Legacy exchange rates
Comment of the Day

May 09 2012

Commentary by Eoin Treacy

Legacy exchange rates

Eoin Treacy's view Government bonds spreads have come under renewed pressure following the results of the Greek and French elections. There have also been negative repercussions for many stock and commodity markets. I thought it might be instructive to review some of the relevant spreads and legacy European cross rates in order to put some of the recent market action in context. I last posted charts of legacy exchange rates for various Eurozone countries against the US Dollar and Deutsche Mark in Comment of the Day on December 19th 2011 and September 30th 2011 respectively. Both are now available in the free public archive.

There is a high degree of commonality when comparing the performance of the Franc, Lira, Peso, Escudo, Drachma and Punt against the Deutsche Mark prior to the adoption of the Euro. Each country relied on a persistently weak currency compared to the Deutsche Mark to remain competitive. On accepting the Euro, they swapped their right to devalue for access to cheap credit. This was reflected in the convergence of French, Italian, Spanish, Portuguese, Greek and Irish spreads over German Bunds as countries adopted the single currency.

The essence of the problem today is that countries did nothing in the intervening decade to improve their competitiveness versus Germany while concurrently gorging on credit. As government bond spreads have returned to where they were before the creation of the Euro, and some cases considerably above them, countries are being forced into austerity without recourse to the traditional devaluation option. Electorates are increasingly voicing their opposition to accepting increasingly stiff bouts of spending cuts, wage cuts and higher taxes. Just how much more austerity populations are willing to take is perhaps the greatest unknown within the context of the Eurozone crisis. At some point debt forgiveness will almost certainly need to form part of the solution to this crisis if, as appears likely, political will to support the project remains.

Back to top