In this essay we evaluate the alleged costs of a euro exit and propose practical steps to make a withdrawal from the euro as smooth as possible.
The costs of remaining within the euro are very high. These costs do not only include the costs of the open bailouts and guarantees for the rescue funds. The euro is a misconstruction as several independent governments can finance their deficits through one (central) banking system. The incentive is to run higher deficits than other states of the EMU. The setup of the Eurosystem made interest rates converge and enabled monetary redistribution. Due to its incentives there is a tendency for price inflation.
To save the euro the ECB will have to be highly inflationary in the future. The ECB will have to keep accepting or buying governments bonds and finance the rescue funds. Within the EMU the incentives to reduce deficit spending are diminished. There is a general tendency for the size of government to increase due to this inflationary deficit spending. Most likely, only a centralization of some sort (fiscal union) will be able to save the euro at this point with its current members. The growing size of government and the centralization imply a loss for individual liberty for citizens of governments that remain within the euro. Lastly, the redistribution may cause conflicts between nations and disturb the harmonious cooperation in Europe.
The problems of a euro exit have been largely exaggerated. Introduction costs, wage inflation, trade losses, political costs, legal problems, procedural costs, banking crisis, costs of disentangling of the ECB, pose important but no insurmountable problems. With accompanying measures and careful negotiation these problems are all solvable.
We found three ways to exit.
First, redenomination of all contracts and deposits into a new national currency. Coins and notes bearing the national symbol are exchanged gradually into the new currency preferably at a 1:1 exchange rate. In order to prevent disturbing flows of capital a “provisional” redenomination allowing for democratic discussion is found as the most elegant way.
Second, issue of a parallel national currency. This national currency may be backed by government or central bank assets preferably gold and would compete with the euro.
Third, currency competition. All legal tender laws are abolished. Gradually, citizens will start using more stable currencies and possibly adopt commodity based means of payment.
It is essential to accompany an exit from the euro with supporting reforms to alleviate transition costs. The sovereign debt and euro crisis is foremost a crisis of the state that has grown to a dimension that threatens the stability of the euro currency. Accompanying measures must roll back the state. In order to introduce a new currency with success it is essential that the new currency is expected to be less inflationary than the euro.
As a banking reform will be necessary in any case, an exit from the euro should be used to thoroughly reform the banking and monetary system putting them finally on a sound basis. Moreover, the public deficits should be eliminated, old public debt restructured, public assets privatized, markets deregulated and made flexible, and taxes lowered.
I recently presented these ideas to the European Parliament in a conference sponsored by the EFD group (starting from 41:20):
There are basically three scenarios for the future of the European Monetary Union as I argue in my book The Tragedy of the Euro.
First, the Stability and Growth Pact (SGP) is reformed and enforced with automatic sanctions for countries not complying with its conditions. This requires harsh austerity measures, privatizations, labor market reforms and reduction of living standards in the periphery. The case of Greece shows that this option may just not be viable considering political structures and socialist voters resisting a reduction of the state’s size. Indeed, for 2011 the Greek deficit is expected to be at 9.5% of GDP, far above of the 3% limit established by the SGP and the 7.4% target established by the European Commission.
The second scenario is a break-up of the monetary union. The periphery has no interest in exiting the Eurozone. Periphery governments are benefitting from guarantees by the core and from monetary redistribution. An exit would imply a substantial reduction of living standards in the periphery. But why are core countries not leaving the Euro? While a euro exit would be in the interest of the common population, the political elite and their financiers from the banking sector want to continue the Euro project. As we have seen in the summit on the second Greek bailout, German Chancellor Merkel not only defied the “no-bailout clause” of the Maastricht Treaty but also a resolution of the German parliament against purchasing commonly-guaranteed bonds from February 2011. This leads us to the third scenario, which we are approaching fast: a transfer union and a European superstate. The EU summit of Thursday, 21st of July 2011 marks a big step in this direction.
The Greek government will get an additional €109 bn. bailout loan until 2014. Maturities for Greek bonds from the first bailout were raised from 7.5 to 15 years (originally it was 3 years). Interest rates were reduced from 4.2 % (originally at 5.2 %) to 3.5 %. Likewise, interest rates on loans to Portugal and Ireland were reduced.
The day brought also another bailout of banks. Banks, insurance companies and other private investors can swap their old Greek government bonds against new ones with a longer maturity. Joseph Ackermann, CEO of Deutsche Bank, estimates write-downs for banks around 21%. Politicians sell the so-called “participation of private investors” in the bailout as a great success. However, it is just another bailout for the banking system, limiting losses to 21% and putting taxpayers’ money on the hook. Old bonds are swapped into new bonds that are guaranteed by the EFSF and such by European taxpayers. Without the second bailout the Greek government would have had to default. Banks would have had to take much higher losses in a restructuring. Estimates of losses range between 50-70%. After the swap, banks are effectively protected. The financial industry, the governments’ main financier, can be very happy about this covert bailout.
The most important consequence of 21st of July was the official establishment of a transfer union by granting more powers to the EFSF (the European bailout fund). In the Eurozone, there have always been transfers through monetary redistribution: The ECB accepts bonds from the periphery as collateral thereby monetizing deficits indirectly. Last year, the ECB even started to buy government bonds from the periphery outright, spreading the burden of the bailout to all users of the currency. Yet, from now on, direct purchases by the ECB may become unnecessary. The burden of the bailouts will be more concentrated. Not all currency users will pay in form of a dilution of the Euro but rather taxpayers in countries that effectively guarantee the EFSF.
The EFSF now can give credit lines to countries that are expected to have financing problems. In addition, the EFSF may purchase government bonds on the secondary market. The role of the ECB is thereby partially taken over by the EFSF.
The possibility of financing through the EFSF reduces the pressure for countries to eliminate deficits and reduce government debts. Why introduce harsh austerity measures, reform labor markets and privatize the public sector if there are loans available from the EFSF at ridiculously low interest rates? If you want to win elections, you should not reform but spend. Only through deficit spending one can maintain the artificially high living standards in the periphery. Indeed, debts are still on the rise. Deficits are huge and far from being eliminated. Most probably, Greece, Ireland, Portugal and soon Spain, Italy and even Belgium will borrow exclusively from the EFSF. To be effective, the size of the EFSF will have to be extended. The main guarantor will be Germany. Considering peripheral funding needs, a report from Bernsteincalculates:
As the guarantees of the periphery including Italy are worthless, the guarantee Germany would have to provide rises to €790bn or 32% of GDP.
If France is downgraded, the German share increases to €1.385 trillion — 56% of GDP.
The transfer union implies a transfer of power to the European Commission. We get ever closer to a European superstate. Incentives to reduce deficits will be reduced both in the periphery and in the core. Germans will start to resist cuts in public spending. Why save if the savings flow to the periphery? Instead of reducing German pensions to guarantee Greek pensions, German voters will push for more public spending. To pay for welfare states and transfers, more taxes (maybe a European tax) and money production will become necessary. The centralization of power allows for harmonization of regulations and taxes. Once tax competition ends, there will be a tendency towards ever higher taxes. With the transfers, the power of Brussels will continue to rise. There seems to be only one bold, albeit costly way, to stop the process towards a EUSSR: withdrawal from the transfer union. With an exit from the Euro, Germany could bring down the whole Euro project and save Europe.
The political project of the Euro is in deep trouble. It seems that Friedman’s curse is beginning to materialize. Despite the European Union and International Monetary Fund pledging three quarters of a trillion of our Euros to put out the debt crisis wildfire, interest rates on troubled sovereign debts are even higher than before the announcement of the bailout funds.
Not that this is a surprise to anyone. Another loan to an already over-indebted country is not a real solution to its problems, something private investors know very well. It’s just a very expensive buying of time for those who happened to own the bonds and wonder what to do now. During this bought time, one can pretend that the problem will disappear thanks to sudden and miraculous economic growth. Ireland got bailed out, Portugal got bailed out. For Greece, one bailout was not enough. Now, just a year later, Greece is asking again for the common European credit card in order to support a standard of living they became accustomed to thanks to the Euro and with which it is very hard to part.
Greece is a perfect example of the consequences of the implicit bailout guarantee from other EMU member states. A country on the edge of default with a debt-to-GDP ratio of over 150% – even after “radical” austerity measures – posted a public finance deficit of 10.5% of GDP in 2010. One troubling question keeps reappearing: What will happen to the patchwork safety net if the Italian or Spanish elephant falls into it? Will it hold? Or should Germany and the other countries holding it be better off letting go, so as to avoid being pulled over the cliff of default as well?
Today, we are no longer just uninvolved bystanders, watching with interest as the Euro drama unfolds. Since 2009, the Euro’s problems are our problems, too, and now our chips are on the table. When you see press conferences announcing newer and bigger bailout packages, just divide the figures quoted by one hundred to find out just how much European “solidarity” will cost us.
To mention solidarity while bailing out countries with irresponsible fiscal policy and banks misled by the ECB’s illusory easy money policy leaves a bad taste in Slovaks’ mouths. This kind of “solidarity” is not permitted by the recently ratified Lisbon treaty. Moreover, the Slovak worker can only dream of a Greek-level pension, and Slovakia’s own banking sector had to be restructured just a decade ago at a huge cost (over 10% of GDP). And now, as the second-poorest EMU member, we are expected to send money to pay Portuguese public workers and to save French banks after their unwise investments in Ireland?
There was not much of a discussion about Euro adoption in Slovakia. The eagerness of politicians, experts and the lay public to adopt the Euro as soon as possible is easy to understand. The Euro was supposed to protect us from our own politicians, who clearly showed what they are capable of in the late nineties. And it was flattering, too, to finally be a leader in at least something among our post-communist neighbours. But this desire clouded our perception of the club we were about to join.
Yes, the common currency has its advantages and monetary nationalism is costly and economically indefensible. But many ignore the key question of the currency’s quality: What is the backing of the currency and who controls its production? In fear of another failure by our own political class, we forgot that the Euro is not a gold standard lying outside the reach and control of politicians, but only a bigger and more complicated political project with all the ills that attend this sort of centrally-planned structure. The fact that a politician speaks French or German doesn’t make him a morally pristine agent free of any self-interest.
Thanks to its institutional character, the Euro is a common resource utilized by the EMU countries. Control of money production and all related benefits has been moved from national governments into the platonically guarded supranational space of the Eurosystem. Suddenly, it is possible to cover public finance deficits with newly created Euros, while the costs of this process – in the form of price inflation, various asset bubbles and a deformed production structure – fall not just on the irresponsible country but on all members of the club.
Slovaks have a very intense historical experience with common resources. For them, the Tragedy of the Commons is not just an abstract economic concept, and the saying “He who does not steal, steals from his family” hints at an intimate public understanding of all the problems brought about by ill-defined or undefended property rights. The rules of The Stability and Growth Pact were supposed to police the Euro commons, but the countries involved have simply ignored the rules, making the pact into an impotent manifesto.
With the onset of the financial crisis, the illusion created by newly-created money and cheap loans not backed by savings evaporated. Losses from malinvestments – along with necessary reductions in standards of living or deep cuts in generous social benefits – are painful but inevitable. Changes in the rules of the Euro game (the creation of the European Stabilization Mechanism by the addition of a new article to the Lisbon Treaty) should allow a shifting of the losses from the places where they originated or to taxpayers in other countries. The European Union is changing into a wealth redistribution mechanism between countries before our eyes. The potential default of one member state is automatically – and illogically – associated with the end of the union or even a potential war in Europe by EU representatives. However, hardly anything stirs nationalistic passion more than inequitable transfers of wealth. And an increase of indebtedness among the last relatively healthy countries left in the effort to avert the inevitable defaults doesn’t add to the strength of the Euro.
After 2013, as a part of the permanent European Stabilization Mechanism, Slovakia should guarantee debts of up to almost six billion Euros (one fifth of the current government debt). You won’t find risks like this in the official Slovak SWOT pre-EMU entry analyses. Neither would you find discussion about possible government failures and fiscal free-riding allowed by the institutional setup of the Eurosystem there. We saw the Euro as we wanted to see it, not as it really was. Ireland was presented as a role model for the positive effects of the common European currency, not as a Celtic Tiger on the steroids of irresponsible European monetary policy. The evidence of misuse of the Euro for irresponsible fiscal policy was right in front of us, and in spite of the countless breaches of the Stability and Growth Pact, nobody held the fiscally unsound countries responsible: nobody had to pay.
Even though we have already made the decision and the Euro is already in our pockets, it’s not yet too late in Slovakia to focus on the issues that didn’t resonate enough in the pre-entry, Euro-optimistic discussion. At least we will better understand what is happening to our money these days.
Let us establish some principles first. Central banks do indeed pose a risk to economic stability but not because their monetary policy is constantly too tight but because is it systematically too loose. Inflexible commodity money – such as gold and silver – has everywhere been replaced with state-issued fully flexible paper money under the control of central banks for one reason and one reason only: so that the supply of money can be constantly expanded in accordance with politically defined goals (such as a certain growth rate, a certain inflation rate, a certain unemployment rate….and constantly expanding bank balance sheets). Today’s consensus believes the following: When inflation is low and thus not an imminent threat, the central bank should ‘support’ economic growth via low interest rates and a moderate expansion of the money supply.
Wrong.
This is precisely the dangerous fallacy that made the dramatic events of the past four years ultimately inevitable. Yet, nobody seems willing to learn the lesson.
Constant expansion of the money supply and the persistent lowering of interest rates below the levels that would be justified by available savings – the raison d’etre of paper money and central banking – lead to misallocations of capital. Always. This – and not higher consumer price inflation – is the most immediate negative effect of monetary expansion. Today’s consensus is, sadly, still obsessed with CPI inflation (CPI= consumer price index). As long as monetary expansion doesn’t lead instantly to a higher grocery bill, the mainstream considers it a welcome boost to growth and practically a free lunch. This is a gross misconception, and this misconception is in essence still behind most of the commentary on monetary policy today. And it was again on display in the debate about the ECB’s recent move.
You can read Detlev’s superb article in full here but beware: he believes “that a collapse of the paper money system is practically inevitable”…
The world centre of gravity of the Austrian Economics movement has long been the United States, especially since Ludwig von Mises arrived there on August the 3rd, at the age of fifty-eight, in a turbulent 1940.
The 1998 Spanish publication of Money, Bank Credit, and Economic Cycles, by Jesús Huerta de Soto — followed by the English translation in 2006 — then helped to revive European claims of an Austrian equality with the United States, particularly with the trans-Atlantic returns of Hans-Hermann Hoppe and Guido Hülsmann, after long periods of residence in North America.
In particular, a burgeoning growth of the Spanish echelon of the global Austrian movement — initially under the wing of Professor Huerta De Soto — may be starting to prove that a few years in the United States is becoming an option, rather than a requirement, for an Austrian academic to be taken seriously as a heavyweight intellectual force.
This brilliant monograph, written in crisp classical English, flows like a rising tide.
It begins with a description of the rise of the European Union, which was always a dialectic, claims Bagus, with four classical liberal freedoms of movement on one side of a divide; these liberal freedoms covered goods, capital, people, and the provision of services. These four virtues then clashed up against the many vices of socialism, and particularly the desire for new imperial satrapies, especially given the WWII fall of colonial European empires and their replacement by the all-embracing and invisible empire of the American government, particularly after the Suez crisis.
Just before his first chapter, Two Visions for Europe, Bagus removes his gloves and goes straight for the throat, in the best uncompromising style of Von Mises himself; this is perhaps a delight to all of the writers at The Daily Bell, in Switzerland:
“In reaction to the [recent financial] crisis, the political class has tried desperately to save the socialist project of a common fiat currency for Europe.”
Once he has established his outright grip in this manner, Bagus refuses to let go throughout the entire book. Essentially, he claims that the fundamental schism at the heart of the EU project is one of a classical liberal Roman Catholic Church model engaged in a do-or-die struggle with a socialist Roman Empire model. From its Capitoline Hill inception in Rome, in 1957, upon the very site of the Temple of Jupiter Optimus Maximus, the EU project has thus always been doomed to be one of conflict and strife, driven by a perpetually unsatisfactory compromise between these two bitter rival forces of the human condition; liberty and tyranny.
On top of this conflict comes the later antagonism between the Austrian-influenced post-war Germans and their economic miracle, combined with the Saint-Simon socialist French and their desire to rebuild the empire they had lost when the Wehrmacht crushed their Napoleonic republic in 1940 (a military conflict in which Mises himself was swept up as he managed somehow to keep just one bus journey ahead of the Panzers on his terrifying road to New York). Bagus is uncompromising:
“The real reason the German government, traditionally opposed to the socialist vision, finally accepted the Euro, had to do with German reunification. The deal was as follows: France builds its European empire and Germany gets its reunification. It was maintained that Germany would otherwise become too powerful and its sharpest weapon, the Deutschmark, had to be taken away — in other words, disarmament.”
After this first layer of his intellectual pyramid is built, Bagus delves into The Dynamics of Fiat Money, in his next chapter. In a Michelin-starred culinary mix of monetary history, contemporary politics, and Austrian Economics, Bagus makes a bold prediction:
“Governments started to get heavily involved in banking. Unfortunately, interventions are a slippery slope, as Mises pointed out in his book, Interventionism. Government interventions cause problems from the point of view of the interventionists themselves: begging for additional interventions to solve these additional problems, or the abolition of the initial intervention. If the course of adding new interventions is chosen, additional problems may arise that demand new interventions and so on. The road of interventions was taken in the field of money, finally leading to fiat money and the Euro. The Euro begs for political centralization in Europe. The end result of monetary interventions is a world fiat currency.”
God forbid that should happen, though the world elites may try it on with us for a while before that power-grab collapses too, just as their precursor fiat currencies are collapsing today in the face of their endless money printing to bail themselves out from a gigantic mess of their own greed-fuelled creation.
After explaining this end-game strategy, Bagus details how we got to this point, in one of the clearest expositions of the Austrian Business Cycle Theory that I have yet to read. Indeed, he leads us towards the intriguing idea that the intertwining of central banking and fiat currency, with expansive state war, epitomised by both world wars, is much more than a coincidence:
“After the collapse of Bretton Woods, the world was dealing in fluctuating fiat currencies. Governments could finally control the money supply without any limitations to gold, and deficits could be financed by central banks. The manipulation of the quantity of money has only one aim: the financing of government policies. There is no other reason to manipulate the quantity of money.”
Yes, the diamond-hard spirit of Von Mises is alive and well, and living in the home of Francisco de Vitoria and the other Spanish Scholastics, from which Mises and the other early Austrians, such as Menger, also drew much inspiration.
But one impregnable bastion still stood between the nascent world government elites and their rotten self-serving dream of unlimited money printing and a world Soviet financial gulag — which in my opinion is a hopeless dream anyway, as it will quickly go the way of the Soviet Empire — and that was the post-war Wirtschaftswunder Germany of Konrad Adenauer and Ludwig Erhard, and the semi-granite rock upon which this economic miracle was built, the German Bundesbank.
Yes, although the Bundesbank did inflate its currency, like all other central banks, its intimate knowledge of the consequences of Weimar caused it to inflate a lot less than the rest, with perhaps its only rival to fiat currency hardness being the Swiss National Bank. Bagus explains how the destruction of this bastion was approached, in his third chapter, The Road to the Euro:
“Not surprisingly, governments and central banks wanted to escape the ‘tyranny’ of the Bundesbank. The system finally failed. The declaration of surrender was made when the [European Monetary System] corridor was amplified to ±15 percent in 1993. The Bundesbank had won; it had forced the others to declare the bankruptcy. It had followed its hard money philosophy and not succumbed to the pressure of other governments. Anyone who inflated more than the Bundesbank was showing its citizens a weak currency. The Deutschmark, in turn, was respected throughout the world and very popular among Germans. It brought relative monetary stability not only to Germany, but to the rest of Europe as well. The Deutschmark, of course, only looked stable in comparison to the rest. It itself was highly inflationary and lost nine tenths of its purchasing power from its birth in 1949 to the end of the EMS.”
Of course, this begs a simple question about all of the various intellectual pygmies who call themselves ‘servants of the people’ within the various European governments. If they truly wished to serve their peoples — rather than serve themselves as masters — then instead of being jealous about German financial success and the relative prosperity of the German people, they should simply have copied German policies rather than deriding the Bundesbank for being too effective at making ordinary people wealthier and happier, at the cost of preventing politicians from engaging in their endless dreams of aggrandising themselves, at the cost of everyone else, via unlimited money printing.
In fact, Bagus makes this point clear in his final paragraph in his second chapter:
“If Europeans had just wanted monetary stability and a single currency in Europe, Europe could just have introduced the Deutschmark in all other countries. But nationalism would not allow for this. With a single currency, there were no embarrassing exchange rate movements that would reveal a central bank’s inflating faster than its neighbors. For the first time there was a centralized money producer in Europe that could help to finance government debts, and open new dimensions for government interventions, and redistribution of wealth.”
However, the ‘problem’ remained of how to get the German people to give up their ‘evil’ independent Bundesbank and its relatively honest-money policies? Obviously, German politicians would go along with the plan. Exploitative elites in different countries have always felt more at home with other exploitative elites, rather than with the exploited hoi polloi who pay the taxes to make their lives comfortable, who share merely a language and a physical geography with ruling elites, rather than the same attitude towards life; the politicians and civil servants of our current EU may require translators — if they lack fluency in the lingua franca of English — but they get on much better with each other at their cloistered conferences than they do with their respective peasant rabbles beyond the gates.
This is the trick Bagus believed the elites settled upon:
“The implicit blaming of Germany for World War II and making gains as a result was a tactic that the political class had often used. Now the implicit argument was that because of World War II and because of Auschwitz in particular, Germany had to give up the Deutschmark as a step toward political union. Here were paternalism and a culture of guilt at their best.”
Indeed, you may have noticed yourself that for several years it almost became a Rite of Passage for world elite members to make the required pilgrimage to Auschwitz, to really nail the point home, with Gordon Brown, of course, being several years too late.
More, however, was needed than the promised removal of a continual drip-feed of collective guilt (as if people born decades after WWII should ever really consider themselves blameworthy for what other people did before they themselves were alive). The endless drone about Auschwitz was the stick; but what about a carrot to sweeten the bitter pill of the Euro?
This was constructed in the form of the ‘Stability and Growth Pact’, in which other non-German members of the Euro would be forced to jump rigorous financial hurdles and to pass continuing acid tests, to prevent the Mediterranean La Dolce Vita lifestyle — fuelled by the printing presses of the peseta, the lira, and the drachma — from diluting the iron-hard rules of the soon-to-be ex-Bundesbank.
It was all a despicable sham, of course, and nobody believed any of it, especially the lying politicians of Germany, even when it was being put together. But as they say with the eternal hope of marriage; proceed in haste and repent at leisure. The German people were thus hoodwinked into giving up their precious Bundesbank, which had served them so well since 1948:
“The Stability and Growth Pact was not as harsh as Theo Waigel had suggested. When the SGP was finally signed in 1997 it had lost most of its disciplinary power. The result prompted Anatole Kalteksky to comment in The Times that the outcome of the Treaty of Maastricht represented the third capitulation of Germany to France within the century, citing as well the Treaty of Versailles and Potsdam Agreement.”
As Mark Twain said, history usually fails to repeat itself, but it does often rhyme.
Moving into his fourth chapter, Why High Inflation Countries Wanted the Euro, Bagus gets much more technical and produces lots of charts and graphs to detail and highlight his developing thesis. He does, however, continue in the same refreshing Misesian vein within the text:
“Governments of Latin countries, and especially France, regarded the Euro as an efficient means of getting rid of the hated Deutschmark. Before the introduction of the Euro, the Deutschmark was a standard that laid bare the monetary mismanagement of irresponsible governments.”
In the fifth Chapter — Why Germany Gave Up the Deutschmark — Bagus drills deeper into the cunning plan to part the German people from their wealth and their independence, via the machinations of their rapacious and power-hungry politicians, eager to seek further baubles from the EU bureaucracy and a luxurious financial independence from their rotten capricious voters.
The Bundesbank thus had to be destroyed, to allow the dreams of Keynesians within governments everywhere, to flourish and prosper:
“Mitterand, France’s president from 1981–1995, had hated Germany in his youth and despised capitalism. The French patriot was a staunch defender of the socialist vision of Europe and geared his policies toward defending France against the economic superiority of its Eastern neighbor. Germany’s superiority was based on its currency. Mitterrand’s intention was to use Germany’s monetary power for the interest of the French government.”
So, a relationship built on love and trust then. It was surely bound to last.
Of course, the plan would never have worked without the duplicity of German politicians:
“The Euro allowed German politicians to rid themselves of stubborn Bundesbankers, promising the end of the bank’s ‘tyranny.’ More inflation would mean more power for the ruling class. German politicians would be able to hide behind the ECB and flee the responsibility of high debts and expenditures.”
As you might say in a high quality jazz club after listening to a particularly dense and interwoven melody; “Nice”.
Bagus finishes his fifth chapter with a summation of what the Euro has really been about all along:
“In sum, the introduction of the Euro was not about a European ideal of liberty and peace. On the contrary, the Euro was not necessary for liberty and peace. In fact, the Euro produced conflict. Its introduction was all about power and money. The Euro brought the most important economic power tool, the monetary unit, under the control of technocrats.”
Bagus is particularly scathing about the political gnomes and bureaucratic dwarves of the various exploitative tax-eating classes, who are currently trying to rescue their own miserable political careers by wrecking the economic futures of their exploited tax-paying classes. For instance, he has a lot to say about that quisling betrayer of the German people, Angela Dorothea Merkel:
“Merkel herself stated that: ‘If the Euro fails, the idea of European integration fails.’ Her argument is a non sequitur. Naturally, one can have open borders, free trade and an integrated Europe without a common central bank. Here Merkel showed herself to be a defender of the socialist version of Europe.”
The rest of the book then contains a brilliant and detailed analysis of the relationship between the Federal Reserve and the European Central Bank, and the political interconnections between the two, as well as an up-to-date breakdown of how the Euro crisis has developed over the last three years. Bagus also explains how the ECB is stoking up the fires of future European conflict in its bid to help the EU create a strait-jacket Force majeure political union.
At the end of his tenth chapter, The Ride Towards Collapse, Bagus neatly summarises the current situation after an interesting discussion of the concept of ‘qualitative easing’, the evil twin of ‘quantitative easing’:
“The European Union has become a transfer union. Interest rates that most governments have to pay on their debts remain at a high level. Sovereign debt levels are still on the rise. The future will tell us if the situation was sustainable.”
In the next chapter, The Future of the Euro, Bagus clearly and succinctly answers the following set of questions:
“Have we already reached the point of no return? Can the sovereign debt crisis be contained and the financial system stabilized? Can the Euro be saved? In order to answer these questions we must take a look at the sovereign debt crisis, whose advent was largely the result of government interventions in response to the financial crisis.”
No stone is left unturned, as they say, though Bagus does it in as few words as possible.
In summation, most living Austrian authors fall into one of three broad camps; the Misesian traditionalists, the Hayekian cerebralists, or the Rothbardian essentialists. I can only say that if forced to pick one of the three, I believe the spirit of Von Mises still lives on within the pen of Bagus. For example, was this written by Mises or Bagus? (The clue is in the last sentence):
“As Austrian business-cycle theory explains, the credit expansion of the fractional-reserve-banking system caused an unsustainable boom. At artificially low interest rates, additional investment projects were undertaken even though there was no corresponding increase in real savings. The investments were simply paid by new paper credit. Many of these investments projects constituted malinvestments that had to be liquidated sooner or later. In the present cycle, these malinvestments occurred mainly in the overextended automotive, housing, and financial sectors.”
Or is the directional style of Bagus a combination of all three broad camps, plus something new? Are we going to have to invent a new term, such as ‘Bagusian’, to create an evolving fourth camp? If we get three books of this quality, in sequence, then I feel we may be forced to deploy such a term.
To wrap up, in his conclusion, Bagus outlines all of the various possible futures he believes the Euro may possess in various different random universes. Its outcome is in the lap of the Gods, he thinks, as to which one of these universes the Euro will finally enter, though he outlines one or two of the more likely predictions and why he thinks these will be favourite with the bookmakers.
I will let you download, buy, or in some way imbibe this required-reading book, to find out what the details of these predictions are. However, I think we all know the general conclusion; all fiat monies ultimately end up as worthless. The interesting part of the story is how they get there.
And if you want to know the illuminating and interesting history (and future) of the Euro, and how it interconnects with the planned world fiat money — which you can call ‘the Bancor’ or ‘the SDR’, though I prefer ‘the Soviet’ — then you must read this book.
In a detailed 28-minute conversation, I spoke last night to Professor David Howden, Associate Professor of Economics at St. Louis University, in Madrid, about the current fiscal situation in Portugal and Spain, particularly as regards the Euro and its ongoing woes and tribulations in the international bond markets:
We also brushed upon the debt and deficit situation here in Britain, the mysterious and interesting involvement of the Chinese in the Euro crisis, and the Douglas E. French prize awarded at the Mises University each year for the student who emerges from the Mises University oral examination with the best academic record, particularly after being grilled by Professor Hoppe, et al; therefore a prize never won by the faint of heart.
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Two main books are referenced within the interview. You can download complete PDFs of both books, by clicking through the links below:
For over a decade we have heard reports of China’s increasing world dominance. Yet while Beijing has amassed a large war chest of savings over the past decade – $2.5 trillion remain under its control – it has been cautious in waiting for a rainy day to put its savings to use.
The times they are a changing. One day prior to his arrival in Madrid for an official visit, Chinese Vice President Li Keqiang announced that China had the utmost confidence that Spain would recover from its economic malaise. And to put China’s money where his mouth is, Li made an open-ended pledge to “help” (read: “bail”) out Spain in the future.
Citing China’s stance as a “responsible investor” with a long-term view of European financial markets, Li assured investors that purchases of Spanish public debt would continue. Moreover, the man who is widely reckoned to become China’s next premier commented on Chinese support for Spain’s austerity measures, and confirmed the conviction that Spain would achieve a swift economic recovery.
While Spain’s austerity measures are admirable, there is still a long way to go. With a deficit of 9.3 percent of GDP for 2010, and 6 percent forecast for this new year, total debt will grow to 62 percent of Spanish GDP by the time this year becomes bygones. That is, it will be 62 percent of GDP as long as GDP does not collapse further than it already has been. While GDP contracted by over 2.5 percent in 2009, and the final tally for 2010 still to come, the future debt load of Spain is more than a little uncertain.
Meanwhile, Spain’s own Socialist Prime Minister Jose Luis Rodriguez Zapatero noted that the Chinese commitment will “play a key role” in financial stabilization. This seems to be a signal that the stabilization that Zapatero is talking about is different than that which China reckons to be “investing” in.
Real stabilization will not come from having a bailout by different words. The Eurozone economy – of which Spain is a not insubstantial part as the fifth largest economy – is in the midst of a deteriorating debt crisis. Continued bailouts are band aid solutions to the wrong problem. When faced with a crisis of insolvency the solution is not continued doses of more debt. What are needed are drastic cuts to expenditures.
Spaniards, or anyone for that matter, should not be fooled into thinking that Beijing’s generosity will solve any problems. If anything a bailout will exacerbate and prolong the pain which has already been assured by the excesses of the past. When you wake up with a hangover, drinking more does little to numb the pain. More alcohol may get rid of the morning shakes, just as this “bailout” may calm market jitters, but at the cost of a more severe eventual withdrawal.
Philipp Bagus, in his new book “The Tragedy of the Euro”, explains lucidly how the European debt crisis emerged. Southern European countries joined a currency union assumed to be unbreakable. Any eventual signs of trouble with any of the weaker countries – the PIIGS of today – would by necessity be attended to by the strong. Incidentally, with reports of Belgium and even France someday requiring external aid, the list of the strong is quickly shrinking. Adding fresh troubled economies to its scope is not helping this situation either. On January 1st Estonia became the 17th country to enter the Eurozone. While Estonia ran a budget deficit of 8 percent of GDP last year it is only a matter of time before the new addition joins the ranks of the needy.
Unfortunately for Spaniards, what commentators are commonly missing (besides the fact that this bailout will breed more painful adjustments down the road) is that the pain of this bailout will fall mainly on Spaniards.
Guaranteeing a bailout will assure the government that they can continue their spending binge for a little while longer. Necessary cutbacks will not be enacted, as they will not be deemed as necessary. While the punch is still flowing, drink up. Without meaningful budget cuts there will be no improvement in an already tenuous fiscal situation. How long can insolvent countries keep getting bailouts to keep them going?
China has deep pockets, enabling it to keep bailing out troubled Europeans for a long run. But we all know what happens in the long run. Surely such a fate for Spain is worse than some short-term pain today.
The following is Jesús Huerta de Soto’s foreword to The Tragedy of the Euro by Philipp Bagus, a friend of The Cobden Centre. You can buy or download the book here. Philipp Bagus is a professor of economics at Universidad Rey Juan Carlos in Madrid.
It is a great pleasure for me to present this book by my colleague Philipp Bagus, one of my most brilliant and promising students. The book is extremely timely and shows how the interventionist setup of the European Monetary system has led to disaster.
The current sovereign debt crisis is the direct result of credit ex- pansion by the European banking system. In the early 2000′s, credit was expanded especially in the periphery of the European Monetary Union such as in Ireland, Greece, Portugal, and Spain. Interest rates were reduced substantially by credit expansion coupled with a fall both in inflationary expectations and risk premiums. The sharp fall in inflationary expectations was caused by the prestige of the newly created European Central Bank as a copy of the Bundesbank. Risk premiums were reduced artificially due to the expected support by stronger nations. The result was an artificial boom. Asset price bubbles such as a housing bubble in Spain developed. The newly created money was primarily injected in the countries of the periphery where it financed overconsumption and malinvestments, mainly in an overextended automobile and construction sector. At the same time, the credit expansion also helped to finance and expand unsustainable welfare states.
In 2007, the microeconomic effects that reverse any artificial boom financed by credit expansion and not by genuine real savings started to show up. Prices of means of production such as commodities and wages rose. Interest rates also climbed due to inflationary pressure that made central banks reduce their expansionary stands.
Finally, consumer goods prices started to rise relative to the prices offered to the originary factors of productions. It became more and more obvious that many investments were not sustainable due to a lack of real savings. Many of these investments occurred in the construction sector. The financial sector came under pressure as mortgages had been securitized, ending up directly or indirectly on balance sheets of financial institutions. The pressures culminated in the collapse of the investment bank Lehman Brothers, which led to a full-fledged panic in financial markets.
Instead of leading market forces run their course, governments unfortunately intervened with the necessary adjustment process. It is this unfortunate intervention that not only prevented a faster and more thorough recovery, but also produced, as a side effect, the sovereign debt crisis of spring 2010. Governments tried to prop up the overextended sectors, increasing their spending. They paid subsidies for new car purchases to support the automobile industry and started public works to support the construction sector as well as the sector that had lent to these industries, the banking sector. Moreover, governments supported the financial sector directly by giving guarantees on their liabilities, nationalizing banks, buying their assets or partial stakes in them. At the same time, unemployment soared due to regulated labor markets. Governments’ revenues out of income taxes and social security plummeted. Expenditures for unemployment subsidies increased. Corporate taxes that had been inflated artificially in sectors like banking, construction, and car manufacturing during the boom were almost completely wiped out. With falling revenues and increasing expenditures governments’ deficits and debts soared, as a direct consequence of governments’ responses to the crisis caused by a boom that was not sustained by real savings.
The case of Spain is paradigmatic. The Spanish government subsidized the car industry, the construction sector, and the bank- ing industry, which had been expanding heavily during the credit expansion of the boom. At the same time a very inflexible labor market caused official unemployment rates to rise to twenty percent. The resulting public deficit began to frighten markets and fellow EU member states, which finally pressured the government to announce some timid austerity measures in order to be able to keep borrowing.
In this regard, the single currency showed one of its “advantages.” Without the Euro, the Spanish government would have most certainly devalued its currency as it did in 1993, printing money to reduce its deficit. This would have implied a revolution in the price structure and an immediate impoverishment of the Spanish population as import prices would have soared. Furthermore, by devaluing, the government could have continued its spending without any structural reforms. With the Euro, the Spanish (or any other troubled government) cannot devalue or print its currency directly to pay off its debt. Now these governments had to engage in austerity measures and some structural reforms after pressure by the Commission and member states like Germany. Thus, it is possible that the second scenario for the future as mentioned by Philipp Bagus in the present book will play out. The Stability and Growth Pact might be reformed and enforced. As a consequence, the governments of the European Monetary Union would have to continue and intensify their austerity measures and structural reforms in order to comply with the Stability and Growth Pact. Pressured by conservative countries like Germany, all of the European Monetary Union would follow the path of traditional crisis policies with spending cuts.
In contrast to the EMU, the United States follows the Keynesian recipe for recessions. In the Keynesian view, during a crisis the government has to substitute a fall in “aggregate demand” by increasing its spending. Thus, the US engages in deficit spending and extremely expansive monetary policies to “jump start” the economy. Maybe one of the beneficial effects of the Euro has been to push all of the EMU toward the path of austerity. In fact, I have argued before that the single currency is a step in the right direction as it fixes exchange rates in Europe and thereby ends monetary nationalism and the chaos of flexible fiat exchange rates manipulated by governments, especially, in times of crisis.
My dear colleague Philipp Bagus has challenged me on my rather positive view on the Euro from the time when he was a student in my class, pointing correctly to the advantages of currency competition. His book, The Tragedy of the Euro, may be read as an elaborated exposition of his arguments against the Euro. While the single currency does away with monetary nationalism in Europe from a theoretical point of view, the question is: just how stable is the single currency in actuality? Bagus deals with this question from two angles, providing at the same time the two main achievements and contributions of the book: a historical analysis of the origins of the Euro and a theoretical analysis of the workings and mechanisms of the Eurosystem. Both analyses point in the same direction. In the historical analysis, Bagus deals with the origins of the Euro and the ECB. He uncovers the interests of national governments, politicians and bankers in a similar way that Rothbard does in relation to the origin of the Federal Reserve System in The Case against the Fed. In fact, the book could also have been analogously titled The Case against the ECB. Considering the political interests, dynamics and circumstances that led to the introduction of the Euro, it becomes clear that the Euro might in fact be a step in the wrong direction; a step towards a pan-European inflationary fiat currency aimed to push aside limits that competition and the conservative monetary policy of the Bundesbank had imposed before. Bagus’s theoretical analysis makes the inflationary purpose and setup of the Eurosystem even clearer. The Eurosystem is unmasked as a self-destroying system that leads to massive redistribution across the EMU, with incentives for governments to use the ECB as a device to finance their deficits. He shows that the concept of the Tragedy of the Commons, which I have applied to the case of fractional reserve banking, is also applicable to the Eurosystem, where different Euro- pean governments can exploit the value of the single currency.
I am glad that this book is being made available to the public by the Mises Institute. The future of Europe and the world depends on the understanding of the monetary theory and the workings of monetary institutions. This book provides strong tools toward understanding the history of the Euro and its perverse institutional setup. Hopefully, it can help to turn the tide toward a sound monetary system in Europe and worldwide.
As Europe continues bailing out its troubled economies, a subtle point is sidestepped. Providing additional doses of liquidity has brought short-term relief to some of the most troubled countries. Greece’s €110bn bailout earlier this year allowed it to save its burgeoning government payroll from starving. Ireland’s drawing on the €750bn. European bailout fund to the tune of €85bn. has saved some privileged banks. The next country to get bailed out will likely also see its troubles sidestepped for another day.
But the problem that no one wants to answer relates to what type of crisis this really is. Providing additional injections of liquidity may be a good Band-Aid solution if we are faced with a liquidity crisis. By expanding its balance sheet over the last two years, the European Central Bank has provided ample liquidity to keep its Eurozone banking institutions from failing. And if the ECB’s liquidity facilities weren’t enough, America’s Federal Reserve has been on hand to make U.S. dollar funding available at request. Tuesday’s extension of its U.S. dollar liquidity swaps reinforced the Fed’s commitment to maintaining a European banking system awash in credit.
Yet in continually ratcheting up the provision of liquidity, the ECB and the Fed have been battling yesteryear’s fight. Today’s crisis is fundamentally not of liquidity. It is one of solvency.
For a decade European governments spent beyond their means. Indeed, the ECB was one of the prime culprits allowing the newly formed Eurozone to pursue such prolific sovereign deficit spending. By allowing government debt to be used as collateral for its refinancing operations, the ECB ensured that Eurozone governments, especially Southern Eurozone governments, had access to cheap credit. With artificially reduced interest rates on their sovereign debt, Europe’s PIIGS economies were able to partake on a spending binge, with little heed for the coming liquidity crunch. The ECB, after all, had its hand on the lever to keep the liquidity coming.
Implicitly the ECB has treated the whole of the last decade as a liquidity crisis. Instead of functioning in its traditional role of lender of last resort, the ECB became a lender of first resort.
Today the use of liquidity has already largely been exhausted. The prolific spending of the past has created a solvency crisis. The governments of the Eurozone, aided by the excessive liquidity provided by the ECB during the last decade, have partaken on spending paths far overreaching any semblance of sustainability. An imbalance created in the past is now becoming apparent as these countries’ past debts come due.
In fact, the today’s recession is at its core not the result of “tight credit conditions”, “debt contagions”, or any other frivolous explanation. At its core we are faced with the realization that the previous fiscal state of affairs was unsustainable. By the time entrepreneurs realized that we were living in an unsustainable situation, it was already too late.
Of course, once you realize that the crisis is one of insolvencies the question that must be raised is what the best course of action is to get these insolvent situations solvent again. If we were indeed in the midst of a liquidity crisis, keeping the credit channels open may (and we must use the word cautiously) aid affected businesses.
An insolvency crisis implies one of two things. Either institutions are unable to pay off their debts as they are falling due, or, institutions have negative assets – liabilities in excess of assets.
The former seems to accurately describe the sovereign debt situation in Europe. Bond auctions are increasingly dismal. National governments are having difficulties raising the capital to meet their operating expenses. Normally capital is raised primarily through the financial markets – banks, mutual funds, insurance companies and the like purchase government debt as a “safe” asset for their portfolio.
The problem today is that this group of financial companies that typically funds government debts is under the second form of insolvency. The banking system in particular functions in an insolvent position as a normal state of its business affairs. Liabilities are always issued in excess of the assets available to pay them off – this is the fundamental basis of the fractional reserve banking system we are bound to today. As loans are issued in excess of deposits, a ballooning set of liabilities is permitted to be issued against a dwindling balance of assets.
The ECB allows the Eurozone domiciled banking system to issue up to 50 times the liabilities than assets are available to fund them. The Bank of England pursues an even more extreme path. With a reserve ratio on demand deposits set at zero, an unlimited amount of banking sector liabilities can be pyramided off an inexistent base of assets.
An insolvent financial system is unable to purchase additional amounts of government debt. Consequently, the sovereign debt crisis is unable to continue. The ECB pumping additional liabilities into the financial system cannot change the unalterable fact that assets cannot be created from thin air. Insolvency crises require a different exit plan than their less troublesome illiquidity counterparts.
Lacking a quick and easy method to create assets, the only solution to an insolvency crisis is to allow insolvent institutions to fail. Purging the bad debts from today’s financial system is an essential step in creating a sound foundation for recovery. Iceland, over the course of the past two years, has witnessed the bankruptcy of an insolvent banking system – one which had three large banks dominate the economy with liabilities amounting to 1100% of GDP. One would think that permitting such a dominant and centralized part of the economy to “fail” would cause undue hardship.
The purge of insolvent assets from Iceland’s financial landscape allowed for a fresh start. Government spending was forced to be cut as revenues were sharply curtailed. Talk of austerity measures that Britain and the Eurozone only hesitantly discuss became quick reality for Icelanders. An unsustainable situation came to an end, and Icelanders have commenced rebuilding with knowledge of the flaws of their past.
If the Eurozone could realize the same fate it too could have a quick exit. Past mistakes have been made, and insolvent institutions have been created. Allowing them to flourish further will do nothing but prolong the current economic malaise.
The European monetary union is being held together tenuously. After putting €110bn. on the line to save Greece earlier this year, the tab increased by €85bn. as Ireland reluctantly accepted a recent bailout package. While the €750bn. shield brokered by the IMF and EU member states seemed adequate not even one year ago, the outlook grows gloomier by the day. Instead of questioning whether the fund is large enough or has the authority to act quickly enough in an emergency, we should reassess what the original purpose behind it was.
Germany fronted almost €120bn. for the fund, over €1,500 for every German man, woman and child. While it is perhaps not surprising that the EU’s largest economy and population pledged the most support, Germany faces a much starker rationale. The survival of the EU relies on the survival of its periphery. A strong German-centric EU will need help from its core to realize this future. Survival of the periphery, however, may not be in any one individual country’s best interests. So goes the common argument for the maintenance of Europe’s political and monetary unions.
In a recent commentary Mohamed El-Erian points out that the continued support of the periphery is straining Germany’s balance sheet. German government bunds have seen their rates surge over the past weeks, despite the country’s continued dedication to austerity. It shares the same fate as its periphery, without any of the “benefits” of a German funded bailout.
Luckily for the Germans, they largely control a key tool to Europe’s future – the European Central Bank. By continuing to purchase periphery (PIIGS) debt, El-Erian reckons that the ECB can alleviate Germany of this increasingly burdensome role. What he misses are the implicit costs that will result, as well as the promotion of dangerous consequences already in place.
The choice Germany faces is not between straining itself fiscally or inflating its problems away via the ECB. Germany may opt to exit the Eurozone, thus avoiding the bureaucratic costs of its less prudent neighbors. Indeed, after Berlin passed an €80bn. austerity package earlier this year, other Eurozone countries continued their prolific spending programs. The EU’s Treaty of Maastricht “strictly” prohibits member state deficits greater than 3 percent of GDP except for exceptional and temporary circumstances. The Irish deficit could reach 14 percent of GDP this year. Greece is close behind at 13 percent. Although the circumstances affecting these countries do seem exceptional, they are increasingly reckoned as anything but temporary.
Troubled counties such as Ireland would do well to exit the Eurozone to allow their currencies to devalue in an attempt o regain a competitive advantage. Germans will also find their own exit positive.
Continuing to fund bailout packages for less prudent neighbors is not a sustainable nor equitable situation for the Germans to be in. Turning to the ECB to inflate the problems of these periphery countries may be a short-term fix, but at what cost? Germans would be “punished” for not directly bailing out their neighbors with an inflated currency.
While every German man, woman and child has already had to fund the European Financial Stability Facility to the tune of €1,500, an inflated euro would decrease the value of every hard earned euro not already pledged. El-Erian correctly concludes that “The situation this time suggests good economics should play a greater role. Rather than simply doubling up on a faltering liquidity approach, the time has come for Germany to lead a more holistic solution focused on addressing the periphery’s debt overhang and competitiveness problems.”
An exit from the Eurozone and abandonment of the euro would do much to allow individual member states the necessary currency readjustment to regain their competitiveness. Euro membership could be a beautiful thing if it meant that member countries followed the rules – reduce or eliminate deficits and not promote inflationary solutions. Germans, indeed, should quit funding unsustainable situations with bandage solutions, and instead focus on the root problem. The German dilemma between fiscal bailouts and inflation need not necessary cause European-wide problems. A third option exists. Exiting the common currency would do much to remove the root of these problems, both for Germany and the periphery.
