Money Makes the World Go Around

I did not properly prepare you for my last post.  To understand why it is difficult to have one currency that encompasses several economies you have to look at the role that money plays in evaluating the performance of a particular economy.  Money is the measuring stick of how an economy is valued against other economies.  For example, if labour in one economy is less effective than in another, the value of the first economy's money will be discounted so that, economy against economy, prices will be about equal.  If one economy has something that others, worldwide, want, then it's money will be bid up because of excessive demand.  An example:  Canadian currency is largely petro based.  If the cost of oil goes up the Canadian dollar usually follows.  Another example:  when Canadian base metals had no market worldwide then the Canadian dollar fell.  If a country raises it's bank rate so that government bonds pay more interest than is paid on other economies then the value of the dollar goes up correspondingly.

Therefore, the value of money is a good way to "take the temperature" of the performance of an economy. Of course this assumes that the value of money is left to an impartial market.  There is no such thing.  Many countries either directly or indirectly influence the value of their currency to achieve national goals.  China has kept the value of its currency abnormally low so as to make exported goods cheaper.  The US has put downward pressure on its dollar to make exports more affordable.  These actions have the obverse effect of making imports more expensive (you have to spend more dollars to get a Euro, for example).  The effect of manipulating the value of money is that everyone is affected.  Dearer import hurt foreign markets.  Cheaper exports flood foreign markets.  It's like a tariff barrier.

In an open market the value of a country's money will have an enormous effect on domestic economic policy.  Having the "right" value will make both export and imports affordable.  Inefficiencies in the economy will directly affect the value of currency.  This will have the effect of either correcting the inefficiencies or allowing the local currency to go into the tank.

When you have a currency that does not reflect economic reality of the underlying malaise of the economy this inconsistency will not be apparent until things get bad.  Really bad. In Europe the strength of the German economy is propping up the inefficiencies of others in the EEC.  That can go on for only a limited amount of time.  If the Euro tanks it will take the German economy with it.  That's why I have consistently believed that an overall currency for a disparate number of countries is a bad idea.  So did Britain when it voted not to adopt the Euro.

Bernie