Currency ideals

The slow motion train wreck that is the Euro is grinding relentlessly on. Commentators are smugly, if not gleefully, announcing the currency’s imminent demise, enjoying their triumphant occupancy of the moral high ground. The European elites are just as determinedly asserting that the currency will survive, looking for some sand to stick their heads in. The financial markets are looking to exploit the situation to best advantage, gloriously mixing self righteousness with hyper venality. It is quite a soap opera, a sort of financial Groundhog Day.

The noise is obscuring the real questions. The most obvious of these is: “What will the currency markets look like when the situation is resolved?”

It is worth recalling why the Euro was created. It was established to establish a bulwark against the financial markets, which were wreaking havoc with Europe’s Exchange Rate Mechanism. Sovereign governments in Europe were trying to protect themselves against financial markets, specifically hedge funds and the likes of George Soros, in order to protect their control of money. There were also ancillary ambitions to have a reserve currency like the greenback, but that was always on the margin, for reasons I will explain later. It might be added that the greatest absurdity of the current situation is Soros pontificating about European policy and fretting about the power of the financial markets. A tour de force in hypocrisy to accompany his many achievements in making money, I suppose. A bit like an assassin complaining about rising crime rates.

In terms of structure, there seem to be three possibilities. First scenario is that the Euro survives and the world moves into a three part currency world: the American dollar, China’s yuan and the Euro, with the yen, Swiss franc and Australian dollar on the sidelines. This would have an effect on the power of the greenback as the world’s reserve currency because there would be significant euro-yuan trade, partially sidelining the $US for the first time since the 1950s. (That is why the Euro is not a reserve currency, by the way, because 80% of its trades have the $USD on the other side). It would create three currency regions: Europe, Asia and America. A bit reminiscent of the three super states in 1984 it will just have arrived about 40 years late.

Second scenario is that the Euro breaks up, with the world being dominated by the greenback and the yuan. This would leave the $USD with its hegemony, allowing America a degree of financial freedom on its economic policy that no other country enjoys.

Third scenario is that the Euro collapses and the world starts to revert to a more nationalist currency regime, as it had twenty years ago. Once again, this would leave the $USD supreme.

For what it’s worth, I consider the first scenario the most likely, the second fairly likely, and the third unlikely.

In terms of their sound function as money, the question is which system creates the most redundancy, that is, extra capacity to absorb shocks when things go wrong? This is crucial in a system that only relates to itself. I suspect scenario one is probably the most stable, although scenario three may also have capacity to absorb shocks. Scenario two, which would be  similar to the current Euro-$USD axis, is unstable, as we are seeing. In a self referring system dyadic structures (i.e, binary) tend to magnify problems, because they keep bouncing off each other, they have nowhere to go to release the pressure.

In terms of their character, the currency markets are likely to become increasingly post-modern. They have no objective standard; it is an exercise in total relativism. That is why gold bugs look so longingly at the yellow metal, they are pining for an absolute. Thus, when it is said that a currency weakens, it only weakens in relation to other currencies. There is no absolute measure of value. This does not seem to be well absorbed by financial market commentators and politicians. For instance, at the moment, much is being made by traders about the Euro falling to about, 1.1 against the $US, as if that is some harbinger of doom. Yet the Euro has been a lot lower against the greenback, at the moment it is in the mid range:

What one notices when looking at this graph is the volatility. These major currencies have swung in a 100% range since the establishment in 1999. Such extremes can hardly be explained by differentials between their respective economies, or trade, current and capital account flows. They are a measure of sentiment amongst traders. In a world where there is no absolute, perception rules. It is a kind a idealism  in which the idea comes first before reality:

idealism is the group of philosophies which assert that reality, or reality as we can know it, is fundamentally mental, mentally constructed, or otherwise immaterial.”

Such idealism pretends to be realistic, based on objective truth, however. The currency markets are nothing if not riddled with contradictions. What it means in practice, was nicely described by an anthropologist friend of mine commenting on my piece last week about Peirce and pragmaticism:

“So to understand pragmatism is to apply Peirce’s “pragmatic maxim” or rule. That rule was based on identifying the meaning of the behaviour in question (in our case, the transaction). And where the person was acting on the basis of his or her understanding or intent, it was necessary to identify the signs they were basing their understanding.

In this way, Peirce’s pragmaticism was an explanation, or theory, of meaning in action. Which is to point out that Peirce’s was not a theory of truth but a theory of meaning. (Some later philosophers have recognised this material difference, and adhered to it. But not all. And some scholars have criticised Peirce’s philosophy for the way it deals with truth, which is wrong to do.)”

The currency markets are not concerned with truth, they are concerned with meaning. What is yet to emerge is how that meaning will play out in terms of the market structure. What we do know is that it will be extremely volatile, and fast moving. Crises are becoming the norm, which is to say they are no longer crises. That means countries can recover as quickly as they can get into trouble.

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Comments

  1. The point about the volatility in exchange rates not appearing to be based on real changes in differentials between economies is a good one.

    A bit like the behaviour of the Australian dollar only partly due to the mining boom.

    But what then is providing the grease for the volatility?

    Real economy transactions are too rooted in the reality of things and stuff.

    What allows the traders mood rings to dominate?

    Could it be the vast buckets of debt private and public floating around.

    Perhaps what is really post modern is the role of debt right across the board.

    Financial high fructose corn syrup added to everything.

  2. Until such time where english speaking people get a view of the euro from people who actually use it for something else than speculation, will people here understand the real rationale behind the currency existence and importance (and let’s not even start talking about the european union itself)…

    Needless to say, the only reason the euro will survive is because everyone knows that outside the monetary world, it has become so practical for inter-state trade that reverting back to national currencies would be a nightmare – that and of course the mentioned risks around sovereign currency speculation. The stability the euro brought between the european country is critical for inter country trade, just as is the improved leverage for extra european trades… to your point about relativism…

    • Few, english speaking or otherwise, doubt that a common currency is useful and practical and that there is a genuine desire in Europe to keep the Euro.

      What is remarkable is the apparent reluctance of Europeans to accept that for a common currency to work they must surrender a lot of control over their national affairs to the centre.

      Slowly step by step, under great pressure and stress this appears to be happening, but who determines the policies of the centre and how. Presumably at some point the people of Europe will confirm that the centre was right to assume their consent.

      • The savings and convenience associated with intra-trade activity – no more volatility, no more banking costs, etc. are far from being insignificant when the large majority of exchanges is between european countries (to make a point, while working on projects to shift processes and systems in several large organisations, none of those ever complained about it – or the cost – rather were excited about the benefits, something I did find quite surprising at the time).

        That the euro would work better with a consistent fiscal environment is not debated (there was a great deal of resentment against Ireland for setting very low corporate taxes after being effectively bailed out by Europe for 5 years before that); but it was always an understood risk.

        Pooling fiscal policies was something considered at the time of the discussions around the euro, but everyone knows it would significantly shift political power for which the structures are not ready (the minute you collect taxes or set interest rates, you effectively get power since you control income) and setting that political environment right is something that will take decades, mostly because – and the US are certainly NOT comparable here – Europe is a collection of countries that are speaking different langages and have significantly different cultures / history. Political union will take time, a long time.

        The alternative is to do nothing…

    • i would have agreed with you about 20 years ago. when hard physical currency was being traded.

      but is it really inconvenient today when you go overseas and the bank does all the conversions for you??? i don’t think so. i don’t even bother with hard currency these days when travelling.

      it took a massive civil war to unite the US. just keep that in mind.

  3. “Germany’s price for accepting common debt issuance is a euro-zone-wide agreement to transfer control of budgets to the European Commission. Mr. Schäuble repeated a call to establish a fiscal-policy commissioner, or budget czar, in Brussels with broad power over countries’ finances.

    Under the German proposal, the new commissioner could strike down national budgets if they weren’t in line with monetary-union rules and sanction profligate member states with fines and other measures. Until such controls are agreed, European states cannot be made liable for each other’s debts, Mr. Schäuble said.”
    http://online.wsj.com/article/SB10001424052702304830704577494693764255190.html

    I would say that fundamentally, nothing has been changed nor will it be. Europe’s leaders continue to display a monumental inability to come to terms with the fact that governments do not really control the budget outcome and seeking new ways to forcibly implement austerity will not alter that fact. The whole charade will continue stumbling down the same ruinous path until some kind of insurrection finally occurs.

  4. An opinion: ” Out of 440 B from EFSF, 192 B was used to rescue Ireland, Greece and Portugal. 125B is assigned to Spain. Cyrus is seeking 12.5B bailout. The total liabilities on Spain and Italy’s balance sheet is 2.4 trillion. After Spain and Cyprus bailout EFSF will have less then 100 B. This market will tank again, once more detail will come out about this new proposal.”
    http://seekingalpha.com/instablog/1087975-freefdawatchlist/798241-where-is-the-money-in-efsf-to-support-bank-bailout

  5. Perhaps you are all correct! There is another option and it operates in many countries usually with the ‘greenback’ as the unit of international exchange including tourism, and a domestic unit that can (and does) rise and fall independantly.

    So perhaps the Euro has a future in a similar role.

  6. interesting calls, do you see a future without the USD as reserve? With all the rampant printing going on over there atm its hard to see how countries aren’t going to start settling in another more ‘hard’ currency.