Thursday, June 10, 2010

The euro at $1.20.

According to Robert Mundell, the euro’s strength against the dollar in 2008 is a major reason for its current economic troubles and debt crisis. In January 2009, the Nobel Laureate and father of supply-side economics predicted the high euro would cause the currency zone's exports to decline and its debt burden to become relatively more expensive. Mundell suggested the euro needed to fall to the $1.20s to relax deflationary pressure and spur recovery.

Today, however, the euro has fallen below $1.20, so it may be time for the European Central Bank to tap the breaks on the currency’s decline.

It’s important to remember that central banks have monopoly control over the currency's supply, and therefore its value. Currency values are "set by markets" only to the extent central banks choose to remain inert because it suits their interests, or because they are sidelined by incompetence.

If the European Central Bank wants to strengthen the euro, or stop its further decline, it has the option of selling bonds to withdraw base money from circulation and thereby strengthen the currency. If monetary authorities make clear they want the currency at a certain level – say against the gold price – and markets believe they will tighten to get it if necessary, markets themselves may move the currency to that price. No one wants to bet against a resolute and competent central bank.

There's no good reason for the euro's healthy decline to become a rout.

More on this from Nathan Lewis, here.


  1. Sean,

    I was just talking this same issue with Henry Meers this morning. You are absolutely correct. The debt position of the EUs members does not drive the exchange value of the euro as is being reported in the press. The euro is simply the medium of exchange in the euro zone.

    I heard just this morning that the euro was moving back above the $1.20 level. It does appear that Mundell has had an influence.

    If Europe does begin to consolidate and it allows the weak countries to suffer the consequences of their actions the economic attention will shift back to the US.

    Right now 2011 looks like a disaster for the US economy, but with Europe becoming stable the rest of the world could weather the storm and limit the pain.

  2. I really do think it's time to put Mundell out to pasture. As in past recent articles from him, he's again saying nothing.

    Senility has set in, as I said here about a month ago.

    Supplysiders have gotten to the point where they are grasping at things that work and claiming the successes as SS successes while claiming failures as not theirs. Starting with W's failures and accelerating as we go on. This is not capturing the imagination and attention of those who are looking for real solutions. In fact the SS fringe is shrinking even more.

  3. To the Straight Goods - How about some serious economic analysis rather than hyperbole.