Posted July 08, 2022
By Sean Ring
Taking Out the Euro Trash
- The Almighty Dollar is trashing the Euro, along with most major currencies.
- The Euro is a political project, so no amount of market rejection will sway Europes empire builders.
- Say hello to fragmentation risk.
How the Euro Came to Be
My first time on an airplane was in the autumn of 1997.
My college sweetheart was studying in Florence for a semester.
As she already spoke fluent Italian, it was more of a holiday for her than work.
We did Florence, Pisa, Venice, and Rome.
My life would never be the same.
Hilariously, one of my fondest memories was of the Italian Lira.
It was a perfectly ridiculous currency. So much so that turning my American Express Travelers Cheques (remember those?) into the lira prohibited my bifold wallet from closing.
I gave cheques, and I got a brick of currency in return.
But at least the Bank of Italy had control over its monetary policy.
Now, thats the job of the European Central Bank and its misguided head, Christine Lagarde.
If youve never read The Tragedy of the Euro, then put it on your list.
After reading this newsletter, you can download it at zero cost on mises.org.
Professor Philipp Bagus maps out the history of the currency and whats ultimately wrong with it.
I wont give you a synopsis of the entire book, but the beginnings of the euro are interesting.
Bagus outlines the competing visions of Europe: Classical Europe versus Socialist Europe.
The classical liberal model is defended traditionally by Christian democrats and states such as the Netherlands, Germany, and also Great Britain. But social democrats and socialists, usually led by the French government, defend the Empire version of Europe. In fact, in light of its rapid fall in 1940, the years of Nazi occupation, its failures in Indochina, and the loss of its African colonies, the French ruling class used the European Community to regain its influence and pride, and to compensate for the loss of its empire.
Yes, its always the damn French. But you knew that already!
Bagus goes further:
The real reason the German government, traditionally opposed to the socialist vision, finally accepted the Euro, had to do with German reunification. The deal was as follows: France builds its European empire and Germany gets its reunification. It was maintained that Germany would otherwise become too powerful and its sharpest weapon, the Deutschmark, had to be taken awayin other words, disarmament.
So the French handcuffed the Germans to maintain control of the European Unions power levers.
Hows that working for them?
But really, this political project gives its politicians 100% discretion.
That means theres no economic occurrence that will shut down the project.
And thats a complete disaster for Europeans.
Why the Euro Doesnt Work As Intended
Lets start with the original euro.
And thats the US Dollar.
What do I mean by that?
Abraham Lincoln and his Treasury Secretary, Salmon Chase, instituted the Office of the Comptroller of the Currency:
To promote opportunity, a dynamic economy, and a stronger Union, Lincoln and Chase conceived the national banking system and the Office of the Comptroller of the Currency to regulate and supervise it. Lincoln took pride in signing the National Currency Act, which he believed would provide "great benefit" to the people and the government.
"The national system," he declared in this State of the Union message of 1864, "will create a reliable and permanent influence in support of the national credit and protect the people against losses in the use of paper money."Old Abe essentially created the present US dollar by fiat (government decree).In fact, you can argue Lincolns actions were far more dictatorial than Europes.At least the Europeans put it to a vote (however many times you need to vote to choose correctly).And while the ECB and the Federal Reserve work similarly, theres one huge difference.The Fed only has to deal with one Treasury.That means they can coordinate monetary and fiscal policiesObviously, that can go wrong, like right now.Joke Biden is running an enormous fiscal deficit, while the Fed has kept printing money willy-nilly for over a decade.This is one of the reasons your July Fourth BBQ cost $10 more this year than last.But the ECB has to deal with 19 different treasuries, all of whom are answerable only to their national governments.Its a complete mess of a system that fosters zero coordination.In my mind, what Europe has lost in monetary freedom is far greater than the supposed benefits of lower transaction costs between member states.Of course, its going wrong right now. Just like it did in 2011 with the European sovereign debt crisis.Only this time, its Italy thats causing palpitations.
Fragmentation or Redenomination?First, lets see how its going:Yes, thats the euro falling out of bed against the USD. One of my LinkedIn connections wrote, I thought that was a crypto chart!Once we hit parity (1 USD for 1 EUR), look at the 0.85 level.As Ive written before, the exchange rate is the one number that summarizes what the world thinks about your country (in this case, region) and currency.The Euro is clearly out of favor.Not only is Europe impaling itself thanks to its idiotic Russia policy, but now fragmentation is rearing its ugly head.This chart is the spread between Italian and German 10-year bond yields:Theoretically, there shouldnt be much of a spread.But Italy has too much debt (134.8% debt-to-GDP ratio), and Italian banks hold much of that debt.So the worry is that Italy might force a break from the euro to return to the lira.From a European Parliament report titled, 10 years after whatever it takes: fragmentation risk in the current context:
An extreme consequence of the fragmentation in credit and money markets is the possibility that the euro area could break, with the adoption of national currencies and the restoration of national monetary policies. This risk, known as the redenomination risk, can be measured by the risk that an asset denominated in euro can be converted (1 to 1) into a new national currency with a high probability of depreciation.A high probability of depreciation?If this scenario came to pass, the lira would trade 50 to 1 against the USD if its lucky!And Madame Lagarde cant print her way out of this. Her printing is a big reason were in this mess, to begin with.Thank heavens for my offshore bank accounts