Pros and cons of defending a currency?

Discussion in 'Economics' started by jedwards, May 8, 2010.

  1. I just read that the EU will start defending the euro starting May 10.

    I'm wondering why they took so long to decide this? Also, what are the pros and cons of defending a currency they way they will defend the euro? If they start buying euros on the open market, what are the repercussions of this? Obviously this will create a short squeeze, but beyond that, what will it do?

    I'm trying to figure out what this all means, but just simple googling doesn't reveal any results on what the potential side effects of currency intervention is. If there weren't any side effects, countries would be doing this all the time.
  2. morganist

    morganist Guest

    the main factor is the value against other currencies. if they maintain value it could prevent investment (business investment not capital, saving etc) and also exports stopping the recovery. also they cannot inflate the currency to make loan repayments cheaper. if they go the other way it undermines the euro as a single european currency because the return on saving investments from other countries is diminished through the devaluation from inflation.

    in short to get out of the situation they are in, the euro cannot be maintained. if it could the only way would be to rearrange debt obligations to stop immediate default (inflating the currency to get out of debt is no longer necessary), then increase domestic demand to diminish the need of foreign demand and investment (business investment i.e if it is cheaper to buy the currency it makes the cost lower, better to invest in that area). as the interest rate is already low and fiscal policy cannot be loosened it makes this option almost impossible.

    if it is somehow possible it enables the currency to stay strong and does not require demand from elsewhere which is created through weak currency, reducing the cost of goods. as a result allowing the benefit of investment (savings) as a reserve currency through maintaining its value and at the same time sufficient demand to sustain gdp.

    like i said if it is possible. i have a few ideas.
  3. Thanks for the response! Very interesting points. From my understanding as well, if Greece had their own currency, they would be able to depreciate it, so that their exports became cheaper and their imports would get more expensive so that people would buy local things, thus supporting the economy. Because they have no control over their currency, they are screwed, and the collective union has to save them. However, there is no political will, at least from the perspective of the citizens.

    I guess in a more broad question, why don't countries always intervene in the currency markets, especially if they don't want their currencies to drop? What limits them from always intervening to maintain a certain ratio? Is the only problem with defending their currency that they will use up their foreign reserves, or are there other repercussions or consequences of this?
  4. morganist

    morganist Guest

    they do intervene. inflation targeting is intervention. when they alter the interest rate to control aggregate demand.

    in your other point. the eu is unlikely going to be able to help greece. they can lend them money to cover the interest on loans but they expect greece to repay that money, meaning spending less. this however reduces demand and as a result output, the economy will no longer produce the current income and repayment will be impossible. the only solution again is find another form of demand to compensate for the loss of demand from the fiscal reduction.

  5. What are they going to buy euros with? More euros? I suppose they could start dumping their US Treasuries and buy a bunch of Euros in dollars. But if thats what they plan, then china and other countries might start dumping their dollars too and thats it for the US. If thats it for us, it wont be long before the rest of the world follows.
  6. Can anyone answer how any central bank can force inflation? The Fed is printing and we still have deflation because currency isn't circulating. All I hear in response is well it takes time for the printing to catch up. That's very vague and doesn't explain how you reverse deflation.
  7. morganist

    morganist Guest

    it can take a while for the market to realise the alteration in currency and price. the price doesn't react to demand immediately. think about it companies react to the demand for their products and rising costs. these things take a while to adjust. it is called built in inflation.

    secondly the central banks can directly purchase goods of companies to push up demand. therefore the money is in circulation. the reaction is also linked to when the other aspects of the economy fall in line. for example the market is underpriced (theoretically) if the market recovers the price will rise, as the monetary base was increased there is the potential that the ability to compete with the natural demand could push prices up further. ok you are right there is no guarantee but it is likely.

    the other aspect is this. as the currency becomes weaker due to the availability from a larger monetary base. it becomes cheaper to buy internationally and therefore other countries will be competing for your goods. if you wish to buy the goods yourself you will now have to pay more due to the extra demand, as you have a larger monetary base to enable that extra demand it is now possible to do so.

    another example is the employee strikes. staff often demand more money. as this is obtainable it is easier for this demand to be met as the monetary base is larger. there is more money that can be used in the economy.

    in short you are right the larger monetary base does not create inflation in itself you need another pressure. however that is likely to come naturally in time. for example, international demand, employee strikes, war, paying off loans (germany 1920) and the list goes on. these things create a need for greater spending, the monetary base just enables that. the larger the monetary base the deeper the pockets.

    has that helped.
  8. morganist

    morganist Guest

    they don't want to inflate because that means the euro will lose investment (saving) value. this is detrimental to the currency because it means the imports cost more if the currency is devalued. in addition inflating the currency makes it difficult to manage the member states. for example if you inflate the currency overall and give one country the proceeds it means you transfer wealth and in this case it is like rewarding faliure. if you devalue the purchasing power of the euro by diluting it and then give the extra money to one country that country effectively becomes the spoilt brat of the union.
  9. They force inflation by lowering interest rates to get people borrowing and spending more. We have inflation right now, not deflation. Higher prices are a result of inflation which takes more time. Do you notice how prices seem somewhat stable? Only a little over a year ago we started that massive bout with deflation. We got some lower prices pretty quick for a while, but how fast did gas rise after that deflation? And its still going up. So is gold, silver & the stock market(except for last week) Last month we had the highest increase in food prices in something like 25 years. If prices continue to rise like they have in the last year to 18 months, Next year we will see $6 gas, $10 "value" meals at mcdonalds, basically everything doubling. (if we keep the same pace)

    The cause of inflation is an increase in the amount of money that is not supported by a corresponding growth in the output of goods and services. With all the jobs lost lately, and the fact that we are producing less and less, further supports the premise that we will have very high inflation happening very soon.
  10. Defending a currency against a hostile trader(s), simply requires having more money than your opponent(s).

    That's why Hong Kong kicked Soros' ass.

    Defending a currency against fundamental laws of economics has never been successfully executed...ever.

    That's why Soros kicked England's ass.

    Which do YOU think the Euro is up against, right now, today?
    #10     May 9, 2010