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Stay Hungry. Stay Foolish.

A blog by Leon Oudejans

Euro 101

16 January 2015

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Some country leaders confuse the fall of the Euro with their own popularity and in doing so confuse their voters too.

The depreciation of the Euro mirrors the appreciation of other currencies like the US dollar. This appreciation stems from positive economic news while the Euro depreciation is related to continued negative economic news.

The real issue is whether an appreciation or a depreciation is good or bad news.

While some political leaders suggest that a currency depreciation is bad news, the real bad news is the underlying economic development causing this depreciation. A currency depreciation allows an economy to recover.

If a currency is not allowed to depreciate (e.g., Russian rouble) then the Central Bank needs to increase the interest in order to stop money from fleeing to safe foreign harbours. Increased interest levels may be interesting for saving money but certainly not for lending money. Using a sky high interest level to maintain a stable currency level is like treating a patient with a delayed overdosis.

Depreciating currencies cause more expensive imports of goods (e.g., cars, oil) and thus increase inflation. The flip side of this coin obviously is that exporting goods becomes cheaper for foreign customers. The balance of import and export is decisive for the overall economy.

One of the main benefits of the Euro zone is that most imports and most exports are within the Euro zone and priced in Euro and thus a Euro depreciation has no immediate impact.

Some important imports are not priced in Euro. Oil is predominantly quoted in US dollars. Historically, there’s been a pretty consistent correlation between oil prices and the US dollar. When the dollar strengthened, oil prices would fall and vice versa. For the longest time, this relationship has been explained by the huge flow of US oil imports. However, more recently this rationale has broken down in the wake of the American shale oil and gas revolution. (source: UK Business Insider)

Given the above it is likely that the Euro zone will now only see the benefits of a Euro depreciation while the normal disadvantages (inflation through a.o. oil prices in US$) stay away.

The only danger that is looming is deflation. When prices fall then customers delay purchasing (e.g., houses). A remedy could be applying negative or penalty interest on bank deposits. This used to be a hypothetical concept but since mid 2014 several European central banks already applied this.

Negative or penalty interest on consumer banking deposits would be another revolution but it may be closer to home then we would like. It would be introduced to force savers to spend their money rather than continue saving. Initial feedback learns that it is far less effective than presumed.

There is also an interesting correlation between introducing negative interest rates and the accelerated Euro depreciation. (source: UK Business Insider)

Using interest levels for changing consumer behaviour may be a kill or cure remedy.

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