Brecht Arnaert writes: 2012 has been a year of great turmoil for the euro. But our economy is not the only thing that is in crisis. Our economic theory is too, and even more so: for decades macro-economic policy has been conducted within a Keynesian framework, and while no Keynesian economist has predicted this crisis, or even is able to explain it’s causes, we are still listening to them today to get out of the mess they brought us into. I would say that this is a problem of legitimacy.
I am telling this not only as an economist. I am a defender of liberty too. What is happening in Europe right now should not only worry economists, but every freedom-loving citizen. As we speak, measures are being taken to take away our liberties in a way that Hayek described so well in his “Road to serfdom”: each government intervention requires more government intervention, until no freedom is left anymore. Step by step our property rights are being eroded, and, not too far from here, in Brussels, a giant Moloch called the European Commission is centralizing powers with a speed that would have been unimaginable before the Treaty of Lisbon.
Why central planning cannot work
Let’s start with the proof that central planning cannot work. In his 1920 paper, called “Economic Calculation in the Socialist Commonwealth”, Mises demonstrates why that is: under central planning, there is no private property. If there is no private property, there is no exchange. If there is no exchange, there are no prices. And if there are no prices, there is no way for a central planner to allocate resources and labor, to know what needs to be produced, for whom, by whom and at what cost. By abolishing the institution of private property, central planners abolish the one institution that could make their plans work. Or in short: the only way central planning could work is by leaving the market free. It needs price information, which can only be generated in a free market.
Most mainstream economists – Keynesians, neo-classicals and monetarists alike – to this day have not understood Mises’ fundamental challenge: how are you going to centrally plan what is needed if the information for that kind of planning can only be generated in a free market? How are you going to decide how many shoes need to be produced if there are no ratio’s of offer and demand? How are you going to decide whether the production of shoes is more urgent than the production of trousers, if there is nothing to indicate a rise in importance? How are you going to decide who is to make the shoes or the trousers, if you don’t know who can make them? How are you going to decide what the cost of that specific product should be, if you have no prices? The answer is: you can’t. The information you need to answer these questions can only be found in the price system, and it is exactly this system that has been abolished.
It is startling to see how little economists really know about the workings of the price system. When I buy an apple, ceteris paribus, the price of all remaining apples raises. This price raise attracts entrepreneurs who see a profit in lowering the price of apples again. They start producing apples. Clean, simple. If I have to wait for a central planner to decide that an apple must be produced, I might as well just eat carrots. By the time he has – politically – decided which orchard has to produce that apple, has transmitted that order to Public Orchard nr. 56 and has replenished the stock of apples, I would already have starved. There is no system faster than the price system to transmit a change in market conditions.
The production of money
Now that it is proven that central planning cannot work, neither in principle, nor in degree, it is easy to conclude that the euro cannot work either, since the euro is just another case of central planning, be it in a monetary form. Most people have accepted the fact that shoes and trousers cannot be produced through central planning, but though money is half of each transaction in the market, accepting the same idea for the production of money, for most people, is a bridge to far.
Nevertheless, money is an economic good, just like all others. You cannot eat it, you cannot use it as a part that fits in the construction of a car, nor can you mow the lawn with it. It seems to be dead matter that has to be traded for something else, before you can actually put it to use. And this, precisely, is its function: serving only as a medium of exchange, not wanted for its own purpose, but to trade goods for goods. It has no other use than this. Money is hoarded because it can be traded against all other goods, and that is that. It is an economic good that has “gained currency”, very popular, but without trade, it is useless. One can have a backpack with one million dollars, wandering trough the desert, but money couldn’t by you a drink if there is nobody to trade with. Money in itself is useless. It is a unique social tool, that allows us to trade value for value.
But just because money is a social tool, a lot of people think that it is a social convention. That someday, people decided that this or that would be money. This thought is not only wrong: it is the root of the problems we are facing today. For how did money come about? By government decree? No, by millions and millions of transactions in the free market. Before money arised from the market, there was only barter. One individual had a bit of fish, and some other a lump of silex, and an exchange took place. Or not. Because this is the biggest problem of barter: what if you really want that fish, but the guy does not want your silex? What if he only wants to trade his fish for a handful of berries? The only way to solve this problem is to look for a third trading partner that has a handful of berries. But that guy might not want your lump of silex either, but some wood for the fire. A fourth person has to be found. In the end, it is possible that a dozen of people has to be involved with one single simple transaction. And even then, not all wants are satisfied.
The function of money
Money solves this problem. It is a good that is accepted for any other good. Out of all the possible exchange materials (berries, fish, straw), free individuals selected that exchange product that would be the most steadfast of quality, have the longest sustainability in time, the easiest divisibility, the rarest occurrence, and the most obvious recognisability. These five main characteristics are what give a regular economic good a monetary premium. Now, if you apply these five characteristics to all materials you know, which ones pop to your mind first? The answer is: gold and silver. Out of all the possible forms of money, these two emerged as being the most wanted.
The rest is history. Taking gold on a business trip soon became too dangerous, and letters of exchange were issued. These letters of exchange, first in person and payable for the exact amount, later on evolved to standard notes of a certain quantity. Notes we now know as bank notes. Gold was kept in the vault, and the notes issued against it were like the ticket you get from the cloakroom in the opera: if you want your coat, you can always get it.
But imagine being a banker, storing all that gold, and seeing that nobody actually ever comes for it. The banknotes circulate in the economy, and nobody bothers to come and pick up their gold anymore. If on average only 10 % of the gold is ever picked up, then why not loan out the 90 % that is “just sitting there idle”? New banknotes are issued, for the same reserves, and all goes well. Only 10 % of the people comes to pick up their gold anyway. The banking business is truly a lucrative business. You namely did not give out the new banknotes for free, of course not, you loaned them out against an interest rate. So people pay you for using money you never owned in the first place. How good does it get?
The deadly shift
As the government propaganda to keep consuming, “because that is good for the economy” wanes, people start to realize that their real needs lie elsewhere. When grandpa needs nearly unaffordable medical attention, suddenly the new IPhone 5 is not seen “a real life saver” anymore. The whole structure of production, geared towards the production of capital-intensive stuff, often even paid for by consumer loans, shifts back to its normal free market proportions, liquidating those branches of the economy that should not have existed in the first place. It is this event that we call a crisis: the macro-economic illusions of policy makers are punctured by the micro-economic decisions of regular people like you and I.
In a free market, shifts like this are no problem, because they are small. People who get fired, easily find a new job, and there is far less debt, or even none. In an unfree market, like ours, these shifts are a huge problem, not only because the companies that go out of business during that shift are heavily indebted and cannot repay their loans, which sets off a liquidation cascade of other bank investments that depend on it, but also because this necessary shift has been postponed time and again by injecting new money to boost demand. While vital laws of reality – for instance that you cannot eat your cookie and have it too – have been denied for decades, reality now breaks through with the sum of its deferred forces. Politicians say that markets don’t work? They work like never before.
This shift is deadly to government finances. During that shift the economy temporarily produces fewer profits, which means that less tax can be collected. But the interest payments do not wait. The only way to fill the gap between revenues and expenditures is by borrowing even more, which means, in our system, that even more “money” is injected into the market, creating ever bigger distortions of the structure of production, resulting in even fewer profits, reducing the tax revenues even more, igniting yet another round of borrowing. It really is a “perpetuum culpabile”, a never-ending amassment of debt.
The euro, finally
One might say this is a fairly long introduction to the actual subject of this talk, but how can one say anything sensible on the euro if one does not know how money originated from the market, how its production was collectivized by the government, what the real purpose of central banking is, what it does to the structure of production, and why this monetary system is bound to fail? All this knowledge is lost, and certainly in Flanders, Austrian Economics, the theoretical school I draw from for this lecture, is not taught at any economics department at any university. At most, it is mentioned as a heterodox theoretic side stream in economics, while it is as orthodox as economics get.
But now, let us use this knowledge to analyse the euro problem. We know that the euro is a centrally planned currency, suffering from all the problems that arise with this form of economic governance. But the euro faces even a greater economic problem, and that is the problem of the commons. In fact, “the” euro does not exist. It is a name for all the currencies emitted by the central banks of 17 countries. There are Greek euro’s, German euro’s, French euro’s, Dutch euro’s. Every euro has the same face value, but the debt that is emitted to back the currency, is often of a wholly different quality. And what is more: the more debt each state incurs, the more money it gets from the ECB. Debt is money, and money is debt.
If you would doubt this last sentence, then let’s see in detail how the monetization of debt really works. It is quite easy, actually. When a government needs money, it emits a bond. This bond is bought up by the central bank. With what money? With no money at all. What the ECB does, is not “printing money” as it is often said in colloquial speech, but printing paper scripts which it calls money, but in reality is credit. Governments cannot make money, nor can central banks. Only entrepreneurs can. The bank notes the ECB produces do not represent present value, but future value: the promise that the state, which has given its debt obligation as collateral, will repay the full amount of the loan it took with the ECB after some time.
If you have missed something here, it is not your fault: yes, the collateral for the loan the state takes with the ECB is a debt obligation, and yes, the ECB pays the state with new debt obligations, which are disguised as money, by painting them in all kinds of colours, and offering them in small denominations. But, theoretically, there is no difference whatsoever between a government bond, and fiat paper money. The fiat money that you have in your pockets tonight is not a property title, but a very liquid debt title, with as collateral the promise that you will pay the underlying value of it back trough taxes. In short: debt is money, and money is debt. If all debts in our economy would be repaid, there would no longer be any fiat paper money.
Full article: The Tragedy Of The Euro! What About Germany? (The Market Oracle)