Inflationomics

Leaving the Euro Behind

Someone recently wrote, “If Greece or Spain leave [the Euro], it will be a disaster for everyone…. If Germany leaves, it will merely be a surprise. No riots. No revolutions. No currency debacles. The deutschemark will go up. The euro will go down. Problem solved.”

I disagree. 

If Germany were to leave the Euro, Germany would become more like Switzerland.  Yes, it would have a relatively strong currency…let’s call it the Deutsche Mark.  But then Germany would be faced with the same dilemma Switzerland has been facing, and that is the rising cost of goods produced by Swiss companies relative to the cost of goods produced by its neighbors.  This became such a problem (according to the Swiss central bank) that Switzerland recently tied its Franc to the Euro, stating that it wouldn’t allow the Franc to rise above €1.20.  Thus, to the extent that the European Central Bank inflates the Euro, the Swiss Central Bank will have to inflate its currency…so much for “a safe haven currency.”

German banks would also have a problem collecting their existing Euro debts, either in new Marks or in ever-diminishing Euros, thus threatening the German banking system.  No real change there.

The thinking is that when a currency appreciates against another currency, it becomes more difficult for the appreciated-currency’s exporters to sell their goods, while it’s easier for the depreciated-currency’s businesses to sell their goods.  And for an economy that relies heavily on exports, this can be costly in terms of jobs in exporting businesses, as foreigners buy cheaper goods locally or from another even-cheaper exporter.  In the short run, unemployment rises among the more expensive exporters and declines among the cheaper manufacturers.  And it is this rise in unemployment that scares local politicians and central bankers into inflating their currencies, or tying them to cheaper inflating currencies.

Alternately, if Greece or Spain leaves the Euro, it would surely spell doom for the Greek and Spanish economies.  That’s because everyone knows that their leaving the Euro is the first step toward their printing a newly founded currency into oblivion.

Another problem with their leaving the Euro is that Greece and Spain’s ability to repay their Euro loans with a depreciating local currency would be further diminished.  And since they already can’t repay their Euro loans, their default would guarantee a domino collapse of Greek, Spanish, and eventually German banks (who loaned money to Greece and Spain, etc).  In the long run (which is getting shorter daily), the German government and the U.S. Fed would come to their rescue.  Unfortunately, neither the German government nor the Fed can afford to bail out the German banks (or anybody else’s banks).  Thus, the problem will spread to the U.S. (and anyone else holding U.S. dollars); i.e., a world-wide banking collapse.

What a mess!  An internationally interconnected banking system tied together by the U.S. dollar.  It will be interesting to see who will emerge from the carnage first.

Of course, the best solution would be to follow Iceland’s lead and let the banks fail, sooner rather than later.  Perhaps, that way, martial law could be avoided, and a much needed cleansing of excesses could occur.

Robert Jackson Smith

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