Thursday, April 17, 2014

Is the Euro a (classical) liberal project?

English translation from a Dutch article published in Liberaal Reveil, the magazine of Dutch think tank Teldersstichting

There is little question that the European Union is fundamentally a liberal idea. States promise each other to open their borders to travel, work, buy and sell. A beautiful thing, from a liberal point of view. That the EU doesn’t only secure open borders but also overregulates, puts up toll walls and the prevalence of financial waste at the European level are rightly seen as problems that can be fixed and have nothing to do with the essence of the European project.

Advocates of individual liberty are however less in agreement where the project of a European single currency is concerned. Certainly in Southern Europe, the liberal part of the population remembers all too well the devaluations and high exchange rates that the Lira, Drachma and Peseta brought with them. In Northern Europe, those liberals who still defend the single currency claim that there is nothing wrong with the euro per se, but that the fundamental problem is one of competitiveness that needs to be restored, while a “transfer union” is in no way necessary to hold the euro together.

So who is right in this case? Let’s attempt to clarify.

Governments practically everywhere around the world don’t allow their citizens to freely choose a currency or tender. Through all kinds of regulation and fiscal laws they try to make the use of the government currency, which they declare to be the only legal currency, inevitable.

This offers a great advantage to that same government. For this way promises by politicians can not only be financed through levying taxes or creating debt, but also by manipulating the value of government money. Through central banks politicians set the money supply and make sure that there is more money in circulation than would be the case in a free monetary system. Sometimes they also prevent a contraction of the money supply. The consequence of artificially increasing the money supply is that the interest rate – i.e. the price of money – goes down, which allows politicians to finance the new loans they close to pay off the old government loans (in itself a dubious practice) at better terms. Although anyone who owns the money loses purchasing power.

I a free monetary system one would only be able to spend money if one could trade it in for something that possesses intrinsic value. Gold, silver, natural resources, land, stock, you name it. Any artificial manipulation of e.g. JPMorgan Chase-money would result in a rapid depreciation or even loss of confidence in the money that is issued by that specific bank.

But as we live in a world in which the wishes of the electorate are infinite and the means of politicians limited, the latter are to an extent forced to provide such dubious financing. Liberals may very well oppose all kinds of “free” government services and there are probably naïve communists in existence who would be willing to relinquish 90% of their income for all services they long to receive from government, but the majority of the population is not that consistent and will gladly accept all these “free” services from the government, although it doesn’t want to pay for them whatsoever. Manipulation of the currency then becomes the unavoidable way out, the third technique to finance government besides taxing and loaning: everybody ends up paying for the services, but through devaluation of the currency.

This doesn’t always express itself through higher consumer prices, because in this globalized world the excesses of Western Central Banks can express themselves through investment bubbles in other parts of the world or in specific sectors, such as real estate or the stock market. Falling prices of imported electronics from Asia or the manipulation of statistics also offer an explanation for why the loss of purchasing power is not always visible. The current situation in the Eurozone demonstrates that the artificially low interest rates of the ECB are not necessary and certainly don’t immediately have to lead to a rise in consumer prices. Certainly in Southern Europe the lack of economic growth is causing a fall in consumer prices and wages that would of course be stronger without the heavy-handed interventions by the ECB. A fall in wages and consumer prices may well be a bitter pill to swallow, it is also the medicine that will help Southern Europe to bounce back economically. It is good for tourism, and the lower wages can make the countless youths who are unemployed become competitive again. However, because of the monetary manipulations of the ECB, that economic healing process is stalled.

The best way to counter such monetary manipulation is the decentralization of the evil. A government that exceedingly manipulates its own currency, but also implements a far too strict labour market policy, is bound to see the value of its currency decrease on the international markets. This is unfortunate for the citizens of the country in question, but it will also ensure that those same citizens will regain competitiveness through their lower wages. It is precisely this mechanism that is currently lacking in Southern Europe due to its euro-membership.

In theory one can restore competitiveness through an internal devaluation, although the political culture in Southern- Europe – or maybe even the entirety of Europe – is not very eager to do so. But besides this there is a second, and this time practically irreparable, defect of the single currency. The Euro works like a true debt machine.

Those liberals who thought that the introduction of the euro would export the relative stability of the D-Mark to the rest of Europe had it wrong. The euro is no gold-standard that limits monetary expansion. To the contrary, the euro increases the capacity for monetary expansion. That people and companies are paying with the same currency is but one aspect of the monetary union. A much more fundamental aspect is that banks in every euro country have access to the money-printing presses of the European Central Bank. As has become all too obvious.

In Greece the irresponsible fiscal policy and the gigantic amount of debt, which is currently approaching 180% of GDP, despite 240 billion euros of bailout loans, was only possible because of its membership of the Eurozone which provided the banks – and thus the politicians – of the country with cheap money and artificially low interest rates. Both Belgium and Italy struggled with high interest rates in the 90’s, until it became clear that they would be able to introduce the euro. For investors knew that cheap money was on its way. Despite a very limited reduction of government debt by politicians in both countries, ever since the euro they could load their population with further debt at considerably cheaper rates. In Portugal the prospect of being able to introduce the euro even led to an investment bubble that burst before the country had effectively introduced the euro. This is not to say that excessive debt accumulation is not possible with national currencies, as the U.S. and the United Kingdom demonstrate, but most euro countries would have been punished by the markets long before they had reached their current debt levels.

When they got into trouble, Ireland and Spain didn’t have exceptionally high public debt levels, but a very high private debt, around 200% of GDP. A real estate bubble in both countries led to a quasi-bankrupt banking system. That private debt didn’t pop up out of nowhere, but is also a direct consequence of the maladjusted low interest rates of the European Central Bank. The latter had to set the interest rate for both the rapidly growing periphery and for Germany, which at the time was struggling with slow growth. An interest rate hike to slow down the Irish and Spanish real estate bubbles wasn’t possible, because this would have damaged the German economy too heavily. In this case, the damage isn’t just purely a consequence of the ECB policy of lowering interest rates, but of the ECB being faced with the impossibility of conducting an optimal interest rate policy. The cause is to be found with the fact that the euro was implemented in a group of countries that didn’t form a sufficiently homogenous economic unit. There were certainly bad policies in the euro member states themselves, but those could never have expanded so strongly had it not been for the single currency. Believing that centralizing bank supervision at the ECB-level will do much to tackle the current imbalances is very naïve.  At the very first opportunity for the European institutions to prove themselves things already went wrong. The “stress tests” of the ECB and the European banking authority EBA declared in 2011 that the Irish banks were healthy. A few months later those same banks economically forced the country to its knees.[1] The Belgian major bank Dexia was also supposedly in perfect order, but three months later it presented Belgium with billions of euros of debt.

Since the euro was implemented, it was an undervalued currency for the stronger countries in the monetary union, where citizens as a consequence lost purchasing power, certainly in Germany, while only the export sector profited. Combined with the outflow of capital to the fast growing periphery of the Eurozone, it made Germany sink down economically during the first ten years of the euro. As German economist Hans-Werner Sinn writes[2] Germany had the second highest GDP per inhabitant in the Eurozone in 1995, and now only holds the seventh place. So Germany is not the winner of the monetary union at all. At the most, a couple of German export businesses are.

Applying the rules of the European Treaty would not have prevented the euro crisis. Spain and Ireland respected them more or less, as their debt bubbles were situated in the private sector. One could raise capital requirements for banks in countries with a high private debt rate, but even then banks from other member states would still be able to invest in the cheap ECB-money. One can also not stop the latter, because without open borders and free flow of capital there can be no monetary union. The only fundamental solution is raising the interest rates by reducing the monetary expansion in a certain country, but this is only possible if there is also a national currency.

To add injury to insult, the crisis is now being abused to centralize policy even more, and all manners and sorts of old demons are rearing their heads again. This all with thanks to Ruud Lubbers, Helmut Kohl and mostly also François Mitterand, the man who constantly worried in the 80’s about the so-called German “interest dictate” and whose attempt to subject Germany by abolishing the D-Mark is now turning into German political hegemony in Europe, to the advantage of German politicians and the disadvantage of the German saver and consumer.

Is there an alternative solution to keeping the current monetary union together? That would be a costly affair, and not only for the taxpayers who are saddled with the bailouts and the pensioners who are suffering from the low interest rates of the ECB to help governments, but also for the young in many European countries, considering the ever rising youth unemployment.

The solution then is not the exit of the weaker euro countries, because their debt that is noted in euros would rise substantially. Probably the least painful scenario would be that, as was the case In 1999, a new, preferably national, currency is introduced, at first instance only in the stronger countries. This would ensure that the weaker countries can still pay their debt in their own currency – the euro – and as a consequence that a possible default is not or much less of an issue. This way a gradual revaluation becomes possible. One by one the countries can then introduce a new currency, until only the weakest country remains with the euro.

This would affect certain export businesses in the stronger countries, seeing as how they wouldn’t be able to push their products if their prices rise and consequentially, as was the case in the past, they would have to offer more quality. Because many large export businesses have better political connections than regular consumers do, that solution is however not immediately a probable course. Although it is possible that the Southern European elites will come to realize that this approach is their only chance, under pressure of e.g. Italian industry, which is shrinking year after year. If such a scenario becomes reality, it is the responsibility of liberals to clearly state that there is a fundamental difference between the failed euro on the one hand, and the great realizations of European open borders and free trade on the other.

From a liberal perspective it should be added that national currencies are of course nowhere near ideal. The exchange rate scenario is expensive. However, compared to the high costs of a centralized interest rate policy, the elimination of the automatic adjustment to competitiveness and the problem of a European Central Bank that has the capacity to saddle citizens with an incomparably larger debt than any national bank could, national currencies are the cheaper option. Perhaps one could argue that in assessing on the one hand national currencies and on the other hand a Northern-European monetary union, comprising the Benelux, Germany and Austria, which could at least be seen as a more “optimal monetary union” than the Eurozone,  the latter would be more beneficial from a purely economic perspective. But such a Northern euro would however also quickly evolve towards a more politically centralized authority and would perhaps be more successful at this than the current euro, with all its economic faults. It remains to be seen however whether countries like the Netherlands and Austria would feel comfortable in a “Northern Euro State” dominated by Germany.

The liberal ideal should be a world currency, but a private one at that: a standard that is freely chosen by the market. This is however not possible in a world in which governments play such a large role. If there is to be government intervention into the monetary system, it is best done at a government level that is as closely connected to the citizen as possible.

As the American post-war economist Henry Hazlitt put it, floating exchange rates are the best guarantee to prevent currency devaluation. Ideally, the markets decide what will be used as a monetary standard. Many believe that in this case gold would prevail. But, as Hazlitt said, if we are to have government money, it is probably better to let the markets decide on its value, rather than to have a system of “fixed exchange rates supported by secret government buying and selling operations”. Hazlitt was proven right in 1971, when Richard Nixon had to announce the end of the Bretton Woods system of fixed exchange rates. The current system in Europe, which does not only have fixed exchange rates, but even a single currency, seems even less stable.

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