Mario Draghi today promised to do whatever it takes to fix the euro. ”Believe me, it will be enough.” I don’t know why anyone would believe him, but that is not the point of this article.
There is a Monetarist premise that is accepted almost universally today: the value of a unit of currency is inversely proportional to the money supply. If the money supply goes up, this view argues that the value of the currency must go down. And vice versa. There is only one problem with this idea.
It is wrong.
The euro has been falling against the US dollar for over a year and the most recent leg down began in earnest in May. It has not been falling due to expanding money supply. It has been falling due to increasing market awareness that defaults are coming–reflected in collapsing bond prices not only in Greece but in Spain and Italy now.
And this brings us to Draghi’s statement today. He was not promising to decrease the money supply! All of the “tools” in his “arsenal” are tools to increase the money supply. Basically, he can print and lend (i.e. print money and lend it).
Today, he reiterated his means and intent to expand the money supply. And the euro went up +1.6%.
Something to make one go think in the night …