€ uro, the currency market and the Greek problem

What about the Greek crisis and what is causing us the Euro? Do we need him? Do we have high enough profits from it? And - hasn't it been here before?

Source: zavenieura.cz
Source: zavenieura.cz

Do you even know what it is Euro? Are you even sure? Do you know what role the Euro plays in the current "Greek crisis"?

To understand what it is Euro we need to take a closer look at functioning of the currency market as such.

Imagine that we have two countries here - the country of Kocourkov and the country of Kačerov. Tails are paid in the first country and Beaks in the second. What will be the exchange rate of these two currencies and why?

Suppose that the land of Kačerov is much more developed, developed, richer. The country of Kocourkov is backward, poor.

Suppose that in Kocourkov the price level is ten times higher than in Kačerov and the initial rate is 10 Tails per 1 Beak (10 Ocs / 1 Zob). In other words, for example, a pencil that costs 1 Beak in Kačerov costs 10 Tails in Kocourkov. However, what does not happen will cause the Kacherov Central Bank to go insane and cause the price level ("inflation") to increase by 100%. Out of nowhere in Kačerov is the pencil 2 Beaks, but in Kocourkov it still costs 10 Tails. What happens then?

At the original rate of 10 Ocs / 1 Zob, this means that pencils in Kačerov became more expensive than pencils in Kocourkov. Simply put - in Kačerov you can buy one pencil for 2 Beaks, but in Kocourkov you can buy two pencils for 2 Beaks (which is 20 Tails).

Of course, this difference will be noticed very quickly by Kačerovský and Kocourkovský traders, who will start importing cheap goods from Kocourkov to Kačerov. Imports to Kačerov will increase, while exports from Kačerov will decrease. However, cheap goods in Kocourkov must be bought for the local currency, for Ocásky. Thus, the demand for Tails is growing and at the same time the supply of Beak on the currency market is growing. This results in the Tails appreciating (appreciating) and the Beaks depreciating (degrading). In other words, the price of the Tails increases and the price of the Beak decreases, so you can buy less and less Tails for one Beak. Result? The course will change until it stabilizes at 5 Tails per 1 Beak.

Only then will the pencils have to stand "the same" in both countries, ie in Kocourkov's 10 Tails, which will correspond to Kačerovský's 2 Beaks. At that moment, Kačerovský imports will stop growing and Kačerovský exports will also stop falling, ie Beaks will stop depreciating.

But it's not the end of everything.

Suppose that now that the exchange rate is 5 Ocs / 1 Zob, the interest rate on bank deposits in Kačerov is 6%, while in Kocourkov it is 3%. So it's more convenient to deposit money in Kačerské banks, right?

Of course, this is also known to the citizens of Kocourkov, who will thus start depositing their Tails in the accounts in Kačerov. The citizens of Kocourkov will thus sell their Tails and buy Kačerovské Beaks. This will create an imbalance in the market - the supply of Tails will increase and the demand for Beaks will also increase. This will result in deprivation of the Tails against the Beaks. The course will start to change - there will no longer be 5 Tails for 1 Beak, but more and more Tails for one Beak. Where will it go?

The answer lies in the market of loanable funds in Kačerov and Kocourkov (more about loanable funds in the article Impacts of higher taxes). When citizens and investors transfer their money from Kocourkov to banks in Kačerov, the offer of loanable funds on the Kačerov market will increase, which will lead to a decrease in the interest rate on bank deposits. On the contrary, in Kocourkov, the supply of loanable funds will decrease, which will lead to an increase in the interest rate on bank deposits in Kocourkov. When interest rates on deposits are the same in both countries, the "overflow" of money from one currency to another will stop, and the exchange rate will also stabilize.

However, the state is very happy to intervene in the development of the exchange rate. Practically the only way a central bank can intervene in the currency market is for it to start buying its own currency (for example, the CNB starts buying koruna) and offer its foreign exchange reserves (ie reserves held by the CB in foreign currencies), or vice versa. This can lead to currency appreciation or depreciation, but this is more often used when the central bank wants to maintain a "stable exchange rate".

And yes, she can do it. It may happen that investors start to "run away" from the currency out of nowhere and the central bank can use their intervention to convince them that their panic is unnecessary. However, it happens (I would like to say mostly, but I will not do it) that the attempts of central banks are unsuccessful, the central bank sells and sells its foreign exchange reserves, but the currency is still falling and falling. In such a case, the banks usually end their efforts and let the exchange rate "float" freely. Otherwise, they could sell their foreign exchange reserves unnecessarily and not prevent depreciation anyway, as the market naturally demands something else.

The exchange rate shows investor confidence in the economy. After all, the "Lafontaine case" is a beautiful example of this.

At the beginning of 1999, the euro began to depreciate steadily against the dollar. According to economic experts, the then German Minister of Finance was to blame Oskar Lafontaine, which advocated lower interest rates in Europe. Lafontaine was convinced that the European economy needed a growth boost in the form of lower interest rates.

Expectations of falling interest rates in Europe have led many investors not to wait and to rather convert their money into dollar assets. That is why the euro depreciated against the dollar.

In March of that year, Lafontaine, after disputes with the Chancellor Schröderem, resigned as Minister of Finance. Following the announcement of his resignation, the euro strengthened immediately.

Robert Holman, Economics (p. 575, 4th edition).

So what happens if we firmly link several different economies to one course? Let's look to the past.

In 1979 EEC countries they have reached an agreement - they will keep their exchange rates stable against each other. In other words, against the US dollar, for example, these currencies moved "with each other", ie if the German mark changed its exchange rate against the dollar, the British pound changed in the same proportion. It was called that European Monetary System (EMS).

Everything went well until one important thing happened - Germany was united in the early 90s. What did that mean? The German government began investing in the economic revival of the eastern federal states. Germany thus ceased to be an exporter of capital, but on the contrary became its importer. Thus, the demand for March increased, which thus began to strengthen strongly. There was therefore a danger that the other currencies of the EMS countries would depreciate. These countries thus had to "defend" their currency (due to the agreed monetary system) by intervening in the currency market and raising interest rates. However, high interest rates also mean a slowdown in investment and lending, which can lead to an economic recession. France, Italy and the United Kingdom that is, rather than risking a recession, they would rather break the 1979 agreement and allow their currencies to devalue, devalue.

You also see in that parallel with Greece today? Investors lost confidence in the Greek economy after the mismanagement of Greek governments was revealed. They began to flee the country. If Greece had its own currency, it could devalue, the supply of currency would exceed the demand for it, there would be a depreciation and at the same time a reduction in the supply of loan funds in Greece. This would lead to higher interest rates, but at the same time Greece would become a cheap location for tourists and investors due to currency devaluation. The "strength" of the currency would reflect the real economic situation of the country, which would greatly help Greece - it would become cheaper, more attractive, it would attract foreign capital.

But unfortunately, Greece has the euro. The same currency as Germany, one of the largest and most developed economies in the world. It is, of course, in the interest of Germany, as the strongest country in the eurozone, that the euro exchange rate should reflect the situation of the German economy as much as possible. However, the aim of Greece (or the Greek economy) at the moment is for the euro to reflect the economic situation of the Greek economy as much as possible.

Although the euro is the "eurozone" currency, now, in a time of economic downturn, the weakest link in the chain, Greece, is attracting investors' attention. Investors are afraid of its collapse, they do not trust its economy, so they run away from the "Greek euro", thereby weakening its exchange rate, which is very disadvantageous for a strong Germany, which is "undervaluing" the exchange rate.

In times of boom, ie growth, on the other hand, the strongest economy in the euro area, which is usually Germany, is attracting attention. Investors feel confident in the German economy, so they buy the euro, which leads to its appreciation. However, this is disadvantageous for the Greek economy, for example, for which its currency becomes strongly "overvalued", which makes export prices more expensive, for example.

As a result, the common currency can provide us with a stable exchange rate in times of growth, short however, it will always depend on the strongest player in the currency zone. But it is also dangerous for them, because in times of crisis, attention shifts to weaker players in the zone, such as risky economies, and the currency begins to weaken to reflect the economic level of the weakest players, which in extreme cases can lead to a currency crisis, that is, to the sudden and profound fall of the currency.

Of course, the currency crisis can be avoided. Now it costs us over 100 billion euros, something in between 2,5 and 3 trillion crowns. Is it worth it to us?


  1. So the difference between California and Greece is considerable. The US arose spontaneously from people on one continent. It can be said that it is a "one" nation, one country, Americans, America. Investors and traders then look at this country differently, even if the richest member of the USA goes bankrupt - it is still one country that as a whole is "prospering" (or it is doing well).

    While Greece is Greece. Greece will never be Europe, just as the Czechia will not be Europe or Germany will not be Europe. This changes the view of investors who do not look at the state of the entire "euro area", but at the state of individual members.

    Historical development is also important in economics.

  2. Nicely described. I would be interested in the answer to the argument of the proponents of the euro. It is said that Greece within the EU with the euro is the same problem as, for example, California within the USA with the dollar. I don't like it, but I'm not an economist, so I can't say why.

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