Wednesday, September 8, 2010

Coming soon to a theater near you: The euro peg

It appears that the euro may be doomed to the dustbin of history. As the peripherals (Ireland, Greece, Portugal, Spain, Italy) are forced to default and/or redenominate, central banks will lose confidence in the euro as a reserve currency, and the external value of the euro will collapse. Germany and the other serious countries will exit. There is nothing the ECB could do to avert such a scenario, should it indeed eventuate.

So what next? What would be the currency of last resort, the flight to safety? Well, obviously, it’s the Fed’s #1 selling product, M1. Doesn’t this scenario portend dollar appreciation and dollar deflation as the world rushes to exchange their worthless Audis, Bentleys, Greek villas, Cheddar cheese, prosciutto, tartan tweeds, kimchi and Hermes ties for the new gold standard? Yes, indeed it does.

Which means that the FOMC (assuming the lights are still on that the FOMC) will have no choice but to place the US onto the euro standard. If the euro starts to collapse, the US will be forced to target the price of the $ in euros as the policy anchor. Otherwise, the terms of trade will shift so sharply in terms of the feta, roquefort and parmesian bloc that we might as all move to Nice.

This would be ironic: instead of the world pegging to the Boeing currency, the US would peg to the Pinot Grigio currency. Counterintuitive!

But the US would be crazy to allow the euro to collapse while the dollar soared. So much for a soft landing for the adjustment of “global imbalances”. So much for targeting the value of the dollar based upon the current account. At least the Treasury’s default is 30 years away, instead of next year.

What rate? Why not $1 = Euro 1 = Y100. At least this would eliminate the need for travellers to do fractions in their heads!

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