Euroland: an Austrian view

In the last two weeks the headlines have switched from Greece to Italy. Financial and economic commentators who dismissed Greece as a small cog in the Euroland machine are now seriously alarmed and see no solution to Europe’s sovereign debt crisis other than the short-term expedient of getting the European Central Bank to print lots of money. They castigate Germany’s sound money approach, ignoring the fact that it has been central to Germany’s economic success, preferring to commend the loose-money economics of the unsuccessful “PIIGS” (Portugal, Ireland, Italy, Greece and Spain). And when listening to them, just remember that none of them foresaw this crisis, when it was obvious to Austrian economists in the early days of the banking crisis.

Keynesian and monetarists believed that the problems surfacing in the PIIGS would be resolved by economic growth, which would follow so long as governments maintained their deficit spending. As events are now proving, this analysis was flawed, which is why Keynesians are now confused. They should open their minds and absorb Austrian economic theory to gain a proper understanding of human actions and how people are affected by money and credit.

The first thing they will learn is that the economic benefits of credit expansion are a myth. All it does, by a process of capital redistribution – from savers to those who are first in line to receive the new money – is distort the economy and restrict its long-term potential. By lowering interest rates and diverting private sector resources from genuine production to government spending, the economy becomes less efficient and malinvestments occur. The mistake has been to only consider the visible benefits, such as short-term job creation, while ignoring the destructive effects of deficit financing.

The distortions created by easy money and deficit spending will naturally try to reverse themselves as surely as night follows day. The recession that follows the temporary boom is the way an economy cures itself from unsound money and government intervention. This is hard for interventionist governments to accept because it strikes at the heart of their existence. And while printing money and credit is always popular with an electorate that does not understand what is happening to their money, reversing the process is readily noticed and immensely unpopular.

This brings us back to Euroland’s problems. The creation of the euro twelve years ago allowed banks to expand credit massively in the mistaken belief that sovereign risk had been eliminated. The result was that spendthrift governments availed themselves of cheap credit. Eurozone governments, particularly the PIIGS but also France and Belgium, have squandered huge sums to prevent the unwinding of malinvestments and other economic distortions, preferring to perpetuate existing malinvestments. The only solution is for them to let the unwinding happen, which is what the financial markets (for which read reality) are now forcing them to do.

What we are seeing, the markets unwinding economic distortions from the past, is a necessary process and therefore beneficial, a point which goes completely unrecognised. If only governments had the sense to understand this, it is not too late to plan wisely for regenerated economies and a sounder Europe. Unfortunately, the gut reaction of the political class and its advisors is to continue as before at all costs, deferring this necessary adjustment and increasing its eventual severity.

There is no joy for the informed spectator in seeing continuing economic destruction. However harsh it may be in the short-term, the EU elite needs to start paying attention to Austrian School remedies to Europe’s financial woes – and fast.

This article was previously published at GoldMoney.com

5 Comments

  • John says:

    A glance at the ECB’s monetary statistics would reveal that Germany/Europe did not pursue sound monetary policies at all.

    I am not sure as to what is the “Austrian School” alluded to in this article. My understanding of the Austrian view is that excessively low interest rates can lead not only to inflation (which i.m.o. is really the least of the problems), but would create economic imbalances, possibly reflected in current account deficits and balance of payments issues.

    From this perspective, the German economy is not in a “healthy” condition but is also a sick man, just like the PIIGS. The PIIGS are far from being fully culpable for their plight.

    Either way – the remedy would depend on which course of action is pursued. A break-up of the Eurozone would be my preferred course of action. However, if the Eurozone is to be kept intact, then the proper way out is via money printing by the ECB. The Germans would have to bear part of the burden of economic adjustment through high inflation.

  • John says:

    btw Germany has a huuuuge share of malinvestments too. Arguably the European Central Bank catered too much to the German situation to the neglect of the PIIGS.

    This led to huge economic imbalances between the Northern and Southern states – and this being a microcosm of the imbalances between East Asia (particularly China) and America (both China and America operating on a pseudo-peg, thus in some ways similar to a single currency).

    That is not to say that every balance of payments issue can be attributed to monetary policy. The point is that monetary policy can lead to economic imbalances, and current account deficits are one possible manifestation of that.

    From this perspective, I disagree with the moralizing tone of Germany supported by this article. The PIIGS are really less culpable for the EMU problems. The ECB goofed up big time.

    The debt has to be write-down one way or another – either through a EMU break-up allowing a currency depreciation by the Southern European states, or through many more bail-outs and heavy inflation. As many of the Southern European are undergoing monetary deflation – if there is to be economic recovery for them, a EMU break-up is the only pathway.

    Two nice articles by Ambrose Evans-Pritchard:

    http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100011624/in-defence-of-pigs/

    http://www.telegraph.co.uk/finance/financialcrisis/8755881/Germany-and-Greece-flirt-with-mutual-assured-destruction.html

  • Ivo Cerckel says:

    If only governments had the sense to understand the … euro.

    This is a currency crisis in Europe? I completely agree,,,,,,,,,the dollar will never work!

    If this is a crisis of the euro, show me what’s wrong with the management of the euro.
    http://www.usagold.com/goldtrail/archives/goldtrailtwo.html

    Here’s from my notes of a 28 September 2011 speech in Antwerp by Frans baron Van Daele, chief of staff of EU president Van Rompuy, to the alumni of Leuven University (Baron Van Daele’s main job being the presidency of Alumni Lovaniensis):

    QUOTE (or rather translation):
    existential crisis as a result of an error in the design of EMU (“een constructiefout in EMU” )
    the common interest of 17 euro states is being endangered
    there is a flaw
    THE FLAW = one has imposed budgetary discipline
    but that does not suffice – it has appeared
    Greenspan has brought too much money in circulation
    The survival of Western civilisation depends upon the euro
    UNQUOTE

    I want to know what’s wrong with the management of the euro, not the USA dollar.

    The problem is the construction/interpretation of the euro as if its existence depended on the Maastricht criteria of the Stability and Growth Pact.
    http://bphouse.com/honest_money/2011/11/13/the-euro-is-alive-and-kicking-thankyou/

  • waramess says:

    Great comments John.

    There will be no growth whilst the public sector continues to grow. Shortly the UK public sector, on their own suspect figures, will be consuming more than the private sector.

    Only severe myopia on the part of our Keynesian and Monetarist masters can fail to see the most obvious.

  • I thank John for having recalled the role of interest rates; the current Austrian orthodoxy keeps forgetting this (which would heavily disappoint Hayek and. sincerely, Mises too).
    Germany can politically act as a moraliser as they are the engine of Europe and they have a more rigorous approach to finance and money – this does not mean they are perfect, they are just better than the most of UE members.
    The BCE has not acted virtuosly in monetary terms: they are better than the Fed (the euro has gained a 50% against the dollar since its birth), but worse than swiss franc (the euro has lost 50% in the meanwhile). Numbers don’t say all, but they can say much in this case.

    The European mess cannot dismissed by a mere “let it break apart and inflationate”; the costs would overcome every benefit. Mediterranean EU members (is Ireland mediterranean? *lol*) have exploited near-German interest rates thanks to a Frankfurter-supposed euro, without the wiseness to start spare money; lower interest rates have started then an Austrian cycle, and now they are paying for these micro- and government-level mistakes.
    The solution cannot be a back-to-past inflationism which they have tried to escape by the Euro (even though France has made the EU a trasfer union); the solution is a smaller State, lower spending, industrial conversion far from low-cost sectors where Asia rules. This involves sacrifices, but a jump back to inflationism would involve even greater costs (and I am not sure that the shortening length of the cycles can be coped with the fixed effectiveness-lag of monetary policy forever).

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