Section 2: The Fall and Fall of the Euro

1
Section 2The Fall and Fall of the Euro

• Reasons for the decline of the euro before its
  debut on 1st Jan 2002

2
The Conventional View

• Spectacular performance of US relative to Europe
• Down 25 against USD since inception
• Why?
• Conventional view Prosperous Economy Theory (PET)

3
Three-Pronged Approach

• Explain
• Why the conventional view is wrong
• What exactly happened to reduce the
  attractiveness of the euro
• What could have been done to prevent this

4
Interpretation Errors of Prosperous Economy
Theory-(1)

• Argument for PET
• Spectacular US performance
• gtAs price of assets is price of dollar, dollar
  should rise!

But Supply is key!
5
Decline in US household savings rate
6
Poor US Stock Performance

• If PET were true, then US stock market should
  have risen when dollar rose
• But it didnt...

7
Interpretation Errors of Prosperous Economy
Theory-(2)

• It may not even theoretically be true!
• Higher demand for US shares by European investors
  caused dollar to rise
• Truth is other implications overlooked
• Crowded out US investors may buy Euro stocks
  instead gt zero-sum game
• Wrong focus on transitional demand

8
Interpretation Errors of Prosperous Economy
Theory-(3)

• Transitional use of currency
• Buying of US assets Purchase of dollar
• Conclusion Only increase in demand for US money
  or reduction in its supply will imply its
  appreciation

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Distaste for euro?

• D-marks ( euros) tumultuous fortunes
• Rise in demand in D-marks after 1989
• Used in Poland, Hungary, former Yugoslavia
• Stocks of D-marks in internationally
• 60-90 billion D-marks accumulated

10
Distaste for euro -(2)

• After Jan 1999, D-marks started to be returned
• 9 billion D-marks by end 2000
• Culprit Its virtual form

11
Distaste for euro?-(3)

• Uncertainty over new euro
• Procedures of conversion
• Currency conversion rate
• Commission rate
• gt Hoarding of safer currencies

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Distaste for euro -(4)

• Black market conversions
• Establishment of new laws
• Inability to convert to virtual euro
• gt Conversion to dollar
• Size of Black Money
• 14 of Euro-11 GDP
• 14 of monetary base
• 80-100 billion euros

13
Conclusions

• Exchange rate not price of shares nor that of
  interest bearing assets
• Unwise to have left euro as virtual currency
• Conversion procedure could have been clearer