Weekly Economic Briefing

The sub-optimal currency union

24 February 2015

Global Overview

  • Currency unions are a tricky business; a successful one requires integrated markets, labour mobility, mechanisms for fiscal transfers and centralised financial supervision. The US shows the effectiveness of a union that works.
  • The Eurozone does not meet these criteria and the situation in Greece illustrates the dangers of a sub-optimal union. While a temporary agreement has been reached, Grexit risk has been delayed but not eliminated.
  • Staying out of the Eurozone appears to have been a lucky escape for the UK. Looser ECB policy before the crisis would have stoked deeper imbalances, while the policy response since has been insufficient.
  • Movements in the yen over recent years look to be closely related to policy decisions in Tokyo and Washington. The Bank of Japan’s Kuroda has downplayed the role that QE has played as domestic unease with a weak yen intensifies.
  • Weak economic fundamentals in China are causing concern that currency devaluation is in the works. However, the high import content of China’s exports and capital outflow risks make devaluation less attractive.
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US

The US provides a template for an optimal currency union with fiscal transfers and labour mobility helping reduce asymmetric shocks. The Eurozone should take note.

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UK

The UK was forced to abandon the ERM in the early ‘90s and has not made any concerted effort to join the euro since. Membership might have made an already painful crisis
even worse.

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Europe

Greece and the Eurogroup have come to an agreement. However, Syriza will need to implement a reform agenda contrary to its socialist ethos. There may be limits to the compromises it makes.

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Japan

The arrival of Governor Kuroda has coincided with a sustained decline in the yen. However, can the Bank continue with a proactive policy approach without further talking down the currency?

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Emerging Markets

Expectations are rising that China will seek to devalue its currency, which would do more harm than good. Gradual depreciation is possible, but do not expect a sharp, deliberate weakening.

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Standard Life Investments’ Global Strategy team provide regular analysis of the key economic data that has been influencing financial markets.

Available on a weekly basis, the Weekly Economic Briefing takes a detailed look at the global economic issues that have been impacting our investment strategy. The regional approach aims to provide an easy-to-navigate guide to the most recent developments in the global economy.

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