The Euro, Past, Present and Future

“Our role as central banks is to guarantee price stability in the Eurozone. I’m convinced that the future of the euro is fundamentally linked to the support of the population, and that this support depends on the confidence Europeans have in the stability of their money.”  

“The mandate is deeply rooted and stems from the lessons learned during the seventies and eighties," he said. "It’s when a central bank ensures price stability that it contributes the most to durable growth.”  

“Governments must take on their responsibilities and not subcontract them out to monetary policy.” 

Jens Weidmann, Bundesbank President (article)

The persistent Euro crisis has garnered much media attention in the aftermath of the credit crunch. With benefit of hindsight many have concluded that the Euro was always doomed to fail from the start, with both sides of the political spectrum fervently believing they were correct all along. In Britain, right wing thinkers always believed that 'Brussels' never had a solution and should stay out of Individual Nations affairs. The left initially thought the Euro to be a good thing, seeing old currencies as symbols of Imperialism, but would later object to the Austerity imposed on member States. The left during the seventies were opposed to the common market, while the right were in favour. When the European Exchange Rate Mechanism was in use it was the right who were generally in favour. After the pound was ejected the left could claim it was a disaster made by the Tories; after the event had occurred.

You can see the confusion and schizophrenic nature from both ends of the political spectrum. History has shown both camps to support one form of monetary union, but then to oppose another. There has never been a thorough discussion on the Euro in mainstream politics with either end of the spectrum unable to rationally determine what the real issues are. 

Claims have been made that "You can't have monetary union without political union" or "A Nation and its Government should always have control of its own money supply", to "You need the power to devalue in order to regain competitiveness". All are stabs in the dark, as these were never raised as issues back when the currency was created. Only when catastrophic events have transpired do these so called shortcomings come forth. Like all events in history, it is never a simple yes or no, and requires a rational look of what caused the current situation to arise.

During Bretton Woods I, when the US was on it's quasi Gold Standard, they pegged the dollar to gold allowing only foreign central banks to redeem their dollars for gold. With increased deficits by Kennedy and then by Lyndon Johnson this spending had to be paid by someone, therefore the government does what it usually does, it printed money to pay the difference. When the Bretton Woods agreement was created the Keynesian's proclaimed that redeemability of the dollar for gold would cause no issues as institutions would never need to claim. Unfortunately for them they didn't count on Jacques Ruff advisor to former French president Charles De Gaulle. 'They run deficits without tears', thus Ruff advised De Gaulle to call the Americans bluff and trade in the paper promises for something that the American Administration couldn't create out of thin air. Others followed suit.

The rest as they say was history. Bretton Woods I was abandoned, in which we moved to the current global monetary system we still have now. The erratic fluctuations of the currency markets during the seventies accompanied with widespread financial turmoil prompted many European nations to look for solutions to stabilise trade, thus the chaos became one of the prime reasons for the single monetary currency created two decades later. (Taken from a previous post)

After the post war era Western Europe progressively moved towards economic integration. Many reasons exist, to combat American dominance, to unify against Eastern Europe, to enable greater trade - it was always a strength in numbers philosophy. 

Prior to the Euro, Europe had the ERM which attempted to tie the various currencies on the continent to the German D-mark; which at the time was one of the hardest currencies in Europe. It was doomed from the start as fixing currency exchange rates is a foolhardy scheme. It was price fixing and like any attempt to fix market prices it fell apart in the end. The principle however was to maintain low inflation among member nations and to stop political pressure to devalue in a race to the bottom. The right wing in Britain joined the ERM under Majors Government, despite the Majority Conservative Euroscepticism we see now. 

When the Euro was created nations who had an association with soft currencies clamoured to obtain membership. Its easy for complaints to be made towards the Euro now when austerity is imposed, but when the single currency was introduced it was seen as an economic boon by such countries.  Nations such as Spain, Greece and Ireland benefited greatly from the introduction of the Euro. Inflation fell, interest rates stabilised, capital investment spending increased. The whole point of the Euro is to ensure inflation is kept low by borrowing inflation credibility from the old Bundesbank who had a long history of doing just that. Interest rates fell across Europe in part due to this factor. Bond markets could therefore ask for a lower rate of interest on Greek or Italian bonds as Monetary Policy had been handed over to the more competent Germans. Historically Mediterranean countries would erode the value of their bonds with expansive monetary policy, but when these powers were absolved to the ECB, markets lowered prices for such Government debts.

A similar mechanism happened here the United Kingdom, whereby monetary automonoy was taken out of political hands. In 1997 the new Labour Government gave interest rate decisions to the Bank of England, a supposed neutral organisation. The idea was to take such decisions away from politicians who had in the past set interest rates to create inflation, and/or economic booms during election times. Both sides of Parliament, agreed that this was a good policy. The rest of Europe did something similar to the above, it handed monetary policy over to the Bundesbank. Another example of the contradictive nature of mainstream thinking.

The principle in keeping inflation low is a good thing. This spurs capital investment and production so that citizens can obtain better living standards. The more stable a moneys purchasing power is, the better off its people will be. The faster a currency devalues over time, the poorer its economy and people will be.

Many of the countries however still worked under the spend now, act later mentality. Government and consumer debts kept rising along with off the record liabilities. The European Welfare state was supported by this illusion, along with heavy Government corruption, rigid regulation or absurd employment traditions. The Credit Crunch was just the spark to highlight all these underlying issues to the market that has since demanded the bankrupt countries get their house in order. Markets have been trying to do this by asking for higher rates of interest on bonds; increased risk means the return an investor requires should be higher. This is the markets price mechanism trying to force bankruptcy/spending reform upon the political system. Without this dynamic the old political system tricks people to believe that an easy fix is within sight, allowing Government spending to get out of control. The problem is whenever these prices have been raised, a bailout fund is announced in an attempt to bring these prices back down. Initially the markets predictably put money on the new policy but not for long as markets know the underlying issues are only compounding.

The quotes taken from the Bundesbank President are exactly the reason the Germans have such a strong reputation in financial markets for running a sound currency during the Post War Period. It also highlights cultural differences between the Germans and the Mediterranean countries, who historically had Governments that pursued high inflation for their political failings. The periphery countries want all the benefits that accompany the common currency, low inflation, low interest rates, real terms capital investment, while at the same time oppose the fiscal constraints that help foster such benefits.

The simple problem with the Euro, or any money controlled in a monopolistic manner, is its openness to abuse. Money should be provided, like all goods and services, by a free market, competition, consumer sovereignty and choice. Thats the real issue behind the Euro and the solution not just to its ills but all problems that will arise with Government controlled money. 

We are witnessing the end of the Euro as many analysts/pundits/commentators are proclaiming, who state it should never have been created (usually these were the same people who were saying the UK should have joined, or were selling their Dollars and buying Euros a few years back). It is impossible for any commentator to predict what Governments will do, however I believe the Euro has the potential to prosper from recent events, only if the Germans maintain a hard line. This will entail Government defaults, bank collapses, members leaving, but if they decouple the currency away from political pursuits it will be a sound currency relative to others.

The real crisis will be if the Germans do not uphold a hard line. Many are distracted at the crisis occurring in Europe but are unaware of the crisis building up in nations who are overstretched, but still have monetary autonomy. Countries like Japan, the UK and the US are the ones who will have real problems. Their spending is also out of control, but the politicians are just using monetary tools to mask their problems. Interest rates for Government bonds are low in such countries because the market knows they will just monetise their debts if there are no buyers. Its certainly not because they are any more creditworthy. However this postpones any reforms that need to occur, with the situation getting worse. Look at Japan. Its debts are astronomical and will no doubt have great problems during the decade.

The Euro, if it is managed correctly, will be a strong contender to challenge the Dollars world reserve currency status. If this occurs, contrary to popular opinion, I believe the UK will eventually join as we continue to mismanage pound sterling. 

As mentioned in previous posts, I believe the 21st Century will be a great Century for liberty, individual freedom and human innovation. Statism, Monarchies, dictators have all had their time in the West. Such nations will increase individual freedoms as the states role diminishes over time. It will be an evolutionary process, not revolutionary. I also believe that the Euro may be a step towards the abolition of Government control over money. Its a pseudo gold standard that has the potential to stop endless devaluations for political means. As the state shrinks, people will realise the state is not required to help run our lives with money also falling under a similar observation, we don't need our Government to issue money. The Euro may well be run by Government officials, but its not tied to a single nation or a unified political system. Therefore the Euro, to some extent, decouples political affairs from monetary policy. We are a long way from free market money, but the Euro could be the start of a long path towards such a goal.

The 'China Hedge' and Western Zombies

Earlier this week the Chinese Government did something that Governments don't usually do. State television began promoting Gold and Silver as a good investment.



So why is the Chinese Government telling its people to buy Precious Metals? Of course I have previously mentioned the Chinese Government increasing their own holding of gold but now it is telling its citizens to follow the same strategy. To me it would seem their leaders must realise that the economy is in a bubble and whatever they try and do, China is heading for a hard landing. The trick with governing people is to try and provide the illusion of prosperity. Its what the West did during the housing bubble. Despite average workers incomes stagnating, people were content as their home was rising in value, giving them a false sense of wealth. People didn't mind that NHS waiting lists got worse, Governments role in the economy expanded along with deficits so long as their homes kept appreciating. When that disappeared, then people became restless. Recently with the 'green shoots' (read another dose of inflation from the government) people again believe how good it is that their houses will hopefully hold or increase in value and we can return to the old days of easy living. The problem comes when people realise the green shoots were in fact weeds, and that the asset prices will fall back - then we go back to unrest.

The Chinese Government aware of this dilemma, seem to be trying to hedge their citizens from the global depression. Their exports continue collapsing, millions of jobs are being lost, the Baltic shipping index is once more on the slide similar to 2008 before the financial carnage occurred. To cover their citizens against this and falling stocks and real estate they are encouraging people to buy precious metals. As recent as 7 years ago citizens were banned from owning such assets. This illustrates how radical the policy is. What does this mean for the price of such assets? I do not know. All I know is that the Chinese Government, again, seem to have studied their history and see where we in the West are now leading the whole world. China has grown phenomenally in the past 30 years, but its still America, Europe and Japan who have the most influential economies. It seems that we wish to create a new set of zombie institutions just like Japan did to try and maintain our illusion of past 'prosperity'.

Western Zombie Banks

"At the moment the investment slump is being compensated by public spending. As long as global growth is supported by public help, we cannot talk of sustainable growth"
Yves Mersch, ECB Council Member

Whenever I mention to people that what we are doing is creating Zombie Banks that will stagnate the economy for years just like Japan I am greeted with exactly the same comments before the housing bubble burst. "It's different this time", "We are not like Japan", "It won't happen here". Well it will happen and as the years go on it will become more evident to everyone.





We haven't learnt anything from the events last year. Bankers are getting their bonuses once more. Banks have merged creating even larger "too big to fail" institutions with the Government guaranteeing all of them. They will use Lehman from now on to scare people, to legitimise further government involvement. Politicians don't dare bring up any previous discussions regarding reforms as they all try to maintain this illusion of prosperity but it won't work. Earlier posts back before Lehman collapsed that I wrote had some hopeful comments, on what needed to be done - saving, the abandonment of wasteful consumption, independent thinking. However I thought we would try and prop up everything, repeating the same mistakes of history with everyone tricked into believing the governments 'solution'. We should have made sure there were more Lehman's. Its just finance. People would have rebuilt their lives. We would still would have all our tools, skills and infrastructure.

So how long will China pursue Gold?

As I have previously mentioned China are acquiring gold to try and build a reserve currency contender against the US Dollar. I have read many articles on how the USD is going to collapse or be replaced by the Euro or some other currency. But as I've said before where is the alternative? The Euro has too many soft nations such as Spain, Italy and Greece. If it was just the sounder economies such as Switzerland, Germany, France, Norway then maybe there would be a sounder alternative. The Chinese RMB is pegged and that's before we come onto the smaller size of the economy compared to the US. I can not see the government letting the RMB float freely while the current crisis is present, they will keep it under control not risking further dislocation that could ensue by allowing it trade in the markets. The Japanese economy has gone nowhere for two decades and despite what people may say that they are due a boom I can't see it happening. The Government has to walk the right path first and I'm yet to see it.

If China did wish to challenge the USD as an alternative world reserve currency then the only way I can see other nations taking up the offer would be to peg it to Gold. The Chinese could then say "sure you can have your paper dollars backed up by American Governments lies as they continue to devalue them, or you can use our currency, fully convertible into Gold". Whoever holds the reserve currency status has a huge advantage in that they can export their inflation to others just like the US has been doing for decades. China and Russia may discuss alternative world currencies but they would both secretly prefer their own nations currency as the reserve standard. In order for China to do this they still have to accumulate a lot of gold. The 1,000 tonnes they already have would not be enough. China still has a lot more to accumulate, just as the gold bull market still has a lot further to go.

Building Bridges

“The Chinese government attaches great importance to Asia Pacific regional co-operation,”
Hu Jintao, Chinese President

Since Mao Zedong's death in 1976, China's move towards a more market centric economy has yielded some spectacular economic effects. Deng Xiaoping launched the four modernisations and began the slow process of reforming not just the economy, but the political party into accepting the new 'Social Market' system. Despite China's rise into the global political landscape, there are still numerous challenges they have to attend to domestically, such as individuals rights and the overwhelming presence of the state that still exists. China's current President, Hu Jintao seems to have the right ideas on the path his nation needs to follow, continuing with integration into the global economy and not just economically but politically also.

It was during the 1980's and 1990's that China opened up the special economic zones, areas that were designated for foreign investment and private enterprise. A frenzy of capital ensued, seeking cheap abundant labour. Some of the largest investments during this time came from Hong Kong and Taiwan, as they had large numbers of expatriates who left during the Mao era. This investment, along with Western capital, began transforming the Chinese economy from a predominantly low subsistence level of agriculture to the manufacturing hub of the world, as global business leaders outsourced many of their operations.

On Sunday, China and Taiwan signed a new set of agreements to open up their financial services and further open trade and investment with one and another. It was only last year that both declared peace and began talks as there had been diplomatic complications between the two sides in recent decades. During the Communist revolution with the beginning of Mao's various witch hunts many of the old Nationalist party members fled to the island of Taiwan, and ever since there have been unfriendly relations between the two with the US protecting Taiwan from Chinese threats.

The recent diplomatic progress between the two brings more stability to the region and potentially increased trade. It also signals China continuing to form ties beyond the US. This has also been seen in recent years as Hu Jintao has expanded relations between Australia, Venezuela and Iran. China knows that in order to continue growing economically it requires a stable region, and strategic alliances with nations rich in the resources it lacks. China in recent years has also been moving into more high tech manufacturing such as computers and semiconductors, and this agreement can only help bring about the continuing knowledge transfer over the coming years. The extra stability will also bring about increased investment in the region from overseas investors, as political instability is always an investors nightmare. With recent Gold acquisitions almost doubling, which I mentioned back in September to watch out for, China is looking to become a world reserve currency contender. There can be no doubt about that. They are long way from this goal, which will at least take a decade or two, but as the villain in the recent Bond film states "The Dollar isn't what it used to be". Euros were his choice.

Various restrictions still exist but this is the nature of how China has been moving in recent years, that of gradual change. The senior members of the party saw what happened to Russia when it introduced Perestroika and are aware of the importance to not make the same mistake. Over time, if the ruling party continues on its current course, and Chinese citizens increasingly embrace these market reforms then it is only a matter of time before China supplants the US as the global superpower. However nothing in life is inevitable. As the population becomes better educated and gains further exposure to Western culture they will no doubt demand a more democratic political structure on which the people can influence decisions. In all probability this will be years away, but when it does come this will be the next critical transition period, just like Deng Xiaoping's market reforms 30 years ago. Again here, China can learn from Taiwan who over the past few decades moved from a dictatorship to a democracy. China has a lot more to do, but she is continuing to head in the right direction. The significance of events such as these should never be underestimated.

Dr. Doom

As the worlds leaders continue to make mistakes and economies continue their decline I found the following video of particular interest.



For people not aware of who Marc Faber is, he is known for his bearish views on Western economies and how the problems began with Black Monday of 1987 from which point the Central banks embarked on expansive monetary policies and would not let the free market function. You could dismiss the above video as economic thespian commentary. After all high inflation only happens in distant lands, with historically weak economies. Argentina and Zimbabwe used to be economic giants in their respective regions, with prosperous living standards for their people, yet economic crisis came and ruined their peoples way of life. Some of the points in the video are very interesting:

• "The Fed will never raise interest rates to real levels" - Meaning they will give up on their currency. In the event of inflation running at 10% they will have rates at 1%. They won't even bother trying to bring the money supply under control and will just give up on the currency to keep inflating to pay government and societies debts. Of course this isn't free. It ruins the economy, but still this is what Central banks think will solve the credit crunch. When something goes wrong print (tech bubble pops - interest rates to 1%), when something else goes wrong print (housing bubble pops - interest rates to 0% and QE implemented).
  
• "We are a while from high inflation" - Dr Faber is precisely correct on this point. Inflation doesn't happen immediately. It's a gradual process. All examples of serious inflation have taken time to work through, even while calls about deflation were being made. The final chapter of fiat money is always destruction. There are still many chapters to go, but we are getting through the book at an alarming rate.
  
• "Totalitarian State?" - More state control along with less individual decisions in the economy signals the beginning of government control as it crowds out the private sector. Further Government debts are being imposed on its citizens without their consent. We still have the ballot box, so are a long way from succumbing to totalitarianism although it is perfectly plausible in the long run.
  

The video sums up the irresponsible stance institutions and Governments have taken in recent years. The debt burden can not be paid. The only way to not default physically on the debt is default by the printing press - the governments most dangerous weapon. Not 'A Step into the unknown' or 'will it work?' or 'Just enough to move the credit markets' - just plain debasement. Destroying genuine capital and saving that is so desperately needed at this current time to assist with the recovery.

It really was a historic week. The Federal Reserve have announced they plan to buy Treasuries by printing money, not real savings, but with fictitious money. The history books of the future will illustrate this event as a milestone, a turning point where the great credit crunch of 2007 got a whole lot worse. Ben Bernanke has now openly admitted that they are printing money, no swapping of assets, parking of securities just printing new money, to buy government debt. This is always how it begins. As public speakers continue talking of moral hazards they miss the biggest moral hazard of all, that of fiat money. A money with unlimited supply means governments can inflate and bail out everything, with no immediate cost. Perpetuating the irresponsible behaviour from reckless individuals, squandering societies scarce resources.

Budget Deficits are rising, seemingly by the week. A latest forecast for Britain has come in at 12.5% for next year, with the IMF saying Britain has the worst fiscal position in the Western World. Unemployment relentlessly carries on rising, with forecasts of 3.3 million or even as high as 4 million people out of work, putting further downward pressure on economic activity and increasing public spending to cover those out of work. As the private sector reacts to the market forces correctly by reducing pay and redeploying labor, public jobs are sheltered in the governments own wonderland, thus further crippling the private sector, the real engine of human prosperity. As state spending increases it is not only consuming scarce capital that could be used by the productive private sector, but labor. Private sector talent heads into the public sector as conditions worsen, thus stifling innovation and future economic growth. Trade figures deepen as international markets further dry up, meaning more firms cutting jobs.

It will be interesting to witness the coming budget report form Alistair Darling. Will he have a credible fiscal framework (as though there is one now, as the BoE buys government bonds with printed money)? People are still not with the program. The public are still talking about property, stocks, a recovery, the bottom of this market, the bottom of that. The inevitable bull moves in these great bear markets will no doubt fool many into a false bottom. People still don't appreciate the severity of the issues we face.

The FSA has recently begun to look into setting limits against income multiples to be lent against houses. 3.5x salary is being proposed, with suggestions of a 15% minimum deposit. If the above is the case, I can't see many people buying homes. Most British people don't have the discipline to save, never mind save the huge sums required for a house. Why do we have regulators? Why do we have regulatory institutions such as the FSA and the ratings agencies? So after the crisis has hit, they can come up with the regulatory framework. It's similar to a civil engineer not putting supports into a bridge that gets used by the public, and when a disaster occurs admitting that they should have put supports in place as the bridge never stood a chance. Will the new framework work? Of course it won't. The market is smarter than any bureaucratic institution. Regulation doesn't get to the root problem, as true free markets regulate themselves.

Religion was seen for centuries as an institution of wisdom, a beacon of light, defending people against invisible evil forces. As time passed, the enlightenment, the progression of science, slowly religion became exposed for what it was, a mass cult following of stories passed down from generation to generation with no real rational basis. Rather than religion being the saviour, it was indeed part of the problem. Catholic and Protestant divisions in Ireland, Hindu and Muslim tensions in India, centuries of pogroms in central and eastern Europe against the Jews. It became a convenient means to segregate and persecute people. When Fascism rose, Catholicism praised it for its opposition towards Communist and Socialist parties. Movements that believed in equality. Just like religion, Central Banks are just an institution run by a select few, who are not the solution to 'market failure' but are part of the problem. Dr Doom may be viewed as a 'non-believer', just like atheism was demonised during religions dominance. Dr Faber knows the cause of the problems we see, and thus what problems these policies will create further down the road. Back in 2002 Ben Bernanke made a speech entitled "Deflation: Making Sure "It" Doesn't Happen Here", in which he now seems to be implementing the very policies he proposed 7 years ago.

"The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt ... Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. "
Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, 2002