Working Papers

The Euro:  Too Crappy, Even for the Italians

One of the great attractions of the euro was that it offered instant monetary credibility to countries with less than stellar inflation records like Italy.  For these countries, the euro was a free lunch.  They could import monetary policy credibility, without having to make difficult monetary and fiscal policy decisions over and above satisfying the convergence criteria.

Italian politicians are now seeking support for a referendum to pull Italy out of the euro:

Roberto Maroni, Mr Berlusconi’s social security minister and a joint acting leader of the Northern League, said his party would start collecting signatures for a referendum on the issue later this month. He also appealed for the process of ratifying the EU constitution to be halted.

Days after it was reported that senior German ministers had discussed the disintegration of the single currency, Mr Maroni pledged to start collecting signatures for a referendum later this month. He branded the euro a “disaster” which was product of a “European model whose failure we are witnessing with concern”...

Mr Maroni held up Britain as a model to be copied. “It is growing [and] developing while keeping its own currency,” he said.

(via Alex Singleton)

posted on 05 June 2005 by skirchner in Economics

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The Euro is seriously problematic for all the member countries, but more importantly it is most problematic for those European countries, which generally ran a more inflationary monetary policy than the rest. The reason is that before the Euro, some of the member countries were able to cheat their way through life through inflation. Italy, a prime example of this policy can no longer cheat or inflate. Neither can it run large government deficits (although there is more “tolerance” these days) larger than 3.5% of GDP because the Union members are corseted by the stability pact, originally imposed by Germany to spot profligate spending by the “soft” countries.
The Euro now acts like the Gold Standard of old where adjustments to shocks can no longer be taken through currency depreciation. However, prices such as labor rates can’t adjust downward to allow for necessary adjustment like they once did. The price of labor or course is one of two most important prices in any economy. The only possible outlet for this kind of pressure is for the ECB to run monetary policy to assist the weakest members of the Union, which is unlikely. The other scenario is for the Italian economy to adjust downward: a recession. We recently saw Portugal announce it had made a small “error” in its budget balances, sending the domestic deficit way over the limits imposed by the treaty.

What are we likely to see out of the referendum result? Credit spreads between the perceived strong members to the weakest are going to widen substantially. The Euro is also going to move from a “premium” against the US Dollar to a discount as people build the risk of Euro default, i.e. it fails as a currency. It is also going to be perceived as a currency without a country, which is “radioactive” to currency markets. As currency traders will soon be saying, “it’s never too late to sell the Euro”. This may be one hell of a move.

My guess is that we are starting to see is the beginning of the beginning of end of the end of the Euro.

What to own against the Euro? Well the Dollar is not exactly in great shape either. My best bet spanning the longer term, which in trader terms means a little more than a week, is that Gold against the Euro will rise more than 30% over the next year or so, maybe even sooner. What helps this trade even more is that the ECB won’t be able to raise rates for at least another 12 months as it is locked into trying to paper up this disaster of a currency.

Posted by .(JavaScript must be enabled to view this email address)  on  06/07  at  12:56 PM

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