Euro in Peril #1

The debate over the continued existence of the Euro has moved from a whacky fringe view to one, while still more unlikely than not, needs serious consideration.

What is clear is that Greece is struggling through the inability to devalue their currency and complication with defaulting while remaining part of the Euro. The Germans are very unhappy with the ECB’s bond-buying to keep Spanish and Italian bond yields down so as not to create a self-fulfilling solvency problem out of a liquidity problem.

Now, the top German official at the ECB, Juergen Stark, has resigned in protest at the ECB’s purchase of government bonds. In fairness, he is being replaced by a more pragmatic German, but the focus on the ECB’s mandate will not relent. Officially, the ECB’s objective is to manage inflation. I think the target is “a little below 2%”.

In fairness, one of the “further tasks” mentioned is financial stability, which one could argue is what the government bond purchases are doing. One might also argue, although I don’t think the ECB has done so yet, that by purchasing government bonds, increasing the money supply and lowering long-term borrowing costs, they are fighting deflation, which is within the “a little below 2%” objective. Since the ECB was talking about overly high inflation in recent years (what a mistake) it is a stretch for them to now argue that deflation is the answer.

It’s also clear that the European fiscal response has been overwhelmingly one of austerity – hardly the response to concerns about deflation, let alone unemployment and a stagnant economy.

It’s an aside to the main point of this post, but the ECB has struggled to keep to its inflation target for many years. This is largely due to their use of an inflation definition that it subject to too much volatility from exogenous shocks that cannot and should not be controlled through monetary policy.

The most current nail being carried towards the Euro’s coffin is UK Foreign Secretrary, William Hague, asking for Britain to have looser ties with Europe. There has been noise for Prime Minister David Cameron to hold an “in out” referendum on the European Union altogether.

It’s early days, but the anti-Euro noises are getting louder not softer.

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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