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.
“On October 15, the mark’s rate against the pound passed 18 milliards. On October 21, after the mark had moved in three days from 24 milliards to 80 milliards to the pound, Lord D’Abernon noted with some statistical glee that (at 60 milliards) this was ‘approximately equal to one mark for every second which has elapsed since the birth of Christ’. At the end of the month the banknote circulation amounted to 2,496,822,909,038,000,000 marks, and still everybody called for more.”
– From ‘When money dies: the nightmare of the Weimar hyperinflation’ by Adam Fergusson.
The internet has been nicely described by Lars Nelson of the New York Daily News as “a vanity press for the demented”.
Notwithstanding the bitter accuracy of this statement, we flit from time to time to sites like Twitter to attempt quixotically to redress the balance of popular opinion away from wrong-headed nonsense with regard to the financial world in favour of rational (perhaps even moral?) analysis. Last week we engaged in the following conversation:
Anonymized Tweeter: “are u a conspiracy theorist?”
Us: “No, I just believe in sound money and small government. And not in central bankers – who caused this depression too.”
AT: “we aren’t and never hv been in a depression. I’d also argue without current radical policy action from Bernanke we’d be MUCH worse off.”
Us: “If this ends in currency collapse, which I think it might, will we all be better off? Fed to blame in any case.”
AT: “Perhaps ud have preferred a much deeper recession / depression and full banking collapse Japanese style deflation over QE?”
Us: “I think I would rather have a nasty short term recession and bank nationalisations over a perma-depression.”
Admittedly, it’s not exactly War and Peace, but there you go.
The conventional reaction to the extraordinary economic and policy events of the last five years has been to accept an alphabet soup of trillions of dollars’ worth of taxpayer-funded inflationary monetary stimulus directed exclusively at banks as averting what would otherwise have been a nasty though perhaps relatively short-lived deflationary bust. As with the 1930s there is no counter-factual, so we will never know for sure. But we incline more towards Michael Lewis’s take on things. In this summary, our favourite brokerage firm and definitive non-bank Goldman Sachs can serve as the representative of broader banking interests:
Stop and think once more about what has just happened on Wall Street: its most admired firm conspired to flood the financial system with worthless securities, then set itself up to profit from betting against those very same securities, and in the bargain helped to precipitate a world historic financial crisis that cost millions of people their jobs and convulsed our political system. In other places, or at other times, the firm would be put out of business, and its leaders shamed and jailed and strung from lampposts. (I am not advocating the latter.)
Instead Goldman Sachs, like the other too-big-to-fail firms, has been handed tens of billions in government subsidies, on the theory that we cannot live without them. They were then permitted to pay politicians to prevent laws being passed to change their business, and bribe public officials (with the implicit promise of future employment) to neuter the laws that were passed — so that they might continue to behave in more or less the same way that brought ruin on us all.
Like Michael Lewis, this commentator also once worked as a bond salesman – nobody’s perfect – so we claim a modest degree of informedness when it comes to the workings of the banking and investment banking business. So our take on things can perhaps best be summarised as follows. We are living through the tail end of a 40-year credit bubble that has reached the terminal phase of its expansion. As Herbert Stein rightly observed, if something cannot go on forever, it will stop. But bankers don’t want the music to stop, and they are perfectly willing to steal from taxpayers in order to pay the orchestra. Politicians cravenly obeying the unfit-for-purpose four- or five-year electoral cycle are now displaying the biggest tin ear in history to the ever-louder complaints of constituents of what remains of the real, productive economy as opposed to narrowly self-interested Big Finance.
The popular debate, if any, runs out of road once we start to discuss money itself – a critical component within the debate, but insufficiently understood by just about everybody. Why have the untold trillions of central bank ex nihilo base money not already triggered eye-watering levels of inflation? 1) Because they mostly sit inert (so far) as commercial bank reserves. 2) Because commercial banks’ balance sheets remain mostly upside down (i.e. the banks are still pretty much insolvent), so the last thing these firms are going to do is actually lend it out to anyone. 3) There is already uncomfortable inflationary leakage feeding into the prices of many financial assets, including the obvious usual suspects, stocks and bonds.
And so the economy, like that of Weimar Germany, remains moribund even as more and more money gets printed. At some point, which may be fast approaching, the marginal user of money is going to get fed up at this constant devaluation of their purchasing power, and the rush into hard assets will begin. As longstanding readers and our clients are well aware, we love hard assets. As one highly successful fund manager recently wrote to us, hard assets rock.
In the meantime, the financial media continue to prattle on about this mythical ‘Great Rotation’, whereby a polarised constituency of bond investors is mysteriously going to get religion and an overnight mandate change and pile into overpriced stocks instead. This theory is so absurd we won’t waste much more time on it. Suffice to say, if stocks are “attractive” primarily because of their valuation relative to bonds, their “attractiveness” breaks down when bond prices do, as they surely will at some point in the near to medium term. And bond prices are only where they are because of extraordinary monetary stimulus in the form of money which is being devalued on a daily basis. Did we mention hard assets?
Unfortunately, debate is useless because only politicians have sufficient clout to bang heads in the banking (and central banking) sector, and most politicians don’t appear to understand money creation (or destruction) either.
Back to Adam Fergusson:
What really broke Germany was the constant taking of the soft political option in respect of money. The take-off point therefore was not a financial but a moral one; and the political excuse was despicable, for no imaginable political circumstances could have been more unsuited to the imposition of a new financial order than those pertaining in November 1923, when inflation was no longer an option. The Rentenmark was itself hardly more than an expedient then, and could scarcely have been introduced successfully had not the mark lost its entire meaning. Stability came only when the abyss had been plumbed, when the credible mark could fall no more, when everything that four years of financial cowardice, wrong-headedness and mismanagement had been fashioned to avoid had in fact taken place, when the inconceivable had ineluctably arrived.
Money is no more than a medium of exchange. Only when it has a value acknowledged by more than one person can it be so used. The more general the acknowledgement, the more useful it is. Once no one acknowledged it, the Germans learnt, their paper money had no value or use – save for papering walls or making darts. The discovery which shattered their society was that the traditional repository of purchasing power had disappeared, and that there was no means left of measuring the worth of anything. For many, life became an obsessional search for Sachverte, things of ‘real’, constant value: Stinnes bought his factories, mines, newspapers. The meanest railway worker bought gewgaws. For most, degree of necessity became the sole criterion of value, the basis of everything from barter to behaviour. Man’s values became animal values. Contrary to any philosophic assumption, it was not a salutary experience.
What is precious is that which sustains life. When life is secure, society acknowledges the value of luxuries, those objects, materials, services or enjoyments, civilised or merely extravagant, without which life can proceed perfectly well but which make it much pleasanter notwithstanding. When life is insecure, or conditions are harsh, values change. Without warmth, without a roof, without adequate clothes, it may be difficult to sustain life for more than a few weeks. Without food, life can be shorter still. At the top of the scale, the most valuable commodities are perhaps water and, most precious of all, air, in whose absence life will last only a matter of minutes. For the destitute in Germany and Austria whose money had no exchange value left existence came very near these metaphysical conceptions. It had been so in the war. In All Quiet on the Western Front, Müller died ‘and bequeathed me his boots – the same that he once inherited from Kemmerick. I wear them, for they fit me quite well. After me Tjaden will get them: I have promised them to him.’
In war, boots; in flight, a place in a boat or a seat on a lorry may be the most vital thing in the world, more desirable than untold millions. In hyperinflation, a kilo of potatoes was worth, to some, more than the family silver; a side of pork more than the grand piano. A prostitute in the family was better than an infant corpse; theft was preferable to starvation; warmth was finer than honour, clothing more essential than democracy, food more needed than freedom.
We have been warned. And we have been here before. What really broke [Germany] was the constant taking of the soft political option in respect of money. Are our politicians, journalists and central bankers even listening? There are none so deaf as those who will not hear.
Last Wednesday the Bundesbank released a statement to the effect that 300 tonnes of Germany’s gold will be moved from New York and 374 tonnes from Paris. This should be a simple operation: rail or trucks from Paris, and a few military planeloads (or ships) from America – as soon as they have somewhere to store it.
Instead they plan to do it over the next seven years, which is a postponement. This tends to confirm suspicions that the gold does not actually exist. As a side issue, along with the Bundesbank statement is a PDF download with slide number 14 entitled “Storage at the Federal Reserve Bank New York”. It looks like a photomontage rather than real gold, and the come-on is to believe it’s the Bundesbank’s. This gives the game away: the whole exercise is a public relations stunt.
Why hold any gold in New York nowadays? The Soviets are no longer menacing the Fulda Gap. Yes, New York is obviously still a critical trading venue, but not for physical gold – the Bundesbank apparently withdrew 940 tonnes from the Bank of England in 2000, where the physical market is actually located.
The reason this matters is that independent deductive analysis has concluded that the central banks have been supplying the market with physical bullion in order to suppress the price, all of which is either officially denied or goes unanswered. The origin of price suppression actually go back to the 1990s, and was exposed by Frank Veneroso in a paper published in 1998, confirmed by detective work from our own James Turk, and triply confirmed by the evasive responses on this issue given by central banks and the IMF to the Gold Anti-Trust Action Committee (GATA). The public are unaware of this issue because the mainstream media, with the occasional exception, refuses to investigate the subject.
But here is something that joins up a few more dots. We know that Gordon Brown sold half of Britain’s gold at the bottom of the market from 1999-2002. We commonly assume that he was just incompetent. What is not commonly appreciated is that he learned his economics from Ed Balls, the current Shadow Chancellor. As his economics advisor, Balls was the puppet-master and Chancellor Brown the puppet. Ed Balls was also a close friend of Larry Summers, who was US Deputy Secretary of the Treasury from 1995 and then Secretary of the Treasury from 1999 to 2001 – the time of Britain’s gold sales. As Treasury secretary Summers was head of the Exchange Stabilization Fund, the US government’s mechanism for supplying bullion to the markets. In the light of these deeply Keynesian relationships from the mid-1990s, it is unlikely that Brown acted in isolation. More than likely Washington was also supplying the market through swaps and leases that were never recorded as changes of ownership.
The net result is that there is not enough physical gold left in the vault to deliver to Germany, which is why they are stalling for time. What was presented to us last Wednesday was just a desperate attempt to stop the whole issue becoming more public.
Episode 86: Professor Patrick Barron is an Austrian School economist who teaches courses in banking and economics at the University of Wisconsin-Madison and the University of Iowa. He also writes regular pieces for Mises.org.
Professor Barron has put forward the idea that the only route out of the ongoing euro crisis for Germany is an initial return to the Deutschmark, followed preferably by a subsequent move to a golden Deutschmark. He discusses this idea with GoldMoney’s Andy Duncan, along with the three major obstacles to his desired outcome, which include a lack of current party-political support in Germany for this idea, along with outside political influences over Germany’s monetary policies, and the growing uncertainty over Germany’s access to its own physical gold supply.
As well as exploring the current financial situation in Europe, Professor Barron also comments upon the recent fiscal cliff event in the United States, and mentions the recent article in The New York Times, by Paul Krugman, on the subject of a special trillion dollar platinum coin. He explains why eventually he believes the US dollar will go back to a link with gold, and why he thinks the price of gold may then reach $38,000 dollars an ounce. Professor Barron runs his own website, which GoldMoney subscribers can find at www.patrickbarron.blogspot.com/.
The book mentioned heavily in the interview, The Tragedy of the Euro, by Professor Philipp Bagus, can be downloaded for free from this link.
This podcast was recorded on 11 January 2013 and previously published at GoldMoney.com.
Every Monday morning the readers of the UK’s Daily Telegraph are treated to a sermon on the benefits of Keynesian stimulus economics, the dangers of belt-tightening and the unnecessary cruelty of ‘austerity’ imposed on Europe by the evil Hun. To this effect, the newspaper gives a whole page in its ‘Business’ section to Roger Bootle and Ambrose Evans-Pritchard, who explain that growth comes from government deficits and from the central bank printing money, and why can’t those stupid Europeans get it? The reader is left with the impression that, if only the European states could each have their little currencies back and merrily devalue and run some proper deficits again, Greece could be the economic powerhouse it was before the Germans took over.
Ambrose Evans-Pritchard (AEP) increasingly faces the risk of running out of hyperbolic war-analogies sooner than the euro collapses. For months he has been numbing his readership with references to the Second World War or the First World War, or to ‘1930s-style policies’ so that not even the most casual reader on his way to the sports pages can be left in any doubt as to how bad this whole thing in Europe is, and how bad it will get, and importantly, who is responsible. From declining car sales in France to high youth-unemployment in Spain, everything is, according to AEP, the fault of Germany, a ‘foolish’ Germany. Apparently these nations had previously well-managed and dynamic economies but have now sadly fallen under the spell of Angela Merkel’s Thatcherite belief in balancing the books and her particularly Teutonic brand of fiscal sadism.
Blame it on ze Germans
The pending bankruptcy of France’s already semi-nationalized car industry is, of course, not to be blamed on high French taxes, strangling French labour market regulation, increasingly uncompetitive French wages, and grave business errors – French car companies have been falling behind their German rivals for years – but the result of French ‘austerity’, which hasn’t even started yet and will culminate in – quote AEP, and drum roll please! – a ‘shock therapy’ next year of 2 percent. Mind you, France’s state has a 57% share in GDP, and the economy deserves the label socialist more than capitalist. Does France really need more state spending, or even unchanged state spending? Another government stimulus? I bet you could cut the French state by 10 percent instantly, and in a year or two you’d have faster growth, not slower growth!
However, Monsieur Hollande is eager to live up to his socialist promises, all the egalité he was voted for, and does not shrink the state but instead raises taxes further, lowers the pension age and raises minimum wages, none of this a demand from Rosa Klebb in Berlin, as far as I know, but AEP doesn’t quibble over such detail. It is all ‘austerity’ to him and ‘austerity’ is always imposed by Germany, and to make really sure that you get that this is a bad idea, and a bad idea coming from Germany, he now calls it the ‘contractionary holocaust’.
Nice touch. There is no place for subtlety, I guess.
Bootle does not stoop quite so low but his pieces are equally filled with the Keynesian myth that there is no economic problem that cannot be solved by more debt and easy money and the occasional devaluation. The fallacy here is the standard Keynesian one: there is no limit to debt, the market doesn’t matter, people can be fooled forever.
The real issue
The reality is different: the markets are slowly waking up to the fact that the social-democratic welfare-state that dominated the West since the First World War is going bust. Everywhere. Faster in some places (Greece, the UK), more slowly in others (Germany), but the direction and the endpoint are the same. This is not a specifically European problem, or even one that is particularly linked to the single currency project; it is pretty much a global phenomenon, and it will shape politics for years to come. It is naïve, dangerous and even irresponsible to dress this up as a design-fault of the euro and thus imply that the problem would be smaller or more easily manageable, or even non-existent, if countries could only issue their own currencies, print money, keep running deficits and devalue to their hearts’ content. The false impression that is being conveyed by Bootle and AEP is that Spain, Greece, Portugal and Italy could somehow simply turn back the clock and, in the more open, more competitive world of the 21st century still run the cosy big state, high inflation, frequent debasement policies of the 1970s.
Bootle and AEP represent the naïve Keynesianism that still believes deficits just pop up in recessions as a ‘natural corrective’ – in fact, AEP exactly describes it that way. The truth is, countries like Greece have been running big deficits in good times and now run bigger deficits in bad times, and they are far from being alone in this. Since the introduction of unconstrained fiat money, most states see no need to balance the books but operate blissfully under the assumption that they can keep accumulating debt forever. Since Greece joined the euro and thereby benefitted from lower borrowing costs, the country’s average wage bill went up 60%, compared to 15% in Germany over the same period. Present Greek structures are simply unsustainable. An economy that has been stifled for decades by the persistent political rent-seeking of its powerful, connected and self-serving interest groups, by an overgrown public sector and uncompetitive wages, simply will not be reinvigorated by yet more debt. And in any case, the bond market has now had enough and won’t fund the Greek state any more anyway. Letting deficits rise, as AEP suggests, is no longer even an option. Not now in Greece, and soon elsewhere. Austerity is, increasingly, not a policy choice but an unavoidable necessity.
So what about devaluation? — It is a bad idea. It must mean inflation, the confiscation of wealth from savers – and savers are the backbone of any functioning economy, even though Bootle and AEP apparently believe it is the state and the central bank that make the economy tick – it must lead to persistent capital flight and hinder the build-up of a productive capital stock. And once you have accumulated a certain level of debt, devaluing the currency could undermine confidence completely and end in hyperinflation, default and total economic destruction.
No country has ever become prosperous by having a soft currency and devaluing repeatedly, yet many have become poor. A hundred years ago, Argentina was among the 8 richest nations in the world and has since managed to decline from first world status to third world status through persistent currency debasement. Since the end of Bretton Woods, Britain has consistently debased its currency, more rapidly than Germany or even the United States, a policy that has undoubtedly contributed to the country’s de-industrialization over this period, its high debt-load, low savings rate and its dependence on cheap money that lasts to this day.
True and lasting prosperity – as opposed to make-believe bubble wealth – has the same sources everywhere and at all times: true savings, proper capital accumulation, and as a result, rising labour productivity. Hard money is the best foundation for these powerful drivers of wealth creation to do their work.
Default instead of devaluation
It is not my goal to defend the policy of the German government or of Chancellor Merkel here. The present policy is wrong in many ways and will fail. But the reasons and my conclusions are different from those advanced by AEP and Bootle. Merkel is desperately trying to pretend that these governments are not bankrupt, that the debt will be repaid, and in so doing she throws good money – that of the German taxpayer – after bad. Most of the governments in Europe, plus the US, the UK and Japan, are unlikely to ever repay their debt, and the big risk is that, once the 40-year fiat money boom that facilitated this bizarre debt extravaganza has ended for good, and the illusion of living forever beyond your means has evaporated, a lot of that debt will have to be restructured, which means it will be defaulted on. That is not the end of the world, albeit the end of the type of government largesse that has defined politics in the West for generations, and it will be the end of the modern welfare state, and herald an era of proper austerity, imposed by the reality of the market and not the Germans. The question is only if policymakers will desperately try and postpone the inevitable and in the process also destroy their fiat monies.
In the case of Greece and Portugal and other countries, default should simply be allowed to occur, a proper default, not the type of managed default that Greece went through and that left the country with more debt as a result of more official aid – all in the vain attempt to pretend the country is somehow still solvent and creditworthy. Whether any issuer is solvent or not, is not decided by a bunch of Eurocrats in Brussels but by the market. The market is not lending to Greece, ergo Greece is bankrupt. Period. It would be better for everybody to admit it.
Germany is far from healthy. It, too, is travelling on the road to fiscal Armageddon, just at a slower speed. Merkel’s policy of bailing out her ‘European partners’ – a policy for which she gets little credit from AEP, Bootle and the rest of Europe – will only hasten that process.
Proper defaults on government debt would also teach bond investors a lesson, namely that they should not engage in the socially destructive practice of channelling scarce savings through the government bond market into the hands of politicians and bureaucrats with the aim of obtaining a ‘safe’ income stream out of the state’s future tax receipts (i.e. stolen goods) but to instead invest savings in capitalist enterprise and thus fund the creation and maintenance of a productive, wealth-enhancing capital stock. Losing their money in allegedly ‘safe’ government bonds is, quite frankly, what they deserve.
In defence of a common currency
None of this means that defaulting nations should be forced to leave the single currency. There is, in most cases, simply no need for leaving, and staying in a widely shared common currency does indeed have many benefits.
The idea that numerous countries – even countries with very diverse economic characteristics – should share the same money is entirely sensible and highly recommendable. Money is a medium of exchange that helps people interact on markets and cooperate via trade, and this cooperation does not stop at political borders. Money is valuable because it connects people via trade, and the more people money can connect (the more widely accepted and widely used any form of money is), the more valuable it is, and the more beneficial its services are to society overall. Yes, the best money would be universal money, global money, such as a global gold standard. It is nonsense to have money tied to the nation state. This type of thinking is a relic of the 19th century when the myth could still be maintained that a ‘national economy’ – somehow magically congruous with the political nation state – existed, and that the national government should manipulate the national money according to national objectives. That is the type of thinking that Bootle and AEP epitomize. Although, already by the late 19th century, this myth of the national economy was dying, as the Classical Gold Standard began to provide a stable global monetary framework that allowed peaceful cooperation across borders by vastly different states, and heralded a period of unprecedented globalization, harmonious economic relations and relative economic stability.
Every form of money is more valuable the wider its use. Currency competition is deceptively appealing to many free marketeers, and as an advocate of pure capitalism, I would never stop anybody from introducing a new form of money. But the economic good ‘money’ conveys enormous network benefits. Because of its very nature as a facilitator of trade, there will always be an extremely powerful tendency for the trading public to adopt a uniform medium of exchange, that is, for everybody to adopt the same money.
There is a persistent fallacy out there, and Bootle and AVP are among its numerous victims: the fallacy is that countries can do better economically by cleverly manipulating their own domestic monies. This is erroneous on a very fundamental level. Any easing of financial conditions through extra money creation, through an extra bit of inflation or a bit of devaluation, can never bestow lasting benefits. Such manipulations of money can only ever result in short-lived growth blips, at the most, and these growth blips always come at the price of severe economic costs in the medium to long run. Monetary manipulation is never a free lunch. It is always damaging in the final analysis.
Being part of a currency-union means the end of national monetary policy, and that is, on principle, to be welcome. The main problem with monetary policy today is that there is such a thing as monetary policy. Money should be hard, inflexible, apolitical and universally accepted to best deliver whatever services money can deliver to society. The problem with the euro is not that it encapsulates so many diverse countries but that it is not hard, not inflexible, and not apolitical. The euro is a paper currency, and like any state fiat money it is a political tool, constantly manipulated to achieve certain ends, and over which ends to pursue there is, quite naturally, almost constant conflict.
If only the euro was golden!
Some people say that the euro is like a gold standard and that its failure demonstrates the undesirability of a return to gold. This is nonsense. To the contrary, the euro would work better if it operated more like the gold standard and if it was as hard, as inflexible and as non-political as gold. Then, interest rates could not have been kept artificially low back in the early 2000s, for the benefit of Germany and France, a policy that laid the foundation for the real estate and debt bubbles in the EMU-periphery. Then banks could not have ballooned their balance sheets quite as much as they did with the help of the ECB and not have dragged us all into a major banking crisis, and once the banks had self-destructed, they could not have been bailed out with unlimited ECB loans and artificially low and even lower rates so that they might continue in their merry reckless ways. Today’s major imbalances, from over-extended and weak banks to excessive levels of debt, are inconceivable in a hard money system. But even now that these imbalances have been allowed to accumulate, it would still be preferable to go back to hard and inflexible money. Under a hard money system politicians and bureaucrats cannot lie and cheat and pretend, at least not as much as they can today. Hard money has a tendency to expose illusions.
This is not a defence of the EU, which is a wretched project, and increasingly morphs into a meddling, arrogant super-state, an ever more potent threat to our liberty and our prosperity. I am not particularly keen on the fiat-euro either. But still, the idea of many countries sharing the same currency is a good one. No question.
If Bootle and AEP were right that weaker nations should opt for weaker currencies, for the monetary quick-fixes of devaluation and inflation, what would that mean for so-called national currencies? By that logic, shouldn’t Italy not only exit the euro and return to the lira, but instead adopt a number of different local liras? Should Italy’s Mezzogiorno not issue its own super-soft currency and devalue against the hard lira of the north? Why should these two diverse regions be tied together under the same currency? Should Scotland have its own currency and happily devalue versus more prosperous South East England? And wouldn’t Liverpool and Manchester not benefit from their own monies, conveniently manipulated to stimulate and reinvigorate their local economies? The absurdity of the whole idea becomes quickly apparent.
But AEP is quite happy with his little island nation state. The extent to which he hopelessly underestimates the challenges facing his home nation – and by extension, the world – becomes apparent when he assures the reader that he, AEP, too, supports modest austerity, namely the present coalitions’ pathetic and entirely insufficient attempt of trimming spending by ‘1 pc of GDP each year’, ‘thankfully’ (AEP) flanked by generous debt monetization from the Bank of England and constantly checked by the Labour Party’s opportunistic clamouring for more deficit spending. Well, last I checked, the UK was running 8 pc deficits per annum. Next to Japan, Britain is the most highly geared society on the planet (private and public debt combined), and when the markets pull the plug on this island nation, the fallout might make Greece look like a walk in the park.
But then, AEP won’t be able to blame it on the Germans.
In the meantime, the debasement of paper money continues.
The greatest threat to worldwide prosperity is the collapse of what remains of free-market capitalism. Not depletion of scarce natural resources. Not environmental degradation. Not global warming (or is it “climate change” now?) No, the greatest threat to worldwide prosperity is the complete collapse of what little remains of free-market capitalism. Throughout the world, and not just in totalitarian countries, the state has been advancing at the expense of economic liberty. The indispensible tool that enables the modern state to usurp our liberties is its access to unlimited amounts of fiat money controlled by central banks — i.e., the unholy alliance of the state with the central bank.
Fiat-money expansion has made the advance of statism possible through its ability to thwart the wishes of the people as the final arbiters of state spending. The state can obtain an almost limitless amount of fiat money from its central bank. It need not increase taxes or borrow honestly in the bond market, so it need not fear a tax revolt or high interest rates respectively. All it needs to do is convince the central bank to buy its debt. The state then takes control over more and more resources, squandering them on war and welfare, depriving the free-market economy of its capital base. Once the capital base has been depleted, the economy will go into a steady decline.
The poster child of this phenomenon is the (former) Soviet Union. Yes, total collapse is a real possibility — for us too. The Russian people may have believed that economic decline would reach a plateau, stop, and then reverse. As explained in stark terms by Dr. Yuri Maltsev, former economic advisor to Mikhail Gorbachev, in Requiem for Marx, the Soviet economy deteriorated into one of subsistence. The capital base of Russia had been destroyed, and collapse soon followed.
The monetary printing press is seen as an alternative to saving and investing as the means to grow the capital base. Monetary stimulus attempts to generate economic recovery mainly through exports.
If a nation can increase its exports, so the logic goes, it can increase employment, pay off debts, etc. So, rather than properly reforming the economy, monetary authorities engage in a destructive “race to the bottom” through competitive debasement of their currencies. First one country then another intervenes into its own currency markets to cheapen its currency against all others. But currency devaluation will not work, as explained in “Value in Devaluation?”
What is desperately needed is for one country to break from this failing and ultimately disastrous model of fiat-money expansion and its horrific effects. This one country must be in a special position whereby it is readily apparent that it is being harmed by currency debasement over which it has no control. Fortunately for the world there exists such a country: Germany.
The Intolerable Monetary Position of Germany Creates a Unique Opportunity
Germany is the fourth-largest economy in the world, behind only the United States, China, and Japan. Amazingly, it does not control its own money supply, because it is a member of the European Monetary Union (EMU), composed of 17 nations using a common currency — the euro. Each member, regardless of size, has an equal vote over monetary policy, administered by the European Central Bank (ECB). Increasingly Germany’s is the lone voice for monetary restraint — recently it was outvoted 16 to 1 over an ECB plan to print euros in greater numbers in order to bail out bankrupt members of the EMU. This is a situation that would be intolerable for any other country; however, due to Germany’s history, it is reluctant to be seen as “anti-Europe” and instead has tried to work within the EMU framework to force bankrupt countries to reform their economies. But this is a hopeless exercise, as explained by Dr. Philipp Bagus of King Juan Carlos University, Madrid, in his brilliant book Tragedy of the Euro. All the benefits flow to the irresponsible countries, so there is little incentive and no enforcement mechanism for meaningful reform. Therefore, in a previous article (“A Golden Opportunity “), your authors have called for Germany to leave the EMU, reinstate the deutsche mark, and anchor it to gold.
Most recently there have been calls within Germany to repatriate substantial gold reserves held overseas. The Bundestag — federal Germany’s legislature and, as such, representing all diverse elements and factions in the country — is the impetuous behind this movement. The Bundesbank, Germany’s still-extant central bank, has agreed to repatriate about one-tenth of its vast overseas gold deposits over the next three years.
But this is inadequate for the real task at hand. Germany must repatriateALL of its gold. There is only one reason that a central bank would wish to repatriate its gold: to serve as reserves in a gold backed monetary system. The market must be assured that the gold actually exists, that it is under the total control of its rightful owner, and that it is not leased or part of a swap arrangement. Furthermore, the central bank must be willing to honor demands to deliver gold in the quantity specified in exchange for its paper money certificates and the commercial-bank book-entry deposits.
Delivery of Gold upon Demand Is Crucial
If Germany is to back the deutsche mark with its own gold, markets must be certain that the Bundesbank can and will deliver the gold upon demand. For under a gold-backed system the gold isthe money. The pieces of paper that people carry in their wallets and keep in cookie jars and the book-entry receipts at commercial banks are not money per se; these are money substitutes that can be exchanged for real money — gold. The central bank can meet this requirement only if it has absolute control over its gold.
The Bundesbank has significant portions of its overseas gold deposits at the Federal Reserve Bank in New York and the Bank of England in London. At one time it may have made sense to deposit gold in these countries in order to protect it from the possibility that the Red Army would overrun Germany. Fortunately that threat is no more. But the Federal Reserve Bank has been very circumspect about displaying Germany’s gold to its rightful owners. Now, I ask you, is this not very suspicious behavior? Why would the Fed refuse to show the actual gold to Germany or any other nation with gold deposits? The reason usually given is one of security, but what does the Fed think is going to happen? Does it think that armed robbers will be able to abscond with some bars? This is preposterous! The gold is the property of Germany. Germany should insist on viewing its gold, counting its gold, testing its gold for fineness, and making quick arrangements for moving its gold to its own vaults in Germany.
Let Justice Be Done
Either the gold is all there, and rumors to the contrary are baseless, or some portion of the gold is not there or is encumbered in some way. If the former, all is well. If the latter, then let’s learn about it now, so that we can stop any further theft and so that we can establish a financial-crimes tribunal to try all who had a part in the theft. If that means prosecuting central-bank officials in the United States or the United Kingdom, so be it. If that means that the exchange rates for the dollar or the pound sterling fall in relation to other currencies, so be it.
Let’s learn the truth, whatever that may be, so we can get on with the important work of placing the world’s finances on the solid foundation of sound money and not on promises of confidence men. Let us adopt the Latin legal concept fiat justitia ruat caelum, “Let justice be done though the heavens fall,” and not lose sight of the goal of saving what remains of free-market capitalism and beginning the difficult process of restoring our liberties.
This article was co-authored with Patrick Barron and previously published at Mises.org.
In his recent Mises Daily article “Fool’s Gold Standards“, John P. Cochran warns his readers against accepting any monetary reform less than that of money created by the free market. Therefore, he felt it necessary to criticize our previous Mises Daily article “A Golden Opportunity,” in which we advised Germany to leave the European Monetary Union, reinstate the deutsche mark, and tie it to gold.
Although he admits that our “recommendation may be a step in the right direction … it leaves Germany with a central bank and a discretionary monetary policy.” That it does — for now.
In no way was our essay intended to imply that central-bank control of gold-backed money was the point at which we desired monetary reform to cease. As Austrian economists, we fully understand and support the goal of full monetary freedom of the marketplace as that which best advances liberty, prosperity, and peace. The question becomes, how will we achieve it?
We believe that Germany is in a unique position to end the destructive forces of fiat monetary expansion that seem to gain new impetus every day. That is number one. Before we can have the perfect money, we must have a better money, and Germany is in a position to show us the way. All of us who desire liberty, prosperity, and peace should ask Germany to seize this opportunity to stop what surely will destroy free-market capitalism. By reinstating the deutsche mark and tying it to its vast gold holdings, Germany can be the catalyst that creates a cascade of similar virtuous acts that will lead eventually to full monetary freedom and all that that will bring.
Consider the likely consequences of the world’s fourth-largest economy establishing a 100 percent gold-backed currency. This currency would dominate world trade, because all trading nations would desire to denominate their exchanges in the soundest money available. For a while at least, that would be the deutsche mark. Demand would drop for the currencies of all other nations unless and until these countries did the same thing. A virtuous cycle would ensue as first one then another country linked its currency to gold. The country with the most to lose would be the United States, whose dollar currently is preferred for international trade. But as demand increased first for the deutsche mark and later for the currencies of other nations who followed Germany’s example, demand for the dollar would fall and prices would rise precipitously in the United States as countries no longer found it advantageous to hold dollars abroad. At this point, the United States would be forced to return to gold. In our opinion, nothing less will bring the world’s superpower to its senses; i.e., the United States will not voluntarily adopt gold, because it benefits the most from the current inflationary system. However, if the major trading nations of the world adopt gold-backed currencies, even the United States will be forced by the market to do so.
But this is not the end. Once the peoples of the world see the advantages to using gold money, they will begin to understand that central banks are not required to perform the money function at all. Why couldn’t HSBC, Citibank, Barclays, Deutsche Bank, or any of a number of well-respected international private banks do the same? These international banks are more nimble than any ossified government bank to meet the needs of business and finance. Furthermore, these international banks are more trustworthy than national central banks, which tend to operate in great secrecy in order to hide the risk they are taking with our money. Private banks would have to answer to stockholders employing their own independent auditors.
Consider how religious toleration arose in the West, first as an expediency by princes who vied for power with the Catholic Church. Different religions were established and protected by the state. But over time, religious tolerance came to be seen as a good in itself. Today we accept religious tolerance in the West as a universal given, yet it is a relatively recent phenomenon.
It is in this vein that we recommend that Germany end the tyranny of the inflationary euro and adopt a golden deutsche mark. Such a courageous yet self-protective action will lead to a U-turn in monetary policy, away from monetary destruction and toward better and better money everywhere.
This article was previously published at Mises.org.
Godfrey Bloom is a financial economist by profession and winner of international fund management awards. He is a member of the European Parliament Economic and Monetary Affairs Committee and chairman of the Parliamentary Mises Book Club. | Contact us
4 December 12 | Tags: Euro, Germany, Gold | Category: Economics | 2 comments
Episode 63: 2012 marks the centennial of the publication of one of the Austrian School of economics’ most important books on monetary theory: The Theory of Money and Credit by Ludwig von Mises. GoldMoney’s Andy Duncan interviews Professor Guido Hülsmann about his forthcoming special book – a “Festschrift” honouring Mises which will be published to mark this centennial.
They discuss the importance of The Theory of Money and Credit, along with the impact of a 1912 review of the book by a then little-known scholar by the name of John Maynard Keynes. Hülsmann uses Austrian theory as a basis for his predictions of how the global financial situation will develop. He thinks Germany will stay in the eurozone come what may, and also comments on the interesting case of two German members of parliament who were recently refused entry to the Bank of England and the Bank of France, after they requested to inspect German gold reserves stored at these institutions.
The minor uptick in China’s ‘flash’ PMI estimate for October – from 47.9 to 49.1 – has sparked the usual explosion of uncritical hopefulness (on the part of those who, by and large, thought there never could be a slowdown under the aegis of the all-powerful CCP to begin with,) that this finally marks a bottom in that country’s economic cycle.
In giving vent to such optimism, the Sinomaniacs conveniently overlooked the fact that much of the improvement was down to the fact that it was the price indices, rather than those relating to output or employment, which struggled back above the expansion/contraction threshold of 50 – a circumstance which might just temper their extend-and-pretend expectations of an ever-imminent monetary relaxation, were they to reflect on it for a moment between jubilations.
Worse still, the Pollyannas appear to have forgotten that the PMI simply gauges whether things are generally better or worse than they were last month – and that in a non-quantitative manner, to boot. The unequivocal answer is worse (if marginally so, this time) for the twelfth consecutive month and for the fifteenth out of the last sixteen occasions. Thus, it may be true that the rate of decline seems to have slowed – how enduringly, only time will tell – but the fact of that ongoing decline itself remains, even after so many uninterrupted months of economic deterioration.
China bulls and the other assorted, ‘next quarter’ blue-skyers may have either venal or psychological reasons to puff this one reading up as a sign of a coming (and oft-postponed) dawn, but the test of an analyst who knows his stuff – and who is not afraid to be honest with you – is whether he makes this simple, but crucial, distinction in his commentary.
Of course, such an outpouring of positive sentiment will be very much to the taste of those in Beijing who have managed the seemingly miraculous feat of going into the Party Congress to the glowing accompaniment of an official GDP series which has been accelerating all year, quickening from a 6.1% annualized pace in the first quarter to 8.2% in the second and a resounding 9.1% in the third.
The fact that those same quarters have seen rail freight traffic slow from 3.7% YOY to 0.8% and on to a contraction of 5.8%; or have witnessed Shanghai port container throughput reverse from an expansion of 3.5% YOY to a shrinkage of 1.2% is, apparently, not to be invested with any significance.
Nor is the fact that while industrial production is officially up 10% YTD, those same industries have managed to consume smaller and smaller marginal increments of electrical power along the way; sliding, month by month, from a 4.1% YOY gain in March to a 3.2% one in June and on to a paltry 0.9% increase in September (which slender, overall uptick was comprised of an actual fall in heavy industrial usage).
In much the same manner, apparent consumption of refined oil products was up only 3.4% YTD, with diesel barely ahead at +1.1%. Again, not much evidence of a robust economy, there.
As the slowdown progresses, everywhere but in the reports of the authorities and the minds of their cheerleaders, profits have collapsed in their turn. So far this year, the chemical industry has seen earnings decline 18.1%; cement makers returned 53% less than in 2011; flat glass makers swung to a loss equivalent to around one-third of last year’s reported profits. Miners – whether ferrous or non-ferrous – saw income slip by around 5%, while that accruing to smelters/processors in the first group slumped by no less than 81%, flattering the performance of companies in the second category, even though they themselves booked 30% less.
The other side to this has been a surge in the debts companies owe to one another. As Caixin reported, the China Iron & Steel Association said that, at the end of July, the amount of net receivables and net payables of the 81 steel companies it monitored were up 17.8% and 10.6% respectively from the same month the previous year.
In even worse straits, the 90 enterprises monitored by the China National Coal Association reported an increase of 48.7% in net receivables from 2011, while the China Machinery Industry Federation said those for its members were up 16.9% YOY to a monster CNY 2.5 trillion. No wonder Caterpillar announced it was ‘ramping down’ production in the country.
To see these trends in a little more detail, let us examine those cosseted children of the latest economic cycle, the SOEs. These reported 9-month revenues of CNY 31 trillion which represented a relatively anaemic 9.5% gain from the like period in 2011 when sales had stormed ahead by almost a quarter from 2010. Costs were up 11.1% and hence profits fell a sharp 11.4% to CNY1.6 tln.
That represented a nominal ROE of 5.1% overall, split as to 5.5% for the centrally-controlled firms and a bare 2.9% for their local peers – which latter therefore made a big fat zero in real terms after accounting for the concurrent rise in consumer prices.
Even that does not tell the full horror of the troubles afflicting them, for the simultaneous rise in the tally of accounts receivable amounted to 1/3 of those ostensible ‘profits’ (the overall stock of receivables now stretches to 1.7 times annualised earnings), while inventories swelled by an amount equivalent to the whole of reported income. Days’ sales of inventory rose from 83 to 94.4, while days of receivables climbed to 31.8 from 28.8, putting their combined drain on working capital up to a whopping 126 days-equivalent!
So, here we have a bleak vista of mounting credit, declining margins, unpaid bills, underemployed capacity – even the rare earth market has swung so far from dearth to glut that plant is now being mothballed! – and there also remains precious little hope for making non-operating gains by diverting preferentially-granted credit into a bubbling property market. A clear indicator of this stress is that credit (deferred payment) is rising much faster than money (immediate payment).
This is an ugly constellation indeed, especially since it is giving rise to official concerns about the state of local government finances. Faced with slowing – even falling – tax revenues, these latter are squeezing already pincered companies by demanding advance payment of taxes, as well as by organizing sweeps whose aim is the mass-levying of ‘fines’ for alleged regulatory violations (presumably something of a shock after all these years of turning a blind eye in the pursuit of growth at all costs). These are also, of course, the very same local authorities who are nursing the sickliest of the SOEs and they are the same institutions who will supposedly be riding to the rescue by showering trillions of yuan on even more infrastructure and real estate developments of dubious commercial worth.
According to a report issued by the Development Research Centre of the State Council, the final months of this year will be critical to the pretence of providing ‘stimulus’ via this medium as something of the order of two-fifths of all local government debts fall due by the end of this year, with another 10% or so scheduled to mature by the close of 2013.
Having all but tripled in the last six years, something in excess of CNY11 trillion is now owed by such entities – largely through the conduits offered by the infamous ‘financing vehicles’ – leaving Wei Jianing, deputy director of the Macroeconomy Department at the DRCSC, to fret that: “There are worries over whether local governments could pay off the principal and interests when the repayment hike comes.”
Presumably Mr Wei will be taking little comfort from the happenstance of a nugatory uptick in the Purchasing Managers’ Index!
Far across the Senkaku Islands, Japanese money supply has been decelerating from its recent impressive lick, while small business confidence has plummeted below even the post-Fukushima trough. Meanwhile, the nation’s exports languish at levels first seen in 2004, thanks to the toxic mix of the fallout from the territorial spat with the Chinese and the general Asian weakness – also evident this week in Singapore (IP -2.5% YOY), Thailand (manufacturing output off 13.7% YOY to rest where it was in 2007), and the Philippines (exports off 9% YOY to stand no higher than in 2005).
All this sufficed to bring about a record trade deficit of close to Y1 trillion in Japan itself last month, at which point it was threatening to swallow the large monthly investment income component whole and, hence, to restrict the growth of the capital pool on which the country so heavily relies.
Nothing daunted, after two decades of bluebottle-against-a-windowpane policy-making, the country is again to be dosed with the same old, ineffective, patent medicine as the BoJ prepares to increase its version of QE by a cool Y10 trillion ($125 billion), some of which will help fund the already over-indebted government’s imminent Y700 billion fiscal injection.
You would think they would long since have have learned the futility of what they are about; the fact that this has eluded them for all these years should worry us greatly about our own masters’ willingness to draw the correct lessons on that grim tomorrow when their own programmes are undeniably seen to have failed. Can we not admit it is folly always to resort to the crude economics of a Krugman – the macroeconomic equivalent of the château generalship of the Somme – and to whine that we have only failed because we have not thrown enough money or lives into the fray.
In Europe meanwhile, the gaudy circus of summitry has again rolled through town to little effect. Greece seems to be back to playing brinkmanship with the Troika. ‘Two more Years of Foot-dragging’ was the headline in one German newspaper as it was rumoured that our inveterate Hellenic hand-out seekers were about to pouch another €20 billion, together with extended payment terms and a reduced coupon on their Pelion upon Ossa of existing loans. Talk about creating financial zombies!!!
Draghi bearded the lions in their den when he dissembled before the Bundestag, giving them his earnest that he would never exceed his mandate; that it was simply inconceivable that his unlimited bond purchases could be construed as monetizing state debt, or that it could in any way turn out to be inflationary.
No-one asked the obvious question that if all this was true, and if the OMTs were to exert such a subtle influence on the economy, why he felt compelled to ride roughshod over the (adopted) traditions of the institution he heads in order to implement them.
Among the few dissenting voices was that of the president of the German Savings Bank Association, Georg Fahrenschon, who declared that: “Private savings should not be further penalised. The ECB should not direct itself to minimizing the outlays of the debtor countries, but to ensuring monetary stability, today, tomorrow, and the day after that”
At the same press conference, however, he revealed the schizophrenia which Draghi’s actions have induced. German savers prefer to hold their wealth in the form of savings accounts – out of distrust and uncertainty – yet half of them see a house as the best guarantee for their old age and a third of them intend to buy one now.
If the former impulse gives way only a little in favour of the latter, that double-digit rate of increase in the local money supply will soon deliver the thrifty German burgers, almost the last of their breed, into that vortex of balance sheet ruination which is widely seen (if less openly articulated) as the real key to solving Europe’s otherwise intractable debt crisis.
Before then, however, it would seem that the country might be in for more testing times than has been the case to date. Certainly the decline in the IfO index this past six months – registered despite a rising stock market and a diminution of the sense of crisis in the Zone – is of a magnitude which has typically accompanied significant downturns in activity. With monetary creation running so hot in Germany, it would be unusual, to say the least, for revenues and profits to fall sufficiently far to trigger a serious setback – which is essentially what the IfO index is telling us is expected to occur – but nevertheless this does bear close attention.
Finally, there are one or two hints that the US is starting to sputter. Certainly, the rapid decline in core (ex-defence and aircraft) capital goods numbers tells us so. At -10% YOY, orders are now falling at the sorts of rates experienced in both the Tech bust and the GFC itself. In the past three months, nominal levels have come to rest where they were in the late 1990s while, in real terms, the series has not been this depressed since it was first compiled in the current form, two decades ago.
Those, like us, who have tended to regard the States as the best of a bad bunch, will have to hope this is nothing more than a little pre-election caution and that it will be accordingly reversed in a month or two’s time.
Sean Corrigan is an economist of the Austrian School Liberal Tradition. Corrigan is Chief Investment Strategist at Diapason Commodities Management. | Contact us
29 October 12 | Tags: China, ECB, Euro, Germany | Category: Economics | Comments are closed
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.