The Euro, the Pseudo Gold Standard

The Euros showing signs of stress lately. The Dollar climbed to $1.43, its highest in three months as the fiat race to the bottom continues. Greece's sovereign debt was downgraded with the third generation of a Papandreou residing at the helm in what looks to be another Greek catastrophe. Spain somehow continues to mask the mess it finds itself in. At some point the poison will inevitably seep through. Meanwhile with regards to the other PIIGS (yes thats two i's, Ireland and Italy) we find Ireland have launched their second cost cutting budget in an attempt to appease the other 'sounder' Euro states. According to the governments figures they have come out of recession unlike here in the UK. Italy's leader Berlusconi took a beating, literally. Although the attack was appalling, its more disturbing to see such popular support for Massimo Tartaglia, the person who carried out the senseless assault. Austria's Government followed the new global trend by effectively nationalising the countries 6th largest bank, Carinthian Hypo Alpe Adria Bank AG, with the taxpayer now becoming it's largest shareholder. It's not the only bank in trouble with the countries 4th largest, Oesterreichische Volksbanken AG, also under the governments watch. Exposure in the Balkans and Eastern Europe, Austria's banking system is looking more insolvent as time goes on. Despite what Americans say about their banking losses at least their banks are declaring them. Europe's financial system is one monstrous black box, with everyone trying to call each others bluff. Even Germany seems to be throwing out the rule book announcing tax breaks despite a widening budget deficit, however compared with many other countries double digit percentage horror shows it won't sound an alarm with the bond vigilantes.

There's been many commentaries written in relation to the Euro the single currency that's used by 16 separate nations, usually critical toward the faceless bureaucrats who reside in Brussels. However its important to understand how the Euro came about. 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. There was an obvious issue from the start. Two distinct tribes existed within the union, the North dominated by Germans who had previously presided over the Mark, a currency as hard as any other in its day. The other faction, the Southern Mediterranean nations a historic bunch of pansies that would use their currency at the first instance of economic trouble to try and solve their problems. During its first 10 years all seemed well but when disorder came, the Mediterranean nations suddenly found themselves in a bind. They couldn't devalue or print as they had in the past, instead they were told by the Northern circle that they must cut their deficits along with reckless spending. Don't get me wrong, the ECB have dabbled in QE however in comparison to the Drachma, Lira, Escudo or Peseta if they still existed and were in the hands of the irresolute Southern Europeans, then things would be getting a whole lot worse for such countries as we tread into unknown waters.

The Euro is in effect a Pseudo Gold Standard for some. Similar to when the majority of nations had a fully convertible Gold Standard, there are checks on Government spending such that they can not rob the public through inflation, or sidestep genuine long term fixes with short term devaluations. This is not to say the rules can't be bent, the rules are always for bending when the government is solely in charge. For example the deficit limit for states that were to join the Euro was originally set at no more than 3% of GDP. Problem being that nations such as Portugal just moved some of their deficit from the official figures to assist in their entry into the Euro to meet the criteria. After the financial crisis fiscal restraint has been put on the back burner, another crisis will need to occur before anyone gets serious again.

Like a Gold Standard, the old bundesbanks dominance on the ECB acts as a check against others that are more willing to deploy looser monetary policy. It depends if you have the stomach for such medicine as to whether you believe it is beneficial.

Many commentators state that the Euro is the problem facing countries like Greece, the reasons given are usually the very same policies that got them in the hole in the first place, in this case excessive government involvement and monetary inflation. They are usually correct on one point, that it was the Euro that exacerbated the credit boom for many such nations. Generous subsidies to promote the Euro's launch created undeserved prosperity, accompanied with negative real interest rates in such countries, meant loose lending was endemic.

Ideas that increased inflation and spending can alleviate the problems we face are wrong. They instead increase the states control and crowd out private enterprise and initiative. Not only does it fail, but it becomes an immoral path as genuine savings are stolen from the people.

One of the questions people ask is what will become of the Euro? Will it survive? Will its members fragment? Will it gain in numbers and strengthen? I don't think we can arrive at a conclusive decision on any of the above as they are all legitimate possibilities.

Fragmentation could be possible. A number of nations could drown in their own debt but we have to realise governments always bend the rules. The ECB may show a tough hand for the moment but could ease if events got out of hand. If a nation did wish to exit then imagine the stigma attached to the politician in office at the time. It would take a brave politician to declare an exit from the Euro while others in the Balkan's, Baltic's and the East are clamouring for such prestige.

Would others join the Euro as a refuge? Possibly, however if the above were to occur we could see the emergence of a new strengthened Euro. Nations such as Norway or Switzerland could join, forming what would be one of the soundest currencies in the world. They didn't join in the beginning with the current members therefore , if the weakest were weeded out they could have a change of heart. This would be the only reason I could see them joining.

Survival? I'm bearish on all fiat money. Even the Euro. There are many problems contained in Europe. It could however emerge as a genuine contender to the Dollar if the harder money circles have their way.

So is the Euro a good or bad thing? Well I'd prefer the ECB administering my nations currency rather than the current set of inept individuals who are running riot with the UK's monetary policy. German jokes aside, you have to wonder how they do it. After a crippling war they arose as the dominant power of Europe once more, a dynamic economy that produced quality products, while other Western nations industries went into decline. It dealt with unification as Communism collapsed thus inheriting a nation with years of decay that required to be rectified. She then became one of the key participants to unify Europe under the single currency opting to bin their sound Mark. Subsidies were provided to Ireland and Spain to promote the Euro, subsidies paid for by the German taxpayer. She wasn't even resource rich, importing many commodities. There was however a culture of hard work, along with the abstinence of partaking in speculative activities such as Real Estate even as the 'Anglo-Saxon' economic models mocked the Germans for relative stagnant growth in comparison. Since the arrival of the crisis the jokes have stopped and once more the Germans hold the key to Europe, to the pseudo fiat Gold Standard known as the Euro. History leads me to the opinion that I'd prefer the Germans to manage my sovereign currency. Its the same story for many others who are current members of the Euro, it just depends if their culture can adapt to a different monetary way of thinking.

Purchasing Power is Wealth - Not Money

Today, more than ever people are obsessed with money. It has become a key driver of the employment people choose, how we view individuals and one of the measures that helps form class structures. Yet money today, is one of the causes that has disrupted and distorted our financial systems and ultimately, that affects our prosperity. Sound money it seems, always evaded society, instead a continual debasement of currencies is the preferred approach. Yet it doesn't have to be like this. We could implement sound money, thus abolishing the periodic economic disasters we have become indoctrinated to accept. Unsound monetary expansion that occurs when banks expand credit in concert with the support of a Central bank and government, always leads to a loss in purchasing power of the money we have saved, the preferred commodity we use to store our labour. Our paper notes that we assume always have the ability to store wealth, don't. It is constantly debased, inflated, to pay for government programs, the invisible taxation. I think an historic, hypothetical example is required in order to explain this simple process.

The King who acquires money, without taxation

Let me explain the title above. It's no magic act, just monetary trickery. Lets say our King lives in the Kingdom of Hyper, and decides he needs money for his own consumption, in order to buy a new castle and land and chooses debasement to pay for his pet project. He announces to his people to call in of all of the gold coins in the kingdom to be re-minted with the kings face on the new coins. Currently each coin within the kingdom contains 10 grams of gold, and these are used to pay for goods, the unit is called the Crown. During this process however the King decides to readjust the amount of gold in the Crown, and only puts 5 grams of Gold in each Crown, using the excess Gold to create new coins for himself to use. The people don't really notice the weight as it is the unit, the crown, that they use to purchase goods not the gold content. However the money supply, to pay for the Kings extravagant life style, has increased 100 percent. With more Crowns in circulation and the same goods and services, the effect is that prices rise as the the money supply has increased, thus distorting the previous price equilibrium. The King benefits the most as he is the first to use the new crowns thus has the purchasing power he requires to pay for his consumption, but as the money moves through the Kingdom it effects the prices of goods and leads to inflation.

Other common historic forms of debasement was the alloying of Gold and Silver coins with more common forms of metal, thus giving the illusion of the coins having the same weight but they would now contain less Gold or Silver. The effect was the same. More Coins were minted and it lead to the inflation of prices.

So how does the above example link into the modern financial system we live in today? Well in modern times all a government had to do was print more paper money, they didn't even need to re mint coins. Today it has become even easier, in fact far to easy with the use of computers. They can just digitalise the extra monetary units without the need for deforestation and paper printing. This is what is happening now as this post is been written. Governments are now deploying "Quantitative Easing" in order to "Stimulate" the economy. In other words taxing all of us, ensuring our currencies have less purchasing power. Rather than all of us enjoying the fruits of prices falling in a free market system, we instead have to continually witness the decline of our wealth we have built up, for those of us who are prudent enough to save - which is a crucial function in any developed economy. Savings pay for increased productive efficiency.

We can see Debasement directly in our own currencies

Ever wondered why a unit of pound Sterling is called a pound? Well a pound used to be worth a pound of silver, or 16 ounces of silver. Now a pound is worth around, well, not even 1 ounce of silver. Rather it now takes around £8 to buy an ounce of silver. I'll leave the reader to do the arithmetic, as this shows the complete loss of purchasing power Sterling has had and most of it within the past century. Sovereigns, a common bullion coin that are still traded today used to represent a pound and contain 1/4 ounce of gold. That same coin today is now worth around £137. These were still used in the later years of the 19th Century, which shows how much inflating our governments have done. Ever look at your coins and wonder what they are made of? Very cheap metal, however the debasement has got so serious that even these more common metals used in the 1p and 2p coins are now being melted down as the metal is worth more than the coins. The new editions however are just copper plated steel - it makes you wonder whats next. We might as well start using monopoly money.

When we had currencies backed by gold or silver, our notes used to read redeemable in gold or silver, whichever metal was the preferred backing chosen. Now they just have empty promise statements, meaningless in terms of future purchasing power and value. One of the reasons that the US had to abandon Bretton Woods in 1971 and consequently loose ties the Dollar had with gold, was due to the printing during the sixties, that paid for Vietnam, President Johnson's Social spending programs and NASA's space adventures along with various other deficit spending policies. When the French and British got wise, they started trading some of their Dollars for physical gold. With a run on Fort Knox Nixon had to act, thus removed the Dollar from Gold convertibility. It was quite simple - the currency was being debased, just like the King of Hyper above.

So why are goods still so cheap?

Simple - The Free Market. Through technological advance, the reinvestment of capital to increase productive capacity and the relocation of production to low cost destinations (recently China), this has all created the mirage for a seemingly stable purchasing power. However we should have all basked in the falling prices of the free market more than we have. Perpetual inflation means we have to work until we are 70 and not 50. It means we have to speculate on investments, in order that inflation does not destroy the value of our money we save for the future. Investments that are based on rising capital gains caused by inflation, rather than dividend payments from solid business models. These investments where main street looses, while Wall Street gains. Just like a casino, the players (public), don't stand a chance. DVD players for £20 - more like 10 pence if our currency had retained value. We have China to thank for the gain in purchasing power we have received as they began industrialising, along with artificially pegging the Yuan lower, in order to achieve spectacular export growth. Their huge productive capacity has flooded our markets with goods - we haven't increased our production - they have provided the illusion. I don't care if I have £1,000 or £1,000,000 - I care about how much that money may be worth in the future. Money that has in all likelihood been gained by the use of my labour.

We mistake wealth for money when real wealth is the labour and goods that we produce - its stuff. Money is mearly the preferred mechanism we use to exchange these goods and services between one another, a contractual agreement. In order for these contracts to be valid, it is vital that money is a stable store of value. This, however, as history has shown, and economic theory can prove, is not the case.

"To put it another way: a continuing, sustained inflation — that is, a persistent rise in overall prices — can either be the result of a persistent, continuing fall in the supply of most or all goods and services, or of a continuing rise in the supply of money. Since we know that in today's world the supply of most goods and services rises rather than falls each year, and since we know, also, that the money supply keeps rising substantially every year, then it should be crystal clear that increases in the supply of money, not any sort of problems from the supply side, are the fundamental cause of our chronic and accelerating problem of inflation. Despite the currently fashionable supply-side economists, inflation is a demand-side (more specifically monetary or money supply) rather than a supply-side problem. Prices are continually being pulled up by increases in the quantity of money and hence of the monetary demand for products."
Murray Rothbard, The Mystery of Banking

The Next Great Depression?

A great deal can be learnt through history. In a practical sense its completely useless, as it merely just documents past events, but past events can help explain current and possible future events. If you can never get to grips with a subject matter it is best to look at history to try and to identify possible similarities. I have taken some quotes from a historical book and I think a lot of the quotes below could be said of the current situation we find ourselves in.

"If the Federal Reserve had an inflationist attitude during the boom, it was just as ready to try to cure the depression by inflating further. It stepped in immediately to expand credit and bolster shaky financial positions. In an act unprecedented in its history, the Federal Reserve moved in during the week of the crash—the final week of October—and in that brief period added almost $300 million to the reserves of the nation’s banks. During that week, the Federal Reserve doubled its holdings of government securities, adding over $150 million to reserves, and it discounted about $200 million more for member banks. Instead of going through a healthy and rapid liquidation of unsound positions, the economy was fated to be continually bolstered by governmental measures that could only prolong its diseased state."

"The Federal Reserve also promptly and sharply lowered its rediscount rate, from 6 percent at the beginning of the crash to 4.5 percent by mid-November. Acceptance rates were also reduced considerably. This enormous expansion was generated to prevent liquidation on the stock market and to permit the New York City banks to take over the brokers’ loans that the “other,” non-bank, lenders were liquidating."

"Dr. Anderson records that, at the end of December, 1929, the leading Federal Reserve officials wanted to pursue a laissez-faire policy: “the disposition was to let the money market ‘sweat it out’ and reach monetary ease by the wholesome process of liquidation.” The Federal Reserve was prepared to let the money market find its own level, without providing artificial stimuli that could only prolong the crisis. But early in 1930, the government instituted a massive easy money program. Rediscount rates of the New York Fed fell from 4.5 percent in February to 2 percent by the end of the year."

"During 1930, the Federal Reserve had steadily lowered its rediscount rates: from 4.2 percent at the beginning of the year, to 2 percent at the end, and finally down to 1.2 percent in mid-1931."

"President Hoover was proud of his experiment in cheap money, and in his speech to the business conference on December 5, he hailed the nation’s good fortune in possessing the splendid Federal Reserve System, which had succeeded in saving shaky banks, had restored confidence, and had made capital more abundant by reducing interest rates. Hoover had done his part to spur the expansion by personally urging the banks to rediscount more extensively at the Federal Reserve Banks. Secretary Mellon issued one of his by now traditionally optimistic pronouncements that there was “plenty of credit available.” And William Green issued a series of optimistic statements, commending the Federal Reserve’s success in ending the depression. On November 22, Green said: All the factors which make for a quick and speedy industrial and economic recovery are present and evident. The Federal Reserve System is operating, serving as a barrier against financial demoralization. Within a few months industrial conditions will become normal, confidence and stabilization in industry and finance will be
restored."

"By early 1930, people were generally convinced that there was little to worry about. Hoover’s decisive actions on so many fronts—wages, construction, public works, farm supports, etc., indicated to the public that this time swift national planning would turn the tide quickly. Farm prices then seemed to be recovering, and unemployment had not yet reached catastrophic proportions, averaging less than 9 percent of the labor force in 1930."

"During the second half of 1930, production, prices, foreign trade, and employment continued to decline. On July 29, Hoover called for an investigation of bankruptcy laws in order to weaken them and prevent many bankruptcies—thus turning to the ancient device of attempting to revive confidence by injuring creditors and propping up unsound positions."

"As a consequence, while the immigration law had already reduced net immigration into the United States to about 200,000 per year, Hoover’s decree reduced net immigration to 35,000 in 1931, and in 1932 there was a net emigration of 77,000. In addition, Hoover’s Emergency Committee on Employment organized concerted propaganda to urge young people to return to school in the fall, and thus leave the labor market."

"He hailed the Federal Reserve System as the great instrument of promoting stability, and called for an “ample supply of credit at low rates of interest,” as well as public works, as the best methods of ending the depression."

"As 1931 drew to a close and another Congressional session drew near, the country and indeed the world were in the midst of an authentic crisis atmosphere—a crisis of policy and of ideology. The depression, so long in effect, was now rapidly growing worse, in America and throughout the world. The stage was set for the “Hoover New Deal” of 1932."

"During 1929, the Federal government had a huge surplus of $1.2 billion"

"From a modest surplus in 1930, the Federal government thus ran up a huge $2.2 billion deficit in 1931."

"One thing Hoover was not reticent about: launching a huge inflationist program. First, the administration cleared the path for the program by passing the Glass–Steagall Act in February, which (a) greatly broadened the assets eligible for rediscounts with the Fed, and (b) permitted the Federal Reserve to use government bonds as collateral for its notes, in addition to commercial paper"

"Thus, the Hoover administration pursued a giant inflationary policy from March through July 1932, raising controlled reserves by $1 billion through Fed purchase of government securities. If all other factors had remained constant, and banks fully loaned up, the money supply would have risen abruptly and wildly by over $10 billion during that period. Instead, and fortunately, the inflationary policy was reversed and turned into a rout. What defeated it? Foreigners who lost confidence in the dollar, partly as a result of the program, and drew out gold; American citizens who lost confidence in the banks and changed their deposits into Federal Reserve notes; and finally, bankers who refused to endanger themselves any further, and either used the increased resources to repay debt to the Federal Reserve or allowed them to pile up in the vaults. And so, fortunately, inflation by the government was turned into deflation by the policies of the public and the banks, and the money supply dropped by $3.5 billion."


Notice some parallels between the present and the period being described above? The things I find most striking are the fact the FED drastically cut rates from 6% to 1.2%, compared with today in which they cut from 5.25% to 2% at present. Also the fact that at the beginning of the bust the government were running huge budget surpluses, and within a couple of years were running huge deficits, compared with now where the US has persistently for years now been running up huge deficits which will get worse.

Of course the period being described was the Great Depression and the Quotes were taken from Murray Rothbards book, Americas Great Depression. Contrary to what people believe the great depression was not suddenly brought about after the infamous stock market crash in October 1929, it was brought about over a 3-4 year period of excessive monetary inflation in the previous years during the 1920's boom and increasing inflationary policies during the bust along with increased government interference, which made the Depression so great. In fact the stock market also rallied during this time and didn't bottom out till around 1933. Hoover was the creator of the New Deal, Roosevelt just merely carried on with it with even more enthusiasm contary to the myth that Hoover had a no hands approach to the economy. In the end this is where we now stand,


"But here, in the crisis of 1933, the banks could no longer continue as they were. Something had to be done. Essentially, there were two possible routes. One was the course taken by Roosevelt; the destruction of the property rights of bank depositors, the confiscation of gold, the taking away of the people’s monetary rights, and the placing of the Federal Government in control of a vast, managed, engine of inflation. The other route would have been to seize the opportunity to awaken the American people to the true nature of their banking system, and thereby return, at one swoop, to a truly hard and sound money."


We all know what happened in subsequent years. Nixon removed the US from the gold standard, and in effect all western currencies from gold as bretton woods was dissmantled. Now the dollar and world currencies are backed with nothing as we enter another dissasturous chapter in history of fiat currency.

If we wish to draw the parallels to today, roughly in 1928 real estate prices began to fall compared with 2006 in the US. 1929 and stock prices began to fall, compared with 2007 when the Dow was at its all time high. So what does that mean in the next few years if we are only at 1930. Well we have a lot further to go and the governments and Central Banks are doing exactly what history has taught us not to do.

However there are differences, which I believe position the US in a worse position. Back then the US had huge budget surpluses in previous years, exported goods throughout the world and had huge oil reserves (cheep energy reserves which can never be overstated). They also theoretically had the dollar backed by Gold which meant even though the FED tried to inflate they were constrained, where as now it is a complete fiat currency meaning there will be no limits to inflate this time. Ben Bernanke the current head of the FED is supposedly a student of the Great Depression but from what I've seen, he's repeating what was done 75 years ago, and he's doing a pretty good job of fooling everyone. Nationalising Fannie and Freddie Mac, that were created at the end of the Great Depression, is an absolute disaster as I have said before, and is exactly what President Hoover and the FED would have done during the last depression.

I will end on the following note from Murray Rothbard. Maybe we are facing another depression and crisis of the same magnitude? Or worse?

"What was the trouble? Economic theory demonstrates that only governmental inflation can generate a boom-and-bust cycle, and that the depression will be prolonged and aggravated by inflationist and other interventionary measures. In contrast to the myth of laissez-faire, we have shown in this book how government intervention generated the unsound boom of the 1920s, and how Hoover’s new departure aggravated the Great Depression by massive measures of interference. The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy, and placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of “enlightened” economists. And in any other depression, past or future, the story will be the same."