Impending Demise

of the Euro
Tahmeed Zaman
Agenda
The Austrian Business Cycle Theory

Credit creation and Inflation

Sustainability of Euro

Viability of reverting to the Deutschmark

The Way Forward

Conclusion
Methodology and Hypothesis
• Deriving results based on the deductive reasoning principle of
the Austrian School.

 Hypothesis: If monetary expansion continues, then the euro

will be unsustainable, and Germany should revert to the
Deutschmark.
Austrians vs. Keynesians

 Keynesian viewpoint: governments should run large budget

deficits in times of crisis

 Keynesian fallacy: increasing consumption can be the solution

to current economic problems.

 Austrians: booms are created by false signals given to

businessmen when central banks lower interest rates.

 Keynesians look to mitigate the adverse impact of the busts;

 Austrians look to prevent artificial booms.
 Austrian School of Economics
 Founder: Carl Menger.

 One of the oldest schools of economic thought.

• Austrians warned of the formation of bubbles and predicted the financial

crash before anyone else.

• Innovation and entrepreneurial profit seeking drives growth.

• Entrepreneurs help to enhance productivity by utilizing resources

efficiently, which makes it possible for people to consume more.

• The economy does not prosper due to a rise in consumption first, but
rather the increase in consumption is brought about as a result of the
growth of an economy.
Austrian Business Cycle Theory

 ABCT focuses primarily on credit expansion by the

government in cooperation with the banking system as
the origin of booms and busts.

• By buying government securities and lowering interest

rates, a central bank can trigger an increase in money
supply.

• This money goes into the stock market and real estate,
leading to banking crisis.
ABCT (Continued...)

• ABCT suggests that the misallocated resources

should be liquidated and redirected into sustainable
ventures.

• Bailouts promote an environment of bad decision

making, and the issue of moral hazard arises.

 Moral hazard - increased likelihood of risky behavior

arising whenever a person believes that costs will
be borne by a large group of people.
Credit Creation
Government
• issues bonds

Central Bank
• accepts bonds, prints
money and lends to
banks
Banks
• buy bonds to use as
collateral
 Inflation

 An increase in the money supply which causes prices to rise.

• Most politicians and economists insist on defining inflation as a

rising price level.
– it is a harmful consequence of monetary inflation.

• Monetary expansion also leads to asset price inflation.

• For Austrian economists stimulus packages result in the creation

of widespread inflation.

 Best cure: stop manipulating the money stock.

 Asset Price Inflation

 Money has gone to the stock market and not into the economic system.

 NASDAQ previous benchmark: 5,132 points in March, 2000.

– Surpassed that peak in July, 2015.

DOW Jones
On October 9, 2007, the 20000
Dow Jones Industrial 18000
Average stood at 14,164.53 16000
14000

- Previous highest close 12000

ever 10000
8000
6000
- Surpassed in early 2013.
4000
2000
- Past the 18,000 mark now! 0
01/01/2010
01/04/2010
01/07/2010
01/10/2010
01/01/2011
01/04/2011
01/07/2011
01/10/2011
01/01/2012
01/04/2012
01/07/2012
01/10/2012
01/01/2013
01/04/2013
01/07/2013
01/10/2013
01/01/2014
01/04/2014
01/07/2014
01/10/2014
01/01/2015
01/04/2015
01/07/2015
01/10/2015
- 18,472.79 on July 25,
2016.
Asset Inflation (Continued...)
 DAX reached the 8,000-point level for the third time in its
history (after 2000 and 2007), back in mid-2013.

• Record peak: 12,374.73 on April 10, 2015.

• P/E ratio:
• Historic average – 14 to 15 | Current level - 20
DAX
14000

12000

10000

8000

6000

4000

2000

0
01/01/2010

01/04/2010

01/07/2010

01/10/2010

01/01/2011

01/04/2011

01/07/2011

01/10/2011

01/01/2012

01/04/2012

01/07/2012

01/10/2012

01/01/2013

01/04/2013

01/07/2013

01/10/2013

01/01/2014

01/04/2014

01/07/2014

01/10/2014

01/01/2015

01/04/2015

01/07/2015

01/10/2015
 •
•
•

0.1
0.2
0.3
0.4
0.5

-0.3
-0.2
-0.1
01/01/2012

01/03/2012

01/05/2012

01/07/2012

01/09/2012

01/11/2012

01/01/2013

01/03/2013

01/05/2013

01/07/2013
Interest Rate

01/09/2013

01/11/2013

01/01/2014

EONIA
01/03/2014

01/05/2014

01/07/2014

01/09/2014

01/11/2014

01/01/2015

01/03/2015

01/05/2015

01/07/2015
In June, 2014, the ECB cut its deposit rates from 0% to -0.1%

01/09/2015

01/11/2015
Negative interest rates would do nothing to improve the situation.

01/01/2016

01/03/2016
Low investment in Europe is due to regulations and political uncertainties.
 Government Deficit & Debt
 Before 2011, there were around 70 cases of violations of the 3% deficit.
Nation 1999 2003 2007 2011 2015
Germany -1.7 -4.2 0.2 0.2 0.7
France -1.6 -3.9 -2.7 -2.5 -3.5
Portugal -3.0 -4.4 -3.0 -7.4 -4.4
Threshold:
Ireland 2.4 0.4 0.3 -12.6 -2.3 3%
Italy -1.8 -3.4 -1.5 -3.5 -2.6
Greece -5.8 -7.8 -6.7 -10.2 -7.2
Spain -1.3 -0.4 2.0 -9.6 -5.1

Nation 1999 2007 2011 2013 2015

Germany 61.3 65.2 81.7 77.2 71.2
France 59.0 64.2 85.4 92.4 95.8

Limit: 60% Portugal 49.6 68.3 105.6 129 129

Ireland 48.5 24.8 106.6 120 93.8
Italy 113.7 103.1 120.9 129 132.7
Greece 100.3 107.4 161.7 177.7 176.9
Spain 62.4 36.2 69.6 93.7 99.2
Optimum Currency Area
 Similar inflation rates
 Financial integration
 Degree of diversification 
 Degree of openness
--------------------------------------------------------------
 Price and wage flexibility
 Mobility of labor and capital
 Fiscal integration 
 Political integration
 Unemployment in EU

 The EU as a whole has 8.6% of the workforce unemployed

-10.1% in the eurozone.
- Average youth unemployment is 22.5 percent in the eurozone.

Youth Unemployment (%)

Germany Ireland France Portugal Italy Greece Spain

7.20%

21.30%

24.50%

32.60%

42.70%

49.70%

49.90%
Impending Demise of the Euro
 The single currency has allowed the peripheral countries to live beyond
their means, and shattered their competitiveness.

 Rescue packages not only violated the terms of the treaties, but also
exacerbated the problems.

 Due to the inherent fundamental flaws in the euro, a breakup of the

monetary union is a plausible scenario in the medium-term.
 EU: Approval Rating
Approval Rating: EU's Handling of Economic Issues
Disapprove Approve

92%
Greece 6%
68%
Italy 22%
65%
Spain 28%
55%
UK 28%
66%
France 27%
38%
Germany 47%

 Germany should withdraw from the EMU but stay in the EU.

 The Maastricht Treaty does not provide for a mechanism to exit the EMU.

 Solution: a simultaneous exit from both the EMU and EU, and then
reentering EU immediately or after a short lag.
Reverting to Deutschmark
 Claim: Europe will collapse if euro fails

• Does not hold much substance from a historical

perspective.

• Cooperation took place for more than 40 years

without the euro.

• Cooperation with other European countries outside

the monetary union is going on without difficulties.

 The common currency has created resentments

among various nations of the monetary union.
Reverting to Deutschmark
 Claim: Germany’s export industry will collapse with DM

• A new DM would appreciate against other currencies.

• Between 1953 and 1999, Germany was consistently among the

three leading exporting nations in the world.

• Germany's exports improved after each appreciation of DM.

• Success of German products is due to comparatively higher

quality, brand loyalty, and innovative power.

• The price usually plays a secondary role for foreign buyers.

• A new, strong DM will also reduce the cost of raw material

imports coming into Germany.
Reverting to Deutschmark
 Claim: Reverting to DM could be costly

• Germany would incur losses of around 160 billion euros, if the

new DM appreciates by 20%.

• It would be difficult for peripheral countries to regain the

level of competitiveness required to repay all the debts.

• Future bailouts seem inevitable.

• The cost of exiting EMU would be lower for Germany

compared to the risks of the alternative.

 Euro is a soft currency, so Germany should consider

reverting to a strong DM, preferably backed by gold.
The Way Forward
 Dismantle the single currency

 Additionally, a market-based agenda must be put in place for growth

and job creation.

• A monetary policy aiming for sound money should be implemented.

• Foster more entrepreneurial spirit by reducing tax rates.

• Government spending should be reduced by at least 10% more than tax

cuts in order to move towards balanced budget.

• Eliminate or reduce government regulatory policies over the business

sector.
The Way Forward

• Instead of trying to prop up the European economies by increasing

debt, they should be allowed to take the hit, so that stronger economies
can be built.

• Avoiding systemic risk:

– the solution is to limit activities of big banks

– break them down into smaller units that are not too big to fail.

• Gold should be reintroduced into the monetary system to keep credit

expansion in check.
Conclusion

 The sovereign debt crisis was the consequence of a monumental failure in

monetary policy.

 Sound money is the foundation of healthy and sustainable economic growth.

 Difficult to pinpoint one particular course of action as a concrete solution due

to excessive manipulations

 Important for the citizens of the world to look towards the future, and not
only focus on short-term solutions.
THANK YOU!
QUESTION
SESSION