What the media calls a “currency war,” whereby nations engage in competitive currency devaluations in order to increase exports, is really “currency suicide.” National governments persist in the fallacious belief that weakening one’s own currency will improve domestically-produced products’ competitiveness in world markets and lead to an export driven recovery. As it intervenes to give more of its own currency in exchange for the currency of foreign buyers, a country expects that its export industries will benefit with increased sales, which will stimulate the rest of the economy. So we often read that a country is trying to “export its way to prosperity.”
Mainstream economists everywhere believe that this tactic also exports unemployment to its trading partners by showering them with cheap goods and destroying domestic production and jobs. Therefore, they call for their own countries to engage in reciprocal measures. Recently Martin Wolf in the Financial Times of London and Paul Krugman of the New York Times both accuse their countries’ trading partners of engaging in this “beggar-thy-neighbour” policy and recommend that England and the US respectively enter this so-called “currency war” with full monetary ammunition to further weaken the pound and the dollar.
I am struck by the similarity of this currency-war argument in favour of monetary inflation to that of the need for reciprocal trade agreements. This argument supposes that trade barriers against foreign goods are a boon to a country’s domestic manufacturers at the expense of foreign manufacturers. Therefore, reciprocal trade barrier reductions need to be negotiated, otherwise the country that refuses to lower them will benefit. It will increase exports to countries that do lower their trade barriers without accepting an increase in imports that could threaten domestic industries and jobs. This fallacious mercantilist theory never dies because there are always industries and workers who seek special favours from government at the expense of the rest of society. Economists call this “rent seeking.”
A Transfer of Wealth and a Subsidy to Foreigners
As I explained in Value in Devaluation?, inflating one’s currency simply transfers wealth within the country from non-export related sectors to export related sectors and gives subsidies to foreign purchasers.
It is impossible to make foreigners pay against their will for the economic recovery of another nation. On the contrary, devaluing one’s currency gives a windfall to foreigners who buy goods cheaper. Foreigners will get more of their trading partner’s money in exchange for their own currency, making previously expensive goods a real bargain, at least until prices rise.
Over time the nation which weakens its own currency will find that it has “imported inflation” rather than exported unemployment, the beggar-thy-neighbour claim of Wolf and Krugman. At the inception of monetary debasement the export sector will be able to purchase factors of production at existing prices, so expect its members to favour cheapening the currency. Eventually the increase in currency will work its way through the economy and cause prices to rise. At that point the export sector will be forced to raise its prices. Expect it to call for another round of monetary intervention in foreign currency markets to drive money to another new low against that of its trading partners.
Of course, if one country can intervene to lower its currency’s value, other countries can do the same. So the European Central Bank wants to drive the euro’s value lower against the dollar, since the US Fed has engaged in multiple programs of quantitative easing. The self-reliant Swiss succumbed to the monetary debasement Kool-Aid last summer when its sound currency was in great demand, driving its value higher and making exports more expensive. Lately the head of the Australian central bank hinted that the country’s mining sector needs a cheaper Aussie dollar to boost exports. Welcome to the modern version of currency wars, AKA currency suicide.
There is one country that is speaking out against this madness: Germany. But Germany does not have control of its own currency. It gave up its beloved Deutsche Mark for the euro, supposedly a condition demanded by the French to gain their approval for German reunification after the fall of the Berlin Wall. German concerns over the consequences of inflation are well justified. Germany’s great hyperinflation in the early 1920’s destroyed the middle class and is seen as a major contributor to the rise of fascism.
As a sovereign country Germany has every right to leave the European Monetary Union and reinstate the Deutsche Mark. I would prefer that it go one step further and tie the new DM to its very substantial gold reserves. Should it do so, the monetary world would change very rapidly for the better. Other EMU countries would likely adopt the Deutsche Mark as legal tender, rather than reinstating their own currencies, thus increasing the DM’s appeal as a reserve currency.
As demand for the Deutsche Mark increased, demand for the dollar and the euro as reserve currencies would decrease. The US Fed and the ECB would be forced to abandon their inflationist policies in order to prevent massive repatriation of the dollar and the euro, which would cause unacceptable price increases.
In other words, a sound Deutsche Mark would start a cascade of virtuous actions by all currency producers. This Golden Opportunity should not be squandered. It may be the only non-coercive means to prevent the total collapse of the world’s major currencies through competitive debasements called a currency war, but which is better and more accurately named currency suicide.
This article was previously published at Mises.org.
We use the term “reserve currency” when referring to the common use of the dollar by other countries when settling their international trade accounts. For example, if Canada buys goods from China, it may pay China in US dollars rather than Canadian dollars, and vice versa. However, the foundation from which the term originated no longer exists, and today the dollar is called a “reserve currency” simply because foreign countries hold it in great quantity to facilitate trade.
The first reserve currency was the British pound sterling. Because the pound was “good as gold,” many countries found it more convenient to hold pounds rather than gold itself during the age of the gold standard. The world’s great trading nations settled their trade in gold, but they might hold pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment. Toward the end of World War II the US dollar was given this status by international treaty following the Bretton Woods Agreement. The International Monetary Fund (IMF) was formed with the express purpose of monitoring the Federal Reserve’s commitment to Bretton Woods by ensuring that the Fed did not inflate the dollar and stood ready to exchange dollars for gold at $35 per ounce. Thusly, countries had confidence that their dollars held for trading purposes were as “good as gold,” as had been the Pound Sterling at one time.
However, the Fed did not maintain its commitment to the Bretton Woods Agreement and the IMF did not attempt to force it to hold enough gold to honor all its outstanding currency in gold at $35 per ounce. The Fed was called to account in the late 1960s, first by France and then by others, until its gold reserves were so low that it had no choice but to revalue the dollar at some higher exchange rate or abrogate its responsibilities to honor dollars for gold entirely. To it everlasting shame, the US chose the latter and “went off the gold standard” in September 1971.
Nevertheless, the dollar was still held by the great trading nations, because it still performed the useful function of settling international trading accounts. There was no other currency that could match the dollar, despite the fact that it was “delinked” from gold.
There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value vis-à-vis other commodities over time. These two factors create a demand for holding a currency in reserve. Although the dollar was being inflated by the Fed, thusly losing its value vis-à-vis other commodities over time, there was no real competition. The German Deutsche mark held its value better, but German trade was a fraction of US trade, meaning that holders of marks would find less to buy in Germany than holders of dollars would find in the US. So demand for the mark was lower than demand for the dollar. Of course, psychological factors entered the demand for dollars, too, since the US was seen as the military protector of all the Western nations against the communist countries for much of the post-war period.
Today we are seeing the beginnings of a change. The Fed has been inflating the dollar massively, reducing its purchasing power in relation to other commodities, causing many of the world’s great trading nations to use other monies upon occasion. I have it on good authority, for example, that DuPont settles many of its international accounts in Chinese yuan and European euros. There may be other currencies that are in demand for trade settlement by other international companies as well. In spite of all this, one factor that has helped the dollar retain its reserve currency demand is that the other currencies have been inflated, too. For example, Japan has inflated the yen to a greater extent than the dollar in its foolish attempt to revive its stagnant economy by cheapening its currency. So the monetary destruction disease is not limited to the US alone.
The dollar is very susceptible to losing its vaunted reserve currency position by the first major trading country that stops inflating its currency. There is evidence that China understands what is at stake; it has increased its gold holdings and has instituted controls to prevent gold from leaving China. Should the world’s second largest economy and one of the world’s greatest trading nations tie its currency to gold, demand for the yuan would increase and demand for the dollar would decrease. In practical terms this means that the world’s great trading nations would reduce their holdings of dollars, and dollars held overseas would flow back into the US economy, causing prices to increase. How much would they increase? It is hard to say, but keep in mind that there is an equal amount of dollars held outside the US as inside the US.
President Obama’s imminent appointment of career bureaucrat Janet Yellen as Chairman of the Federal Reserve Board is evidence that the US policy of continuing to cheapen the dollar via Quantitative Easing will continue. Her appointment increases the likelihood that demand for dollars will decline even further, raising the likelihood of much higher prices in America as demand by trading nations to hold other currencies as reserves for trade settlement increase. Perhaps only such non-coercive pressure from a sovereign country like China can wake up the Fed to the consequences of its actions and force it to end its Quantitative Easing policy.
This article was previously published at Mises.org.
The euro debt crisis in Europe has presented Germany with a unique opportunity to lead the world away from monetary destruction and its consequences of economic chaos, social unrest, and unfathomable human suffering. The cause of the euro debt crisis is the misconstruction of the euro that allows all members of the European Monetary Union (EMU), currently 17 sovereign nations, to print euros and force them on all other members. Dr. Philipp Bagus of King Juan Carlos University in Madrid has diagnosed this situation as a tragedy of the commons in his aptly named book The Tragedy of the Euro. Germany is on the verge of seeing its capital base plundered from the inevitable dynamics of this tragedy of the commons. It should leave the EMU, reinstate the deutsche mark (DM), and anchor it to gold.
The Structure of the European Monetary Union
The European System of Central Banks (ESCB) consists of one central bank, the European Central Bank (ECB), and the national central banks of the EMU, all of which are still extant within their own sovereign nations. Although the ECB is prohibited by treaty from monetizing the debt of its sovereign members via outright purchases of their debt, it has interpreted this limitation on its power not to include lending euros to the national central banks taking the very same sovereign debt as collateral. Of course this is simply a backdoor method to circumvent the very limitation that was insisted on when the more responsible members such as Germany joined the European Monetary Union.
Corruption of the European Central Bank into an Engine of Inflation
When the ECB was first formed around the turn of the new millennium, the bond markets assumed that it would be operated along the lines of the German central bank, the Bundesbank, which ran probably the least inflationary monetary system in the developed world. However, they also assumed that the EMU would not allow one of its members to default on its sovereign debt. Therefore, the interest rate for many members of the EMU fell to German levels. Unfortunately, many nations in the EMU did not use this lower interest rate as an opportunity to reduce their budgets; rather, many simply borrowed more. Thus was born the euro debt crisis, when it became clear to the bond market that debt repayment by many members of the EMU was questionable. Interest rates for these nations soared.
Over the past few years the European Union itself has established several bailout funds, but the situation has not been resolved. In fact, things are even worse, for it now appears that even larger members of the EMU succumbed to the debt orgy and may need a bailout to avoid default. Thus we have arrived at the point predicted by Dr. Bagus in which the euro has been plundered by multiple parties and the pot is empty. The ECB and many sovereign members of the EMU want unlimited bond buying of sovereign debt by the ECB. Only Germany opposes this plan, but it is the lone voice against this new bout of monetary inflation.
The Historical Context of German Antipathy to Monetary Inflation
In 1923 Germany experienced one of the world’s worst cases of hyperinflation and the worst ever for an industrialized nation. The reichsmark was destroyed by its own central bank, plunging the German people into misery and desperation. Now, after only a dozen years of relative monetary discipline, the euro faces the same fate as country after country demands to be bailed out of its mounting debts by unlimited printing of money by the ECB. Because Germany is part of the EMU, it must accept these newly printed euros. This threatened monetary inflation of unlimited amounts has shaken German bankers to the core. It is the nightmare scenario that they feared when, against their better judgment, the German politicians agreed to give up their beloved deutsche mark and place the economic fate of the nation in the hands of a committee of foreigners not as concerned about monetary inflation. But Germany can put a stop to this destruction and save the world while it saves itself. It can leave the EMU, reinstate the deutsche mark, and tie it to gold.
A Golden Deutsche Mark Is Possible and Desirable
Despite the haughty pronouncements of EU officials, there is nothing that can stop a sovereign country from leaving the EMU and adopting a different monetary system. The most likely scenario would be a one-for-one redenomination of German banks’ euro-denominated accounts for deutsche marks. Thereafter, the DM would float freely in currency markets in the same way as British pounds and American dollars. The Bundesbank would be responsible for monetary policy just as it was before Germany joined the EMU. By leaving the EMU Germany would insulate itself from the consequences of the euro as a tragedy of the commons; i.e., monetary inflation by third parties would end, Germany would not experience higher prices due to the actions of third parties, and the capital-destroying transfers of wealth would end.
Yet Germany should go one step further. It should anchor the DM to gold. Germany is the world’s fourth-largest economy, behind only the United States, China, and Japan. Furthermore, Germany owns more of the world’s gold than any other entity except the United States, more than either China or Japan and more than any other European country. A prerequisite to market acceptance of any gold money would be confidence in the integrity of the sponsoring institution. Not only is the Bundesbank known for its integrity and reverence for stable money; Germany itself has a worldwide reputation for the rule of law, advanced financial architecture, and a stable political system. For these reasons, Germany would prove to the world that a gold-backed money is not only possible but desirable. Expect a cascade of similar pronouncements once Germany’s trading partners realize the importance of settling international financial transactions in the best money available — which initially at least would be a golden DM.
Germany Should Seize the Moment!
Of course the beneficial consequences of tying money to gold go beyond ending price inflation and capital-destroying wealth transfers. We can expect all the beneficial consequences of a return to limited government, for government could no longer fund itself through the unholy alliance with an inflationary central bank that creates fiat money in order to monetize government’s profligate spending. The people would no longer be so subservient to government, pleading and begging for special interests at the expense of the rest of society, for government would be forced to go to the people for approval to increase its budget. The list of benefits goes on and on. Suffice it to say that it all begins with truly sound money, money anchored in gold. Germany can lead the way and earn the just respect of a grateful world. It is in the right place at the right moment in history. It should seize the moment!
This article was previously published at Mises.org.
This summer Roger Bootle won Lord Wolfson’s £250,000 prize for the best advice for a country leaving the European Monetary Union (one may assume that this advice is aimed at Greece). A more statist, anti-liberal policy than his could hardly be envisioned, which is a sad commentary on the mindset of the judges chosen by Lord Wolfson. His advice contrasted sharply with that of Dr. Philipp Bagus, whose liberal, transparent, and free market-oriented policy advice was rejected in favor of Mr. Bootle’s call for state secrecy and coercion.
Mr. Bootle’s statist advice stems from his misunderstanding of basic economics in which he views symptoms as causes. He offers no explanation for Greece’s unsustainable debt burden, high cost structure and high unemployment other than the standard Keynesian explanation of inadequate aggregate demand. Once this fallacious view is swallowed, the prescription follows axiomatically; i.e., devalue the currency to restore competitiveness vis a vis foreign markets, which will increase aggregate demand and reduce unemployment. Oh, and the Greeks may have to default on their foreign debt, but history shows that this is not a problem. Really?
Despite his lengthy and repetitive prize submission, Mr. Bootle’s recommendations can be summarized in this one sentence: In complete secrecy and with no prior discussion, redenominate all Greek euro-denominated bank accounts into Drachma-denominated accounts and devalue the Drachma.
That’s it! There is no need to cut public spending. Quite the contrary, because public spending adds to the Keynesian concept of aggregate demand, and aggregate demand cannot be allowed to fall. The secrecy part is essential for Mr. Bootle’s plan. If the Greek people got wind of what was to happen, they would take measures to protect their property, such as transferring their euro-denominated bank balances to banks in Germany. Mr. Bootle refers to such a development as a crisis, but a crisis for whom? Taking measures to protect one’s property would not be a crisis for the common Greek citizen. It would be exercising rational self interest. Mr. Bootle’s so-called plan is nothing more than robbing Greek citizens in the middle of the night!
Give the Greeks a Better Currency
The aim of currency reform–and, do not mistake my intention, currency reform IS needed–should be to replace a poor currency with a better one. But Mr. Bootle (and his Keynesian colleagues) see the world upside down. In their world of aggregate demand, a weaker currency always is preferable to a stronger one, because a weak currency purportedly makes a nation more competitive in international markets. But this is pure propaganda. A weak currency not only makes necessary imports more expensive, reducing prosperity, but it also is an outright subsidy to foreign buyers of a nation’s goods. As I have argued in my essay Value in Devaluation? and as James Miller has argued in Mark Carney’s Zero-Sum Game, currency devaluation is merely a transfer of wealth from all of a nation’s citizens to politically favored industries, usually export industries. It is no different than giving a subsidy to any domestic producer. The subsidy is paid by all the citizens of the subsidizing country, not by the foreigners who buy the subsidized good. They get a bargain.
Furthermore, devaluation does NOT make a nation more competitive. It does nothing to spur increased domestic saving or external capital investment which lead to the increased application of capital per capita, the only sources of increased worker productivity and the only sources of increased real wages. Devaluation does not reveal the onerous, wealth destroying effect of economic regulation, not does it reveal the true costs of the welfare state, which relies upon high taxes to fund present consumption at the expense of future prosperity. What the state spends cannot be saved and invested, no matter how cheap the currency.
And, contrary to Mr. Bootle’s statement that “improving competitiveness is at odds with the objective of reducing the debt burden”, Greece will not be able to reduce its debt until it does become more competitive. It may well be impossible for Greece to pay all of its debts, but this merely reveals the dire reality of current policy; it does nothing to change that reality. The increase in the debt burden must stop! It must stop now!
Mr. Bootle misses the cause of the euro debt crisis completely when he fails to see that ECB euro-denominated loans to captive national banks, with worthless sovereign debt as collateral, is the manner in which the European Monetary Union subsidizes failed economic policies. As long as the Greek government can get unlimited euro loans from the ECB, there is no real reason to reform the nation’s economy and there will be no end to the debt crisis.
So, Mr. Bootle proposes an even WORSE currency, a devalued drachma, as the replacement for a bad one, the euro. And if the Greek people resist outright theft through devaluation, then the government must trap their wealth internally, where it can be plundered later, by using capital controls to stop euro transfers to safer, foreign banks. The fact that the free movement of capital was one of the pillars of the European project apparently must be sacrificed for the benefit of the state. In fact Mr. Bootle admits that capital controls are illegal under current EU law, but he recommends them anyway. All tyrants love a crisis, because it can be used as an excuse to break the law!
Truly Liberal Alternatives
Dr. Philipp Bagus of King Juan Carlos University, Madrid offered the truly liberal alternative. He proposed a long period of public discussion about alternatives to leaving the euro, which would allow ample time for Greeks to move their property out of the greedy reach of their own government, should they decide to do so. The currency crisis might be solved in this manner as Greek banks closed and the Greek government shut down its welfare and regulatory system for lack of funds. The Greek government could repeal legal tender laws which currently require Greek citizens to transact business in one currency only, always that issued by the state itself. Concomitantly it could reinstate the drachma as a strong currency backed by gold. Then good money would drive out bad, as people freely chose which currency to use. They would choose the one that is most marketable. One element of that marketability would be that it would retain its purchasing power.
Of course, Mr. Bootle desires the opposite; i.e., an ever depreciating currency that robs currency holders of their purchasing power. Naturally Greeks will resist this, therefore, the Greek government must install capital controls. Yet, the essence of self-government and democracy and the great triumph of post war Europe was the freeing of the individual first from fascist tyranny and then communist tyranny, whose primary means of enforcement were control of the economy.
The future of Europe will emerge from the euro debt crisis. Mr. Bootle desires a return to state currency controls as a means to prop up the decaying welfare state. Dr. Bagus desires a step back from this unfortunate detour that took concrete form with the formation of the euro. Rather than compound the errors of the euro with even more state intervention, the alternative is to anchor currencies in gold. This will force individual nations to engage in true democratic processes to determine the scope of state action. It will end the stealth transfer of wealth via euro monetary expansion. In that regard it will force each nation to live within its own means. What’s wrong with that?