Posts Tagged ‘ECB’
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.
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.
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.
I finally got around to reading Jorg Guido Hulsmann’s Deflation and Liberty (pdf) today, which put the news that Ireland and the UK’s M2 money supply had contracted in a different light. Ireland is but a small fraction of the entire Eurozone, but the inflation/deflation debate (not just in terms of prices, but also of the money supply) is front and centre now, so surely worth finding some clarity on. From page 26:
There is only one fundamental change that deflation brings about. It radically modifies the structure of ownership. Firms financed per credits go bankrupt because at the lower level of prices they can no longer pay back the credits they had incurred without anticipating the deflation. Private households with mortgages and other considerable debts to pay back go bankrupt, because with the decline of money prices their monetary income declines too whereas their debts remain at the nominal level. The very attempt to liquidate assets to pay back debt entails a further reduction of the value of those assets, thus making it even more difficult for them to come even with their creditors…
The point is that other people will run the firms and own the houses—people who at the time the deflation set in were out of debt and had cash in their hands to buy firms and real estate. These new owners can run the firms profitably at the much lower level of selling prices because they bought the stock, and will buy other factors of production, at lower prices too.
Therefore, deflation by the collapse of a fiat money regime is really a kind of spontaneous economic revolution. As Jim Rogers put it, the credit crunch is like a brush fire – it eliminates the rot which developed over time, allowing the forest to start all over again. Given that most political incentives are to do with maintaining the comforts associated with the status quo, then, it is clear why authorities would be absolutely determined to prevent it. Where is the great Henry Ford when you need him?
Failure is simply the opportunity to begin again, this time more intelligently.
Of course, Ford also said (of the US):
It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”