Saturday, November 26, 2011

Currencies can leave monetary union-----By Shan Saee

Currencies can leave monetary union and no harm can be done. It could be devastating in the short run but in the long run, its perfectly normal for the financial markets as they factor in the risk of that particular monetary union.

I have analysed least 87 examples of countries leaving currency unions and establishing their own money since 1940. Establishing an independent currency allowed the country concerned to set more sensible interest rates and exchange rate to help them grow. In every case it gave them more independence, strengthening their ability to make their own decisions free of foreign interference. They can have internal devaluation ---lower price and wages to boost their competitiveness in order to remain float in the global economy. The biggest advantage to the countries leaving Euro zone is they can print money in their own currencies and have control of monetary inflation or deflation i.e. money supply in the financial market

The Euro remains under pressure severe pressure. Its down from 1.43 to 1.32 [ lost 7.5% value against US Dollar] . Leaders in Euro zone are waiting for Mrs Merkel to relent. They just want her to say the ECB can buy up many more EU country bonds, and QE/print the money to do so. The Governor of the Bank of England this week in his press conference explained her reasons very well. He pointed out that a Central Bank has a role as the lender of last resort. That means it acts as the lender who supplies cash to commercial banks in its jurisdiction if they are solvent but in need of temporary loans. They are lent money at a penalty rate to see them through. It is not the job of a Central Bank to act as lender of last resort to countries that have run out of credit and whose solvency is in doubt.

Within Western Europe the latin currency union led by France and the Scandinavian currency union both broke up without great calamity at the time of the First World War. Between 1945 and 2007 according to the Monetary Authority of Singapore 69 countries have left currency unions. This figure leaves out a good number, including the break up of the rouble currency in the early 1990s. It also excludes the split of Czech and Slovak currencies in 1993. It includes the ones which left the sterling area, like New Zealand in 1967 and Ireland in 1979. It happened by agreement with a relatively smooth transition. Some like Bangladesh left the Pakistan union. Others left former colonial unions: Mozambique for example left the Portuguese area in 1977 and Algeria left the French franc area in 1969. Eritrea left Ethiopia. Again these changes caused so little disruption that most have forgotten they ever happened.

The uncertainty about the end game for the Euro continues to damage the markets. The battering of the bonds does make things far worse. It means banks will lose yet more money on what were meant to be safe holdings. This in turn means they will lend less, slowing growth still further. It is surprisingly common for countries to leave common currencies. So, if Greece, Italy , Portugal or Spain leaves the Euro zone, its perfectly normal and will continue to compete globally with their own independent currencies.

Disclaimer: This is just a research piece and not an investment advice. All financial transactions carry a RISK.