28 December 2010

Christmas Greetings

Wishing a particularly Happy Christmas to those wonderful people who broke into our office and stole our newly acquired large screen TV for displaying properties and some of our brand new computers. I do hope they enjoyed their free gifts!

10 December 2010

The first logical explanation I have seen of 'What if the euro collapses?"

Forex is one of the major currency exchange companies, and this article by Kathleen Brooks, Director of Research UK, Forex.com, is the first one I have seen which puts plainly the possibilities and options, as the financial markets see them.

'Europe's debt crisis is the first major credit issue to rock the currency bloc, but what if this becomes a currency crisis and could it lead to the end of the euro?

European lawmakers' piecemeal approach to the worst crisis in the monetary union's history is generating fierce debate about the sustainability of the project in its current form.

Bespoke rescue packages for Ireland and Greece are failing to placate the financial markets, who can see that it is not really targeting the heart of the problem and merely plugging a solvency gap with cheaper, short-term liquidity.

Each day that passes without a sustainable solution to Europe's heavy burden of (bad) sovereign debt brings us a step closer to a cataclysmic event — the collapse of the euro.

This may sound extreme, but the last three years have taught us that black swans are less rare than we may think. While we continue to believe that the euro will pull through this crisis, it is worth imagining how a breakdown of the euro would work.

If the euro falls the first thing European lawmakers would need to agree on is what form of alternative currency would replace the euro.

Two choices immediately spring to mind: the first is a return to the members' original currencies, so Italy would return to using the lira, Spain the peseta, Germany the Deutschmark etc. The second would be to create a new currency for Europe's weaker members.

The German and French public have in the past shown nostalgia for the franc and the Deutschmark, but restoring old currencies that were taken out of circulation eight years ago would be a logistical nightmare.

Lawmakers would need to debate and agree on new exchange rates for all of the 16 member countries. Also, due to the fragile state of some peripheral nations' economies, it may be necessary to wait for growth to stabilise before introducing the national currencies.

Reference rates would be necessary — for example growth or inflation targets — to ensure a smooth transition to a new method of exchange. This would be crucial and it could be a lengthy process, possibly taking many years.

If it was not handled with care then weak nations would be plunged into a debt-deflationary spiral as their currencies get battered in the markets in favour of the Deutschmark and French franc.

This wouldn't be good for France or Germany either, as it would make their exports less competitive and hurt economic growth.

Returning to national currencies also comes with a hefty price tag. Member countries would have to re-build the infrastructure necessary for managing their own currencies — such as central banks, mints and coin printing facilities.

The waste would be unimaginable. What would happen to the ECB, the European Commission? Could the economy of Brussels cope without being the centre of the EU?

It would also require a degree of political cooperation and decision making by eurozone officials that has been missing during the sovereign debt crisis.

On top of this there are also technical implications to consider such as updating calculators, keyboards and cash machines with the old currency symbols.

A more manageable situation would be the creation of a second-tier euro for the weaker peripheral nations with the core economies keeping the original euro as well as the ECB.

It would be more logistically manageable as it would already have a reference rate from which to value itself (the core euro) — at least for the early years.

The difficult thing to decide would be a name (it couldn't be too patronising) and whether or not countries could graduate up to the top tier euro if they reached a certain criteria.

Another weaker version of the euro would reduce the political cost: it would keep the union together.

It would also reduce economic costs since instead of doing everything 16 times you would only need to do it once.

A two-tier euro would also increase currency flexibility within the eurozone as one would expect the second tier euro to trade at a discount to the original.

This could help weaker economies get back on their feet and export their way back to growth.

It would also help rebalance growth in the European Union with the rich core countries buying up the exports of the less wealthy peripheral nations — this has been in reverse in recent years, much to the detriment of the peripheral nations' balance of payments.

But what about the expansion of the EU? What currency would the newcomers join?

Ironically, the countries preparing to join the eurozone probably have better financial positions than the troubled peripheral nations as they have had to adhere to strict fiscal rules (such as having a fiscal deficit of no more than 3% of GDP) in the years running up to their membership.

However, it seems logical that these countries would join the second-tier euro with the possibility of ascending to the top tier if they pass a number of milestones. This may not be the fairest option, but it would be the most practical.

Where does this leave the UK? The pound would most likely be clubbed together with the stronger European currency so we would expect to see sterling appreciation.

This could have mixed blessings. As long as the core euro was stronger than the pound, UK exports to the strong nations like Germany and France could receive a boost, while exports to the weaker nations would be constrained by the relative outperformance of the pound.

The end of the euro in its current form could also boost the pound's global position. In recent years the proportion of sterling in global foreign exchange reserves has shrunk. If the euro is split in two it may lose some of its appeal as a credible alternative to the dollar as a reserve currency, boosting the relative attractiveness of the pound.

Imagining the world without the euro is overwhelming and the above analysis is only scratching the surface. But while Europe's policy makers continue to disagree and bang the drum for their own self interests a cataclysmic event seems ever more likely.'

I liked very much the comments I have marked in bold about waste - waste in the EU, surely not! Political co operation - equally hard to believe!

All very interesting though.