases, they are always alternating. They are both outcomes of human nature, a sort of behaviour that was the same throughout the years.

All of the great investors throughout history understood this. People are always prone to good or bad feelings. A bear market (e.g. a falling index in the stock exchange) occurs when people feel overly pessimistic about the present and the future and a bull market (the exact opposite, a rising index) occurs when people feel overly optimistic about it.

A great example of this is the banking situation nowadays. Banking institutions after expanding rapidly in the last decade (overly optimistic) are now contracting their business operations to operating only at the local level (overly pessimistic). Cross-border lending is steadily declining in the EU reaching 2007 levels in last June. Otmar Issing, a former ECB chief economist states: "Over the long term, the monetary union can't be maintained without private investors,because it would only be artificially kept alive." While this is true and many feel that getting rid of their assets in euros and buying gold or real estate is a great idea, others have gone even further by removing themselves from the monetary zone. 

Many investors are even betting against the euro surviving. John Paulson, who made billions shorting (i.e. selling something now - e.g. a stock or a currency - in hope of buying it later at a lower price and thus profiting with the difference) during the sub-prime lending crisis in the US and the now retired George Soros stated that they are betting against the common currency. 

As for me, I wouldn't worry about bank contraction. Both economies and firms contract and expand as they react to the general feelings of threat or hope for the future. A crisis is a good opportunity for people, firms, economies and states to learn from their mistakes. What I hope is that politicians and policymakers will realize the need for action. Even late action is better than no action, however too late would mean the end of the euro as many investors prophesied.

The Effects of a Euro Collapse

Some believe that the destruction of the Eurozone, and as a consequence the collapse of the common currency, is eminent. Many actually look at this favorably as they believe that such a result would be beneficial to the world. I have read articles stating "why doesn't the Euro collapse to get over with this situation? We will deal with the consequences and then be better off". The problem is no one seems to understand what these consequences are. 

The following is an excerpt from a Financial Times article in 2011 (article can be found here):

"A euro area breakup, even a partial one involving the exit of one or more fiscally and competitively weak countries, would be chaotic. A full or comprehensive break-up, with the euro area splintering into a Greater Deutschmark zone and about 10 national currencies would create pandemonium. It would not be a planned, orderly, gradual unwinding of existing political, economic and legal commitments. Exit, partial or full, would likely be precipitated by disorderly sovereign defaults in the fiscally and competitively weak member states, whose currencies would weaken dramatically and whose banks would fail. If Spain and Italy were to exit, there would be a collapse of systemically important financial institutions throughout the European Union and North America and years of global depression."

Does this sound bad enough? The article states that a Greek exit could be manageable. It could be, only if the ECB decides to bail-out the EU countries which would be affected by that exit (That would be hmm... almost every country in the EU, even Germany). If the ECB decides that it would help the countries which would face disaster after a Grexit then why not help Greece directly and avoid such an outcome? The outcome of an Italian exit would be even worse given that it is the 8th largest economy in the world. You may only imagine what would happen if Germany were to exit.

The aftermath of an exit would occur not only to the Union but to the exiting country as well. For example, a Greek exit would mean that prices and wages in the country would fall rapidly, gaining a short-run competitive advantage which would be lost after inflationary powers settle on the country. As a result, the country would be poor, uncompetitive and with the additional disadvantage that no one would dare lend it because it that had just exited the EU. If Germany exits then the new German currency would suffer such an up-rise which would make all German products uncompetitive, leading the now booming German exports to a downward spiral.

In another article, a euro collapse is called as the "mother of all financial disaster". Robert Zoellick, the former president of the World Bank has stated that Europe may have a Lehman moment. (Just like the Lehman Brothers collapse in 2008, which triggered the worst recession in the world since the 1930's).

The worst part of all is that most of the consequences which may occur under a Euro collapse are still unknown. Germany is thought to be the state with the most sound economy in the EU now. However, German investors hold 550bn euros of sovereign bonds outside of Germany. What would happen if the euro collapsed? Most likely they would lose it all and the German government would have to bail them out. One may only imagine how many EU bonds are in the hands of non-European banks and other investors.

My simple conclusion agrees with this LSE article: It is better to do everything to save the euro than to let it fall apart.

Two-Speed Euro aka the Moses Plan

It has been proposed before and it seems that it's back in vogue: Make a 2-speed euro. The idea is that richer countries like Germany, Finland, Luxemburg, Austria and others, should have an "expensive" euro, whilst Greece, Spain, Italy and others which face problems should be better off with a "cheaper" euro. I like to call this the Moses solution (think of what he did to the Red Sea). The rationale is that now, the Euro is too cheap for rich countries (whatever that may mean!), while it is too expensive for the poorer ones.

It is not the first time something like this has been proposed. The main problem in the Eurozone is non-integration and what is the brilliant solution of some economists? An idea that divides the EU even more. Remember what I said about economists and real life?

The idea is simply absurd: First of all what does it mean that a currency is too cheap for a rich country? I don't think that the Germans are having trouble sleeping because their exports have boomed, due to a falling euro. The same holds for all other "rich" countries. Second, what defines what a rich country is? Ireland was a rich country before 2008 but I don't believe that anyone would consider letting them in the "rich" country ghetto now.

As in the case of Ireland, a nation may be rich one year and in the next, faced with an unprecedented disaster (of any kind not just economic) may fall into the "poor" class of countries. What would happen then? Just change to the low currency and if the country gets back on its feet change back to the expensive one again? I do not think that the public would really much appreciate this, having to change their hard money every time the economy takes a downturn. The future is unpredictable and uncertain. No country can guarantee that it will be solvent and trustworthy in the future.

Another important consequence is that there will be a "rich country ghetto" in the Union. To be accepted into the rich currency you will have to be accepted by the already existing countries, which would breed political disputes. The same problems would occur when a country should be exited from the rich country union as nations would be reluctant to dismiss a country like Germany, even if it has sever financial problems.

What economists with no real-life experience fail to see is the infeasibility of a Moses plan and the disastrous consequences that it may have if it is applied. Now is the time for more union and more integration. Dividing the EU would be a step towards breaking it up. I do not think that if the South US states had a problem, Bernacke would divide the dollar into two. Why should we?

Conspiracy Theories and the Eurozone

I do not like conspiracy theories. To be really honest I hate them. I believe that conspiracy theorists are those kinds of people who do not want to take responsibility for their actions (or their government’s actions) and think that this is all part of a massive hidden elaborate plan devised by -insert nation here- to control/take over their homeland’s economy/natural resources or whatever. Thus, anything they will do will be futile; all they can do is blame the one "responsible" for this as they sit around and do nothing. This kind of thinking I truly, honestly hate. 

However, lately I have been thinking about one. I am not proud to say it but I have. It all started when I began thinking about what they could do instead of the large haircut on Greek debt last year. If that haircut had not taken place the only country that would have been in direct danger from Greece would have been Cyprus, due to the explosive growth of its banks there. And even Cyprus wouldn't have been so worried then. Read more here.

What I have been thinking was this: Let's assume that policymakers in Eurozone are not stupid. Let's assume that what they have been doing has some rational reason hidden behind it. What were the consequences of their actions and who would benefit from that?

The first direct consequence would have been the fall of the value of the Euro. The following graph indicates this trend for the EUR/USD pair. (Graph was made by Yahoo!Finance)

As one may observe the value of the Euro versus that of the US dollar has declined dramatically of the past year and a half. Thus, it would mean that European products are now cheaper than they were 1.5years ago. Thus, more exports. This can be seen by the following graph (made by www.tradingeconomics.com)

As we can see exports began to rise after February 2010 and continue to rise to this day. (An examination of most EU countries individually would confirm this but to be honest I am bored to upload and comment on 20 graphs! I am sure you would be bored to read one article like that too.)

Thus the only conclusion we may draw was that the EU policymakers are deliberately keeping the EUR/any other currency rate down so as to export more. Any good news about the Euro economy would have as a result an increase in the rate and thus decrease exports. Thus the conspiracy theory would be that policymakers want to flood the world with EU goods (or maybe just German goods for obvious reasons. Wolfgang are you there?) and make us rich by large trading surplus; however not now but in a few years. It's a merchants world after all!

Or, they just make bad decisions. What do you think?

German Government doesn't fear about Grexit. How about Itexit, Spexit or Cyexit?

While the Bundesbank states that a return to national currencies would not make economies better off, the German Vice Chancellor Philipp Rösler has stated earlier this week that the horror of a Greek exit has worn off I felt that he was trying to play tough cop when there was no criminal around. Otherwise, he was just really ignoring the economic reality of the EU (that is the polite way to say that he was being stupid silly).

What he seems to be forgetting here are the interconnections between the EU nations. If Greece fails and returns to drachma, then the next ones to fail will be Cyprus and Spain. And then Italy. Then maybe England if they decide not to print any more pounds. What then? Should Cyprus bring back the pound, Spain the peseta and Italy the lira just to save themselves if Germany will not is not afraid of them fleeing and will not aid them? Well then how about we just have a good north-euro? Great way to increase faith in the currency Philipp!

If Greece exits, the domino consequences will be catastrophic for the union. Euro is now the second most circulated currency in the world (after the almighty dollar of course!). 332 million people in the Eurozone use it daily and another 175 million worldwide have currencies pegged to it. Just imagine the consequences if the currency is destroyed. Great depression would seem like joyful period after such a case.

By the way Philipp I know you were only born in 1973 (errr you didn't want to say your age? Sorry!) but if you had studied German economic history you would have seen that immediately after WWI when the Allies demanded reparations paid by Germany to repay the damages and debt they had obtained during the war it was the German president of Reichsbank Hjalmar Schacht who had fought the idea most of them all. Indeed, even Maynard Keynes was against reparations as he believed that they would be a burden on the German economy which was just barely alive after the war. The allies did not want to adhere to the two economists, but the combination of a horrible inflationary period (during which Schacht was not in the Reichsbank) and the 1929 Depression made the Allies see that it would be economically irrational to pursue the policy of reparations. (which would last for more than 50 years) I do not know if Philipp can see the resemblance here which is quite obvious if you just substitute Germany with Greece and Allies with Germany. It is true that history repeats itself but I would hate for us to reach the brink of destruction just to realize that what we had been doing was wrong.

Although I am quite pro-German in several areas of the economy and society I cannot really understand this obsession with not helping the countries in need. What are they afraid of? Yesterday, Mario Draghi had an idea similar to what I had proposed here. This made me go to bed happy but today I learned that the Bundesbank has objected to such a plan. One wonders what their reasons might be! ''This seems like a good idea for the European economy so lets just say no!" While ECB seems all powerful, they will just not let it use this power. It is not acting as a real Central Bank the way the Federal Reserve acts in the US. I repeat once again: buy government bonds, expand credit in the Eurozone and let inflation rise for a year. Then go back to listening to stubborn German politics if you desire. Just do this now before it is too late.

P.S. I do not understand why we need to have IMF experts checking up economies in the Eurozone. (Well OK I do if the ECB does not want to act like a Central Bank) Don't we have enough technocrats here? Or are 4-5 troikans the only people in the world who can understand public finances?