Wednesday, March 3, 2010

The Euro Is Preventing Inflation

Stefan Collignon in the Social Europe Journal writes that conservatives do not understand the euro. He takes my favorite mainstream economist, Martin Feldstein, to task on this point.

Colligon has something here. I would also add that in addition to "conservatives,' traders are misunderstanding the euro.

As long as the ECB does not print more euros to bailout Greece and any of the other PIIGS, the PIIGS crisis should have no impact on the euro. In fact, a Greek bankruptcy would be the best thing for the euro. It would show that the European monetary union is less subject to political pressures than individual sovereign states, for most assuredly the PIIGS, if they still managed their own moneys right now, would certainly be printing away right now.

The weakest link in the union comes from the possibility that one or more of the PIIGS screams, "Enough!" and breaks from the union to re-establish an independent currency. This link is holding so far. If this link breaks, there may be a kneejerk drop in the euro, but in actuality, PIIGS breaking from the union means the union has refused to inflate, even at the cost of losing members.

The long term perspective would thus be that the euro has survived an important test and has not succumbed to pressures to print.

All this said, the euro is now weak partly as a result of traders not comprehending the above, and partly the result of dollar strength as a result of the Fed not printing any money. At some point though, given the enormous debt the U.S. has to raise, the euro should resume its previous upturn. All this is another way of saying that the euro should be bought long-term on any panic sell offs caused by the PIIGS crisis, as long as the ECB continues to resist the pressure to print euros.

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