Sunday, June 12, 2005

The crash of the euro

In its recent issue, The Economist reports about the troubles that the euro is suffering from. Mentioned are the facts that the “Stability and Growth Pact” has been seriously weakened in march 2005, that Portugal has announced that its budget deficit will top 6.8% of GDP this year (more than twice the 3% limit of the Pact) and that the ECB is finally obeying politicians that since the introduction of the euro are insisting on lower interest rates.

The problem with the Stability and Growth Pact was that it imposed the same rules to balance the budget to countries with a high government debt, such as Belgium and Italy, and countries as the Netherlands, that didn’t spoil that much money in the past. Everyone knows that an unbalanced budget is far more damaging in Belgium than in the Netherlands, but as the EU doesn’t really have the legitimacy of a government, it can’t treat countries unequal.

In 1993, with the Treaty of Maastricht, a monetary union was agreed on. This meant that the strong German D-Mark had to disappear. France was tired of having to devaluate its own currency, because it had printed to much money, and spended to much. In exchange for the German unification (a bad thing), the French got a monetary Union.

The Germans needed to have something to make sure that the common currency would be strong. Therefore, stringent rules were agreed on, but of course everybody knew that to bring government debt below 60 % would never happen fast in countries as Belgium, where the debt was 100 % of gdp. In 1997, this was already clear, so then the “Stability and Growth Pact” was agreed on, and this relaxed the rules.

In the end, every country that wanted could enter. Belgium, despite its high government debt. France, because it was its idea. Greece, because there was – proved – corruption.

In several countries the introduction of the euro was a big scale – robbing operation by the government. In the Netherlands and in Italy, for example, the exchange rate has been admitted not to be correct, so people didn’t get enough euros from their government in exhange for their guldens and liras.

In 2001, Ireland, then being the best growing economy in the world, after China, got a reprimand from the European Commission for not obeying to the Pact, as Ireland was planning to disrespect the Pact slightly. When in 2003, France and Germany, did the same, they of course didn’t got a reprimand, which proves the Union is not governed by law, but by power. As a consequence, the Stability Pact was more or less given up.

Monetary expert Paul De Grauwe was always against the Pact, and doesn’t mind that it is been given up. He says, as is generally accepted, that you can not have a monetary union, without having a political union, that can discriminate among countries. No euro without a political Union.

What problem does that pose now, considering the no-votes in France and the Netherlands, founding EU-members? These no-votes caused serious damage to the idea of a political Union (with reason).

The consequence will be that the EU can not refrain memberstates from making high deficits. Only the fact that the creditworthiness of countries is downgraded by rating agencies will refrain them, but that won’t be enough. The euro will become a weaker, more uncertain, currency.

The euro has had some positive consequences, such as the saving of conversion costs, but especially the stringent monetary policy of the ECB, that didn’t listen to politicians, always looking for short term benefits, asking it to lower interest rates.

In the US, the Federal Reserve can already be said being nothing more than a tool for the executive, creating bubbles and a debt-thriving economy. The dollar has seriously weakend and the Americans are living on the merits of the past, when the dollar was strong. The OPEC is already considering to change the reckoning of oil barrel prices in the Chinese currency, the “Renminbi”.

When in Europe, politicians don’t want to cut expenses, the pressure on the ECB will become bigger, and the ECB will have to lower the interest rates. The report of The Economist says this point has been reached. The consequence of that will be an even weaker euro, being a tool for politicians to rob their citizens through inflation.

Inflation is even worse than taxes, as it not only extracts value from the citizens to the government, it moreover makes the value of money uncertain.

There have been signals that the probable new German Chanchellor, Angela Merkel, will blame the euro for Europe’s problems. There have been reports of meetings in Germany to investigate how to withdraw from the euro. Let us hope this will come true.


Steel Monkey said...

So, which nation will be the first to reintroduce their own currency? Italy? The Netherlands?

I have to think that it will be a nation that would be capable of maintaining the value of its own currency by keeping its debt to GDP ratio under control.

Say what you will about America's economy. But its debt to GDP ration is only about 50 percent, with a 12 trillion dollar economy and a 6 trillion dollar debt.

In the United States, the individual states do not have their economic policies directly dictated to them by the federal government. Certainly, the federal government's power to tax, spend and regulate does impact the 50 individual state economies.

But their is no "harmonization" policy that requires the individual states to either adjust their tax rates, spending habits or debt levels. All that restrains them is a desire for having businesses locate in their state and a good credit rating.

Pieter Cleppe said...

-If it happens, it will be a country being capable of having its own strong currency: Holland, Germany.

- It could be that it doesn't happen, and that we just live with the losses it generates, as the US do. The unified currency isn't of course the source for all evil, the labour regulation is also very damaging. And that's where Europe differs from the US.

Steel Monkey said...

I don't know if you would agree with me on this. But I think that more currency types is better than fewer currency types, as people naturally move towards currencies that they believe are stable and likely to retain or increase in value relative to other currencies.

So, perhaps the Netherlands should consider reintroducing their national currency in addition to being part of the Euro zone. Is that possible?

Pieter Cleppe said...

I think that's possible. I know in Belgium in the nineteenth century for example, there were competing currencies. You could pay either with Dutch or with the French money. There were also problems with that, as the Belgians were dependent of the policy of foreign regulators.

As with everything, it is best to have a regulation as nearby as possible, and in the case of money, it is indeed possible to have multiple competing regulators of the product that money is on a territory. Nice suggestion, I would say.

Steel Monkey said...

Nico Wirtz writes for Tech Central Station What Price Victory?

Interesting reform proposals coming from within the Free Democratic camp, such as Health Savings Accounts, partial privatization of Social Security, competition inside of Germany's education system, weakening the influence of counter-productive political meddling by Germany's labor unions, or reducing public sector employment, are out of the question for the CDU/CSU. In many respects, the CDU/CSU is still dominated by a philosophy of political reluctance, and hesitation to fundamental change and a policy of "weiter so!".

Pieter Cleppe said...

Some years ago, ane of the leaders of the FDP wanted to change the party, because it had on old image. He wanted to make of it the "party party", but he failed dramatically in the election. The FDP has lost of some its serieux.

Steel Monkey said...


Among the current democratized and industrialized nations of Europe, North America and Asia, which of them do you believe has the best currency/central banking system?

I realize that you, in principle, oppose all central banking systems (at I think you do). But, for example, do you think the British system, where one person is the head of the American equivilent of treasury and the central bank is better or worse than America's system?

Pieter Cleppe said...

I have to admit I didn't know that in Britain HM Treasury is also head of the central bank. But maybe this is just a formal matter and the British central bank is more independent than the American one?

In any case, if you have a central bank, it is better that it is independent and tries to mimic what it thinks it is the most efficient interest rate. It will of course fail in that purpose, as a regulation can be never so precise as an interest rate emerging from market forces.

Nevertheless, the attempts to favour on purpose short term looking politicians or other interest groups, is worse than a central bank just making mistakes, and will be avoided by a truly independent central bank.

I think a mentality that disapprooves of irresponsible policies of the central bank is the best garantuee to achieve that purpose, more than any procedure.

Steel Monkey said...

Yes. Gordon Brown is the Chancellor of the Exchequer, which is the equivilent to being the Secretary of the Treasury and the Chairman of the Federal Reserve Bank in the United States. In addition, Gordon Brown is a member of Parliament and stands for election.

I remember seeing a column over a decade ago titled, "Elect the Fed," which argued that since fluctuations in the money supply and interest rates have an important influence on America's economic growth, the American people should vote on who holds that position. It's an interesting idea, but there is no support for it in America right now.

It seems to be conventional wisdom that governments issue currency and issue debt (bonds). So, it would seem that an "independent" bank would have to be in addition to, not a substitute for, a central bank.

Am I wrong?

Pieter Cleppe said...

The question is if unelected experts deliver better work than elected experts (democracy).

I think democracy is probably better than being governed by technical skilled, unelected experts?

I believe a democracy won't fail in determining if the ruler is really bad. At the other hand, you can argue that a democracy will stimulate welfare policies, robbing the rich minority.

Maybe we are being governed by experts already?

In Belgium, one should dare to question the degree of democracy. The government has the parliament in its pocket, and parliament is in the pocket of the party leaders, because there has been a system created in which it matters if you're on top of the list of a party (then you get all the votes given to the party as such). Also, if an MP resigns, for becoming Minister, not the one with the second most votes, but the one who has on a special "second list", under the "first list" the most votes. In Belgium, you can more or less predict who's going to be elected. It is the percentages of the parties that matters to determine who has the power.

The European institutions have a "comitology" procudure, in order to hand over their powers to unelected expert groups, who can regulate then. For financial regulation this is frequent.

Whether unvoluntary government is through elections, or through experts, it is still unvoluntary, and you cannot compare this with a company that has to be afraid to lose customers. Although a government can try to approach this.

-Concerning your last post, you're arguing that a central bank can never be really independent. True, of course.

Steel Monkey said...

Perhaps there is nothing wrong with a government issuing currency (though one could argue against a government issuing debt) as long as the government does not prohibit private citizens and corporations from issuing their own, competing, currency.

It is true that government, even democratic government, is built on force, whereas businesses are built on voluntary decisions of people based on their self-interest.

I guess the question that we all must deal with is: Where is the demarkation point? Where is the point where the free market must yield to the government?

Socialists, of course, almost always have the free market yield to the government. Libertarians rarely do.

I'm a "moderate" libertarian.

Pieter Cleppe said...

As a government doesn't accept private money to pay fines etc, and taxes, this is already a huge subsidy for its own valuable goods.

There is no clear distinction between market and government. As governments do also good things (although certainly not the majority of all it does), which would be accepted by people anyway, the government is partly working as a company. I would like to see this expand.