What is wrong about the euro, and what is not

Hard money has a tendency to expose illusions

by DETLEV SCHLICHTER

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 had 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 do 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 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 19^thcentury 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 19^th 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.