Why the euro needs to fall

November 3, 2011

By Kenneth Rogoff
The opinions expressed are his own.

Although I appreciate that exchange rates are never easy to explain or understand, I find today’s relatively robust value for the euro somewhat mysterious. Do the gnomes of currency markets seriously believe that the eurozone governments’ latest “comprehensive package” to save the euro will hold up for more than a few months?

The new plan relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding. Even the best part of the plan, the proposed (but not really agreed) 50% haircut for private-sector holders of Greek sovereign debt, is not sufficient to stabilize that country’s profound debt and growth problems.

So how is it that the euro is trading at a 40% premium to the US dollar, even as investors continue to view southern European government debt with great skepticism? I can think of one very good reason why the euro needs to fall, and six not-so-convincing reasons why it should remain stable or appreciate. Let’s begin with why the euro needs to fall.

Absent a clear path to a much tighter fiscal and political union, which can lead only through constitutional change, the current halfway house of the euro system appears increasingly untenable. It seems clear that the European Central Bank will be forced to buy far greater quantities of eurozone sovereign (junk) bonds. That may work in the short term, but if sovereign default risks materialize – as my research with Carmen Reinhart suggests is likely – the ECB will in turn have to be recapitalized. And, if the stronger northern eurozone countries are unwilling to digest this transfer – and political resistance runs high – the ECB may be forced to recapitalize itself through money creation. Either way, the threat of a profound financial crisis is high.

Given this, what arguments support the current value of the euro, or its further rise?

First, investors might be telling themselves that in the worst-case scenario, the northern European countries will effectively push out the weaker countries, creating a super-euro. But, while this scenario has a certain ring of truth, surely any breakup would be highly traumatic, with the euro diving before its rump form recovered.

Second, investors may be remembering that even though the dollar was at the epicenter of the 2008 financial panic, the consequences radiated so widely that, paradoxically, the dollar actually rose in value. Although it may be difficult to connect the dots, it is perfectly possible that a huge euro crisis could have a snowball effect in the US and elsewhere. Perhaps the transmission mechanism would be through US banks, many of which remain vulnerable, owing to thin capitalization and huge portfolios of mortgages booked far above their market value.

Third, foreign central banks and sovereign wealth funds may be keen to keep buying up euros to hedge against risks to the US and their own economies. Government investors are not necessarily driven by the return-maximizing calculus that motivates private investors. If foreign official demand is the real reason behind the euro’s strength, the risk is that foreign sovereign euro buyers will eventually flee, just as private investors would, only in a faster and more concentrated way.

Fourth, investors may believe that, ultimately, US risks are just as large as Europe’s. True, the US political system seems stymied in coming up with a plan to stabilize medium-term budget deficits. Whereas the US Congress’s “supercommittee,” charged with formulating a fiscal-consolidation package, will likely come up with a proposal, it is far from clear that either Republicans or Democrats will be willing to accept compromise in an election year. Moreover, investors might be worried that the US Federal Reserve will weigh in with a third round of “quantitative easing,” which would further drive down the dollar.

Fifth, the current value of the euro does not seem wildly out of line on a purchasing-power basis. An exchange rate of $1.4:€1 is cheap for Germany’s export powerhouse, which could probably operate well even with a far stronger euro. For the eurozone’s southern periphery, however, today’s euro rate is very difficult to manage. Whereas some German companies persuaded workers to accept wage cuts to help weather the financial crisis, wages across the southern periphery have been marching steadily upwards, even as productivity has remained stagnant. But, because the overall value of the euro has to be a balance of the eurozone’s north and south, one can argue that 1.4 is within a reasonable range.

Finally, investors might just believe that the eurozone leaders’ latest plan will work, even though the last dozen plans have failed. Abraham Lincoln is credited with saying “You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time.” A comprehensive euro fix will surely arrive for some of the countries at some time, but not for all of the countries anytime soon.

So, yes, there are plenty of vaguely plausible reasons why the euro, despite its drawn-out crisis, has remained so firm against the dollar so far. But don’t count on a stable euro-dollar exchange rate – much less an even stronger euro – in the year ahead.

This piece comes from Project Syndicate.


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Hi Kenneth, thanks for the opinion. Your six reasons against the euro falling are persuasive.

However I disagree with your single point as to a fall – absence of a clear path to a much tighter fiscal and political union. This is a rather weak argument.

In the first instance, fiscal and political union in the EU is a conundrum to those raised in the mindset of more autocratic models of fiscal authority. Almost analogous to the recent published ECB study between Catholic and Protestant behaviour towards capitalism. Conundrum is used in the sense of EU consensus decision-making. This phenomenon is often denigrated as muddling through. Far from it.

Secondly even though fiscal union seems to operate as a co-operative, consensual exercise – that is not necessarily bad management. Fluidity and adaptability might be better strategies for culturally, heterogenous communities such as the EU.

Thirdly, membership of the eurozone is contiguous with membership of the EU. So the behaviour, the desire to remain united belies the absence of more formalised appearances.

Fourthly. in countries such as the USA, overt fiscal union can be contradicted by the political/legislative factions squabbling over raising the ceiling of the 14 trillion dollar deficit. Similarly there are municipal, local government bankruptcies occurring within the USA despite the institutional norms for fiscal unity.

Perhaps the strength and long-term value of the euro is far beyond the pips in the eyes of the currency speculator.

Posted by scythe | Report as abusive

Here is the main reason: If anything has been proven lately it is that a EU member has to EARN belonging to the Eurozone. Underperformance leads to complaints from peers. Far different from the US where the political system doesn’t correct itself, the voter has no power, and the central bank manager just sights and puts the interest rate to zero. Worthless.

Ask yourself, Mr. Rogoff, why average deficits in the EU zone are around 3 % and the US is at 10 %.
The US is a clear underperformer and nobody in the USA system does even a tiny thing about it. Now look at some OECD numbers and you will see the correction that took place in the EU countries from 2009-2011. It is impressive and it should have formed the core of your argumentation.

Posted by FBreughel1 | Report as abusive

And of course, here are third party figures to back it up:

OECD report government DEFICIT: (2010 2011 2012)
France -7,0 -5,6 -4,6
Germany -3,3 -2,1 -1,2
Italy -4,5 -3,9 -2,6
Spain -9,2 -6,3 -4,4
Eurozone -6,0 -4,2 -3,0
As a comparison:
USA -10,6 -10,1 -9,1

Now who is not managing their finances here ?

Posted by FBreughel1 | Report as abusive

Rogoff is an academic with little if any background in how the Brussels and ECB institutions work in political terms.

His third argument is selfish-motive because he can’t visualize why Euro reserves are attractive to emerging markets – compared to bankruptcy of US fiscal pespective.

May be he (and his academic likes) need to listen carefully to Draghi’s first press conference and why ECB decided to cut 25bp.

EZ and EU deficit outlook is much more manageable in comparison to US decline and fall globally.

Posted by hariknaidu | Report as abusive

What do the raw numbers actually mean anyway? Who would care if €1 EUR was worth $200 USD, if wages were roughly in proportion? This side of your presentation is a bit too simplistic for my liking – by this measure, the Latvian lat should be considered one of the world’s strongest currencies, and the old Italian lira should have been substantially strengthened in real terms (and not just nominally), every time the decimal point was moved. Not so, obviously!

You mentioned quantitative easing, in passing. Both the USD and the EUR are fiat currencies. Their value and exchange rates are determined by:
* How influential these currency areas are, in trade;
* How much fiat money the Fed/ECB circulates.

Since the U.S. reneged on its obligation to maintain the direct convertibility between the USD and gold; it has been in the world’s long-term interests to diversify their reserves. This means, reducing long-term dependency on the USD, and increasing involvement of the EUR, CNY and other currencies in world trade. Since the value of these other currencies is not directly determined by the Federal “Reserve”‘s dollar policy, why should we be surprised to see the EUR holding its own against the USD, at least for the time being?

These are honest questions. I respect your credentials but I’m bemused by the U.S. mass-media’s attacks on the prospects for European success. It seems that as soon as the U.S. economy starts looking a bit ropey, the American response is not,
“Let’s fix our system NOW”; but
“Let’s convince the world that even though the USD is pretty worthless in reality, and our system imbalanced; everyone else’s currency is even MORE worthless than the USD… Then we’ll be able to carry on palming off fiat currency on everyone, devaluing our bad-faith debts whilst living the high life…”

It’s no wonder if investors are taking flight to gold, while ever there’s a race to the bottom between the central banks’ currency positions. The EUR is not falling relative to the USD because the Federal Reserve is not letting it…

Posted by matthewslyman | Report as abusive

r u holding a position against EUR?

Posted by robb1 | Report as abusive

@robb1: Reuters editorial policy says the author must declare if he holds any relevant positions/ stakes in the subjects he’s discussing… So I’m guessing he doesn’t, unless he amends his article… Good question though!

Just imagine the economic earthquake if China announced that the CNY would henceforth be directly convertible with gold! We could just about wave “good bye” to the USD as we know it, if they did that…

Personally I don’t understand why the global reserve currency also has to be legal tender in everyday trade by private citizens. Couldn’t an alternative global reserve currency [illegal for private citizens to hold] co-exist with a range of national fiat currencies? At least then, the politically undermined USD would not furthermore undermine the system of global trade… Why should the citizens of a few particular nations hold the exclusive right to receiving the global reserve currency in their personal wage-packets? And why should they have the exclusive right to pressure their government (via domestic voting) to devalue their debts [held in the global reserve currency]? I don’t understand it.

Americans might not like Vladimir Putin, but he’s right in suggesting that the United States is shifting some of its burdens onto the global market by dishonoring their natural obligations as the issuers of the global reserve currency. Unless sanity returns to Federal Reserve policy, it may soon be time for USD dominance of world trade to be tempered.

Posted by matthewslyman | Report as abusive

@hariknaidu: Yes, typical Harvard, just shovel some good marks to the American clique and make a funny story about Italy and the EU. Unfortunately, Italy is a better performer in most economic indicators than the USA. Italians have money, Americans nothing. But I think Mr. Rogoff is smart enough to know these numbers. He knows he is in an economy that, besides the favours of Moody’s, is in deep, deep trouble and Italy is a cheap shot. Too bad for him the EU has pretty smart business schools as well.

Posted by FBreughel1 | Report as abusive

One thing in the author’s favour that everybody seems to be missing so far… The USA has natural advantages over Europe in:
* Land, natural resources & land-economy (America’s cities developed later, and so streets are laid out in a fashion more amenable to modern life). Land advantage translates to population growth (demographic advantage) which translates to economic growth (if not badly managed).
* Mercantile culture & ideology (the business culture in California is “go big or go home”, whereas in Europe which is culturally and linguistically much older and more diverse, it’s fashionable to be a cottage industry or boutique supplier. The American culture has more natural advantages in competition for large-scale world trade.)

Because of these natural advantages in economic growth, it’s quite acceptable for the USA to have higher deficits than Europe; because the USA’s ability to repay their debts is growing faster than Europe’s ability to repay theirs. (This is the very purpose of lending – to support America’s growth, and invest in the regions/ sectors most likely to bring a return on investment for Chinese and European pensions in the 2040’s and 2050’s.) Only, like other commenters, I seriously doubt that America can sustain a 10% deficit for long…

Posted by matthewslyman | Report as abusive

The Euro most certainly should not fall against the dollar, at any rate. The US dollar is grossly overvalued and that gross overvaluation has virtually destroyed the country. It simply must be driven lower, no matter what bankers and billionaires want.

If you would like to create your own currency, independent of the territory of the USA and the population, go ahead. If you want to deal with us, we will print however much paper you need, at a zero interest rate and high transaction tax rate, to keep our currency cheap enough we can work. If you do not like that, move somewhere else please.

The United States belongs to its people. Now, in case there is some misunderstanding, that is the bottom 90% of the income distribution. If those of you in the top 10% do not like it you can get out. It is time to take our country back, and to expel people who fiddle us out of majority rule with corrupt judges and politicians.

Posted by txgadfly | Report as abusive

The author worries about the stronger Northern states having to put up with the constant financial drain of the weaker southern states.

This is not likely to be problem. After all, in the US the same thing has been going on for centuries and the net result has not been so bad overall except for one really notable exception from the middle of the 19th century.

Posted by Hmsinflammable | Report as abusive

@matthewslyman: painful to use California as an economic/political example….but let’s not go into the dire situation of that lost state.
Let’s clear up the following: the top 500 stock-listed companies in Europe are more profitable or equal profitable than those in the US. The US had an advantage in the 90s somewhere. The reason our pension funds are in the states is because of the US financial powerhouses and diversification.

By the way growth, what growth ? It’s only inflation. Do you pray and hope the rest of the world doesn’t see it ?

Posted by FBreughel1 | Report as abusive

[…] http://blogs.reuters.com/amplifications/ 2011/11/03/why-the-euro-needs-to-fall/ Like this:LikeBe the first to like this post. Posted by equitybriefcapital Filed in Sovereign Debt Crisis ·Tags: EquityBrief Capital Management, Ryan Parker Leave a Comment » […]

Posted by Commentary from Ken Rogoff « EquityBrief Capital Management | Report as abusive

The European Central Bank is charged with managing the euro in a manner that minimizes inflation. By contrast, the Bank of England and the Federal Reserve Bank are charged with managing their currencies in a manner that optimizes the trade-off between inflation and other economic considerations (such as unemployment). Thus, the euro inflates less than the pound or the dollar. In essence, the euro is the mark.

Posted by Bob9999 | Report as abusive

One minor correction.

After the US removed itself from the Gold Standard to stop the looting of its national gold reserves by European countries that were not on the gold standard…

Carry on, thereafter!


Posted by REDruin | Report as abusive

The U.S. and U.K. are just participating in a tried and true method to make debt less onerous and keep the wheels turning. When debt gets too high, devaluation makes it easier to pay off so we can buy more stuff – keep the economy moving. What is so difficult to understand? EU will eventually come around or stay in a recession. Not saying it’s right or that it rewards hard work and thrift – it’s just the way it’s done – century after century.

Posted by brazil_83 | Report as abusive

@REDruin: I always thought (based on my light-weight reading of history) that massive U.S. expenditure on the Vietnam war and the Apollo space program, eventually caught up with the USA, so that the Americans were no longer able to pretend that they could back their dollars with gold. I thought there was a genuine crisis of confidence. Given that America received much of Britain’s gold by profiteering on Britain’s position early in the 2nd World War, at a time when Britain was selling under duress, and when Jews particularly were migrating with everything they had (paying for a new life in the West with their gold, under duress again of course)… I always thought that gold convertibility was a key part of the obligations the United States willingly took on, in return for Western European acquiescence in the rise of the dollar as the undisputed global reserve currency. So it’s odd to read the suggestion that European countries that actually took advantage of the terms of the original contract, were “looting” American gold! It’s interesting however to learn of another perspective.


From one perspective, American default on the gold standard is a simple case of breach-of-contract, plus Americans living beyond their means and trying to take advantage of their side of the original contract while agitating against other currencies & markets in order to make the dollar look comparatively good (despite its loss of yellowish lustre).

From another perspective, American default on the gold standard was ultimately inevitable, since a small amount of inflation is an essential part of a healthy modern industrial economy operating within a competitive world & wider market.

I suspect the truth is somewhere in-between…

Posted by matthewslyman | Report as abusive