Tuesday, 23 November 2010

On the much-misunderstood Euro

Many people are screaming at the top of their lungs that the European Central Bank (ECB) should print up wheelbarrows full of Euros to give out to desperate Eurozone nations in order to cover their over-spent public budgets. Some of these people are even in the camp who are calling for a "gold standard".

The problem is a misunderstanding of what the ECB and the Euro are. The Euro is a sort of synthetic gold. A "gold-lite".

The "problem" with a gold standard (a fixed, convertible price against gold for any given currency) is that it forces fiscal responsibility on those least able to deal with it: politicians and their electorate!

Politicians love nothing more than to be in power. That is their whole modus operandi summed up in a single sentence. They will do whatever they can to stay in power by winning as many votes as possible -- and the surest way to win a person's vote is to promise to put them on the payroll in some way, or to promise them free money or a tax break. That is all they have to offer you.

The electorate love nothing more than to live at the expense of everyone else. You want to tax other people and give me some of the money? Perhaps you're going to offer me a public sector job or offer my private company public sector contracts? Or perhaps you want to offer me some kind of tax credit to keep me sweet? Perhaps all of the above? Great! Where do I put the cross?

Within a paper money system under the control of the local politicians, such as the US Dollar, the UK Pound, the Yen, etc, anything is politically possible. They will just magic up some extra "money" and add it to their local monetary system, in order to balance the budgets and pay all the bills. They will call it "Quantitative Easing" because this sounds fancy and the man on the street will take no notice since it's obviously very complicated. The currency unit will be devalued by doing this, but hey -- nobody takes any notice of that, right? It's all good. We'll increase the money supply by, what? 30%? 50%? Hell, this year let's go with 100% why not! (It went down OK in 2008 after all, few people seemed to really notice eh?) And to make up for this, people will get, what do you think? Perhaps we go to town and give them 3% pay rises, what do you say? We can make the CPI and RPI numbers say whatever we want, so let's just pick a number and the pay rises will follow it pretty closely.

The difference with the ECB's Euro currency? Like gold, it is not under the direct control of any nation's politicians. You cannot just have as many new Euros as you want, to paper over your inconvenient political realities. Realities like, say, a massively over-extended bank credit boom that has gone pop and tipped into credit deflation. Or perhaps you have 50%+ of your population either sucking on the public welfare teat or working in/for the public sector. Mentioning no names, but there are a good few countries actually trying to cope with both of these example realities right now.

The good news is that, unlike gold, the Euro can be produced at will. Just not at the will of your nation's local politicians, but only by consensus of the ECB. The ECB are interested in one thing, and one thing only: price stability within the Eurozone area. They are only concerned with maintaining very close to 2% inflation, as measured by Eurozone-wide CPI. So far, for the last 12 years or so since the birth of the Euro currency, they have achieved this feat -- yes, even in the last couple of economically-challenging years. They achieve this objective by strictly controlling the Euro money supply. They don't achieve this by printing up more Euros willy-nilly like the Bank of England or the US Federal Reserve. They are able to negotiate temporary liquidity-enhancing programs, which are in line with their aforementioned price-stability objective. It is a breed apart from other currencies.

A classic gold standard carries the problem that it is rigidly restrictive. When a crisis appears, you cannot bend it to your will no matter how much you attempt it. You will just end up having to devalue, which will be a permanent thing since who ever heard of anyone getting away with revaluing their currency UPWARD before now?

A locally-controlled paper fiat currency carries the problem that politicians cannot be trusted to show restraint in the issuance of the currency. They will devalue it any time they get an excuse to do so, and their electorate will provide them with plenty of excuses because they are simple folk who know not what they request.

So that leaves the Euro, in between the two monetary extremes. The externally-enforced responsibility of a gold standard, but with the temporary flexibility of paper currency during times of crisis like today.

The problem today for nations who have opted to join the Eurozone, is that they didn't understand what it was they signed up to. They are going to have to get used to the idea that they will have to devalue themselves internally against the Euro. Everyone's getting a pay cut.

8 comments:

Patrick said...

well written...we like to call it freegold.. perhaps you should also read some stuff Jacques Rueff wrote

DP said...

Thanks, Patrick. Feedback is always most appreciated.

You may have noticed the FOFOA link near the top right. ;-)

Dave Narby said...

You are a joy of clarity to read. One question though, when you write:

"They are going to have to get used to the idea that they will have to devalue themselves internally against the Euro. "

What exactly do you mean?

DP said...

Hi Dave, and thanks for the vote of confidence -- much appreciated. ;-)

What I meant by that was people will have to make the adjustment from expecting to all get paid a lot of money, when compared to people elsewhere in the world doing comparable work I mean, and having the expectation that every year they will just get paid more and more and more through the everlasting god-given payrises that they have become accustomed to over the recent decades. The politicians cannot continue to just borrow/issue more new money indefinitely to enable this inflation, the debts that are involved now are just too extreme to get away with inflating much further.

There is also going to have to be an adjustment in people's understanding of what is affordable in terms of public sector employment and services. Again, the magic money mountain of the Western governments is being brought to a controlled halt in Europe.

My view is that the Eurozone sovereign debts will all be sustained, through issuing of Euros by the ECB after negotiation with national politicians. The politicians have to adjust to the idea that they can't print up money for free any more if they're in the Eurozone, they're going to have to pay for it (at a fairly modest rate of interest, less than the free market investors would require as we can see lately in the CDS rates for certain countries).

Regarding the debts of private corporations, particularly banks, I would say there is going to be much less enthusiasm by national politicians to accept the risky lending of the past, and certainly I would hope there is a growing appreciation by the pols that they cannot afford to say they will make the banks whole on their losses in future.

I am interested to hear your take, Dave?

Cheers

DP :-)

Dave Narby said...

Hey DP,

Oo-fa, my take? I count myself among the ponderers, but these waters are plenty deep. But I love to spitball, so here goes.

Misthos actually took a stab at it recently on his blog http://fiatcollapse.blogspot.com/2010/12/euro-apres-moi-le-deluge.html , but decided not to post his original essay due to developments in Europe(!) I have entreated him to post it anyway, with a disclaimer that his thesis may have to change if necessary. But his posts are well worth the read. Hopefully he has some insights there.

It seems a given that governments will absolutely have to contract as percentage of their nations' expenditures. Once government grows beyond it's role to be a fair and impartial arbiter of contracts (rule of law, and the occasional national project needed to grease the wheels of commerce, e.g. national highways, rail systems, etc. much of which can be contracted out), it becomes a drag on the productive economy until it is forced to contract. This is how it's been throughout history, and I don't see this changing in our lifetimes. I personally hold the view that government work should be paid less than the prevailing wage because you have *job security*, which has become pretty important of late. But that's a political opinon on my part, and debatable.

I believe that the question might not be whether or not the Euro will survive, but if anyone still wants to use it. The same question exists for the dollar. I guess those are really the same thing...

The ECB actually owns gold and lists it as an asset. The Fed doesn't own gold, the US government does, which makes me a lot more confident the Euro will survive instead of the dollar. The US gov't could simply devalue FRNs by making them exchangeable for NewDollars backed by gold at some rate (100:1? Who knows). Trading partners would scream bloody murder, but the only ones that really matter are the OPEC nations, and I expect they will continue to get 20 barrels of oil per ounce of gold as long as the oil holds out. They may boycott us for various products we produce (except maybe the partners we choose not to screw, say Canada and Mexico), but as long as there's one country that takes our goods, those boycotts won't work, and after a few years people will mostly forget about it and start trading again... Or perhaps not. Again, I really don't know, I'm spitballing here.

The Euro will have to be revalued vs. gold and all other assets held on it's books to make up some of the debt, for sure. Whether or not the ECB can maintain price stability when it does this is another matter. It could be done, but it might not be pretty. Hard to say.

I think that as this starts to really heat up next Spring (second wave of mortgage resets coming), we'll see tremendous political pressure to resolve things.

Lot of actors on this stage, and much of the direction seems improvised, so I think we're going to have to wait and see. Hopefully things will become clearer soon. The anticipation is killing me! (In a good way!).

DP said...

We're all of us ponderers just playing spitball around here, Dave! :-)

I hear what you're saying about public sector pay, but at the same time I think things are right now in the process of changing when it comes to the *job security* aspect. Certainly they are on this left hand side of the pond. I think are starting to follow on your side very recently too, through the brute force of necessity.

Perhaps the euro price stability will deviate from the 2% target in the short term, we can see on their own stats at the ECB website that it has indeed deviated to some extent both above and below for brief periods already, but the goal is the goal and the ECB will do whatever it takes to meet its one mandate of zone-wide consumer price stability over the medium term. They are a busted flush if they don't, so they won't allow it to slip away easily.

The voters might whinge a bit, perhaps throw around more of their toys in the pram than they have started to lately, but in the end what all of them really wants, even though they don't understand it, is price stability. Relative economic stability. The way things are being dealt with in Europe just now, the pain is real, but it's at least muted. We in the UK, and especially you guys in the US, are still just keeping on kicking the can further and further down the road, probably until it falls apart and all hell spills out one day. I wish there was something realistic you or I could do to prevent this happening, but we can't. We can only talk about it, hope more people will start to see what is happening, and to look out for and prepare Number One & Co.

DP said...

We're all of us ponderers just playing spitball around here, Dave! :-)

I hear what you're saying about public sector pay, but at the same time I think things are right now in the process of changing when it comes to the *job security* aspect. Certainly they are on this left hand side of the pond. I think are starting to follow on your side very recently too, through the brute force of necessity.

Perhaps the euro price stability will deviate from the 2% target in the short term, we can see on their own stats at the ECB website that it has indeed deviated to some extent both above and below for brief periods already, but the goal is the goal and the ECB will do whatever it takes to meet its one mandate of zone-wide consumer price stability over the medium term. They are a busted flush if they don't, so they won't allow it to slip away easily.

The voters might whinge a bit, perhaps throw around more of their toys in the pram than they have started to lately, but in the end what all of them really wants, even though they don't understand it, is price stability. Relative economic stability. The way things are being dealt with in Europe just now, the pain is real, but it's at least muted. We in the UK, and especially you guys in the US, are still just keeping on kicking the can further and further down the road, probably until it falls apart and all hell spills out one day. I wish there was something realistic you or I could do to prevent this happening, but we can't. We can only talk about it, hope more people will start to see what is happening, and to look out for and prepare Number One & Co.

Dave Narby said...

Hey DP,

Oo-fa, my take? I count myself among the ponderers, but these waters are plenty deep. But I love to spitball, so here goes.

Misthos actually took a stab at it recently on his blog http://fiatcollapse.blogspot.com/2010/12/euro-apres-moi-le-deluge.html , but decided not to post his original essay due to developments in Europe(!) I have entreated him to post it anyway, with a disclaimer that his thesis may have to change if necessary. But his posts are well worth the read. Hopefully he has some insights there.

It seems a given that governments will absolutely have to contract as percentage of their nations' expenditures. Once government grows beyond it's role to be a fair and impartial arbiter of contracts (rule of law, and the occasional national project needed to grease the wheels of commerce, e.g. national highways, rail systems, etc. much of which can be contracted out), it becomes a drag on the productive economy until it is forced to contract. This is how it's been throughout history, and I don't see this changing in our lifetimes. I personally hold the view that government work should be paid less than the prevailing wage because you have *job security*, which has become pretty important of late. But that's a political opinon on my part, and debatable.

I believe that the question might not be whether or not the Euro will survive, but if anyone still wants to use it. The same question exists for the dollar. I guess those are really the same thing...

The ECB actually owns gold and lists it as an asset. The Fed doesn't own gold, the US government does, which makes me a lot more confident the Euro will survive instead of the dollar. The US gov't could simply devalue FRNs by making them exchangeable for NewDollars backed by gold at some rate (100:1? Who knows). Trading partners would scream bloody murder, but the only ones that really matter are the OPEC nations, and I expect they will continue to get 20 barrels of oil per ounce of gold as long as the oil holds out. They may boycott us for various products we produce (except maybe the partners we choose not to screw, say Canada and Mexico), but as long as there's one country that takes our goods, those boycotts won't work, and after a few years people will mostly forget about it and start trading again... Or perhaps not. Again, I really don't know, I'm spitballing here.

The Euro will have to be revalued vs. gold and all other assets held on it's books to make up some of the debt, for sure. Whether or not the ECB can maintain price stability when it does this is another matter. It could be done, but it might not be pretty. Hard to say.

I think that as this starts to really heat up next Spring (second wave of mortgage resets coming), we'll see tremendous political pressure to resolve things.

Lot of actors on this stage, and much of the direction seems improvised, so I think we're going to have to wait and see. Hopefully things will become clearer soon. The anticipation is killing me! (In a good way!).

More commentary at the Facebook page

Visit the page to find more news, commentary and community... (Like the page and you'll also see comments on links above - jus sayin.)

Twits can also apply here...