Tragedy of the Euro potx

THE TRAGEDY

OF THE EURO

THE TRAGEDY

OF THE EURO

By

Philipp Bagus

Ludwig

von Mie

Intitute

A U B U R N , A L A B A M A

Copyright ©  by the Ludwig von Mises Institute

Published under the Creative Commons Aribution License ..

http://creativecommons.org/licenses/by/3.0/

Ludwig von Mises Institute

 West Magnolia Avenue

Auburn, Alabama 

Ph: () -

Fax: () -

mises.org

        

ISBN: ----

To Eva

Foreword

by Jesús Huerta de Soto

It is a great pleasure for me to present this book by my colleague

Philipp Bagus, one of my most brilliant and promising students. e

book is extremely timely and shows how the interventionist setup

of the European Monetary system has led to disaster.

e current sovereign debt crisis is the direct result of credit ex￾pansion by the European banking system. In the early s, credit

was expanded especially in the periphery of the European Monetary

Union such as in Ireland, Greece, Portugal, and Spain. Interest rates

were reduced substantially by credit expansion coupled with a fall

both in inflationary expectations and risk premiums. e sharp fall

in inflationary expectations was caused by the prestige of the newly

created European Central Bank as a copy of the Bundesbank. Risk

premiums were reduced artificially due to the expected support by

stronger nations. e result was an artificial boom. Asset price

bubbles such as a housing bubble in Spain developed. e newly cre￾ated money was primarily injected in the countries of the periphery

where it financed overconsumption and malinvestments, mainly in

an overextended automobile and construction sector. At the same

time, the credit expansion also helped to finance and expand unsus￾tainable welfare states.

In , the microeconomic effects that reverse any artificial

boom financed by credit expansion and not by genuine real savings

started to show up. Prices of means of production such as commodi￾ties and wages rose. Interest rates also climbed due to inflationary

pressure that made central banks reduce their expansionary stands.

vii

viii e Tragedy of the Euro

Finally, consumer goods prices started to rise relative to the prices

offered to the originary factors of productions. It became more and

more obvious that many investments were not sustainable due to

a lack of real savings. Many of these investments occurred in the

construction sector. e financial sector came under pressure as

mortgages had been securitized, ending up directly or indirectly on

balance sheets of financial institutions. e pressures culminated in

the collapse of the investment bank Lehman Brothers, which led to

a full-fledged panic in financial markets.

Instead of leing market forces run their course, governments

unfortunately intervened with the necessary adjustment process. It

is this unfortunate intervention that not only prevented a faster and

more thorough recovery, but also produced, as a side effect, the

sovereign debt crisis of spring . Governments tried to prop up

the overextended sectors, increasing their spending. ey paid sub￾sidies for new car purchases to support the automobile industry and

started public works to support the construction sector as well as

the sector that had lent to these industries, the banking sector. More￾over, governments supported the financial sector directly by giving

guarantees on their liabilities, nationalizing banks, buying their as￾sets or partial stakes in them. At the same time, unemployment

soared due to regulated labor markets. Governments’ revenues out

of income taxes and social security plummeted. Expenditures for

unemployment subsidies increased. Corporate taxes that had been

inflated artificially in sectors like banking, construction, and car

manufacturing during the boom were almost completely wiped out.

With falling revenues and increasing expenditures governments’

deficits and debts soared, as a direct consequence of governments’

responses to the crisis caused by a boom that was not sustained by

real savings.

e case of Spain is paradigmatic. e Spanish government

subsidized the car industry, the construction sector, and the bank￾ing industry, which had been expanding heavily during the credit

expansion of the boom. At the same time a very inflexible labor

market caused official unemployment rates to rise to twenty per￾cent. e resulting public deficit began to frighten markets and

fellow EU member states, which finally pressured the government

to announce some timid austerity measures in order to be able to

keep borrowing.

ix

In this regard, the single currency showed one of its “advan￾tages.” Without the Euro, the Spanish government would have most

certainly devalued its currency as it did in , printing money

to reduce its deficit. is would have implied a revolution in the

price structure and an immediate impoverishment of the Spanish

population as import prices would have soared. Furthermore, by

devaluing, the government could have continued its spending with￾out any structural reforms. With the Euro, the Spanish (or any

other troubled government) cannot devalue or print its currency

directly to pay off its debt. Now these governments had to engage

in austerity measures and some structural reforms aer pressure

by the Commission and member states like Germany. us, it is

possible that the second scenario for the future as mentioned by

Philipp Bagus in the present book will play out. e Stability and

Growth Pact might be reformed and enforced. As a consequence,

the governments of the European Monetary Union would have to

continue and intensify their austerity measures and structural re￾forms in order to comply with the Stability and Growth Pact. Pres￾sured by conservative countries like Germany, all of the European

Monetary Union would follow the path of traditional crisis policies

with spending cuts.

In contrast to the EMU, the United States follows the Keynesian

recipe for recessions. In the Keynesian view, during a crisis the

government has to substitute a fall in “aggregate demand” by in￾creasing its spending. us, the US engages in deficit spending and

extremely expansive monetary policies to “jump start” the economy.

Maybe one of the beneficial effects of the Euro has been to push all

of the EMU toward the path of austerity. In fact, I have argued

before that the single currency is a step in the right direction as it

fixes exchange rates in Europe and thereby ends monetary nation￾alism and the chaos of flexible fiat exchange rates manipulated by

governments, especially, in times of crisis.

My dear colleague Philipp Bagus has challenged me on my rather

positive view on the Euro from the time when he was a student in

my class, pointing correctly to the advantages of currency competi￾tion. His book, e Tragedy of the Euro, may be read as an elaborated

exposition of his arguments against the Euro. While the single

currency does away with monetary nationalism in Europe from a

theoretical point of view, the question is: just how stable is the

x e Tragedy of the Euro

single currency in actuality? Bagus deals with this question from

two angles, providing at the same time the two main achievements

and contributions of the book: a historical analysis of the origins of

the Euro and a theoretical analysis of the workings and mechanisms

of the Eurosystem. Both analyses point in the same direction. In the

historical analysis, Bagus deals with the origins of the Euro and the

ECB. He uncovers the interests of national governments, politicians

and bankers in a similar way that Rothbard does in relation to the

origin of the Federal Reserve System in e Case against the Fed.

In fact, the book could also have been analogously titled e Case

against the ECB. Considering the political interests, dynamics and

circumstances that led to the introduction of the Euro, it becomes

clear that the Euro might in fact be a step in the wrong direction;

a step towards a pan-European inflationary fiat currency aimed to

push aside limits that competition and the conservative monetary

policy of the Bundesbank had imposed before. Bagus’s theoretical

analysis makes the inflationary purpose and setup of the Eurosys￾tem even clearer. e Eurosystem is unmasked as a self-destroying

system that leads to massive redistribution across the EMU, with

incentives for governments to use the ECB as a device to finance

their deficits. He shows that the concept of the Tragedy of the

Commons, which I have applied to the case of fractional reserve

banking, is also applicable to the Eurosystem, where different Euro￾pean governments can exploit the value of the single currency.

I am glad that this book is being made available to the public by

the Mises Institute. e future of Europe and the world depends

on the understanding of the monetary theory and the workings

of monetary institutions. is book provides strong tools toward

understanding the history of the Euro and its perverse institutional

setup. Hopefully, it can help to turn the tide toward a sound mone￾tary system in Europe and worldwide.

Anowledgements

I would like to thank Philip Booth, Nikolay Gertchev, and Guido

Hülsmann for helpful comments and suggestions on an earlier dra,

Arlene Oost-Zinner for careful editing, and Jesús Huerta de Soto for

writing the foreword. All remaining errors are my own.

xi

Contents

Introduction xv

 Two Visions for Europe 

 e Dynamics of Fiat Money 

 e Road Toward the Euro 

 Why High Inflation Countries Wanted the Euro 

 Why Germany Gave Up the Deutsmark 

 e Money Monopoly of the ECB 

 Differences in the Money Creation of the Fed and the ECB 

 e EMU as a Self-Destroying System 

 e EMU as a Conflict-Aggregating System 

 e Ride Toward Collapse 

 e Future of the Euro 

Conclusion 

xiii