Euro Crisis & Inefficient Markets

The Greek parliament narrowly approved a fresh austerity package on Wednesday night, opening the way for international lenders to transfer a long-delayed €31.5bn slice of funding and take steps to ease the terms of the country’s €174bn bailout. Why the Greek crisis was much larger, more complex and a greater risk than anyone assumed.

Gold prices were rallying in tandem with the dollar. As the market began to crater and eventually crash 1,000 points in one day the gold market actually continued to rally along with the dollar! For anyone familiar with gold and forex markets this was more than odd. But there is a reasonable explanation for the move.

The irony behind the Euro crisis is that it is not at all a condemnation of fiat money. In fact, it is a condemnation on single currency systems such as the gold standard. Arguing against the mess the EMU created in 1999 with the inception of the Euro was unlikely to survive a serious global recession in its original format. This was due to one primary argument. The gold standard and single currency systems have all ended in demise for similar reasons. There are several flaws in single currency systems, however, two are most notable:

They are inflexible
They are susceptible to corruption

The inherent inflexibility and inherent weaknesses imposed on particular trade partners within the currency system is always apparent in single currency systems

The move off the gold standard and convertible currency systems has generally been due to the inherent restraints imposed by such systems. For instance, trade deficit nations are at an inherent weakness when attempting to respond to recession because the trade imbalance results in rising unemployment and falling output and prices – an inherently deflationary environment. With your own currency this imbalance would naturally offset over time, but under a single currency system there is no opportunity for the floating exchange system to reach balance. This is just one very simple example of the types of inherent restrictions a single currency system imposes on a nation, but it’s particularly pertinent as we see this exact event unfolding in Greece – where the single currency system is destroying the country and handcuffing the government from properly defending their economy and thus providing for their citizens. Instead, they are risking default (a risk which does not exist within a sovereign issuing floating exchange system) and forcing their citizens into recession all so the surplus nation of Germany can enjoy price stability and continued high exports. Such a system is wondrous during the boom, but it can be catastrophic during the bust.

The inefficient market irony within all of this is that the markets are viewing the Euro crisis as a condemnation and failure of fiat money. That couldn’t be farther from the truth. What we are seeing in Europe is in many ways what we would see if the world were living in a gold standard world or a convertible currency world. The same unnecessary restrictions would occur and trade deficit nations would be at risk of recession which would ultimately result in regional and perhaps global recession. The recent rise in gold prices is not based on the true fundamentals of mined gold, but rather on the hope that the Euro’s failure will increase demand for gold via its potential return as a true currency. As we’ve described above, that is entirely misguided thinking and perhaps the greatest real-time example of the inefficient market.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s