Markets vote for the euro

May 24, 2012

By Edward Hadas
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Companies are broken up when managers think the whole is worth less than the sum of the parts. Smaller enterprises are more flexible, they say, than incompatible organisations artificially joined into a single, excessively bureaucratic entity. Investors often agree and share prices commonly rise on rumours of a split. The euro is clearly different. The fear of a break-up is making the single currency fall.

The market’s vote in favour of the euro is usually portrayed as its equivalent inverse – a vote against the woes which would accompany a retrograde transition to national currencies. Yes, the euro has dropped from $1.32 to $1.25 since the beginning of May because a messy Greek exit would cause all sorts of grief, even for the stronger members. A recession would be unavoidable, just as after the bankruptcy of Lehman Brothers in 2008. Yet while that dire forecast may be justified, it is itself a tribute to the benefits of cross-border integration within the euro zone. The financial ties have are so tight that breaking them would cause a great deal of trouble.

The market’s judgment would probably be the same even if traders believed that a euro split could be managed without much additional financial stress. A currency demerger would reverse significant economies of scale. With floating exchange rates, companies will be more national and less European, cross-border capital flows will become even more capricious and Europe will look pathetic in international negotiations.

National currencies would indeed be more flexible and less bureaucratic than the euro. In practice, that means national governments would be more likely to use inflation and devaluation to avoid tackling structural economic challenges. The loss of a global currency would also be the loss of potential future gains from hosting a global reserve currency. The euro might someday replace the dollar; the deutschmark never will.

It might have been better not to have started with the single currency without more political and financial unity in Europe. But almost 14 years into the experiment, a break-up would be value-destructive. The falling price of the euro shows the market has got this one right.

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The Euro was ill conceived and has been poorly managed from the outset. It’s sole real objective was to topple the dollar. What it has done is to accelerate the economic demise of Europe and make it a laughing stock. It has shown the world the true tribal nature of the continent and has strengthened the £ and moved the UK further and further away from a block with which we had little real empathy anyway. Soon after the creation of the Euro (I hestitate to call it a currency) I was at lunch with the minister of finance of one of Africa’s strongest economies. He produced several bank notes including £s, $s etc and a Euro. He read the inscriptions on the bank notes, commenting that he was happy that the Bank of England and thus the UK government was guaranteeing the note and so on with the $ etc until he came to the Euro. There was no declaration as to it’s value – he said until some government or serious bank takes responsibility for this piece of paper it has as much credibility as Monopoly money, it is worth only what confidence and thus value that anyone is willing to place on it. When it comes under pressure there is nothing to prevent it from becoming rapidly worthless. Until the Europeans establish some sort of meaningful financial guarantee to support this item, it will not form any significant part of my reserves. It was so obvious to people, even then, that the Euro was not a serious financial instrument. Osborne and others have warned the Europeans, especially the Germans that they either step up and support it or it will fail and the real losers will not be outside the Eurozone, despite the political rhetoric no-one needs it. It will be the Germans, who have enjoyed the benefit of an undervalued currency from the outset. The Eurozone members and the UK have been supporting the German economy for far too long. The answer is simple – kick the Germans out of the Euro or wind it up. If they don’t, the rest of Europe will continue it’s rapid decline into third world status, whilst the Germans refuse to face up to the realities of living in the present international, financial environment. Progressively, the Germans will lose more and more foreign investment until, eventually, they have bled the Eurozone members completely dry and then we shall see an insignificant Europe descend into the warring and bickering it knows best but by then the world (including the UK) won’t care because the Eurozone will be of little more importance than a second rate African State (my apologies to the Africans, the analagy is purely for presents day comparisons). As for Germany, she’ll have to clean off those wheel barrows again and start begging, only this time there will be little sympathy from the international community ! It is not really a question of if this will happen more a matter of when. I guess the answer to that is when the members of the international community are satisfied that they have reduced their individual exposure, sufficiently, to write off their Euro asset positions and that could be very soon at the rate that the Euro is falling.

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