To conduct international trade and financial transactions, a reserve currency is necessary to eliminate the costs of settling transactions, involving different currencies. Prior to reserve currencies, the gold standard was used to align all currencies, but Gold did not grow at a pace with the real economy and caused crashes as a result. The financial economy has to grow faster than the real economy, otherwise there is deflation, and this wasn’t achieved. Today paper money flows instantly, the financial economy is a multiple of the real economy, and if we didn’t have the USD then we would need the IMF(SDR(Special Drawing Rights), which is an amalgamation of the world currencies).

The Euro as a reserve currency would require the Euro region to run deficits so as to create more paper, to then issue to the world to finance growth. The Eurozone has enjoyed a low-interest world environment, yet in Germany for example, its overvalued currency should mean it is experiencing deflation and reality seems to be fitting the theoretical model. Germany’s monetary variables are starting to look quite deflationary, even in nominal terms. The simple answer is that the Euro has permanent structural issues, which will render it ineffective as the global reserve currency.

However much one dislikes the Dollar as the global reserve currency, the Dollar sceptics cannot compete with the structural and cost advantages of the dollar, and they can “opt-out” of the dollar system, as the Chinese have done. But it is important to mention that they do so at great risk to their growth (as China is showing today). There are such things as “natural monopolies”, think of the George Washington Bridge to get from northern NJ into Manhattan. Markets and liquidity are one of those industries where the desire for deep liquidity lends itself to a natural monopoly (you see this in interest rate markets, stock markets, etc.) and so the dollar is one of those markets. Prior to the dollar it was the Pound. It may not be in everyone’s interest to keep the Dollar, but it is certainly in the US interest(but this also depends on US military dominance). Either way, there is nothing anyone else can do about it. Look at Delaware law. It is all about protecting shareholder interests in corporations, and political pressure on DEI, for example, cannot change that, which benefits US stock markets.

On January 1, 1999, the Euro currency was introduced into markets following decades of careful consideration and planning. This came to fruition as political leaders wanted an integrated currency for geopolitical reasons (continued peace on the Euro continent) and strategic economic reasons (to reduce the risk of economic crises and enhance the region’s economic standing vis a vis the US Dollar). Positively, the Euro has succeeded by replacing and merging together the old German Deutsche Mark (DM) and the French (FF) currency blocs thus becoming a very successful currency trading area, as well as maintaining and even growing the influence of those blocs.

However, the Euro area is structurally short US Dollars in times of global financial stress and relies on the US Federal Reserve to open the dollar funding window to the ECB to assist in the funding of the Euro banks. When this did not happen during the GFC, many Euro banks went into deep distress, and even bankruptcy including the most important German mortgage bank, Hypovereinsbank. The Fed accomplishes this USD funding via the use of swap lines which are designed to improve liquidity conditions for dollar asset markets in the US and abroad in times of stress by providing foreign central banks with the capacity to deliver U.S. dollar assets to their respective banks, which then can themselves access the Central Bank funding windows with collateral to receive US Dollars for funding daily liquidity of their institutions. This was necessary just recently during the Silicon Valley Bank crisis, suggesting the Euro system is still very short US Treasuries. As an aside, the Euro is probably correctly weighted (by the nominal effective exchange rate, or NEER for short) in Central Bank reserves, having a weighting of about 22% of world GDP and also 18% of world currency reserves(dependent on international trade).

In addition to the European Central Bank being structurally short US Dollars in times of stress, making matters worse for the Euro investors as a whole is that their return on US Dollar investments is very low, both from an asset allocation perspective (buying government bonds with negative real returns) and from an investment selection perspective (within asset classes, security/stock selection is also below average). In this sense, the US Dollar is really an insurance policy on liquidity stress within the Euro bloc region. This can be the only reason the Euro investors as a whole accept inadequate returns on their US Dollar investments (which also happens to be true for Chinese and Japanese investors). Alternatively, what could be happening is that the Current Account is receiving the bulk of economic returns (i.e. LVMH or Mercedes having superior profit margins in the US than in Europe), but this is beyond the scope of this paper. Whatever the explanation, the fact that US overseas investments are superior to Euro and Asian investments in the US is otherwise known as the US’s “exorbitant privilege,” a phrase coined by the French finance minister Valéry Giscard d’Estaing, which encapsulated President Charles de Gaulle’s broadside against the dollar half a century ago (1965), complaining that the US was allowed to issue debt at the cheapest costs, whilst running massive trade and budget deficits.

Furthermore, another structural weakness is that the European debt markets are very shallow in their liquidity and too dependent on banks. The total debt market is not large enough for the demand for risk-free assets (which pushes liquidity to US markets). There is also a dearth of risk-free Euro assets, since Italian debt and “lower quality” countries are not considered risk-free. Furthermore, the dollarization of Central Asian Economies (CAEs) and the MENA, allow them to enjoy low-interest rates and all but eliminates the Euro as a competitive worldwide currency, and keeps it regional at best.

Uncoordinated economic policies across countries and regions in the Eurozone, a well-known argument by Kenneth Rogoff, is further evidence of the Euro’s structural weakness. Firstly, monetary policy cannot offset fiscal policy on a country-by-country basis, in other words, if a country extends itself fiscally and has to retract, there is no countervailing monetary force to absorb this negative impact, making it extremely painful to the labour market. On January 1st, 2002, Greece effectively made the euro its legal tender currency, thus handing over its monetary policy to the European Central Bank, losing the tool which gave Greece the ability to devalue its currency (a time-tested financial tool for dealing with excess debt, insufficient growth and necessary adjustments to be at purchasing power parity with trading partners). This made it less expensive for Greece to borrow (by essentially importing the best-in-world German DM funding rate) and ultimately contributed to the Greece Crisis in 2012 by encouraging excess borrowing at ridiculously low rates. Furthermore, their labour market had to adjust downward its labour prices to make the country competitive with northern Europe.

Another current example of fiscal policy offsetting the effect of monetary policy is Italy, whose public and private debt equates to more than 330% of GDP. Similarly to Greece, a mix of political instability, enormous amounts of debt, and a poor demographic led to a crisis in 2022. A result of this crisis on the labour market has sparked a debate on, “la questione salariale”(the salary issue). In short, Italy has been unable to generate stable, well-paying jobs, due to low productivity and weak economic expansion. Inflation adjusted wages have fallen 3% according to the OECD. No amount of fiscal policy will be able to offset this structural deficiency in Italy. Italy is two countries, the north which is exactly like Germany, high savers and great engineers, and the south which produces nothing. The people are generally well off, and live well. However, the government is poor and indebted. Eventually, Italy will simply get hollowed out, as the people move their profits to Anglo-Saxon economies they trust and educate their kids at anglo saxon Universities which deliver the best jobs. It is better off than Spain and Greece, but perpetually worse than Germany and France.

So, is it true that Italy, Greece, and Spain are more prone to crisis than Germany? Is Germany benefiting at the expense of Italy, Greece, or/and Spain, which is already a problem? Essentially, have the rules set forth by the Eurozone done anything?

The answer is yes and no. Italy is more prone to crisis in that it cannot grow out of its debt problems, therefore, there is no path forward except to adjust labour costs to labour value on the world market, or at least certainly on the euro market. Furthermore, if labour is uneducated, not hard working, too dominated by the public sector, not promoting the best and brightest, then Italy will have problems and they do. Since the Euro has been in use, Germany has benefited the most, gaining €1.9 trillion, while the Netherlands saw the second highest return at €346 billion. However, not all EU countries have seen such positive results. Italy has lost €4.3 trillion and France has lost €3.6 trillion. Germany’s monetary union membership helps to reduce the cost of international trade, and provides protection against excessive exchange rate volatility, which has undoubtedly benefited them. The Euro has not appreciated accordingly with Germany’s rise in exports. Yes Germany is benefiting from the Euro, and more indebted countries in the region have been propped up by the Euro, hurting the competitiveness of their goods in international trade. However, another theory, one put forth by macro-economists argues even still that Germany would benefit more from having their own currency.

Finally, structural asymmetry due to differences in productivity and production specializations are also dragging the Euro. The percentage of the economy in manufacturing versus services, and the types of services have no doubt added to the Euro’s worldwide decline. Take Germany versus Switzerland for example, as they have the same economy, exports imports wise(50% exports, 40% imports). A stronger currency has forced Switzerland(a <1T$ economy) to produce higher-quality goods and services to maintain its competitiveness. Germany(a >4T$ economy), on the other hand, has a 45 million labour force, with 8 million in manufacturing, buoyed by the cheap Euro. However, Switzerland’s purchasing power upgrade(as the CHF is 20% stronger than the Euro) from low-quality manufacturing to high-end services has offset any unemployment, and attracted more wealth. Think of skiing, as Germany is cheaper than Switzerland, one would assume wealthy individuals would rather ski there, however; ironically Switzerland attracts a larger crowd. Furthermore, Germany’s Income transfers are impossible without a federal system to offset this; therefore permanent differences in wealth and income are prevalent. A total lack of investment in the human labour market with respect to growing talent for next-generation industries further adds to this argument(there is no European engineering school that has a major Google or Apple or Amazon, or Microsoft HQ next door to absorb the best and brightest as those companies do at Stanford, MIT, Carnegie Mellon, etc.). Furthermore, higher price regulation in Swiss industry, 1⁄3 of CPI is regulated, and in no other country in Europe is the share so high. Consequently, goods imported into Switzerland from abroad become cheaper, dampening inflation, and the goods produced are price protected internationally, offsetting the same challenges faced in the Eurozone’s crisis countries (Spain, Italy, Greece). 

Without the Euro, the DM would look like the CHF, the same or stronger. There would be very little country debt (relative to GDP < 100%), trade surplus (which would probably fall a little bit, but not a lot since people who buy Mercedes can afford higher prices (luxury goods are inelastic), and a very modest budget deficit.

Yes, Germany is benefitting in that their export markets are more stable and have a higher purchasing power than would otherwise be the case with previous currencies. Also, Germany has a lower currency value than the CHF (which is a proxy for the DM) and thus has much more competitiveness in its industries. However, the German consumer is worse off because their purchasing power is lowered. This is ironic because there are 80m people in Germany, 40 million workers and 20% or 8m in manufacturing. Therefore, those 8m people would be more competitive, if the CHF was their currency. Yet, 72m people and some 40m or so households have lower purchasing power by approximately 50%(guessing where the DM would trade assuming it behaved like the CHF). Is that a good trade for Germany? Maybe, if you believe that manufacturing is the be-all and end-all to a country’s economic future.

I believe they have made a mistake, and that Germany overstates the value of manufacturing mostly because of its engineering and military background. Today, its value is in services, from software to accounting. And Germany is far behind in these service industries, which are dominated by the Anglo-Saxon economies. Furthermore, the Electric engine reduces from 1000 to 100 moving parts what is required relative to the piston engine. So a cheap currency hasn’t protected German manufacturing from competition from new industries. I believe as such, the Euro will prove to be a mistake (economically speaking) for Germany. From the perspective of peace in Europe, the Euro however is very helpful to Germany since Germany today essentially is Europe. Maybe thus the Euro was the correct price for Germany to pay for this leadership position, since military warfare never delivered the same goal.

Accordingly, the Euro has been held to a regional bloc currency, limiting its global competitiveness. However, according to a recent Bloomberg addition by Niall Ferguson, The Dollar’s Demise, the Euro has become the world’s second favorite reserve currency. He writes, “In any case, the principal shift that has occurred since the 1990s is that the euro has become the world’s second-favorite reserve currency. The same goes for international debt issuance, international loans, foreign exchange turnover and global payments through Swift: In each domain (especially the last) the euro has clearly established itself as numero dos.” As I stated earlier, this simply means the Euro is correctly weighted on world currency reserves, but does not suggest the Euro is structurally sound and can continue to grow its global competitiveness, rather the opposite may be true.

Since twenty years, a long list of proposed reforms have been put forward, however, there seems to be little room for compromise. Many of the Euro’s main structural weaknesses remain unresolved and depress expectations for its future. Recently, due to its heavy dependence on Russian energy and widening monetary policy gap between the Fed and the ECB, macro economist analysts indicate that the euro will continue to depreciate to the dollar, from 1.05 to 1 EUR/USD. Furthermore, ING analysts project the Eurozone economy will not grow as quickly as the US, indicating the Euro could fall further.

The Euro’s fundamental problem lies in its permanent structural issues, which prevents it from being anything more than a regional bloc currency, and thus limiting European power, even if they would have a unified version for that power (such as a European military or European Federation), which they do not.

Bibliography:

Relative ranking of countries within EU: https://ec.europa.eu/eurostat/statistics-explained/index.php?title=GDP_per_capita,_consumption_per_capi ta_and_price_level_indices
Recent econ growth: https://www.statista.com/statistics/263008/gdp-growth-in-eu-countries-compared-to-same-quarter-previou s-year/
Inflation rate in each sector EU history: https://www.statista.com/statistics/328540/monthly-inflation-rate-eu/
Interest Rates:
https://www.ecb.europa.eu/press/pr/stats/mfi/html/ecb.mir2302~efed62bf73.en.html

https://www.statista.com/statistics/225698/monthly-inflation-rate-in-eu-countries/ https://www.statista.com/statistics/1102546/coronavirus-european-gdp-growth/

https://www.macrotrends.net/countries/CHE/switzerland/inflation-rate-cpi Swiss Stats

https://www.macrotrends.net/countries/EUU/european-union/gdp-growth-rate Stat for Euro https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?locations=CH&start=1999 Swiss

https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?end=2022&locations=DE&start=2002&view=c hart German stats

https://www.macrotrends.net/countries/EUU/european-union/inflation-rate-cpihttps://www.macrotrends.net /countries/EUU/european-union/inflation-rate-cpi Euro Stats

https://www.reuters.com/article/uk-eurozone-idUKBRE84U0JZ20120601 https://www.imf.org/external/pubs/ft/scr/2005/cr05401.pdf
Italy and Spain suffer while germany thrives with cheap e…

Pettis, Trade Wars are Class Wars