January 12, 2011

The euro, evolved. Europe's way out?

As we discussed in an earlier post, one of the possible solutions to the problems the single currency is causing to some eurozone members would be to split said currency into two different ones. The main purpose of this would be to better focus on the members' vastly different and diversified needs and demands. However this move would not be free of charge... 

Let's do a quick analysis of what this currency split would mean. 

First of all, who would be placed in this new euro? The purely exporter, strong eurozone countries or the mostly troubled, mainly importer, ones? Common sense makes you think that the troubled countries are the ones who should move away to the new currency, but these countries are in fact the ones which are comfortable with the actual euro exchange rates,  they simply have no reason to move. So instead let's face the opposite scenario for this new euro, for simplicity's sake I will call it 'euro2' from now on. Imagine the euro2 being the shiny new currency for Germany, France, Netherlands, Denmark... strict rules should be established to define which countries should be part of the euro2. This would guarantee the stability and homogeneity of the euro2, avoiding the errors committed by its old brother... 

The sweet spot
The critical point for the success of the euro2 would of course be finding the sweet spot in its exchange rate against  the USD (US Dollar), the GBP (Great Britain Pound), the JPY (Japan Yen) and last but not least the CNY (Chinese Yuan)... Fine-tuning and keeping an exchange rate that ensured the maintenance of current export levels for euro2 members would be an important but attainable challenge. Although it is not the object of this post to find numbers for said exchange rates, using the exchange rates the euro had in its origins would be a rough but valid approximation. The euro2 should then be worth close to 1.18USD, 0.71GBP, 134JPY and 9.71CNY respectively. This is not a random choice, not by far. The euro was an awesome, powerful and very well thought idea in the beginning, but it has lost its track lately, it has lost all the advantages and competitiveness that made it such a great idea.
The problem is, maintaining this exchange rates would be a hard task nowadays if everybody keeps trying to improve his commercial position by depreciating its own currency as it has happened in the last months... Depreciating non-stop is a foolish strategy in the long-term though, and nobody in his right mind would keep this strategy going forever so it should not be a perpetual problem.

Keep your friends close
Up until now everything seems fine for the euro2, but one cannot forget its roots and its friends, and neither should do the euro and its hypothetical offspring the euro2. The old euro should have to set an exchange rate against the euro2, and the best option for said exchange rate is obvious to be a currency peg, a fixed exchange rate. A currency peg would ensure the stability of intra-Europe (between countries in the euro and the euro2 zones) trades and investments and would not harm tourism neither. And here comes the squaring of the circle... how can one keep a fixed exchange rate with the euro2 but at the same time have different exchange rates than the euro2 against the rest of the currencies? Doing that would take all the freedom from the old eurozone's monetary policy away, aggravating its actual problems. 
So once the fixed exchange rate option has been discarded the solution left is keeping a close to 1:1 exchange rate between the euro and the euro2. This would leave the old euro some leeway to trade competitively with the rest of the world while maintaining its independence from the euro2 needs, which are quite different as we are seeing everyday... 

Anyway keeping this perfect-equilibrium state going always and no matter what would be as hard as walking on thin ice at night, making the coexistence of two different euros far from possible right now. But everything could change, and if the bad news for the eurozone continue this could be the only way out...

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