Latvia Joins Eurozone Despite Native Disapproval

Latvian Prime Minister Valdis
Dombrovskis holds up a Euro
banknote for a media event

With the addition of Croatia this past summer, the European Union grew to twenty-eight member states composed of slightly over 500 million people. Indeed, there is power in numbers, and yet with size comes complications and numerous conflicting interests. This New Year, Latvia officially adopted the Euro as its national currency, in spite of reports that just over one half of the Latvian population opposed the adoption. The economic integration of the European Union offers many advantages, particularly to smaller nations with history of political or economic instability. Perhaps most importantly, membership in the Union provides obvious benefits in the form of capital, labor, and technological mobility in one of the world’s largest, if not largest economic market. On the other hand, domestic skeptics, most notably in the United Kingdom, worry about the consequences of the loss of national sovereignty that is a direct result of the further integration.  In the case of Latvia, its economy shrank by over a fifth in the wake of the financial crisis. However, significant support from the European Union and the IMF has propelled Latvia’s economy by stabilizing growth. However, this economic growth has also resulted in inflation.

Estonia adopted the Euro in January of 2011, and inflation increased that year by almost five percent.  Latvia’s historical ties to the Soviet Union may also be a factor in the population’s disapproval of the European Union. One of the most obvious limitations of a currency union is the restraint it places on the monetary policy of domestic central banks. The currency zone effectively distorts the market equilibrium. For smaller, undeveloped nations the Euro is over-valued relative to the countries’ previous currencies. This puts a strain on national exports. Conversely, Germany benefits greatly from the Euro because struggling nations in the EU lower the value of the Euro on aggregate, which helps German exports. Many economists assert that the Deutsche Mark would be valued higher than the current Euro. Germany is also the beneficiary of substantial foreign investment relative to other Euro members because it is considered, and rightfully so, to be low-risk. Typically high levels of foreign investment would strengthen the national currency while hurting other domestic industries. This has not occurred in Germany because weaker Union members continue to drag down the value of the Euro. All of this contributes to a modern currency battle, leaving many national populations at odds with one another.
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Chris Kenny

Market Recap (Sep. 17)

The S&P 500 Index (.SPX) fell 0.35% from 1465.42 to 1460.15 over the course of last week amid concerns that turmoil in the euro zone will continue to negatively affect global economic growth. The CBOE Volatility Index (.VIX), which measures volatility in the stock market and is generally considered to be the most accurate indicator of investor fear, traded above 14. The FTSE Eurotop 300 Index traded as high as 1,121.35 and as low as 1105.66 before finishing relatively flat at 1119.32 for a loss of 0.08%. The down trading over the week came as Mario Draghi and the ECB's bond buying plan failed to lift German business confidence and sentiment dropped for a fifth straight month. Spanish Prime Minister Mariano Rajoy's administration will present its budget to parliament this Thursday and bank audit results on Friday. Additionally, Moody's will be issuing a new credit rating on Spanish debt in the coming days that could affect investor sentiment even further.

The currency markets experienced volatility this week as the euro lost more against the dollar than during any other period over the last two months. Although the Federal Reserve's plans to expand the money supply and the ECB's bond buying program has seen the euro recover to heights of ~$1.31 against the dollar over the past few days, EUR/USD was trading back in the $1.28-$1.29 range by Monday, September 24.

Commodities news was dominated by oil prices plummeting. In a three day stretch last week, crude oil prices fell by more than 7%. A large sell order placed by a market mover on Monday triggered stop-losses and prices subsequently continued to decline. Winter months typically cause oil prices to become bearish and hibernate, but depending on how certain diplomatic tensions between key oil producers in the Middle East work out over the coming months, we could see a supply squeeze and a rebound of oil prices.
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Nicholas Hurst