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I think, in that connection, this paragraph is important:
First, the collapse of the  Bretton Woods system of fixed exchange rates pegged to the US Dollar, and by proxy gold, presented the threat of competitive devaluation for intra-European trade.  The experience of the 1930s, in which countries attempted to decrease the cost of their products in foreign markets through currency devaluations, haunted the policymakers of that time.  Thus you get an attempt to restore  a system of fixed exchange for intra-European trade after the  loss of a global system provided as a public good by the US government.
In other words, it's the fact that EEC "partners" didn't trust each other not to engage in an exchange-rate race to the bottom... and they still don't, to this day.

Where there is no trust, how can you have a monetary union, let alone a political union?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Apr 9th, 2012 at 08:37:38 AM EST
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Except, of course, that an exchange rate race will not be "to the bottom." All it does is create a spurt of inflation while the competitive devaluation shakes out and the participants discover the exchange rates that can be sustained without challenge. As long as you do it continuously rather than in one big, messy chunk, it doesn't terribly hurt anybody except bondholders. And fuck them.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 9th, 2012 at 10:03:27 AM EST
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If countries commit to defending their currencies against appreciation only, it's impossible to engage in a race to the bottom. Suppose that Greece wants to game the system and its central bank buys lots of German securities with new fiat Drachma. If the Bundesbank had an obligation to defend the Mark against excessive appreciation, they could just buy off all those drachma with new fiat DM. The net result would be an increase in DM holdings by the Greek Central Bank and Drackma holdings by the Bundesbank. But there need not be any upwards pressure on DM asset prices or indeed on the exchange rate or on German inflation. And the Bundesbank is much bigger than the Bank of Greece.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Apr 10th, 2012 at 04:31:48 AM EST
[ Parent ]
If the Greek CB wanted to put downward pressure on the D-Mark/Drachma exchange rate, they would sell into the open market, not bilaterally to the BuBa. And if the BuBa defended against it, the spread between the Greek attack bid and the BuBa defense bid would go to some arbitrageur, who would accumulate some combination of D-Mark and Drachma, which he would then either spend on goods (giving him a free lunch at the expense of the Greek and German citizens), or (more likely) exchange for other currencies in the open market, putting downward pressure on the D-Mark/Drachma couple.

Eventually one of the principal participants would bow out, the other would set whatever discount it wanted relative to the rate at which the former stopped defending its discount. You would have discovered the exchange rate which neither central bank could feasibly attack (and since the central banks, collectively, have greater pricing power than any speculator, by inference also from speculative attack).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 10th, 2012 at 04:59:38 AM EST
[ Parent ]
But a Germany outside of the Euro is at far less threat of competitive devaluation than a Germany in an EU of a large number of sovereign currencies.

Which suggest that perhaps Germany stepping outside the Euro causes less risk of an outbreak of competitive devaluation than forcing the peripheral countries out one by one.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Apr 11th, 2012 at 06:32:38 PM EST
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