Money has a specific role in economic affairs – the facilitation of specialisation, trade and exchange.
Sure, money has a fantastic set of ancillary benefits, storing wealth, a common unit of account, measuring efficiency and success (or failure), deferring payments and so on, but the historical evolution of money has gone hand in hand with mankind dividing up the complexities of life, specialising in what they are good at and then freely exchanging the fruits of enhanced production. This process has made nearly all of us more comfortable in life than our forebears.
Yet the power of money has proved irresistible to policy makers the world over. Economic difficulties? Cut rates. Terms of trade harsh? Ease monetary conditions to change them. Government struggling to raise funds freely? Print money to buy the bonds.
Gradually authorities subverted and then nationalised money. The trend has been relentless.
Then, along came the Euro. Steeped in the ‘hard money’ tradition of the Bundesbank and the Deutschemark, the European Central Bank was created. The link between a single country and its currency was broken. Remember, the classic liberal standard was that money was Gold, and was not linked to a particular country or economy.
Money was divorced from political control.
The nuclear trigger of devaluation was removed.
Devaluation is an act of economic war – defraud your creditors, shunt your problems onto the unlucky devalue-ee, and create mayhem in your market pricing process by introducing inflation. Much better to honestly, and openly, default, then move on.
In a global crisis, not every economy can get rid of its problems by devaluing. Much as each country couldn’t protect its native industries by unilaterally raising tariffs during the thirties.
Time and again, the ECB was criticised for its hawkish stance, whilst the BoE and Fed printed away to solve our worries. Bankers hated ‘Dim Wim’ Duisenburg due to his ‘luddite’ attitude towards risk and fiscal responsibility and reluctance to respond to economic events. Oh how we now wish all our central bankers were a little less hip with the times…..
Now, don’t get me wrong. This was still a bureaucrat controlled affair, prone to forecasting and estimation errors. It is also a political creation, and what political will puts in place, it can change and destroy. It is not a structure or solution that any of us Cobdenites could advocate.
But, consider Europe’s problems. As ever, they are a failing of government (and its vassal bankers) not the market. What the ECB constantly sought to preach was the need for individual states to be disciplined in their financial affairs. The strong inference was that the ECB would not be there to bail out the irresponsible.
As the European sovereign debt market stumbles forward into its next crisis, the ECB looks set to crumble to political pressure and massively monetise the debts of the profligate, corrupt and incontinent states of Europe. Tragic as this is, the ECB held out a lot longer than its besieged brethren.
The failure of the Euro is a failure of bankers, regulators and politicians, not of the particular choice of the means of exchange that is used by people to do business.
If banks had been forced to survive without special favour, if governments had been forced to live within their means, and crucially, if the tax payers had not been forced to pick up the tab for corrupt bankers (and done this in 2008), we would be growing strongly by now, and the future would look a lot rosier.
And the Euro would be admired, respected and wanted the world over.
Two points to ponder:
Firstly, when the Euro exchange rates were locked, the common consensus was that Germany paid the price with an over valued Deutschemark locking them in at an uncompetitive rate. The PIIGS rejoiced at their advantageous rates. Germany went through tough years, and they had to become ruthlessly efficient to prosper. That they did: who is laughing now?
Secondly, Euro sceptics hail the UK experience of the ERM. We were killed by being in it, and flourished when we allowed the currency to float down after we left it. Sure, we benefited from the exit, but, applying an Austrian analysis to the situation, didn’t the discipline of the ERM membership force British industry to cut waste, reorganise and become hyper-efficient, so that when conditions eased, we could reap the benefits without unleashing yet another inflationary boom, destined to end in despair? A solid boom that lasted for nearly an unprecedented (for us) two decades?
Funny you should write this now; the last few weeks I’ve been thinking along similar lines myself. It terrifies me that people don’t seem to understand that without the power of governments to formalise the banks’ expansion of credit through the printing of actual money, FRB is unstable and always has been.
Yet there’s Ireland, happily running a Fractional Reserve banking system with full deposit insurance, forgetting that the only reason countries can offer deposit insurance is because it’s denominated in a commodity they can create infinite quantities of…
There really is no difference between sterling caught up on a fixed rate of $2.40 – £1 and with Irelang trading (effectively) at a fixed rate to the Euro.
Would you really reccommend UK to go back to the fixed exchange rate? if not then why recommend the Irish commit the same error?
Devaluation is hardly a fraud commited on your creditors unless you view a floating exchange rate in the same way; it is a fraud committed on the population of the devaluing entity who are forced to take a reduction in wages.
Excellent artice, James Tyler. I think you’re right on every point, though I hope you turn out to be mistaken with respect to your forecast of the bail out of the failed states.
In further defence of the Euro, despite the likely monetisation of the debts of the profligate states, the quid pro quo exacted of some measure of austerity has at least been imposed; surely a better outcome than for the devaluers.
In addition, I think that the jury is still out on Spain as to whether these debts will be monetised. It will be hard for the politicians of Germany to convince their very sensible people that this be in their national interest.
This inevitable political battle I look forward to more than any other as determining whether Europe suffers deflation or inflation, while the bed of the US looks all but made.
Some good thoughts, and ones that challenge my thinking. I would take exception on two points however.
1) It is not the failure of government and its vassal bankers, it is the failing of bankers and their vassal governments. Do not forget that the borrower is the slave to the lender (Proverbs 22:7).
2) The other point regards the reasons for the crisis. Whenever money is created, those closest to the point of creation benefit from the new money at the expense of those further away. In a nationally controlled currency scenario, the control of money creation is in one place, the central bank, and decisions to create money through government debt all occur in one place. Where the Euro is concerned, each national government can create all the money it wants through debt (posting its national bonds as collateral to the ECB in return for freshly created money in the form of loans). Its economy benefits from the creation of money at the expense of neighboring countries who pay through exported inflation. Whoever creates money fastest benefits most. Those who create money at a slower pace subsidise their neighbors through inflation. Profligate states are rewarded and fiscally responsible ones are punished. It is a perverse system and the problem is intractable. Hopefully the Euro will come apart through the exit of member states one by one. If it doesn’t then something much worse awaits us.
“…didn’t the discipline of the ERM membership force British industry to cut waste, reorganise and become hyper-efficient, so that when conditions eased, we could reap the benefits without unleashing yet another inflationary boom, destined to end in despair? A solid boom that lasted for nearly an unprecedented (for us) two decades?”
I am sorry but this statement is absolute codswallop. Since 1997 we have experienced the most massive bout of credit expansion through artificially low interest rates in recent history. This has caused malinvestment in tech stocks and then real estate.
We have had the appearance of a healthy economy, with the reality of an economy sinking ever further into a quagmire of debt, with no increase in productive capacity as a result.
The “wealth” effect of rising home values has tricked people into taking on more and more debt which is then squandered on items made in other countries, e.g. China, strengthening these economies and weakening our own.
Our banks are now effectively bankrupt, and so is our government as it has foolishly decided to bail them out. The only thing that keeps this laughable charade from imploding is 0.5 per cent interest rates and a printing press.
“A solid boom that lasted for nearly an unprecedented (for us) two decades” – give me a break. The only effect of an artificial credit expansion like we have experienced is a catastrophic bust. Since we were unwilling to take the pain in 2008, the final bust will be orders of magnitude worse.
Remember, the classic liberal standard was that money was Gold, and was not linked to a particular country or economy.
Yes, but even under the gold standard, the amount of credit available in a particular country was dependent on the gold holdings of that country. The PIIGS would not, under such a system, have had the access to the easy credit which eventually sunk them.
I suppose the concept of the Euro itself is fine, but the existence of the ECB spoiled it.
“A solid boom that lasted for nearly an unprecedented (for us) two decades” – give me a break.
Yep, fair do’s. I allowed myself a little tto much artistic leeway on that one, as I definately do not think the noughties were a period of fantastical imrpovements in productivity, skills, use of capital etc.
However, the point I was making is still valid, IMHO, in that higher interest rates into a downturn in the early 90’s was PART of what help set us up for a more solid period of economic expansion and wealth creation than the pervious stop start monetary booms. It is a shame that Gordon Brown squandered it all…..
Yes, you are right that under a system with a central bank, and centrally held Gold reserves, under some form of managed Gold exchange standard, then yes, the location of said Gold holdings would be important, but it need not be that way. In a free banking system, without a unitary, imposed, central bank, Gold holding would be more widely dispersed, and thus transfers would be more fluid and represent supply and demand better.
‘Would you really reccommend UK to go back to the fixed exchange rate? if not then why recommend the Irish commit the same error?’
I would not have a problem with the UK joining the Euro, and fixing exchange rates, if it was just about a stable moentary media and a free market in goods, services and the movement of people and capital… BUT, and it is a huge, monumental, elephant-in-the-room but… unfortunately… it is not. Joining the Euro is about signing up to needless laws, rules, regulations. Agreeing to the sleazy politicians, the CAP, the ‘managed’ trade, the moral hazzard, the bail outs, the taxes. And so, on forever.
So, no, I am not advocating signing us up to a fixed exchange rate – for those reasons. Which is a shame.
As for Ireland? If they had just let their banks default (New Zealand copes fine without its own domestically nurtured banks, why can’t the Irish?), the fixed exchange rate would not have been of much importance, and they would be looking forward to a brighter future…
Actually, I was conflating Europe and the Euro a bit much in that last comment. I was trying to talk more about the symboilsm of signing away powers, but hope you get the gist.
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