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In September I participated in the
amazing Supporters
Summit, held at the prestigious National Academy of Sciences in
Vienna, where Eugen von Böhm-Bawerk once lectured. After my visit to
Austria, I piggybacked an excursion to adjacent Slovakia where I was
surprised to discover a large number of fans of the Mises Institute and Ron
Paul.
Peter Gonda, working through the
Conservative Economic Quarterly Lecture Series, had arranged for me to give a
lecture, "Money and Banking: the State vs. Market," to two
different audiences. (The videos of the lecture and Q&A period are here.) My lecture itself
was quite theoretical, discussing the Mengerian/Misesian perspective on the development of
money and banking, as well as the Rothbardian perspective on the dangers
of central banking and fiat money.
In the Q&A period of the
lecture, and during my interviews with local journalists, however, most
people wanted to discuss the Greek debt crisis and the fate of the euro. Yet
even here I showed the relevance of the Austrian insights: Germany, Slovakia,
and the other frugal countries were only in this mess because the euro was a
fiat currency. Had it been backed 100 percent by a commodity such as gold,
then the Greek government's debts would be irrelevant to outsiders.
The PIIGS Sovereign Debt Crisis
Investors are very alarmed that the
governments of the so-called PIIGS (Portugal, Ireland, Italy, Greece, and
Spain) will default on their bonds. As of this writing, the crisis focuses on
Greece, but it may soon spread to other countries. The chart below shows how
the foolish bailouts and stimulus spending, coupled with plunging tax
receipts, put the governments in fiscal trouble:
 
Government
Debt as % of GDP, Annual Averages
Source: http://www.economist.com/content/global_debt_clock
When I was in Slovakia, the burning
issue was whether their government should kick in to the European
Financial Stability Facility (EFSF), a €440 billion entity
that would buy bonds, make guarantees, and engage in other transactions to
reduce the stress on debt issued by the beleaguered PIIGS. The Slovaks were
historically a poor but frugal people, and many of them resented bailing out
the Greeks who were spendthrifts yet had a higher standard of living. (For
those who don't like stereotypes, don't send me angry emails: I'm just
repeating what the Slovaks told me.)
The average Slovak was in the same
unfortunate position as the average American back in the fall of 2008: each
was told that they had to pay higher taxes in order to bail out rich people
who had made dumb financial decisions. When Americans were told they had to
pay for the $700 billion TARP, Treasury secretary Paulson and others warned
that failure to do so would lead to a collapse of the banking system. In a
similar vein, Europeans today are warned that they need to rescue the PIIGS
governments lest the euro itself collapse, taking down the banks with it.
Debt Rules and Fiat Currency
When the euro was first introduced,
people were aware of this very danger. That's why the Maastricht Treaty
contained rules on countries wishing to join the euro currency union.
Specifically, government budget deficits were not to exceed 3 percent of GDP,
and total government debt was not to exceed 60 percent of GDP.
Obviously the Maastricht Treaty's
rules were as binding as the Bill of Rights in the United States. Partly
aided by shenanigans involving currency swaps designed by
Goldman Sachs, the Greek government flouted the limits of deficits
for years. Thus here we are, in the very nightmare scenario about which some
economists (such as Milton
Friedman) warned at the euro's inception.
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. That's why the citizens of traditionally hawkish
Germany — who grew up with horror stories of hyperinflation —
would be very wary of joining a currency union with people who elect
spendthrift governments and have central bankers who are doves on inflation.
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.
For an American audience, I have
another way of illustrating the point. Right now, there is a decent chance
that states such as California and Illinois will default on their bonds. Yet
this currently doesn't pose problems for other states, nor does it make
investors worry about the "fate of the dollarzone." This is because
few people expect that the Fed will provide massive intervention to prevent
state-level defaults.
However, suppose that the Fed does
step in and start buying up massive quantities of bonds issued by California,
Illinois, Michigan, etc. At that point — once it became clear that
state-level deficits would influence Federal Reserve policy — you very
well might see something analogous to the current crisis in Europe.
You might see the exchange rate of the dollar against other currencies vary
in response to changing reports about the fiscal condition of American state
governments.
Conclusion
Since the world left the last
vestiges of the gold standard in 1971, the global economy has been set
adrift. The technocrats keep assuring us that they can steer the economy much
more efficiently than the "obsolete" gold standard, and yet a
continual series of crises suggest otherwise. We can achieve the dream of the
euro — an integrated monetary union where people and businesses can
plan their activities spanning several countries without fear of
exchange-rate risk — without its attendant pitfalls, but only if people
go back to using genuine commodity money.
Robert P. Murphy
Article originally published at Mises.org here
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