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Governmental Money - a Market Paradox

Rūta Vainienė, Senior Policy Analyst, LFMI
30-12-2000
Article, "The Free Market", 2000 No. 6
In early September the European Union's common currency, the euro, plummeted to a record low. Since the euro was first introduced into circulation in 1999, it has depreciated against the US dollar by 25 percent. Exporters' complaints about the problems sparked off by the weakening euro continue to pour in. Exporters to the euro zone claim that the strong litas, linked to the US dollar, boosts the cost price of their production, undercutting their competitiveness and ability to sell in the constantly weakening euro zone. Exporters continue calculating unearned income and profits that might have been yielded if the litas had been tied to the euro, rather than to the US dollar. Exporters demand either an immediate re-pegging of the litas to the euro or a floating exchange rate of the litas. But this is just one side of the issue, represented, strangely, by several enterprises that have performed well despite the weakened euro.
 
In reality, this problem is not so one-sided and the proposed solution is far from being a panacea. It may even be the case that tying the litas to the euro would not be of much use to exporters. First, depreciation of the euro will not last forever. One fine day the euro may start picking up and the export conditions may undergo a complete reversal. Does that mean that exporters will once again urge the authorities to do something about the litas? Here's an example that demonstrates just how quickly industrialists forget good things: shortly after the litas was tied to the dollar, the mark, which was in circulation at that time, was strengthening and exporters simply rejoiced over their juicy profits.
 
Second, even if the euro kept loosing against the US dollar for a long time to come, exporters would not necessarily gain from re-pegging the litas to the euro. Lithuania, after all, is not just an exporting country. It imports as well. When the euro drops, it is very handy to buy goods in the euro zone, and most enterprises reap profits by doing so. They purchase not only goods for consumption, but also means of transportation, equipment, new technologies, etc. The opportunity to buy goods that are not manufactured in Lithuania at a lower cost is vitally important. If the litas were tied to the euro this relative benefit would be lost and the costs of the same exporters would be pushed up, not by growing labour costs, but by more expensive raw materials and other purchases made abroad. The final outcome is as unpredictable as tomorrow's exchange rate of the euro or enterprises' future solutions.
 
With reference to changing the anchor currency, it should be taken into account how the alteration of the monetary policy will affect everyone, not just those who are complaining today. It should be taken into consideration how the re-pegging of the litas to the euro would act on the interests of all consumers of the national currency. After all, as long as the euro continues to fall, it will drag the litas all the way down as well. Weak currency is always unattractive for saving, and everybody knows that saving is the driving force behind an economy. Further, savings spur production, which enables people to satisfy their needs in the future. A weak currency is often accompanied by inflation; it impoverishes the most vulnerable layers of society and shifts the burden of the problem on them, not to mention the psychological or political aspects of changing the exchange rate of the litas.
 
But the issue is not about how to tackle exporters' problems by repegging the currency. The issue, rather, is this: whether, if at all, the problems of individual interest groups may be solved by alternating the monetary policy and manipulating the currency? After all, Lithuania has only one currency, and around four million people and thousands of enterprises. All of them have their own problems, interests, solutions, financial circumstances and lives. All of them are unique and constantly changing, every minute. We could find different desirable exchange rates of the litas for every one of them to make their lives easier. However, this implies that the rest of them would be dissatisfied, as there is only one currency. And even if we eliminate the national currency and start using foreign currencies, a vicissitude of intermingled interests, as well as the need to evaluate the currency risk and to minimize it, would still remain in place. Just because there is one currency and a multitude of its consumers, we should look for such attributes of a currency that would please everyone.
 
Such attributes are the credibility of a currency, a relative stability of its exchange rate and predictability. It was all of these acknowledged characteristics combined that enabled the introduction of a currency board in 1994, linking the litas to the US dollar. The public and the business community now view this move as the most successful economic reform in Lithuania since independence. Various opinions are voiced as to which currency should serve as the anchor. Some believe that the Deutchmark, or the euro today, would have been a more acceptable long-term solution. The euro seems to be more acceptable because of the trends in its exchange rate and EU integration. Others, too, are right in saying that in a dollarised economy, such as Lithuania, only the US dollar could have been justified, and that the dollar is the only global currency that could fully meet the stability and credibility requirements attached to the anchor currency. It was the strong dollar, and the litas alongside, that secured a relative benefit for consumers, pensioners, and employees.
 
In retrospect, everybody is quick to teach and criticise. Some blame the authorities for choosing a wrong currency, others reproach them for missing the most suitable time for re-pegging the litas (when one euro equalled one dollar) and so on. Decisions are always made based on scant information because uncertainty is the key feature of the market. Today, we can only guess what will happen to the euro; we can't even be sure whether it will remain a currency at all. Today, we can only speculate which markets Lithuanian enterprises will trade in; we can't even be absolutely certain that the European market, as opposed to the Eastern markets, will be the most solvent and attractive.
 
It is difficult for a market participant to envisage all these things by himself, as the information is widely dispersed. But to predict market tendencies is far more difficult for someone who is not in the market at all. That someone is the government - the world's main issuer of money. Being an indispensable, neutral and inseparable element of the market, money is a governmental product. In most countries it is the product of the national government. In Lithuania, because of the currency board regime, it is the product of a more experienced government, the US government with its federal reserve system. This paradox when one of the essential elements of the market - money - is not the product of the market but, rather, the product of a government, entails a range of problems. Most importantly, it creates temptations to address one's own problems in the easiest way possible, that is, through government aid.
 
The conclusion is simple: to resolve the problems posed by today's currencies, money should be returned to where it evolved and where it belongs - the market. The solution is gold money or private paper money. Today, this idea seems shocking to most people, as is a more moderate decision to allow people to use whichever currency they choose. But understanding the nature of money can help perceive the root causes of the problems that today's money faces. The next step would be either to make essential changes or to accept the system of government money with its unavoidable ills.