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The Euro as a Money Monopoly

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These are my thoughts on reading An Austrian Defense of the Euro by the esteemed Jesús Huerta de Soto, professor of economics at Universidad Rey Juan Carlos.

Proponents of sound money should readily agree that to the extent that the euro is presently a “hard” currency, it can be considered superior to a collection of “soft” national currencies. However, there is at least one tangible benefit for some when national governments control their own currencies: users of money, fearing inflation, can frequently escape from a depreciating currency by switching into one of its more stable foreign counterparts. A floating exchange rate régime complements this system by efficiently reflecting the depreciation of the softer currency in the price and thereby illustrating the relative loss of purchasing power.

The euro abolished these dynamics, preventing escape through exiting the monetary system of just a single nation and requiring instead financial migration from a large supranational bloc.

But is it not true that a fixed exchange rate régime imposes discipline on governments, whereas a floating exchange rate régime allows for profligacy and a race to the bottom? Yes, this is true, so long as the fixed exchange rate in question has been imposed on the producers of money, and not imposed on the users of money. For example, suppose that Central Bank A pledges that one unit of their currency, alpha, shall be worth exactly one unit of Central Bank B’s currency, beta, and succeeds in buying and selling alphas and betas in the marketplace to enforce this rate. The fixed exchange rate should indeed help to impose some discipline on the government which owns Central Bank A. Central Bank A will be incentivised not to inflate the supply of alphas any more than B inflates the supply of betas; if they inflate too much, they will pay the price for it by the requirement to supply extra betas into the marketplace (a currency unit which they cannot create without cost) in order to maintain the fixed rate. This is the mechanism by which fixed exchange rates can help to produce monetary and hence fiscal discipline.

Does the euro impose a fixed exchange rate? Yes, it does. However, it imposes the fixed rate on the people, not on the central bank . The ECB is not required to guarantee the exchange rate of the euro against any other currency. Furthermore, and in particular, the citizens of Spain are not guaranteed that their currency will be maintained at a particular rate against the currency of Italy.

What has happened in reality is that the exchange rate between Spain and Italy has been obliterated. To demonstrate the point: suppose there are two bakers in your town, producing equally desirable bread. Suppose one of them makes a solemn promise that his bread will never cost more than his rival’s. This is fine, so long as he and his rival are genuinely competing to make a profit out of the business of providing you with their bread. But suppose your baker and his rival undergo a corporate merger, and a single entity now owns and completely controls both bakeries. And suppose your baker continues to promise that his bread will not cost more than the other guy’s. What would you make of his promise now? You would laugh at it. He is in a combination. The same entity dictates prices in both bakeries, and therefore the guarantee is worthless. You now have to pay the price dictated to you by the parent company, no matter which baker you go to. In like manner, the promise that one euro in Spain can be exchanged for one euro in Italy is something which carries no guarantee of value to users of the euro.

Many national governments, having been relegated to mere users rather than sovereign producers of money, have experienced great discomfort due to their inability to print their way out of recent difficulties. But the price for fiscal disclipline, in the present, on a national level, is fiscal indiscipline, in the future, on a supranational level.

The euro is a money monopoly, and a monopoly not over one nation (as most currencies are), but over many nations. The institution of the euro represents a grand weakening in the global competition to provide a reliable medium of exchange. This competition was not too strong to begin with, since almost every country holds a money monopoly over its territory, but the momentous consequence of the single currency is that eurozone countries no longer compete against each other to provide an attractive, stable money. Absent any threat of capital flight within the eurozone from nations with poor monetary policies to nations with sensible monetary policies, the ECB has the freedom to produce a form of money less satisfactory to the consumer than that which Europeans on average would otherwise have experienced. We can trust that sooner or later, if they have not done so already, they will choose to exercise this power. As a consequence of this, the EU will be relatively free to follow fiscal policies less restrained than those which Europeans on average would have witnessed. The errors of the nation are replaced by the errors of the bloc.

The route to sound money, whether that may be gold or silver or something else, with 100% or fractional reserves, must require increased levels of competition among producers of money, not decreased levels of competition. Few of us would argue that decreased competition would improve the quality of any other good.

Written by Graham

June 22, 2012 at 10:21 pm

Posted in economics, Europe, finance, money

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A possible return of common sense

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After the grandest of economic failures in recent years, some Irish people are now wondering about a possible escape from the Eurozone. One of the ideas, floated by David McWilliams, is that the country switches over to use Sterling instead. And amazingly, after 250+ votes on politics.ie, the Yes side are winning.

It may sound bizarre to some, but Hayek argued that government need not impose any currency on the territory under its control. The government could simply allow people to use whichever currency they choose. Most people would be likely to use the same one as everybody else in their everyday business (due to money’s network effects), which could be a foreign currency (Sterling, for example) or a new domestically produced currency (a Punt Nua issued by an Irish bank). This would then be the de facto, but crucially not the de jure national currency.

For it to work properly, the government would need to accept taxes in whichever form of money was being commonly used by the people. The government would also need to accept the loss of the ability to counterfeit and to devalue money (which it can be argued was the objective of nationalising money in the first place).

Imposing the Pound Sterling on Ireland would not represent a true liberalisation of the economy. However, by leaving the huge money-monopoly region called the Eurozone and using the currency of Ireland’s closest neighbour instead, with all of the implications which that has for a return to banking and fiscal sovereignty, it does appear to scream of common sense.

Written by Graham

June 12, 2012 at 10:15 pm

Posted in finance, money

May 2009: Irish Recession Still in Deflationary Phase

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We’ve got new central bank figures:

Monthly statistics from the Central Bank show the first net fall in mortgage lending since 1990. The figures also show a sharp fall off in credit card spending…

It is the first time that repayments on existing mortgages has been greater that new mortgage lending since the Central Bank began this monthly statistics series in 1990. The figures show that, overall, mortgage lending fell by over €100m last month.

Contrary to what most people think, deflation is a good thing. Under a free market monetary system, this imaginary digital “credit” would never have been brought into existence in the first place. As loans are paid in faster than they are being created, with the most speculative loans already in a state of default and evaporating from the system entirely, the money supply more closely reflects that which would prevail in a deregulated, decentralised system (however a pale imitiation it might be).

Written by Graham

June 1, 2009 at 8:38 pm

ECB Bailout of Ireland in full swing

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It’s a sign of the times that every public debt offering in Europe has become a “risk event”, with the Irish government among the most vulnerable to what would be a catastrophic collapse in demand. And no longer empowered to produce its own counterfeit money, it is ultimately reliant on the ECB to remain solvent.

The Sunday Independent reports that the ECB has finally started to play ball, providing the funds to ensure that no Irish government bond is left unbought:

Irish banks are using billions of euro from the European Central Bank (ECB) to buy up Irish government debt, the Sunday Independent can reveal.

It has emerged that the banks were “active” in a recent Irish government bond sale of about €1bn, and it was confirmed yesterday the repossession of Irish bonds at the ECB has occurred.

Irish banks are using ECB funds to “create the illusion” of demand on the international markets.

Incidentally, how reassuring that the same governments who collude in this type of activity are fighting the good fight against market abuse by private participants, defined previously here:

Market abuse may arise in circumstances where investors have been unreasonably disadvantaged, directly or indirectly, by others who:

* have used information which is not publicly available (insider dealing);
* have distorted the price-setting mechanism of financial instruments;
* have disseminated false or misleading information.

Of course, the governments themselves would never do anything like that.

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Written by Graham

May 3, 2009 at 10:22 am

Great New Resource

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I’ve discovered a fantastic new website called KhanAcademy.org. It’s an awesome organisation that aims to provide “a high quality education to anyone, anywhere”. It’s has video lessons on everything you want to know about maths and physics, as well as a mean finance and banking section. Sadly there’s no pure economics section…yet.

Here are the Khan Academy’s concerns about the Geithner plan (Hat-tip to Karl Deeter

Written by 20000miles

March 27, 2009 at 4:08 am

Posted in economics, finance, money, news, USA

It’s Just Harmless Counterfeiting

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There is a new blog about the Irish economy by a very impressive list of professional economists, which I’m sure that many of you have been following. It’s definitely a blog worth keeping an eye on.

One post that I noticed recently, “On German Concerns About US Monetary Policy“, contains too many interesting points for me to deal with in one post, but I would like to focus on one simple idea and see if my analysis can add to the conversation. The question is: are central bank asset purchases inflationary? And what about loans? I will write generally about my understanding of some important effects of money creation. Read the rest of this entry »

Written by Graham

March 21, 2009 at 12:03 pm

World Leaders Admit They Are Superfluous

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George Bush, speaking at the APEC conference in Peru argued that the free-market could resolve the current economic crisis while global protectionism could only worsen the situation.

Mr Bush spoke passionately about his belief in the free market despite the recent world economic downturn.

He called for an Asia-Pacific region of “free markets, free trade and free people”.

“It is also essential that governments resist the temptation to overcorrect by imposing regulations that would stifle innovation and strangle growth.

Considering the intensely anti-free market policies recently implemented in the USA, the UK, the EU, Ireland,  as well as on a global level, one wonders what other so-called “free market” solutions we have in store.

Written by 20000miles

November 23, 2008 at 9:19 am

Confusion Multiplies

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When governments of the world agreed to collectively counteract the global turndown, they did not agree to a global “stimulus package”. This however will not stop the industrialised nations attempting such a stimulus packages individually. The UK government, for instance have already bowed to Keynesian depression economics. The idea behind these packages is that George Bush and co. can “jumpstart” the global economy by getting people to start spending again.

This plan is justified by the following paragraph I read on a message board:

If you tax and spend using progressive tax you take 1 euro from a rich man (who would otherwise spend it on imports) and give it to a teacher or other worker who has a higher marginal propensity to consume. That teacher then spends it and it goes into someone elses hands and so on indefinitely. This multiplier effect means that government spending can get us out of a recession. In fact if the marginal propensity to consume is 0.9 (a person who gets a euro spends 90c) then the output effect of the government spending 1 euro is 1/(1-0.9)=10!

So the more we spend, the more the economy grows.

The above is a horrible misrepresentation of how the economy works. In order for any consumption to occur there must first be production. This is summarised by Say’s Law: supply creates it’s own demand.

It doesn’t matter how many green pieces of paper are in your wallet; you can’t “demand” a TV set unless the store has an actual unit on the shelf. Pushing it back one step, no matter how many customers are lining up outside his store, the manager of Best Buy can’t stockpile his shelves with TVs unless the manufacturer has previously assembled them. And of course, the manufacturer can’t do so—regardless of how much money he is offered by the Best Buy manager—unless he can find enough workers, and enough of the relevant parts, to actually make the TVs.

In the Keynesian model of the economy, it is as if the economy is entirely composed of retailers, whereas manufacturers produce consumer goods by snapping their fingers. The multiplier only exists if this is true. However it is obviously not. The economy is made up of various stages of production, which must work to produce the goods that are finally purchased and consumed.

A lot of the “paradoxes” of Keynesian economics would be solved if the “circular flow diagram” of the economy were replaced with the Hayekian Triangle model; a more accurate depiction of the world in which we live.

Written by 20000miles

November 21, 2008 at 5:47 pm

China to pull the plug on the USD, switch to gold

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This marks another major milestone along the bankruptcy of the US economy. The widely predicted collapse of the Federal Reserve dollar grows ever closer now as US creditor nations have finally had enough.

Beijing is considering changing its asset allocations during the financial tsunami in order to build up gold reserves “in a big way,” the source said.

China’s fears about the long-term viability of parking most of its reserves in US government bonds were triggered by Treasury Secretary Henry Paulson’s US$700 billion (HK$5.46 trillion) bailout plan, which may make the US budget deficit balloon to well over US$1 trillion this fiscal year.

The US government will fund the bailout by printing new money or issuing huge amounts of new debt, either of which will put severe pressure on the value of the greenback and on government bond yields.

The United States holds 8,133.5 tonnes of gold reserves valued at US$188.23 billion. China holds gold reserves of just 600 tonnes, worth only US$13.89 billion.

Beijing’s reserves could easily go up to 3,000 to 4,000 tonnes, Tanrich Futures senior vice president Colleen Chow Yin-shan said.

Iran is quoted as having also just begun the process of converting its financial reserves (tip: Max Keiser).

Iranian newspapers are quoting Mojtaba Hashemi Samareh, a top advisor to President Mahmoud Ahmadinejad, as saying the country has converted its financial reserves into gold.

The papers did not specify how much of Iran’s estimated $120 billion in reserves would actually be converted into gold.

This is happening precisely as Peter Schiff predicted.

Written by Graham

November 16, 2008 at 12:52 pm

Keynesian Economics in One Lesson

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Expect inflation to head skywards in the UK.

Do you want to know how I know? It’s no secret. In fact, the decision to inflate was made by Alistair Darling when he revealed the Labour government’s plans to spend its way out of the current recession.

Under Keynes’ own framework, the economy is not self-correcting and can languish for years in what is termed “underemployment equilibrium”. The economy can be “in equilibrium” with high levels of unemployment. As such, a government stimulus of sorts is needed to jump-start the economy – much like a doctor defibrulating a patient.

I won’t bother dismissing these Keynesian assertions here (I’ll leave that to the pros). I will focus on the fact that even within the Keynesian framework, Darling’s move will be inflationary.

What Darling hopes to do is stimulate spending, which will increase aggeregate demand. This is illustrated by the rightward shift of the AD curve (below). The new equilibrium will occur at a higher output (GDP) and at a higher price level (P).

So when Mr. Darling revealed his massive spending spree he announced that Britons will not only be paying off UK government borrowing, but also paying an inflation tax in the near future.

So the lesson is… when prices in Britain begin to creep upwards, it’s because of government policy, not because of anything OPEC does in the next few days.

Written by 20000miles

October 24, 2008 at 1:01 am

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