A clearinghouse for commentary on supply-side economics.
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.