Lost in the obituaries of the Euro — the European currency — is the extent to which the continent remains a fractured reservoir of national monies. To be sure, the Euro circulates in the larger economies of Western Europe, notably France, Germany, Italy, Spain, and the Netherlands. But as a traveling European, I also have in my wallet Polish złoty, Czech crowns, Serbian dinars, Swiss francs, and British pounds, testaments to the nationalist sentiment that every country should have it own money. (Which is similar to the notion that every country should have its own airline, no matter how much it costs.)
Countries, like Poland, which are in the European Union, have their currency pegged to the Euro, but because of local budget deficits, they stick with their old notes. Countries like Britain and Switzerland cling to their currencies out of distrust for the common currency. In theory, what they lose in terms of trading convenience, they gain in the coin of economic independence.
By holding on to the pound, Britain partially sidestepped the recent financial crisis in Europe; London was only on the hook as a member of the common market, not in the currency union.
At the same time, Britain, as the only issuer of pounds, was left to deal with its own banking crisis without the mutual assistance of Germany and France, one reason why the United Kingdom has such high borrowing obligations.
Which is better, national money that floats on international markets — the pound is a good example — or a transnational currency like the Euro?
The rap now against the Euro is that the European Union lacks the authority to impose fiscal discipline in member states. Countries within the Union, it is feared, can borrow to their budget deficit’s content, given that any country in the monetary union enjoys an implicit guarantee from the rest of the pact. For example, Greece could fund its deficit with debt that was issued at rates that equated Greek risk with that of Germany.
Now that this mug’s game is up, the stronger members of the European Union will only let the weaker names borrow in exchange for surrendering a degree of fiscal and budgetary independence. Will that be enough to save the Euro?
In answering, it is useful to recall what money is: a zero-coupon bond, issued by an organization, company, or government. Currency may represent value, but underneath the crisp paper it is a sovereign loan. The dollar bill is best understood as the world’s smallest government bond.
Before there was fiat money, the currency that circulated was either coins or bank drafts, passed around to settle transactions in local markets. The stronger currencies were those of silver or gold, or negotiable instruments issued by a solid creditor, such as a Florentine bank or a London merchant.
In the early days of the American republic, circulating specie included Peruvian coins (valued for their silver) and Spanish dubloons, sometimes mined in Mexico.
Now, instead of a private script, money is a national instrument, based on the full faith and credit of sovereign governments, which, as everyone knows, are run by profligate spenders. (If you owned a bank, would you put Nancy Pelosi on the credit committee?)
Anyone holding U.S. dollars is betting that the Congress will not bankrupt the country with medical, retirement, and national security schemes. In Europe, the Euro gamble is that the large governments, and by extension the European Union, will honor their obligations, many of which were drawn to fund retirement plans that kick in at age sixty-two or to subsidize corporate elephants like the Airbus.
To be sure, the Euro will survive its current crisis, because neither France, Italy, nor Germany — the big engines of the continental economy — want to rerun the political consequences of a fractured Europe. But just because the Euro will remain in circulation does not mean that it will trade at an exchange rate of €1 = $1.50.
Keep in mind that Europe is gleeful at the decline of the Euro against the U.S. dollar, which, measured in Europe, has been at an artificially low exchange rate for the last few years. The weak dollar and the strong Euro meant that U.S. industry and exporters had a competitive advantage against European companies. Now that advantage is less pronounced.
For fun, have a look at the Big Mac Index of The Economist, which prices the global hamburger in world currencies. For the Euro zone, a Big Mac costs $4.62 versus $3.58 for the same happy meal in the United States. China’s triple-decker only costs $1.83, a statistic that is a good measure of the extent to which China keeps its currency, the yuan, artificially low.
Exchange rates are the new tariffs. In the bad old days of Senator Smoot and Congressman Hawley — co-authors of the 1930 tariff bill that so prolonged the Depression — countries sought competitive trade advantages by slapping on tariffs and import quotas to protect national industries.
Even today, tariffs protect local farmers and manufacturers from low-priced international competition, but they are considered “unfair,” the trade equivalent of gunboat diplomacy.
Instead of enacting tariffs, governments now play the game of currency manipulation, and, to use a 1930s expression, “beggar their neighbors” by driving down the value of their money’s exchange rates in international markets. Central banks generally accomplish this by failing to defend, i.e., purchase their currency in world markets.
Two of the very best currency manipulators are the U.S. and China, one reason for their economic success. The U.S. let the dollar fall after the 2008 crisis, which gave American exporters an advantage over European competitors. The price of European products in the U.S. went up about 25 percent.
For years China has fueled its economic miracle by pegging the yuan at low exchange rates to the dollar, to make sure that, no matter what the industry, it would be selling the equivalent of Big Macs that cost $1.83.
In the Euro collapse over the potential Greek default, many see an end to the European common currency. But that will happen only if German taxpayers get tired of bailing out pensioners throwing darts in Dublin or the café klatch on Mykonos.
In the meantime, by letting its currency fall by twenty percent against the dollar, Europe has shown that it understands the power politics of international exchange rates and that it is willing to take on the Americans and the Chinese at the shell game of cheaper money.
What’s the risk? The problem in the manipulation racket is that investors can have a hard time judging when a currency is being depreciated for a reason — to stimulate jobs, say — or when it’s broke. The wheelbarrow money of Weimar was bust while the Euro is just overvalued. In most cases, the vital sign of a currency’s health is its rate of inflation, and for the Euro right now it’s negligible.
For all that diplomatists busy themselves over questions like Israeli settlements and Iranian sanctions, the issue of exchange-rate parity is rarely discussed in world councils.
The story of unfettered money rarely has a happy ending. Breton Woods, which pegged many currencies to the dollar, and the greenback to gold, was signed in 1944 and broke down in 1971, when Richard Nixon unilaterally took the U.S. off the gold standard.
Since then, world money has traded like over-the-counter options, even when it's backed by less collateral than most subprime packages. My own view is that currencies should be pegged to baskets of global commodities, including gold and silver. But governments, like Greece today, or even the U.S., hate the idea of external limits on their ability to raise and spend money.
Italy was among those countries that thought the 1971 U.S. withdrawal from the gold standard set a dangerous precedent for economic stability. But its warnings went unheeded, and prompted an undeleted response from President Nixon, who on the White House tapes was heard to say, “I don’t give a shit about the lira,” words that might express how many investors will come to think about paper money.
Latent print developed on US Currency ($1 bill) using fluorescent magnetic power. http://www.flickr.com/photos/jackofspades/1376867166/
Matthew Stevenson is the author of Remembering the Twentieth Century Limited and editor of Rules of the Game: The Best Sports Writing from Harper’s Magazine. He lives in Switzerland.