By Richard F. Clements    

November 30, 2011

The ECU was first adopted by the European Union in 1979. ECU, which stands for European Currency Unit, was the basket of currencies that is the predecessor to the Euro as we know it today. It was the predecessor, but does not represent the same currencies that the Euro currently represents, which right before launch was tied to the ERM – or European Exchange Rate Mechanism. This was the range in which currencies had to trade prior to moving to the Euro. While remembering the currencies of yesteryear – the French Franc, Deutsche Mark, or the Spanish peseta – does that memory include the moment that sparked an inordinate amount of wealth for George Soros? Who is Norman Lamont? What was black Wednesday?

Black Wednesday was 16 September, 1992, when Norman Lamont pulled the Pound Sterling from the ERM and let it devalue. At the time, England was in a recession and the only way to prop the currency would have been to continue to raise rates, which that day topped at 12% - a rate hike to stave off speculators in the markets - with a promise to raise the rates to 15% to lure Sterling buyers. However, Lamont’s bluff was called and at 7PM that evening, he announced the withdrawal of the Pound Sterling from the ERM. This decision made George Soros $1B. It is said that Soros sold Sterling all day driving the Pound out of the ERM.

Another thing that the Europeans did to work with this single currency is to issue European passports that allow the people of different countries the ability to travel freely throughout Europe, to work in different countries and best of all trade freely within the European Union. Of course when this happened there were standards that were put into place, including the requirement to pasteurize all cheeses that were made in the Union. Needless to say, the French would have none of that accompanied by the English – that’s right the British Stilton is unpasteurized, or should be! While the organizers of the European Union were focused on the physical health of the constituents, they have been less concerned about the economic health of the individual countries. Herein lie some of the major issues with the Euro as a currency.

To begin, the idea that the European Union ($12.2T GDP[1]) is as large as the US ($14.58T GDP[2]) has some very serious issues. While the Europeans enjoy a trading bloc as well as a workforce that can migrate from one country the reality is very different. To address the continued issue that Europe has as a trading bloc is that it synthetically strengthens the currency for countries that would not be able to support those levels if they were to have their own currencies. Most people here would argue that this is a benefit to the Euro – read the next paragraph for arguments therein. Secondly, the idea that Europe has a migrant workforce equivalent to that of the US is a myth. While the US does have regional differences, they pale in comparison with the regional differences in Europe. First off, the US shares a common language, common culture (or lack thereof according to some European, and of course the Amish are the exception that prove the rule) and the common currency pays for a national infrastructure. In Europe, there are many nuances that negate this benefits. While the Europeans can migrate from one country to another, there are still language and cultural barriers. The language barrier is less of a factor as many Europeans are multilingual, but there are still issues that make smooth migration easy. 

Now let’s talk unified fiscal policy. There is none. While there have been discussions in the last few days that there need to be standards (like the cheese?), this will be difficult to pull off. We have witnessed the Greeks rioting in the streets opposing the austerity measures. Many of the European countries have socialist entitlement programs that they just cannot afford. Economics 101 – if you spend more than you make you will go bankrupt (apologies to the dot.commers who thought there was a new paradigm in the late 90s early 2000s). Without fiscal unity, there is a very sharp double edged sword. On the one hand you have the stronger producing countries like Germany and France who have shown little interest in paying the debts of the weaker countries like Portugal, Italy, Ireland, Greece and Spain – otherwise known as the PIGS or in this case the PIIGS. Yet if they were to go back to their own currencies today, and they just might, their own currencies would be so strong as to harm exports and therefor GDP. The other side of the sword is that the countries that have a problem servicing their debt, and there may be one or two of these, they cannot deflate their way out as did many Latin American countries in the 1980s and early 1990s, as they do not control the currency or interest rates. 

So Europe is in a pickle.