The External Value of the Euro

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Jeremy Siegel points out in this FT article that a weakening in the external value of the euro can be important the recovery of the euro area;  Paul Krugman raises the objection that “… Europe as a whole, like America, remains a relatively closed economy. Its salvation must be mainly internal.”

Of course, trade with the rest of the world is a limited channel for the collective euro area.  However, it is important to appreciate that trade with the “rest of the world” is especially important for the peripheral countries, so that a substantial euro depreciation can be a contributory factor to the recovery process.  There is an interesting IMF paper that quantifies the role of external trade for the periphery countries – I will post a link once that paper goes online.

(The heterogeneous exposure of the periphery versus the core in relation to the external value of the euro was also much studied in relation to the very large euro depreciation against the dollar during 1999-2001. For instance, see this paper that I wrote with Patrick Honohan.)

20 Responses to “The External Value of the Euro”

  1. Bond. Eoin Bond... Says:

    I believe a 10% fall in the trade weighted value of the EUR = additional GDP growth of +0.8%, and significantly more for an open export economy like Ireland

  2. BrianH Says:

    Bond: Agree but I think we would need more than a 10% devaluation – 25% is what Siegel advocates. A 25% devaluation vs the US$ would have a very significant impact here.

    A euro devaluation would be very good for Ireland but I can’t see the Germans agreeing to it. But then again, I don’t see the Germans agreeing to anything else but the current course.

  3. DOCM Says:

    The markets seem to be pushing for this solution one way or the other.

    Professor Siegel also identifies the possible alternative;

    “That is why if Greece exits the euro and converts euro deposits into its own currency, it would be necessary for the ECB to quickly guarantee all deposits in all eurozone banks, a policy similar to the one that the Federal Reserve followed after the Lehman bankruptcy in 2008″.

    Could the ECB do this? The answer is almost certainly no. It would be a matter for EA governments. This comment, therefore, suggests that the professor has a weak grasp of EU institutional structures. This is not unusual.

  4. seafóid Says:

    The effectiveness of a devaluation depends on what the Yanks, les Rosbifs and the Japanese do afterwards. So far the Yanks are 2 QEs ahead. Les Rosbifs had a chunky devaluation a while ago but it doesn’t seem to have helped much other than bring inflation.

    Sarazin the former senior German minister has a new book out in which he argues that Germany doesn’t need the Euro.

  5. BeeCeeTee Says:

    Krugman heads his article “Let’s All Devalue Against Each Other”. What he seems to mean is let’s not spoil the devaluation strategies of the US and UK by having the folks in the eurozone follow suit.

  6. The Dork of Cork Says:

    But devaluation against whom ?

    The $ ?

    This is a classic reserve currency problem… for Europeans , the $ is not our currency but always our problem.
    Oil is priced in $s the last time I checked.
    North Sea Production is crashing
    Countries such as China($ pegged) Saudi Arabia , Iran , (at least until recently ?) etc etc are increasing internal consumption which means less BTUs to go around.
    Irish oil imports as a % of total imports is rising even now under this crash scenario to 10 % + of total imports.
    If we had a national currency we could have at least enough tokens in our pocket to engage in Good substitution such as the UK is doing quite effectivally.
    But if the Euro goes to 1 or .85 or whatever our oil import priced in Euros will go up but with a declining number of chips in our pocket which would be even more catastrophically deflationary then it is now.

    I used to think the Euro would survive by bidding up the price of Gold via base euros printing that would cover inter sovergin liabilties & tensions but now I am not so sure.
    The US Treasuary is running this continent me thinks – through the Goldman conduit.

  7. seafóid Says:

    @ Dork

    I read in the New York Review that energy costs account for 8% of US GDP. Any idea what the number would be for Ireland ?

  8. David O'Donnell Says:

    Sterling devalue!

    Christine Lagarde: Time is running out for Osborne’s Plan A
    Chancellor is urged to act to restore UK growth

    George Osborne must adopt an economic “Plan B” and slow the pace of public spending cuts if the British economy remains weak, the International Monetary Fund warned the Chancellor yesterday. The managing director of the IMF, Christine Lagarde, came to the Treasury to deliver the sobering news: that the Government should consider slowing spending cuts if recovery stalls.

    She also called on the Bank of England to do more to support the economy – presently in the grip of a double-dip recession – by printing more money.

    http://www.independent.co.uk/news/world/europe/christine-lagarde-time-is-running-out-for-osbornes-plan-a-7778893.html

  9. David O'Donnell Says:

    @seafoid

    Sarrazin Strikes Again
    German Author Says Berlin Is Hostage to Holocaust in Euro Crisis

    Germany is Europe’s paymaster because it committed the Holocaust, claims a new book by Thilo Sarrazin, a firebrand author and former board member of the German central bank. The claim by the controversial writer achieved the desired effect of stoking publicity for Tuesday’s launch of ‘Europe Doesn’t Need the Euro.’

    Thilo Sarrazin, the former board member of Germany’s central bank who caused outrage two years ago with a bestseller criticizing the impact of Muslim immigrants on German society, presented a new book on Tuesday that could strike a similar chord with Germans: “Europe Doesn’t Need the Euro.”

    http://www.spiegel.de/international/europe/controversial-german-author-thilo-sarrazin-launches-book-on-euro-crisis-a-834459.html

    Linked in the spirit of cosmopolitanism in political discourse !! This guy makes Sinn look like a pussycat …

  10. The Dork of Cork Says:

    @Seafoid
    I not sure , must look at that – but I don’t really look at GDP much these days as I think its a flawed metric.
    I was just looking at energy imports as a percentage of total imports recently and they were 14% ~ of the total in 2011.
    Oil was 10.7% of total imports in Y2011.
    Its much more important then other imports as it has a tendencey to squezze out final consumption.
    These past few years it has overtaken food imports which sheds much more light on the real “domestic” situation.

    I will post these figures again as I think they shed much light on the Irish situation.
    If you look at the department of finance Sep 2011 economic stats document you can find some interesting data from my point of view at least in Table 34

    http://www.finance.gov.ie/documents/guidelines/bessept2011.pdf

    This is imports classified by category of use which includes a oil sub section.
    You can clearly see the 1980s oil glut which reached a through for us in 1988.

    Y1984 : 1240.7 miliion or 11% of total imports
    Y1988 : 493.1 million or 3.8% of total imports
    Y1998 : 736.3 million or 1.9 % of total imports
    Y2008 : 4,913 million or 8.5 % of total imports
    Y2009 : 3,299 million or 7.3% of total imports
    Y2010 : 4,269 million or 9.3% of total imports

    So we are about to spend money on straightening the N86 to Dingle rather then sticking tracks down cheaply on old lines near major population centres such as beyond Brides Glen to Shankill !!!!

    Give me strength.

    http://www.youtube.com/watch?v=jv4lkswxpZM

  11. PR Guy Says:

    Why do anything? The € is heading back to parity with the $ before long at the rate things are going. We’ve been there or thereabouts before and we’ll be there again. Tha’t’s why the Americans still keep calling it the “Eurodollar”

  12. The Dork of Cork Says:

    @David
    What does “devalue” really mean in a free floating currency world ?
    Via QE Sterling is strengthening because its changing the ratio of money to credit withen its economy.
    This is reducing credit waste dramatically but the total money /credit supply is not falling like in Ireland.
    Its drop in oil consumption is almost keeping pace with its drop in oil production without bringing the economy to crashing halt as in Ireland.

    It however needs some more fiscal money production / printing from HM Treasuary if this printing is directed to the correct projects.

    http://www.rail.co/2012/…/17/tram-trains-pilot-given-go-ahead-in-south-y

  13. Colm Brazel Says:

    The ‘stability’ of the euro has a significant downside for an open economy needing flexibility and agility in responding to external volatile currency changes. The authors describe how Ireland because of its open economy is more exposed than other members of the EMU to possible deleterious effects of currency movements outside the euro.

    Much more work should be done in this area. Property bubble had a significant effect on inflation in this country driving up prices/wages. Economists failed to give alarm. Its a pity more work examining inflation in Ireland comparing its origin and effects to other EMUs was not done in bubble years.

    Let’s call this significant exposure of Ireland to volatile currency exchanges IEhi and its deleterious effect on our economy’s ability to respond adequately to such changes as IEhi. I’m guessing (IEhi
    + (IEhi) = IE sunk :-)

    I look forward to reading the IMF paper flagged above. But re relatively speaking ‘ substantial euro depreciation can be a contributory factor to the recovery process ‘I go along with the late James Tobin joke re all currencies needing to devalue against each other as a call to race to the bottom. Plus a lifeboat is more agile than a juggernaut.

    What this country needs is a lifeboat, the euro juggernaut is going down, the authors confirm for me, though I’m sure the authors disagree with this view, that Ireland has been hindered by the euro tying us to an exchange rate, that was not, as well as is not, to our benefit.

  14. Colm Brazel Says:

    Should be

    IEhi + IEhi = IEsunk

  15. Colm Brazel Says:

    oops, didn’t work, this blog doesn’t display subscript/superscript tags

  16. Paul W Says:

    @ BEB Again in more normal times, it should help exports (ex EU….Germany mainly). However, one needs stability over time to realise those gains. However, in these abnormal times, normal theory suffers “abberations”….The current high instability and volatility has the potential to undo any benefit and exacerbate matters via higher market spreads (credit, hedging, etc) and lower resultant interest-rate related asset values, higher oil & energy and resultant lower consumer domestic spending power, lower equities’ values, less confidence, etc, etc.

    Have you any specific rationale for the + 0.8% GDP metric you mention above (correlated to interest rates?), or is that just off the top of your head?

  17. Bond. Eoin Bond... Says:

    @ Paul W

    Roubini noted it this week i think, on the “positives” from the current Euro instability. Its a bit of an “all else being equal” equation, which is not necessarily going to be the case, but its the baseline add-on to GDP.

  18. Paul W Says:

    @ BEB

    http://www.slate.com/articles/news_and_politics/politics/2012/05/greece_will_leave_the_eurozone_sooner_or_later_sooner_is_better_.html

    Roubini “The first option, a sharp weakening of the euro, is unlikely, as Germany is strong and the ECB is not aggressively easing monetary policy. A rapid reduction in unit labor costs, through structural reforms that increased productivity growth in excess of wages, is just as unlikely.”

    http://www.cnbc.com/id/47357542/Counterpoint_Roubini_Forecast_Missing_Something

    http://www.roubini.com/region/country/ireland.php

    Must have been someone else…..!

    Maybe one of those Ibec economists?

    http://www.roubini.com/region/country/ireland.php

    Granted however, there are those on the frontline who know best:

    http://www.irishexporters.ie/section/FallingEuroSettoBoostExportsandGrowthstateIrishExportersAssociation

    Note however….costs of hedging…..There is a price for volatility and forward FX stability (and it will not be a cost forthe banks!).

    Hopefully though, a lower euro will help.

  19. Paul W Says:

    Sorry, one of the Ibec related articles:

    http://www.irishexaminer.com/business/ibec-upbeat-as-it-raises—growth-forecast–to-1-193171.html

  20. Mickey Hickey Says:

    Latest German PMI down to 45 and French PMI down to 44.4, lowest in 3 years. This is now getting serious.

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