The Devil’s Currency

MYOB 2010-12-20
Show #126
Release date: 20 Dec 2010

Notes

What future for the Euro? Is it really the work of evil our show title suggests?

Following bail outs for Greece and Ireland, with others looking likely to follow for Spain and Portugal in 2011, Guy Kingston, Christina Jones and John Richards examine the impact the current Euro crisis will have not just throughout Europe but on global business as a whole.

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La Grande Illusion

Any discussion of currency must begin with understanding that it is – in the most literal sense – a confidence trick.

It has no real intrinsic value beyond the value that people agree to put on it. It was not necessarily so in former times, when tangible commodities with a definite residual value were adopted as the basis for standardised rates of exchange: gold, silver, copper, bronze, bales of cotton, sheep, cattle, and slaves, among other things, were all used in various times and places as convenient ways of indicating the price of something.

It was in fact that residual value that led to the decline of commodities being used as currency. It confused the question of what they were worth. So did the fact that there might be changes in the supply of the commodity, or the demand for it, which made consistent pricing relative to other commodities more difficult.

Modern currency is, or should be, far more stable because its supply and demand can be controlled. Since used paper and linen, and cheap alloys, have negligible residual value, there is less confusion about its value.

It is in itself worth nothing. It has value only because people agree that it has value, that it can be exchanged for more tangible goods and services. That can happen only so long as there is confidence that it can be exchanged – which is why it is a confidence trick.

So money is an illusion but a remarkably persistent illusion. Indeed the illusion takes on a reality of its own – so long as everyone is prepared to accept it as such.

The problem is that, from time to time, for a variety of reasons, confidence can be lost – perhaps as a reaction to a period of overconfidence. Then the whole illusion is revealed for what it is

...which brings us to the euro, the European Single Currency.

For the best part of a decade, underpinned by the power of the German economy, the euro defied the predictions of sceptics by giving every appearance of being the strong contender for a global currency of which its supporters dreamed.

Yet it was always built on sand. The value of a currency depends on its ability to reflect the value of the goods and services it can buy. If there is no confidence in the currency, goods and services will not come to market, and shortage leads to price rises. If there is overconfidence, a number of unsustainable businesses will offer goods and services – but not for long: there will eventually be a reaction.

The problem with the eurozone is that different parts were and are experiencing different levels of confidence relative to goods and services. Countries like Greece, Spain, and Ireland were not producing goods and services that reflected the overall strength of the currency. They were running government deficits that gave the appearance of prosperity without the substance.

Lax rules allowed them to get away with it – it was in no one’s interest to undermine the confidence on which the whole structure depends. However, the blow to global confidence in 2008 revealed how weak the whole structure had become.

So now the illusion is over. Yet another illusion will come to take its place. It always does.