Wednesday, July 23, 2014
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Follow the Euro

CAMBRIDGE: Now that the Euro has arrived, so what? It is useful to review what it can be expected to do. It is also interesting to ask what new risks, opportunities or ideas it offers emerging markets in Latin America or Eastern Europe.

First a negative: the claims of the great gains to be made from transparency, competition, and efficiency are overstated. Price discrepancies in Europe reflect two facts: like politics, all prices are local. Second, price discrepancies do have a lot to do with limited retail competition and a long tradition of anti-competitive practices. Of course, there will be gains in transactions costs from a single money. But that must wait until the money is actually there, a few years from now.

Another negative: will the Euro help unemployment? Per se, the Euro does very little to create jobs or reduce unemployment. True, more financial stability on the periphery and as a result somewhat higher growth must be expected and that brings limited help. The central fact is that higher growth and substantial dismantling of supply side obstacles to job creation and job acceptance are the real cure.

Here is something the Euro will do: reinforce financial deregulation (national and cross border) in Europe to create a broad and deep capital market. Europe comes from a dinky and segmented national, bank-based financial structure. It is on the way to a US-style capital market where households hold funds and companies issue paper and stocks, intermediation margins are small and governance significant. European companies will benefit from the transformation, the most significant supply side influence we will see.

Financial deregulation introduces the possibility of talking advantage of financial technology. Second, financial deregulation and internal market measures open a much larger scope for cross border transactions. Lastly, the Euro crowns these developments by adding huge scale, lowering the cost of capital and that helps growth for the wider range of users.

Next some good news: one payoff on the Euro is the macroeconomic disarmament of the periphery - Italy and Spain, even France. Common money makes these regions safe for investors, reflected in lower interest rates and higher growth; risk premiums are compressed because these countries no longer have central banks or exchange rates to fiddle.

Macroeconomics is gone as far as local initiative is concerned and that is a good thing in a world where whenever the Banca d’Italia practices "independent monetary policy", investors can’t run fast enough. In this respect, the Euro is a thoroughly modern institution, well-adapted to a highly integrated and trigger-happy international capital market.

A non-issue: inspired by their anti-market attitudes Germany and France are searching for a new international architecture to limit exchange rate fluctuations, blaming the latter for the last year’s instability. But forget about fixing North-Atlantic exchange rates and the Yen. Whatever European socialists say, there is no control-freak US government in sight, thus fixing of rates is not about to happen.

What is left for the periphery? A more integrating Europe and marginally better growth performance - good news but not enough to write home about. The real lesson for the periphery is surely this: in anything but mega-countries, nationally managed monies are passe. There is no more room for amateur central banks trying to exploit what they perceive as a residual domestic money illusion.

Having a national money is expensive - that is why Italy and France surrendered theirs. It offers little flexibility and year after year an interest cost is paid for what is the illusion of independence. Mexico or Poland cannot cut their rates below the US or Germany; they would be lucky to get so low. Monetary sovereignty nowadays means only the right to bad money.

How can the periphery get out of the self-inflicted historical curse of a central bank and a national money. Do what Argentina did, or Italy. Give up the national money and create a hard link to a world class currency. A hard link means a currency board, no less. Brazil thinks it can get by announcing that it will never devalue and nobody believes it - real interest rates are 30% because devaluation is just around the corner.

In Eastern Europe where there is a desperate wish to be part of the European Union and the first world, the politics are now easy - Europe has done it, join the crowd, peg the Euro with your currency board. In Latin America, forget about the unending promises of no more devaluations, abandon the mess and move to the dollar.

Citizens at home, and the world capital markets, can look and do choose across borders, which is inconsistent with national financial independence. Saying that the central bank is doing better nowadays - as in Mexico or Poland - is no argument to settle for higher risks. Getting a really good money is worth using political capital, that is the real lesson from the Euro. And the periphery can get there in no time. Lets just accept that and move from there to a 21st century agenda of hard money and better economic performance for everyone.

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