“Death of a Currency”

Lynne Kiesling

One of the great topics of discussion with my in-laws over the holidays was the impending demise of the euro, and whether there was any hope for, or reason to, maintain the euro given the sovereign fiscal challenges of the member countries. The disastrous German and Italian bond auctions, and Spain’s cancellation of its sovereign bond auction, seems to portend “eurogeddon”. One of the articles that helped me interpret these events was this column from Jeremy Warner in the Telegraph:

No, what this is about is the markets starting to bet on what was previously a minority view – a complete collapse, or break-up, of the euro. Up until the past few days, it has remained just about possible to go along with the idea that ultimately Germany would bow to pressure and do whatever might be required to save the single currency.

The prevailing view was that the German Chancellor didn’t really mean what she was saying, or was only saying it to placate German voters. When finally she came to peer over the precipice, she would retreat from her hard line position and compromise. Self interest alone would force Germany to act.

But there comes a point in every crisis where the consensus suddenly shatters. That’s what has just occurred, and with good reason. In recent days, it has become plain as a pike staff that the lady’s not for turning.

In addition to the striking parallel images of Merkel and Thatcher as women who are heads of state fighting (almost too late) for fiscal responsibility, Warner’s column does a good job of pointing to the kind of market and policy movements we can expect in the next couple of weeks. Clearly many parties behaving responsibly have already laid out some contingency plans to mitigate the effects.

But I have a simple-minded question to ask, perhaps one that I should have asked two years ago: why are so many people so worried about contagion from sovereign default in the eurozone? Should they be worried?

Typically, interconnected financial markets have negative feedback loops that lead to the dampening of propagation; price changes as investors move money around in response to changes in relative risk are an example of such a negative feedback. But with so many policies designed to insulate, protect, bail out parties, policies that introduce asymmetries by insuring against losses, have these negative feedback loops been distorted and replaced or outweighed by positive feedback loops that amplify effects? That’s how I’ve been thinking about the bailouts and subsidies and loan guarantees in both the EU and the US — policies that distort the negative feedback effects that can be equilibrating and introduce asymmetries that create destructive positive feedback effects, whereas before any disequilibrating events or shocks could have been smaller and dampened by the normal negative feedback effects in markets. So I would normally say that the forces of self-organization exist to buffer and counter the forces of contagion, but the political rules in operation have stifled the forces of self-organization and exacerbated contagion.

One of those forces of self-organization and negative feedback is bankruptcy and default, both private and sovereign. I wonder if the EU will be able to activate the salutary re-equilibrating benefits of bankruptcy and default while simultaneously being able to either stem contagion or have the political fortitude to carry on through the pain and cost that is larger than it might have been otherwise.

2 thoughts on ““Death of a Currency”

  1. One should probably be careful for what one wishes for, but I think a breakup of the Euro would be good for France where I have my home.

    The political choice in France is between dirigist socialists in opposition or the socialist/dirigist Sarkozy in power. The reaction to the budgetary problems is to squeeze harder, control more, forbid more, collect taxes more efficiently, etc. Self-organisation is an alien concept to the French. It is only through ferocious international competition they could be forced to do what needs to be done.

    Sarkozy has in practice managed to abolish the 35 hour week, but in a very complicated way, with over-time rules, regulations etc. To just abolish it and move back to 40 hours was too simple apparently. It was moved down to 39 by Mitterand when he came to power “to create jobs”.

    The retirement age has been moved up to 62 (why not 67 or just abolish it??) for a full pension, provided you have worked for 42 years. What this means in practice, I haven’t bothered working out. I will probably work to 75 if I am allowed.

    You are not allowed to have two jobs in France. That is stealing a job from the unemployed.

    All jobs are in theory life-time ones. Which means that it is very difficult to get a job because it is so difficult to get rid of someone. When Jospin was prime minister, they doubled the extra cost of getting rid of people over 50 “to prevent them becoming unemployed”. Guess what happened to the employment prospects of people 48 years old and above?

    Sarkozy commented on Renault moving some production to some former eastern-block country that “we haven’t subsidised Renault for them to move”. Who paid these subsidies? Santa?

    A new book just came out regarding the TGV high speed trains and it is relevant to the euro discussion:


    “High-speed bankruptcy, 30 years of TGV”.

    The TGV was an idea from SNCF (state railroad) engineers and it answered a question about what to do with the nuclear energy and how to promote the “glory” of France.

    Unfortunately, there is still a €30 billion debt from the construction. This debt was “given” to a railtrack company. This had two benefits, the railroad operator only pays a small fee and appears profitable. Also, the debt would not be counted in the Maastricht debt criteria for the euro.

    I could go on about this for a very long time, but to a Swede, even to most social democratic governments we have had, France presents such an enormous smörgåsbord of easy pickings for savings that the state budget probably could be reduced by 25% percent in a couple of years, and further reductions would easily be possible over a longer time frame.

    So any “disloyal” “social dumping” from a competitive Germany, not bogged down by having to accommodate the French would be most welcome.

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