We face one of the deepest crises in history. A prognosis for the economic future requires a deepening of the concepts of inflation and deflation. Without understanding their dynamic relationship and their implications is difficult to predict how things might unfold. The economic future depends on the interplay of both these forces. From the point of view of their final effects, inflation and deflation are, respectively, the devaluation and revaluation of the currency unit. The quantity theory of money developed in 1912 by the American economist Irving Fisher asserts that an increase in the money supply, all other things been equal, results in a proportional increase in the price level . If the circulation of money signifies the aggregate amount of its transfers against goods, its increase must result in a price increase of all the goods. The theory must be viewed through the lens of the law of supply and demand: if money is abundant and goods are scarce, their prices increase and currency depreciates. Inflation rises when the monetary aggregate expands faster than goods. Conversely, if money is scarce, prices fall and the opposite, deflation, occurs. In this case the monetary aggregate shrinks faster than goods and as prices decrease money appreciates.
Inflation is a political phenomenon because monetary aggregates are not determined by market forces but are planned by central banks in agreement with governments. It is in fact connected with the monetary expansion to fund their deficits. Inflation raises the demand for goods and decreases the demand for money; it increases aggregate spending and money velocity as the ratio between GDP and the amount of money in circulation which expresses the rapidity with which the monetary unit is spent and respent until it remains in existence.
There is no such things as demand-pull inflation or cost-push inflation. Provided that the quantity of money does not increase, if cost or demand for some goods changes, demand for other goods must necessarily adjust, leaving unchanged the amount of spending and the money aggregate in the economic system. If some people spend more, others have to spend less, thus leaving the purchasing power unaltered. The cause of inflation is nothing but money manipulation.
Inflation is a tax affecting all real incomes. While this is obvious for the fixed ones, it is less so for the variables ones such as business income. Inflation, in fact, overstates profits by making final sale prices to rise as compared to historical sale costs. When the moment arrives that businesses renew their capital assets, the higher price they will pay for them due to inflation will absorb the extra nominal profits. Since taxes are calculated on them, real profits will be insufficient to either replace or increase capital. Hence by decumulating capital, inflation penalizes economic growth and innovation.
As an economic stimulus, inflation sets the stage for deflation. By increasing the nominal taxable economy, it reduces the real one.
Likewise, subsidies and bailouts produce the same inflationary effects because most of them are financed through monetary expansion: a money supply growing faster than the productivity of capital and labor impairs both.
If inflation accelerates and becomes extreme, hyperinflation sets in: the demand for money tends to zero and because everyone hurries to spend it to avoid the loss of purchasing power, its velocity accelerates rapidly. The monetary aggregate and prices tend to infinity and the value of money to zero. Money loses the character of a medium of exchange and the credit-debit system collapses. Because money is the prerequisite of the division of labour, its destruction implies the destruction of the latter. To avoid barter the monetary system must be redesigned. In this catastrophic state of affairs it is small comfort to acknowledge that the overall debt of a nation is repudiated.
Inflation is a precondition of extreme deflation: depression.
Deflation in itself, however, is an economic phenomenon. Economic progress has a natural tendency to lead to falling prices. By increasing production and productivity, prices decrease, signaling that the economy grows faster than the money aggregate, which means that with the same volume of expenditure more things can be bought – i.e. money has a higher purchasing power.
Because depression usually is accompanied by deflation, central banks interpret any incipient downturn in prices as a sign of crisis and try to prevent it with monetary stimulus. But a depression occurs not because the price level falls but because real output, expenditure and all incomes on which aggregate expenditure is based fall. Regardless of the causes and confusing them with the effects, central banks always inflate, opening the door to evil that they claim to cure.
True and false money
There are many definitions of monetary aggregate. Strictly speaking it is the aggregate in the narrow sense which reveals inflation because it includes only the effective means of payment excluding short term redeemable financial assets. In fact, by definition, something that must be converted into money is not itself money. No one pays necessities with short term securities. Money is only the stock or base money needed to buy goods and services. If the public holds 50 in his pocket and banks 1000 in their reserves, the monetary base equals 1050. It’s called “base” because is the foundation upon which the banking system builds a pyramid of money and credit. Whenever central banks purchase government securities either directly from governments or from banks they increase bank reserves and the monetary base setting the pace for credit expansion.
More aggregate expenditure follows, making nominal GDP grow. Because new credit corresponds to new debt, credit expansion by inducing more debt lowers the ratio between liquid assets and liabilities in the entire economy. When a deficit of liquidity follows to a credit crunch, debts repayment can only be made by deleveraging balance sheets and asset prices across the board sharply fall. Moreover part of the overall debt is cancelled by insolvencies and the combined effect of prices and debt reduction shrinks the monetary and spending aggregates triggering deflation in the form of recession. On the other hand the overall debt does not decrease because governments do not liquidate it as the private sector does. Quite to the contrary they increase debt to pay the outstanding so as to avoid default. As a matter of fact they must increase their debt to make up for debt deflation in the private sector.
Should in fact the overall debt collapse, there would be an extreme deflation or depression because the money aggregate would contract dramatically. In fact the money equivalent to the defaulted debt would literally evanish. It is for this reason that central banks monetize new debt at a lower interest rates, raising its value. Because lower interests raise also the values of all assets, the entire economy looks healthier. But debt monetization gives only the illusion of wealth. It produces inflation growing faster than GDP with the effect of diluting wealth. Real incomes fall not only because of money debasement but because by raising their nominal value, inflation pushes them into higher tax brackets. In this context only the financial sector thrives because in a context of ever growing uncertainty and unpredictability, instruments for averting risks proliferate.
All the financial bubbles and the mass of derivatives are just the consequence of debt monetization. By keeping interest rates extremely low, monetary expansion finances speculation at low cost, allowing it to shift huge amounts of money and earn risk-free profits by capturing price differentials between different markets, which, is the only way to gain returns and preserve purchasing power when interests are kept low or even negative. Because new money is dissipated through the process it must continually be recreated. Debt monetization result in a never ending process of creation and destruction of money. It discourages productive activities leaving the economic future at the mercy of speculation.
All this destabilizing process is the consequence of the creation of money out of the debt. Debt monetization is the exchange of new money for a promise to pay it in the future. Now, if money is a function of the debt it is impossible that we can settle debt permanently. Legal currencies are false money because they depend on the debt expanding and contracting accordingly. Real money cannot be a liability or a promise to pay unlimited debt of third parties subject to default.
The role of money can be discharged only by an economic good that is always in demand, preserves its value and is immune from the failure of third parties. The money with these characteristics is gold, the only financial asset which is not dependent on anybody’s promises and is not subject to debasement or default. As long as this truth is not fully recognised no structural reform whatsoever can overcome a crisis which is systemic precisely because it is immanent to an economic and financial system based on debt. Without sound money on the scene of the economic drama, inflation and deflation will continue to play their conflict until the final outcome: the monetary breakdown.
The currency cliff
In a context of false money, fiscal and monetary instruments are not only ineffective, but harmful. The first, trying to reduce the debt by increasing the tax burden results in draining resources when they are most needed. The second by refinancing the debt and boosting the monetary aggregate to prevent its collapse produces inflation. Hence debt cannot be tamed. Only hyperinflation or default can annihilate it. But the first would destroy the money system, the second would trigger a deep depression.
How will this all end? In history debt monetization has always produced hyperinflation. As long as countries are enjoying credit, fiscal deficits through inflation work. But when they incur new debt to repay the outstanding they reach the point of no return because it becomes clear that they cannot repaid it. Thence hyperinflation has always been the consequence of the inability to service the debt. Investors start to lose confidence in the country and its currency and so citizens. At this point, monetary policy can no longer defend it and a collapse ensues.
In Western countries, despite the exponential debt a runaway inflation has not yet occurred. Monetary policy has only inflated the financial sector, starving the private one, which is showing a bias towards a deflationary depression: here the demand for money increases, the velocity and prices fall but the monetary aggregate holds as long as debt monetization works. According to the quantity theory it is the money actually spent on goods and services that causes inflation. As long as liquidity is parked in the bank reserves or finances speculation it does not flow into the real economy and inflation progresses slowly. If money were suddenly released it would have the same destructive impact of a dam breaking and overthrowing water downstream. Central banks in fact control the quantity of money but not its velocity, which depends on social forces.
At the present fiscal and monetary policies try to preserve a precarious status quo, balancing inflation and deflation, a state of affairs which allows the debt perpetuation. But this balance can not be maintained for long because sooner or later inflation will be translated from the financial into the real economy via the general currency debasement taking place worldwide. It must not be forgotten that not only are currencies depreciated by debt monetization and fiscal deficits. Governments debase their currencies, destabilizing their trading relationships too by correcting trade deficits to boost exports. Hence a currency downtrend might eventually trigger a systemic collapse, because speculation causes further debasement through currency short-selling .
Ultimately the combined action of low interest rates and currency depreciation would drive investors away either from financial securities or currencies on behalf of tangible assets, notably commodities, whose prices would escalate. Demand for money would fall and so velocity and aggregate expenditure. At this point the market value of the debt securities would fall, bringing the interest rate to astronomical levels. The value of the whole debt would collapse while the price increases of critical commodities would hit the entire economy, pushing up the consumer prices dramatically.
All this process is not linear but oscillatory: massive flows of money would alternatively inflate and deflate financial and real sectors, causing vibrations in the economy that superimpose, eventually reaching a magnitude sufficient to bring down the whole economic structure. It is impossible to predict whether defaults would occur through hyperinflation or depression and where they would start first. Probably the first countries to be affected would be the ones with the weakest currency and the most fragile political setting. The outcome will also depend on the geopolitical situation. The prospect of the extension of a war would certainly make for hyperinflation. Floating currencies would disappear as suddenly as they appeared a little more the forty years ago. It is very hard to imagine the social cataclysm that it would ensue.
If all the disruptive effects of inflation were understood it would be prevented. The fact is that its effects are confused with real economic growth while inflation is pure and simple currency debasement via increasing currency supply destroying money gradually and systematically. Inflation cannot be controlled. Once the currency loses value it is lost forever. Deflation, by contrast, can be controlled – avoiding its deepening into depression. The latter is like a purge whereby the economic organism expels the poisons accumulated previously with inflation. A gradual deflation induces the recovery because it realigns values with the economic reality, reducing the inflated money stock at level that makes the debt sustainable and repayable. The currency appreciation which ensues is just the antidote to depression itself. In fact, when the quantity of money tends to be measured in terms of absolute purchasing power, it corresponds to more money and therefore to more liquidity.
Note, here, the difference between the true and the false money: defaults make money disappear, while gold, the real money, never does: once in circulation it will remain – it cannot be eliminated by default. The criticism that gold causes depression is unfounded; on the contrary avoids it.
Inflation and its effects can be contended by managing deflation, and this is a political task.
First, to avoid a systemic collapse reciprocal debts have to be either renegotiated or condoned. It must be recognized that their current dimension makes it impossible to repay them, opening the way to uncontrolled defaults.
Second, government spending must be reduced as well as taxes. At the same time, all banks’ bad debts recorded in the accounts as sound credits should be written down. Without this adjustment banks will never be able to operate normally, resuming their credit activity and financing the economy, neither will they be able to attract new capital. The recognition of their losses is the prerequisite for their financial reconstruction. In order to be able to provide new credit banks must first receive it. No investor is willing to lend them funds with the fear of covering losses disguised as gains.
All this restructuring would last a few years and would give a positive signal to markets that facing true values can restore the lost confidence in the economy. Currencies would appreciate again and money would start to flow again without inflating. However, problems would not be solved and crisis would recur with a debt based money. Hence a process of readjustment must contemplate the return of the real money, gold. Since 2010 central banks have become net importers of gold. Why keep it in their coffers? It has to be used immediately to recapitalize banks, and remonetized straight after.
Unfortunately governments and banks will go for more inflation. It is well known that both usually make not only the wrong choices but the exact opposite of the right choices. As history teaches, besides money the freedom of citizens can also be the victim.
 The theory is summed up by the famous equation of exchange whose the simplest expression is MV = Σ pQ, where money (M) multiplied by its velocity (V) equals the sum (Σ) of assets purchased (Q) multiplied by their price (p). Although it has been subject to criticism, statistics of the last two centuries prove that is substantially true.
The production process is based on the division of labor. Each manufacturer specialises in obtaining certain products and obtains other goods he needs through the exchange. The world of production based on the division of labor is necessarily an economy of exchange where money performs at the same time the function of unit of account and means of payment. As Karl Marx put it: the chain “commodities against commodities” become the chain “commodities-money-commodities”. Here is the indirect exchange replacing barter. Because money is used as an intermediary in exchange, what ultimately is traded are always goods. As David Hume wrote, “money is the only instrument which men have agreed upon to facilitate the exchange of one commodity for another. It is none of the wheels of trade: it is the oil which renders the motion of the wheels more smooth and easy. ”
The exchange economy is also a community of payments: every purchase gives rise to debts and credits which sooner or later have to be extinguished by money transfer. Hence an exchange economy is also a monetary economy. But this does not alter the underlying reality: goods are redeemed for goods and not for cash. As soon as the exchange crosses national borders, we have an international economy. Long before the economic policies of states took an interest in the international exchange of goods, private economic actors in a country found it convenient to sell goods and services to businesses in other countries and buy from them. It’s clear that the interstate economic relations in the form of exports and imports of goods made it possible to increase the division of labor. The massive and rapid growth in the production of goods in cross border trade over the past 200 years it’s the consequence of the international division of labor. Today the phenomenon of the global market integration is called globalisation.
The fair exchange
At the beginning of the 19th century, David Ricardo made a notable contribution to the concept of the international division of labor with the doctrine of comparative advantage, depicted by the famous example of trade between England and Portugal. If the latter was more efficient in the production of cloth and wine, having an absolute advantage in manufacturing both products, it would be convenient for Portugal to produce only wine where she was comparatively more efficient and import cloth from England. If Portugal did not trade, she would need to produce the cloth locally, therefore devoting part of her capital to the manufacture of cloth. In the Ricardo’s example comparative costs refer to the relative costs between the goods produced in each country.
Basically the theory asserts that when considering the gains to trade it is not absolute advantage that is relevant but comparative advantage. The existence of comparative advantage is always mutual and reciprocal. Both self-sufficiency and protectionism, cutting ties with foreign countries, would result in missed trade opportunities or impoverishment. An implication of the law of comparative advantage is that under free trade no country or region of the world is going to be left out of the international division of labor. For the law means that even if a country is in such poor conditions that it has no absolute advantage in producing anything, it still would pay for its trading partners to allow it to produce what it is least worst at.
It’s worth noting that between the purchase of English cloth through the Portuguese traders and the purchase of wine through English merchants there is no relationship. As Ricardo put it: “Every transaction in commerce is an independent transaction”. The exporter does not sell wine in order to import cloth. He sells to a stranger in order to make money. On the other hand the importer as a debtor can raise money and extinguish his debt only by selling his good. In the Ricardo’s example the import value of cloth equals the export value of wine. But in the real world there cannot be such a perfect coincidence for two countries because this would require that their supply and demand relationships be such that the value of import from one country equals the value of export of the other, which hardly happens.
Such an equivalence of values can exist only at a multilateral level and in the long run: the value of total exports of one country must always equal imports values because in the international trade which is always accompanied by a change in the relations of credits and debts, a community of payments cannot lend or borrow against another indefinitely. They have to be paid off in real terms which means that in the long run exports pay for imports. Under the gold standard, nations were unable to exchange unless buying and selling goods of similar value and this what a fair international exchange is all about.
The unfair exchange
However, globalisation did not have the positive impact on countries it was supposed to bring and real world growth has come to a standstill. Although foreign goods are available in every country now more than ever before, global market integration has delivered negative effects notably in the developed countries: income inequality, lower living standards, economic imbalances and structural vulnerabilities. How is it that the division of international labor and comparative advantage theory did not work? The popular account is that low labor cost advantage of developing countries has eroded developed nations competitiveness. But is this true?
At Ricardo’s time wages in England were comparatively higher than those of the other countries and yet she was a competitive country. The same applies to United States, Germany or Japan in 20th century: even with the highest wages in the world they were competitive nations. So labour cost differentials do not account for competitive disparities. The actual root causes of development gaps lie elsewhere.
When Ricardo expounded his doctrine, international commerce was regulated by a stable currency, gold, and under this regime world trade in relation of output grew immensely with mutual benefits. In a economy based on the division of labor, for wealth to circulate in the form of goods and services, money itself has to be wealth. Only acting as fungible and generic wealth can money be traded for specific wealth measuring its value and allowing exchanges of heterogeneous goods at a fair ratio. Gold played this role. Changes in its value did not interfere with the function of measuring other values because its momentary fluctuations affected all the goods simultaneously – their relative values unaltered although those values were expressed in higher or lower gold prices. With such an intermediary, the exchange ratio between goods exported and imported did not change unless countries’ respective productivities did. In fact it is productivity that is the source of value determining the terms of trade, not gold which is only wealth acting as a neutral means of exchange. A country might settle its contingent trade deficit either by being more productive or drawing out of its gold reserves. But since the late 20th century, international trade has been deprived of real money and disruption started to unfold.
When the dollar standard replaced the gold standard, a universal demand for the American currency was created. Unlike gold, dollars could be produced without limits at virtually no cost. This gave the US a tremendous advantage over its competitors: they could pay for imports not with the proceeds from export but by “manufacturing” irredeemable dollars. As a global reserve currency, the dollar took control over the currency markets and the US no longer settled debts in real terms. On the other hand, emerging countries, notably China, turned the situation to their advantage by trading cheap goods for a currency endowed with the exclusive privilege to buy commodities essential for growth and accumulating paper reserves to buy other valuable goods.
The dollar as a means of settlement of debts without producing made for US deindustrialization. Ironically this capitalist country, once the largest creditor in the world, became the largest debtor and China, a former communist country, the larger creditor. Since the gold standard abandonment practically no debt has been settled in the international trade because all governments have been creating fictitious money at the same speed. And because today the means of payments are credit creations without any backing, the monetary economy has become a debt economy where obligations are never extinguished.
In fact, as already remarked, debts are fundamentally obligations to give not money but wealth. Thus under a regime of fictitious money, products no longer pay for products, exports no longer pay for imports. As soon as gold was demonetized and irredeemable currencies were put under governments’ political authority, international trade has stumbled in a self-feeding vicious circle: deficits have caused currencies to fall in value one relative to the others lowering the value of exports and making them unable to pay for the same value of imports which in turn have boosted trade deficits further. To correct trade deficits, nations are devaluing currencies with the effect not only of distorting terms of trade but of triggering a universal process of deindustrialization which even the emerging countries won’t escape. As long as countries accept inflated currencies for real goods they are financing consumption at the expense of the capital necessary to fund their production process. Falling currencies lower export values relative to imports, and raise demand for exports. But this far from generating growth is causing an unfavorable shift in the terms of trade resulting in a country having to export more to import the same amount of goods. This amounts to producing more for less pay – lowering productivity, real wage rates and purchasing power.
The gold standard tended to equalize the purchasing power of redeemable currencies to terms of trade so that the exchange rate was a transmission mechanism for real productivity gains. But inflated currencies have obscured this process of wealth creation and competitiveness, turning globalisation from social and economic cooperation into a destructive race among nations.
To make globalisation work and restore balanced economic growth, we urgently need to bring real money back into circulation.
The advent of a European Union with a single currency was hailed by Nobel laureate Robert A. Mundell as
a great step forward, because it will bring forth new and for once meaningful ideas about reform of the international financial architecture. The euro promises to be a catalyst for international monetary reform.
Unfortunately, by underwriting member countries’ financial risk with impunity, the EU made the euro the catalyst of unsound monetary policies that are now leading the Union into an economic maelstrom. Still less has euroization set the pace for an international reform of the monetary machinery.
Milton Friedman was more cautious about this super currency. The euro’s real Achilles heel, he said, would prove to be political: a system under different governments subject to very different political pressures could not endure a common currency. Without political integration, the tension and friction of the national institutional systems would condemn it to failure. Indeed the problem is always political, but not in the sense meant by Friedman. Regardless of the degree of political integration, governments’ spending and dissipation, which are unalterable tendencies of any political organism, make irredeemable paper monies act as transmission belts for financial and economic disruptions.
At the outset of the 2010 Greek crisis that triggered the European domino effect, Professor Mundell pointed out that there was nothing inherently bad in the euro as such; the problem lay in the country’s public debt spiralling out of control. However, being a strong advocate of financial and monetary “architectures” as means for pursuing monetary and non monetary ends, he should have acknowledged that irredeemable currencies cannot be examined independently of the political framework in which they are embedded, because politics inevitably extends the role of money beyond its original function as a medium of exchange, making it trespass into the field of “economic policies”. Official theory does not see money as a neutral device, but as an instrument of policy for purposing ends which conflict with its primary goal: to retain the value of the monetary unit. Failing this primary goal, monetary architectures no matter how they are framed make for economic devastation.
Is a monetary order a constitution?
Robert Mundell’s assertion — that a monetary order is to a monetary system what a constitution is to a political or electoral system — unintentionally sheds light on the authoritarian nature of today’s irredeemable money governance and its fraudulent practices. Where is the flaw in this catching parallel? The flaw is that if a monetary order stands for a constitution, i.e. a democratic framework of laws and regulations, it does not provide for a separation of powers. The money order as a legislative system coincides with the executive power, the money system, embracing the range of practices and policies pursued for monetary and non monetary ends. Moreover, the judicial system is concentrated in the same hands because monetary authorities are not accountable to anyone. With the exception of governments that, being their source of power, may be considered “ghost writers” of monetary constitutions, no one else can influence money legislation. In other words, in this framework there is no room for an “electorate” (producers and consumers). What basic law regulates the relationships between individuals and their monetary orders by guaranteeing fundamental rights?
The basic law of the gold standard was the free convertibility of currencies, allowing individuals to redeem paper into gold on demand. This acted as protection against money misuse by banks or governments. Convertibility was for producers and consumers the means to express their vote on the degree of money reliability. Money was an instrument of saving. Paper money, or fiduciary circulation, as opposed to the banknote which was a title of credit, could be issued too but it had to comply with the law of gold circulation whereby the total volume of currency, coins, banknotes and paper notes had to correspond exactly to the quantity of metallic money necessary to allow economic exchanges. This being the purpose of the monetary system, banks, to avoid insolvency risks and gold reserves outflow had to adjust, through the discount rate policy, the issue of fiduciary papers to the real needs of economy.
Therefore gold was a barrier against the use of money as an instrument of power. Its value was fixed on the world market where gold was always in demand. Gold then had the same value in each country, and that’s why it was a stable international means of payment. Finally exchange rates were stable, not because they were arbitrarily controlled by government but because they were always gravitating towards the gold parity, the rate at which currencies were exchanged, and this was determined by their respective gold content. Roughly stated, the gold standard was an order providing for a separation of powers: the fundamental law of metallic circulation was the constitution, the banking system was the executive power which was controlled by producers and consumers representing the judicial power to sanction abuses. In today’s monetary order, producers and consumers have become legally disarmed victims of monetary legislation, deprived of the weapon of defence against money manipulation.
A trail of broken monetary arrangements
Central banks are the pillars of the monetary order because they are the source of the world’s supply and they regulate it. They control circulation, expand and restrict credit, stabilize prices and, above all they act as instruments of State finances. They are both “anvil and hammer”, trying to adapt the system to all occasions, remedying abuse by a still greater abuse, and considering themselves immune from the consequences. For these reasons, the leading architects of the world financial order should explain how the very same institutions that are pursuing unsound policies domestically might realistically think to establish a sound monetary order at a higher level.
The most important architecture, after the Second World War, was the Bretton Woods Agreement (1944). A “managed” form of gold standard was designed to give a stable word monetary order by a fixed exchange rate system with the dollar as the key currency, redeemable in gold only to central banks, and with member countries’ currencies pegged to the dollar at fixed rates and indirectly redeemable in gold. But the huge balance of payments deficit and high inflation in the US should have made gold rise against the dollar. A crisis of confidence in the reserve currency pushed foreign countries’ central banks to demand conversion into the metal, panicking the US, which promptly closed the gold window.
After the end of Bretton Woods in 1971, fiat currencies began to rule the world
The Smithsonian Agreement (1971-1973) which followed Bretton Woods was hailed by President Nixon as the “greatest monetary agreement in the history of the world” (!). It was an order based on fixed exchange rates fluctuating within a narrow margin, but without the backing of gold. Again, countries were expected to buy an irredeemable dollar at an overvalued rate. The system ended after two years.
Within the West European block, fixed exchange rates remained, but floating within a band against dollar. “The snake”, as the arrangement was called, died in 1976. Major shocks, including the 1973 oil price spike and the 1974 commodity boom, caused a series of currency crises, repeatedly forcing countries out of the arrangement. But this did not persuade them to abandon the dream of intra-European currency stability. The snake was replaced in 1979 by the European Monetary System (EMS) with its basket of arbitrarily fixed-but-adjustable exchange rates floating within a small band and pegged to the European currency unit (ecu), the precursor of euro.
Yet the arrangement ultimately failed, again due to a series of severe shocks (a global recession, German economic and monetary unification, liberalization of capital controls). Rather than abandoning the system, European governments adopted much wider fluctuation bands, reaffirming their commitment to an order based on fixed rates and irredeemable currencies.
So we arrive at an arrangement without historical precedent: sovereign nations with a single legal tender issued by a common central bank — the Euro entered into function in 1999. The stated aims of the single currency were noble: to facilitate trade and freedom of movement, providing for a market large enough to give each country better insulation against external shocks. Unfortunately, it couldn’t provide the member states with a system of defence against the internal shocks inherent to any irredeemable currency.
History confirms that currencies cannot rest on stability pacts and similar restrictions. Mainstream economists have long argued that the euro crisis has arisen from the lack of common social and fiscal policies, but the architects of the European currency were also well aware of this. Their aim was always to forge a European people, and a socialist European superstate, on the back of the euro. They had not the patience for a European state to naturally emerge in the same manner as the US, from a population sharing the same culture and language. “Europe of the people and for the people” was a misleading disguise to give an economic prison the honest appearance of a democratic and liberal project.
So in the end, Euroland has been working as a hybrid framework of institutions to which members countries delegate some of their national sovereignty in exchange for access to a larger market, capital, and low interest rates. But they entered an region of anti-competitive practices, antitrust regulations, redistributive policies, lavish subsidies, and faux egalitarianism — a perfect economic environment in which to run astronomical debts. The euro system represents one of the most significant attempts to place a currency at the service of political and social objectives, and it is for this reason that it will remain a source of problems.
Descent into the maelstrom
Today’s monetary orders are shaped to pursue what Rothbard has called the economics of violent intervention in the market. They are, in essence, based on a socialist idea of money. Accordingly they make for a framework of laws, conventions, and regulations fitting the interests of the rulers. In this framework it is the public debt that has utmost importance. Indeed, it is the monetary order that has developed the concept of debt in the modern sense. Because the management of public finances have become the supreme direction of economic policy, treasuries are now in charge of the national economies. Through the incestuous relationships they maintain with central banks, they are able to create the ideal monetary conditions in which to borrow ad libitum. Purely monetary considerations such as providing a stable currency are disregarded. Political, fiscal and social ends prevail over everything else.
In the last eighty years, monetary orders have allowed an abnormal increase in finance, banking, debt, and speculation completely unrelated to a development of sound economic activity and wealth production, but due instead to government’s overloading of central banking responsibilities. Unfortunately, the outcome is the de facto insolvency of the world monetary order. The ensuing adverse effects may be still delayed with the aid of various measures, interventions and expedients, but not much time is left. The stormy sea of debt has already produced a whirlpool that will be sucking major economies into a maelstrom, and the larger they are, the more rapid will be their descent. It remain to be seen what shape they will take after the shipwreck. Gloomy as the situation may appear, it is not hopeless because such an event might be the sole opportunity to cause a decisive change. It might be that instead of resuming the art of monetary expedients to create irredeemable money, governments and banks let them fade into oblivion. This would allow people to take their monetary destiny back into their own hands.