Fiat Money and the Euro Crisis
My article today at Mises:
Lost in all the analysis of the theory of “optimal currency area,” the possibilities for a structured default, the consequences of a collapse of the euro, etc., are two simple questions: Why does the behavior of the Greek government have anything to do with taxpayers in Germany? Why did the original Maastricht Treaty have rules about fiscal policy as part of the criteria for monetary union?
The answer is that the euro is a fiat currency, and as such it will always provide rulers with the temptation to monetize fiscal deficits.
and
I tried to illustrate the point to my Slovakian audiences with a thought experiment: Suppose that instead of the fiat approach, the euro from day one had been backed 100 percent by gold reserves. In this arrangement, an organization in Brussels would have a printing press and a giant vault. Anybody around the world — whether private citizens or foreign central banks — could order up euros, so long as they deposited the fixed weight of gold in the vault. Thus, at any given time, every single euro in circulation would be backed up by the corresponding gold in the vault in Brussels.
In this scenario, the people issuing the euros wouldn’t have to run a background credit check on the people applying for new notes. So long as the requests were made with genuine gold, the people printing euros wouldn’t care if the applicant were the German government or Bernie Madoff. Even if some other country had adopted the (gold-backed) euro as its own currency, and then that government defaulted on its bonds, there would be no repercussions for the other regions using the euro as money. People would know that their own euros were backed 100 percent by gold in the vault in Brussels, just as always.
Mr. Murphy – how does moving from one fixed currency to another address the lack of labor mobility which is the primary driver of uncompetitiveness within the union?
I’m not sure Mr. Murphy shares your premise, that “the lack of labor mobility which is the primary driver of uncompetitiveness within the union”. It’s not clear what you mean by uncompetitiveness or how this concept relates to the central question of
> the theory of “optimal currency area,” the possibilities for a structured default, the consequences of a collapse of the euro, etc.
Is the problem that Greece is not competitive, or is it that they cooked their books, blew a bunch of borrowed money, and now they can’t pay it back? If they were more competitive, then perhaps their chance of paying it back goes up a bit. However, it seems their debt problem is much larger than few points worth of productivity increases. As well, I don’t see how labor mobility would solve fundamental, historical Greek cultural issues with paying their debts.
It is clear that Murphy refuses to understand the monetary system and makes his living spreading ignorance.
Thanks for not responding at all to what I said. In the spirit of non sequitur, I hereby proclaim bottom-up to trounce top-down as an organizing principle!
Funny, coming from someone who doesn’t understand out monetary system.
I’m not talking about Greece. I’m talking about the entire perifory
What is your argument for labor immobility as the _primary_ driver of uncompetitiveness? [Not saying this is wrong. Just curious about the evidence.]
Think about this way. If you live in California and there is mass unemployment, but Texas is hiring, what will most workers do? Move to Texas. The Spanish (and Irish, and Portuguese..) etc. don’t have this option. They can’t move to Germany and compete with German workers for jobs, because they don’t speak German (among other reasons). The fixed currency prevents wage/cost adjustments when capital leaves Spain, but Spanish workers are prevented from chasing after jobs in German or other parts of the Eurozone because of high barriers to entry.
Germany had a huge leg up on the rest of the Eurozone when they entered the union because they pegged their currency at a much lower level than the rest of the union, and they had a massive pool of cheap labor in their backyard (East Germany).
It should be clear to anyone who looks at the Euro objectively that fixed currencies (including gold standards) PREVENT markets from being free.
Free market economists advocating a gold standard is an oxy moron.
“The Spanish (and Irish, and Portuguese..) etc. don’t have this option. They can’t move to Germany and compete with German workers for jobs, because they don’t speak German ”
That also explains why Europeans who didn’t speak English didn’t emigrate to America in droves during the 1800’s and early 1900’s. That, and the big freakin’ ocean they would have had to cross.
But, if one rejects the Keynesian postulate that falling prices don’t clear markets, then emigration is not the only solution if your country’s currency is ‘fixed’.
“But, if one rejects the Keynesian postulate that falling prices don’t clear markets”
Not sure how this is relevant to my post or any of my comments, but falling prices (wages) is exactly whats happening in Spain right now. The impact of falling wages would be more bearable if an unemployed Spainard could move to Germany and compete for a job, which of course is not possible for a variety of rearsons.
And please don’t compare emigration in 1800’s to 2011. This is just silly.
The silliness of an argument never stopped these guys.
AP,
“And please don’t compare emigration in 1800′s to 2011. This is just silly.”
Right, because, like, you say so.
Mammoth,
“The silliness of an argument never stopped these guys.”
Well, perhaps we should rethink that. Given AP’s dismissal of a point merely inconvenient to his argument, perhaps we should stop indulging such silliness.
“Given AP’s dismissal of a point merely inconvenient ”
Here’s a thought: instead of rambling incoherently, show me some evidence of emigration within the Euro zone.
“It should be clear to anyone who looks at the Euro objectively that fixed currencies (including gold standards) PREVENT markets from being free.”
Not exactly. Yes, government decreed exchange rates and/or legal tender laws do tend to muck things up, just as giving a small group of insiders free rein to make arbitrary decisions with regard to interest rates or money supply will muck things up. But, this certainly isn’t any Austrian position that I am aware of.
I will be honest, I am not fond of the idea held by some people that we make gold the money, just as I am not fond of those advocating a paper-based money system. To me, it seems as if they assume gold as money based upon a historical context while the other side assumes paper as money on a more contemporary ground. In my opinion, a true “free” monetary system allows for competing currencies and goods. Whatever good becomes the money is just that, while also allowing for other mediums of exchange between parties. The key is to not allow any monopoly of the issuance of money, because the propensity for corruption is tremendous in such a case.
So, I am kind of confused by your statement quoted above.
Whoa, I forgot to explain why I said “not exactly”.
“Fixed exchanges” happen in the economy every day. Every contract is based upon some fixed exchange, as are individual exchanges of goods. Fixed exchange is not the problem, it is who is doing the fixing. If it two individuals agreeing on the terms of a contract, not a problem. If it is a monopoly power decreeing it for everybody, not so good.
Joseph,
This much is easy to agree with:
> I am not fond of the idea held by some people that we make gold the money
A legally enforced gold standard, indeed, seems unnecessary. That said, I think free banking advocates would expect gold and/or silver to form the medium of exchange.
If instead BTC or palladium or rhodium is settled on, so be it.
This is one of your best ideology-driven nonsense articles Bob!
The Eurozone crisis has nothing to do with the fact that the Euro is a fiat currency. Actually the main problem is that countries are not issuers of the Euro, so, for all practical purposes the Euro works as a gold backed currency (which is still a fiat currency): governments have to tax or borrow from the private sector in order to spend. Euro countries could never monetize the deficits!
And whether Greece or any other of the PIIGS defaults would have no direct repercussion on the Euro but on the bond holders, which would also be the case with a gold backed Euro.
It is clear that you refuse to acknowledge how the monetary system really works in order to spread your scaremongering in order to promote your ideology to gullible audiences.
I am starting to wonder if you are the devil.
MamMoTh, you’re comparing apples to oranges. Murphy’s point is that if a species (or equivalent) flow mechanism had been in place, the less competitive countries would have had a more difficult time running up these debts. They would have been forced to pay higher interest rates on their debt much earlier.
You’re arguing something else: that if the individual countries could simply print _now_ (now that they’ve run up these debts), they could print their way out of this crisis. It’s not obvious that this is possible. But in any event, this would be best classified as a possible “solution” to the high debt levels, right? Not a “cause.”
Murphy’s point is that if a species (or equivalent) flow mechanism had been in place, the less competitive countries would have had a more difficult time running up these debts. They would have been forced to pay higher interest rates on their debt much earlier.
Not sure that’s what he said, but it’s totally wrong anyway.
The fact the Greeks are not issuers of the unbacked fiat currency puts their government exactly in the same position as if the fiat currency was backed in gold or refrigerators: they had to tax or borrow in order to spend.
So in order to deficit spend like they did, they needed to borrow, and borrow they did.
Mammy, I know that economics is not your strong suit, but it looks as if basic accounting is also lost on you.
A government borrowing money doesn’t contribute to a government’s deficit. Borrowing money generates a receipt , which adds a surplus component, and if the money is spent, which it always has been, it adds a deficit component.
Borrowing money can therefore only ever add to a nation’s surplus, and in practise it almost always leads to a net zero change to the surplus/deficit, because borrowed money is almost always fully spent.
Taxation, in principle, is the same. Money that is taxed is a receipt, and tax money that is spent is an outflow. Since taxes are almost always spent as well, taxation therefore adds a net zero surplus/deficit.
In reality, government deficits can only be financed by inflation. This is why growing deficits signal growing inflation. Now, the government’s inflation through deficits might be counter-acted by credit deflation, thus leading to either a growing, stable, or even declining aggregate money supply, the latter which occurred in the US post 2008 up until around the first quarter of this year, when aggregate money stock started increasing again.
In the example of Greece, the government borrowed and spent too much, relative to their ability to tax.
When you say that in order to “deficit spend, they needed to borrow,” what is actually happening is that Greece engaged in a Ponzi scheme, where they sent out checks to people, and to finance those checks, they borrowed money. This is not a deficit or a financing of a deficit. This is the Greek government accumulating debt way beyond what they could pay back. The reason why they were able to borrow so much more than they could pay back, is because the Greek government massively cooked their books. Government corruption (redundant?) is rampant in Greece.
It’s amazing how you continue to post posts here that are composed of saying what others don’t know. You ought to look in the mirror, because you’re seriously uninformed.
Dumbass, in order for Greece to deficit spend like they did, they needed to borrow, and borrow they did.
Moron, merely repeating the same incorrect statement after being shown why it is incorrect, without supporting it with any further substantiation, is not an argument.
Borrowing and spending from that borrowing does not add to the deficit.
Dumbass, you don’t know what a deficit is.
OK guys let’s settle down.
Suppose it was, and further suppose that the Greeks found a way to steal the gold and thus fund a lavish standard of living. That’s theft right? Illegal… but when a country does it presumably they are breaking some treaty with other countries, and thus subject to whatever consequence of breaking the treaty.
Right, and this is in effect no different to theft, and the Greek government broke their treaty and eventually got caught doing it. The question we should be asking is why are they not subject to the same consequence as they would be if they engaged in physical robbery?
This is not really a fiat currency question here (although I agree that theft of physical gold is more difficult then fiat accounting trickery), this is a question of the rule of law and what you should do when someone has been caught cheating.
There’s a linkage here that you didn’t cover. The powerful banks of Europe (British, German, French) invested a lot of money into countries like Greece. This money represents the retirement savings of German workers (and others) who would like to retire but have been told they need to work “just a few years more” before they can get their money back. Thing is, they won’t get their money back, the money is gone… spent… pissed away.
In some ways this is a very similar scam to what is happening with Social Security in the USA, and of course accounting trickery is at the heart of it, but probably gold would not in itself solve this problem. Those retirement savings needed to be invested somewhere, and the banks who were trusted with that investment decision made a stupid decision.
Needless to say, when you get a large number of workers told they can’t retire because their entire nest egg has been pissed away (after they were told they personally could not be trusted to look after such a nest egg, and it was utterly necessary that they trust the appropriate authorities), yeah you will get some social unrest, and they will (rightly) blame government for ripping them off.
Jiminy Christmas that’s a terrible thought. How long before that becomes a reality in the U.S.? It doesn’t take a genius to foresee an air bubble coming in the straw of the liquid future.
http://www.ssa.gov/OACT/TR/index.html
Select the year 2000 (a file called tr00.pdf), and then skip to page 11 where you find “Table I.E1.— Ultimate Economic and Demographic Assumptions” and you see three scenarios.
The middle scenario (called “Intermediate) presumes 3.3% CPI and 4.3% wage increase (i.e. a real-wage rise of 1% above inflation). It also presumes that investments can achieve an interest return of 6.3% and the unemployment rate is 5.5%.
Compare this to the current situation… unemployment is much worse (higher than expected), CPI is worse (higher), interest rate return on investment is worse (lower), real wages have basically gone nowhere and most likely inflation is also headed in a bad direction.
Now skip ahead to page 26 and look at “Figure I.G3.—Trust Fund Ratios for OASI and DI Trust Funds, Combined” which shows that the intermediate scenario is not sustainable anyhow, and it reaches a turning point around 2013 then hits zero in 2038.
The bad scenario turns around sooner (around 2009) and hits zero in 2026. The real-world scenario is pretty close to the bad scenario in this chart, and the turning point at around 2009 is the point where government can no longer depend on a steady stream of easy money from Social Security and need to start paying it back (i.e. turn the stream around and feed it back the other way). This is also the point where a lot of baby boomers are retiring so tax revenues are falling and claims on medical services are on the rise.
I know you say “Jiminy Christmas” like it’s all some sort of joke, but this has all been know for more than a decade, and no one has done anything about it (other than invent good fortune scenarios where it all just fixes itself).
Late at night, after a few beers, my humor does get a bit fatalistic. It’s funny because it’s true! 🙁
There’s some good research here —
http://www.justfacts.com/socialsecurity.asp
A few key points: they claim the turning point is 2015 and it will exhaust in 2037, I think that’s a bit optimistic but at any rate none of their scenarios are sustainable. Also, very important is this:
So you are forced to pay into the scam, but they are not under any obligation to pay anything back. Just sit and let that soak in for a moment, now imagine your typical American worker sitting and letting that soak in when they are told, “the money is gone”. And then this:
Think about the US economy after a 33% payroll tax increase.
The Germans can blame their plight on the Greeks, but the Americans are facing the difficult situation of only being able to blame each other.
The only thing Americans have to blame is the stupid belief that SS payments must come from an accounting fiction like the SS Fund.
Of course they should rather blame the morons who perpetuate that stupid belief in blogs, etc.
At least Americans still believe that the stuff they might want to buy with SS payments ought to really exist. MMT is based upon a complete suppression of the concepts of Cantillon Effects and, more importantly, the law of scarcity.
No they don’t. Otherwise they would be outraged about government cuts on spending in education, which is the only thing you can produce now that can have any effect on what is produced in 50 years time.
MMT prevents people with PhDs in economics from writing embarassing articles like the one Murphy wrote.
The main purpose of government “education” is to produce a nation of economics deniers.
Economic deniers is what Mises articles like this one Murphy wrote produce.
Economic deniers is what Mises articles like this one Murphy wrote produce.
Am I the only one who giggled at yet another one of Mammy’s Freudian slips?
Tom Woods’ Ron Paul superpac has done the best antiwar ad ever.
http://www.revolutionpac.com/2011/10/revolution-pac-web-ad-blasts-obama-on-militarism/
Now all they need to do is a similar one minute ad so that even 20 something women can effortlessly understand the theft and wealth-shifting impact of Cantillon Effects induced by funny money creation/dilution and that it is the sole cause of inflation. With both pictures and words.
Then, large groups of young women will point and laugh at Mam-mouth when he walks down the street.
Trust me, large groups of young women don’t give a shit about Cantillon Effects or inflation.
A few old men do however.
Trust me. The ad would not use the term “Cantillon Effects”. It would simply display the constant shifting and theft of purchasing power in easily grasped moving graphics and to which you and your ilk will have no response.
Trust me.
Do you really have a graph showing any correlation between deficits and inflation in a monetarily sovereign country? Don’t miss the opportunity to provide it!
Trust me, large groups of young women won’t give a shit anyway. It’s obvious you know very little of that specific population. I know why. Trust me.
Once they see the ad, this will no longer be a “monetarily sovereign country”.
You don’t know them. Trust me.
Where’s the graph Roddis? I thought after 40 years you would be able to provide it. I’m still waiting.
Wait a minute..there is a Ron Paul SuperPac? But Ron Paul claims he does not take Pac money.
http://www.dylanratigan.com/2011/10/05/ron-paul-on-amending-the-constitution-to-get-money-out-of-politics/
It is entirely consistent and justifiable to abide by the rules of the game while simultaneously working to change them in a legitimate process.
Translation: ‘It’s OK for Ron Paul to lie since I happen to agree with his point of view.’
Same as it ever was…..
It’s quite independent of Ron Paul. We’re supposed to wait for Fox News and MSNBC to explain the truth, I suppose.
Roddis!!! The graph!!!!
Economic principles don’t come from graphs. Graphs come from economic principles.
What graphs are you talking about? A historical, empirical graph? You won’t be able to prove anything that way. Not when you have debt deflation counter-acting the inflation financed deficits.
minute 2:35
AP,
I am responding to the ‘thought’ you shared with me above here.
I never claimed that there is mass emigration occurring in Europe today. I don’t see how you can claim I did.
You said people living in PIIGS do not have an option to emigrate because they do not speak German. I pointed out that, historically, people have emigrated to countries where they do not speak the language in search of better opportunities. (If you would like a more recent example, millions of non-German speaking Turks emigrated to Germany beginning in the early 1960’s because of better opportunities there).
Not to mention, I think many Spaniards and Germans speak English. if true, this would ameliorate any concerns over a language barrier.
So why aren’t we seeing emigration from Spain to Germany? I don’t know, though I suspect welfare and jobless benefits are a factor.
What data are you looking at to justify the claim that emigration isn’t happening due to a language barrier despite the fact such emigration has occurred in the past?
Furthermore, as far, as wage adjustment in Spain, can you point me to the data you are looking at showing wages have been falling there?
According to this article from April 2011 in a Bank of Spain bulletin, wages have actually increased with increasing unemployment in Spain, largely due to the predominance of institutional collective bargaining agreements that increase wage rigidity relative to other European countries. Below is an excerpt from the report;
Overall, in comparison with other European countries these results show that temporary employment is used more frequently in Spain as the main way of adjusting to shocks, while wages (including their fixed and variable components) are more isolated from firms’ adjustment needs (see Table 3). This difference is undoubtedly related to the greater importance of temporary employment, the greater protection of permanent employment and the high degree of wage rigidity in the Spanish economy.
One of the objectives of the EU was that their economies will converge eventually and that mass immigration within the EU would no longer be necessary.
Of course that didn’t work, partly because of the straight jacket of a common currency and the lack of a fiscal supra national authority that could rebalance things out.
Mammoth,
“One of the objectives of the EU was that their economies will converge eventually and that mass immigration within the EU would no longer be necessary”
I see, so before the Euro people there had the option to emigrate despite language barriers?
One solution to the Euro crisis would be if all the Greek and Spanish unemployed moved to Germany and claimed unemployment benefits there.
Please tell me that is a joke….
A better solution would be for them to earn lower wage rates, then advocate to stop that which caused their wage rates to decline, which is the EU central banking system.
‘Furthermore, as far, as wage adjustment in Spain, can you point me to the data you are looking at showing wages have been falling there?’
Not wages. Unit labor costs. Unit labor costs have been heading lower in Spain since 2009, according to OECD data, and are currently falling about 1/2% yoy. In Germany, they dipped briefly in 2010, and are running about +2% yoy. And no I don’t have a link because I get OECD data dumped into a database (BB) and do not have the energy to search their website for the data but I assure you it’s there.
“wages have actually increased”
Wages DO NOT equal labor costs.
And firing a bunch of low wage employees raises averag wages.
AP,
Here is why I thought you were referring to wages and not unit labor costs.
In the first post of yours I responded to you wrote “The fixed currency prevents wage/cost adjustments when capital leaves Spain…”
And, in repsonse to my point that employment would increase in Spain if wages were allowed to fall, you wrote “Not sure how this is relevant to my post or any of my comments, but falling prices (wages) is exactly whats happening in Spain right now.”
If you meant falling unit labor costs instead of wages, fine. But, that would not have refuted my point about falling wages, so I don’t why would have done so.
I don’t need you to look up OECD data for me. I agree that unit labor costs have fallen in Spain (meaning total wages/ total workers both employed & unemployed). This is consistent with the article I linked to. But, what the article said was that unlike other ‘fixed currency’ Euro countries, Spain’s institutional ‘collective bargaining’ arrangements have reduced ‘unit labor costs’ by keeping wages high despite the recession. As a result unemployment has increased relative to other ‘fixed currency’ countries. I submit that putting people out of work in order to actively maintain (or even increase!) wages is horribly inefficient policy during a recession. It will keep Spain poorer relative to other ‘fixed currency’ countries with institutions that do not interfere with falling wages as much. This has nothing to do with ‘fixed currencies.’
Fair point. I should have been more clear.
The crux of my point is Spain has a balance of payment issue, which is a direct result of the fixed currency. I did a poor job of connecting those dots.