euro

The only international coin with Ron Jeremy on it.

(UPDATED, June 9: Correction made, thanks to an observant reader. We confused Latvia with Lithuania in one instance.)

This week Latvia became the 18^th country to join the Eurozone. It’s easy to mistakenly equate “Europe”, or even “Western Europe”, with “nations that use the euro”, but there are some glaring omissions:

United Kingdom
Norway
Sweden
Denmark
Switzerland

Latvia becomes the 2^nd former Soviet republic to join up, following Estonia in 2011. By this time next year Latvia’s current currency, the lats, will go the way of the franc (French, that is. The Swiss is very much alive) and the Deutschmark.

The Eurozone isn’t come-one come-all, like the Universal Life Church is. There’s a membership committee, a list of benchmarks you have to meet, even something of an apprenticeship program. So in that respect the Eurozone is more like a college fraternity. Specifically, any aspiring member has to spend 2 years in the European Exchange Rate Mechanism.

The hell is that?

It’s a precursor to the euro, developed in the late ‘70s. The idea was that since the major countries of free Europe planned to eventually unify their currencies, those currencies should be allowed to trade only in narrow ranges before unification. The mechanism was supposed to be a compromise between formally tying one currency’s value to another (like the Bahamian dollar is pegged to the U.S. dollar), and running the risk of one currency being arbitrarily devalued with respect to another (like the Zimbabwean dollar and everything else in the world.) So the lira could only trade between, let’s say, 200 and 250 to the peseta. That’s a gross simplification – the bands were usually narrower than that, except for certain currencies, and those only at certain times – but we try not to overwhelm you with semi-relevant data here. Anyhow, the lats now trades within 1% of the euro, which will be irrelevant a year from now when the lats goes defunct.

For what it’s worth – $1.89 right now – the lats is the 4^th most valuable currency on the planet. And Latvian inflation is minimal, around 1.3%. Which makes sense, given the mechanism. Which brings up a question:

Why would Latvia join a club that would have Greece as a member?

The short answer is “politics”. See the line above about Estonia being the only former Soviet republic that uses the euro officially. Of the 6 unambiguously European former Soviet republics excluding Russia (the other 4 are Lithuania, Belarus, Ukraine and Moldova), each has had to make a momentous decision: embrace the West and all the resultant benefits from doing so, or set the clock back a few decades and re-hitch the wagon to Russia?

Belarus chose the latter, the others the former to varying degrees. By adopting the euro, it makes it extremely difficult for Latvia to fall under Moscow’s influence yet again. Short of an invasion, anyway, and if you think that sounds drastic tell it to the old Latvians who vividly remember the Soviet tanks rolling into Riga in 1940.

Is the euro shaky? Less so than a year ago. The bailouts have stopped, largely because the pool of rich nations to “borrow” from is finite. But more importantly, Latvia doesn’t exist in a vacuum. There are only certain options for its short-term economic future at its disposal, and maintaining the lats isn’t one of them. Joining the Eurozone is the least bad choice at Latvia’s disposal, and it might even turn out to be a good one. Besides, the nation can’t exactly backpedal after consenting to the exchange-rate mechanism in the first place. Extricating would be impossible, and probably not in Latvia’s best interests anyway.

Is this just a piece of international finance and geopolitical esoterica, or does it mean anything to your life? Well, first of all it doesn’t hurt to know a little more about how exchange rates work and how the euro gradually envelops the currencies of Europe into its cocoon of horror (awkward simile ©Peter McNeeley, 1996.) Second, damn straight there’s a microeconomic lesson here. If you need to put food on the table, you take the steady job (Eurozone membership) over the risk of unemployment (a currency of limited utility, and besides euros are accepted throughout Latvia anyway and have been since their inception.)

Criteria for membership in the eurozone are not trivial nor easily achieved. Latvia’s economy is humming, at least relative to its former Soviet counterparts. Its gross domestic product per capita is 50^th in the world, and there are 200-odd countries across the globe. Once you start the conversion to the euro, it’s hard to go back, which is why the United Kingdom (wisely) never started. Accepting Eurozone membership now, effective in 2014, also puts Latvia ahead of the next countries scheduled to join: its neighbor and rival Lithuania, and Old Europe mainstay Denmark. The imprimatur of the euro distinguishes Latvia as a promising economic force. Also, symbiotically, it strengthens the euro’s status as a currency of importance. The more members the Eurozone has, the greater the likelihood of the euro supplanting the U.S. dollar as the international reserve currency of choice.

Not that kind of euro. Alright, as long as we're making jokes, and this is probably the 3rd image we've run of a guy with a purse, what is the purpose behind this? What does a man ever need to carry beyond keys (one pocket), a wallet (another pocket), and a phone (third pocket)? With a standard 4-pocket pair of pants, that leaves one pocket free for lollipops to give to itinerant children.

Unless we’re stuck in a foreign airport, the vast majority of us don’t exchange currencies. But good Lord, do we hear about it. Will (European country) drop the euro? Will its value fall through the floor? Is the recent talk about the euro’s troubles just an indirect ploy to get us to buy gold? How does this affect the U.S. economy?

Nobody knows anything. Nor does anyone remember anything.

Financial journalists have to report every 1¢ swing in the value of the euro as of great significance. Each movement the markets make in a given day – even a given hour – is reported upon ad nauseam. Why? Honestly, the biggest reason is that there’s a 24-hour news cycle to fill. It’s human nature to overemphasize the importance of how we each choose to spend our time. If you don’t believe that, find a teacher and listen to her yammer about how important her job is. The same applies to everyone whose job it is to provide you with financial information. Something utterly unimportant – the euro losing a tiny bit of its value vis-a-vis the dollar – can inspire a 6-person roundtable discussion on CNBC.

That being said, some wags are already calling for the euro’s funeral dirge. Here’s why, kind of:

The euro entered the world on the first day of 1999, trading at $1.174. A year later, it fell to the point where it equaled the dollar for the first time. That fall the euro sank to its nadir, around 84¢. It again outvalued the dollar in July of 2002, briefly (and barely) dipped below again, and has been worth at least a dollar since that November. In July of 2008 it reached its zenith, trading at $1.58. Now it sits at around $1.32, and that alone gives many cause to question the euro’s future.

The euro is the national currency of France, Germany, Italy, Spain, Greece, Andorra, Montenegro, Kosovo, Vatican City, San Marino, Monaco, Slovenia, Slovakia, Portugal, the Netherlands, Belgium, Ireland, Luxembourg, Malta, Finland, Estonia, Cyprus and Austria.

Notice any European country missing?

Yes, Switzerland too. We were thinking of a nation slightly larger. Come on, you can do this. Bad food, no fluoride, used to have an Empire that the sun never set on?

Correct, the United Kingdom.

In 1990, back when the euro was not even a foul thought in its father’s head (a line stolen from Phil Hendrie for just such an occasion), Prime Minister Margaret Thatcher was steadfast in her opposition to eventually dropping the pound sterling in favor of a transnational currency. Steadfast, and outnumbered. Her objections had nothing to do with convenience, national pride or exchangeability. They were much more pragmatic.

Thatcher argued, in print no less, that a modern and robust economy – we’ll call it Country A – and a basket case like Country B can’t share a currency. For one thing, a transnational currency would lower (and has lowered) interest rates. The weaker the replaced national currency, the greater the decrease in the interest rate. Which makes sense – a transnational replacement currency is necessarily weaker than the strong currencies it replaced and stronger than the weak ones it replaced. The interest rate is the price of money. The cheaper money is – i.e., the less it costs to borrow – the lower the interest rate. The countries that had weak currencies going in, such as Portugal and Italy, now found it easier to borrow money. And borrow they did.

Greece, too. Thatcher even mentioned Greece by name. It’s “Country B” above. Country A is Germany, Europe’s most powerful.

There are legitimate advantages to a weak currency; one weak when compared to others, that is (as contrasted with one weak when compared to itself historically.) For one thing, it makes exports cheaper. The U.S. dollar has lost around 10% of its value relative to the New Zealand dollar over the past year. American exporters who would never have been competitive enough to sell to Kiwis before have a brand new market/clientele. To a New Zealander, American goods are now that much cheaper. When a small country has the weak currency and larger countries have the comparatively strong ones, the effect on the small country’s potential for exports (and hence growth) is even greater. But the American dollar and the New Zealand dollar are necessarily different and unequal. It’s when two countries’ currencies should differ, but are prevented from doing so, that problems exacerbate.

Trouble arises when a small country (Greece) can now borrow more money than it did under its old currency, while sharing the new currency with stronger economies. When the euro become reality, it artificially made Greece’s currency more robust while doing the opposite to Germany’s. Greece could borrow more than before. And did. Boy, did it ever. Overextended itself, couldn’t pay its bills. So Germany, by virtue of being the local heavyweight, has to lend billions to Greece. If it doesn’t, Greece has incentive to quit the euro. A less-circulated euro means other weak countries would want to follow suit.

This is what the pound sterling has done with respect to the euro since the latter’s inception. The higher the graph, the stronger the pound. The Brits might be buying goods cheaply from the continent while having to sell them elsewhere, but at least they’re not worrying about their currency imploding.

One more thing. To use the euro, a country needs to qualify. (Several other countries are in line to adopt it as their currency: Latvia, Lithuania, and Denmark, among others.) Qualification means keeping inflation and long-term interest rates under particular thresholds, and the same for debt and deficit (relative to gross domestic product.)

Guess what? When all a government has to do to get access to cheap money is provide certain numbers to the European Central Bank, that government wants those numbers to look as good as possible. Honesty is at best a secondary goal here. The Greeks lied through their ouzo-scented teeth. The Portuguese, Italians and Spaniards weren’t all that forthright either. But now, it’s too late for the ECB to say, “No, you have to go back to your original currency.” Don’t think for a moment that something similar couldn’t happen in the United States, with a Department of the Treasury telling enough lies to keep the cheap money flowing. There’s no transnational currency for the U.S. to back out of, but there’s plenty of economic havoc to wreak.

It’s hard to appreciate how an artifice can create such damage, but it can. In a healthy system, currencies can trade against each other in the open market, correcting imbalances and reinforcing the economic soundness of each currency’s issuing government. When drachma and marken are operating as de jure equals, Greece eats itself into a coma. Which Germany then has to arouse.

“Adapt or die” is a truism throughout life. It’s hard to adapt when you’re forcefully prevented from doing so.

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