February 19, 2012

” Before the euro was created, Robert Mundell wrote about what made an optimal currency area. It is a groundbreaking work that won him a Nobel Prize. He wrote that a currency area is optimal when it has:

1. Mobility of capital and labor – Money and people have to be willing and able to move from one part of the currency area to another.

2. Flexibility of wages and prices – Prices need to be able to move downwards, not just upwards.

3. Similar business cycles – Countries should experience expansions and recessions at the same time (technically this is referred to as “symmetry” of economic shocks).

4. Fiscal transfers to cushion the blows of recession to any region – If one part of the currency area is doing poorly, the central government can step in and transfer money from other regions.

Europe has almost none of these characteristics. Very bluntly, that means it is not a good currency area. The United States is a good currency union. It has the same coins and money in Alaska as it does in Florida and the same in California as it does in Maine. If you look at economic shocks, the United States absorbs them pretty well. If someone was unemployed in southern California in the early  1990s after the end of the Cold War defense cutbacks, or in Texas in the early 1980s after the oil boom turned to bust, they could pack their bags and go to a state that is growing. That is exactly what happened. This doesn’t happen in Europe. Greeks don’t pack up and move to Finland. Greeks don’t speak Finnish. And if Americans had stayed in California or Texas, they would have received fiscal transfers from the central government to cushion the blow. There is no central European government that can make fiscal transfers. So the United States works because it has mobility of  labor and capital, as well as fiscal shock absorbers.” The above is from the authors of http://www.acting-man.com/blog/media/2012/02/February-2012-Eurozone-Breakup.pdf While they say Greece and Portugal should default, they say the other peripherals Spain, Italy and Ireland should strongly consider default.  The fact is they understate the case for default and exit of the euro for Ireland. Currently our fiscal surplus is grossly overstated. Our GNP is in a deflationary spiral downward, our unemployment at 14.5% and growing; taking into account emigration and absorption into retraining/education this figure is understated as well. Our GDP conceals export levels inflated through transfer pricing in the Irish financial sector, so what part of GDP actually fully represents exports originating in Ireland is troubling, to say the least. The euro currency experiment has been a failure for Ireland. Lack of regulation by the Irish Central Bank, Department for Finance and political establishment exploiting lack of regulation in the banking and investment sector particularly in the FIRE (Finance, Insurance, Real Estate) sectors have led to a tale of fiscal and monetary woe. Its time to go. The euro has no system of currency transfers or other shock absorbers required to manage the crisis; its record so far is to provide leeches for someone dying of cancer.

The authors above include many citations to links to external research and provide a comprehensive literature review for the topics they cover. The authors provide a summary here: “SUMMARY Many economists expect catastrophic consequences if any country exits the euro. However, during the past century sixty-nine countries have exited currency areas with little downward economic volatility. The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit. The real problem in Europe is that EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging market crises. Orderly  defaults and debt rescheduling coupled with devaluations are inevitable and even desirable. Exiting from the euro and devaluation would accelerate insolvencies, but would provide a powerful policy tool via flexible exchange rates.

The European periphery could then grow again quickly with deleveraged balance sheets and more competitive exchange rates, much like many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).” Given the lurching of the EMU towards the ‘Compact’ and a lessening of the constitutional independence of member states towards a future EUSSR prototype with calls for greater political union meaning less sovereign independence, I was interested in the following source piece in the above: ” The old soviet system was based on a dual monetary circuit: enterprises could convert rubles in the bank (beznalichnye or non-cash rubles) into cash (nalichnye) only for specified purposes – chiefly the payment of wages, which were paid in cash. All inter-enterprise transactions were required to be in non-cash (beznalichnye) rubles to facilitate central planning and control. This dual circuit continued in the post-soviet ruble zone as well. The implication was that while the CBR had monopoly on cash rubles (nalichnye), other central banks could and did create non cash (beznalichnye) rubles. Initially, the CBR continued the old soviet practice of accepting beznalichnye rubles of other ruble zone countries as payment for exports from Russia to these countries. So the central bank of Ukraine could lend beznalichnye rubles to a local bank which could lend them to a local factory which could use these to buy inputs from Russia. Effectively, Ukraine was paying for this stuff with rubles created by itself.

This has striking similarities to how Germany has been lending to the rest of the eurozone through the ECB’s Target 2 system. Source: Examples of Currency Breakup, Jayanth Varma,http://jrvarma.wordpress.com/2011/12/15/examples-of-currencybreakup/

 ” Readers can makes their own minds up on such comparisons.  Above highly recommended as antidote to the flood of propaganda on the Armageddon euro breakup will entail.  Perhaps  readers will reflect on the Armageddon on the cards if the euro breakup fails and the euro continues on the path it is embarked upon. End.

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