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Tragedy of the Euro 2Nd Edition Th e TRAGEDY of the EURO Th e TRAGEDY of the EURO PHILIPP BAGUS SECOND EDITION MISES INSTITUTE © 2010 Ludwig von Mises Institute © 2011 Terra Libertas © 2012 Ludwig von Mises Institute Ludwig von Mises Institute 518 West Magnolia Avenue Auburn, Alabama, 36832, U.S.A. Mises.org ISBN: 978-1-61016-249-4 To Eva Contents Acknowledgments . Contents. xi Foreword . xiii Introduction . xviii Acknowledgments ..................................................................xi 1. Two Visions of Europe . 1 Foreword ................................................................................xiii 2. IntroductionThe Dynamics ........................................................................ of Fiat Money . xviii. 13 3. 1.The TwoRoad Visions Toward forthe EuropeEuro . ....................................................1. 29 2. The Dynamics of Fiat Money .........................................13 4. Why High Inflation Countries Wanted the Euro . 43 3. The Road Toward the Euro ............................................29 5. Why Germany Gave Up the Deutschmark . 59 4. Why High Infl ation Countries Wanted the Euro ........43 6. 5.The WhyMoney Germany Monopoly Gave of the Up ECB the . .Deutschmark . ..................59 . 73 7. 6.Differences The Money in the Monopoly Money Creation of the of ECB the Fed................................ and the ECB . 81 73 7. Diff erences in the Money Creation of the Fed 8. The andEMU the as aECB Self-Destroying ......................................................................81 System . 91 9. 8.The TheEMU EMU as a Conflict-Aggregating as a Self-Destroying System System . .........................91. 113 9. The EMU as a Confl ict-Aggregating System ............113 10. The Ride Toward Collapse . 119 10. The Ride Toward Collapse ...........................................119 11. 11.The TheFuture Future of the of Euro the Euro. ..................................................151. 151 ConclusionConclusion . ............................................................................. 161 References ............................................................................. 167 References . 167 Index ..................................................................................... 173 Index . 173 vii viii The TRAGEDY of the EURO Graphs 1. Three month monetary rates of interest in Germany, Greece, Spain, Ireland, Italy, and Portugal (1987–1998) . 48 2. Competitiveness indicators based on unit labour costs, for Mediterranean countries and Ireland 1995–2010 (1999Q1=100) . 50 3. Competitiveness indicators based on unit labour costs, for Belgium, The Netherlands, Austria, and Germany 1995–2010 (1999Q1=100) . 51 4. Balance of Trade 2009 (in million Euros) . 51 5. Balance of Trade 1994–2009 (in million Euros) . 52 6. Retail sales in Germany, USA, France, and UK (1996=100) . 53 7. Retail sales in Spain (2000=100) . 54 8. Increase in M3 in percent (without currency in circulation) in Spain, Germany, Italy, Greece, and Portugal (1999–2010) . 56 9. Defi cits as a percentage of GDP in Euro area 2007, 2008, and 2009 . .120 10. Yield of Greek ten-year bond (August 2009–July 2010) . .120 11. Debts as a percentage of GDP in Euro area 2007, 2008, and 2009 . .129 12. Defi cits as a percentage of GDP in Euro area 2009 . .130 13. Euro/dollar (January–August 2010) . .136 Tables 1. Percentage of bailout per country . .. 126 2. Exposure to government debt of French and German banks (as of December 31, 2009) . 130 Acknowledgments I would like to thank Daniel Ajamian, Brecht Arnaert, Philip Booth, Brian Canny, Nikolay Gertchev, Robert Grözinger, Guido Hülsmann, and Robin Michaels for helpful comments and suggestions on an earlier draft, Arlene Oost-Zinner for careful editing, and Jesús Huerta de Soto for writing the fore word. All remaining errors are my own. Foreword by Jesús Huerta de Soto It is a great pleasure for me to present this book by my col- league Philipp Bagus, one of my most brilliant and promis- ing students. The book is extremely timely and shows how the interventionist setup of the European Monetary system has led to disaster. The current sovereign debt crisis is the direct result of cred- it expansion by the European banking system. In the early 2000s, 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 infl ationary expectations and risk premiums. The sharp fall in infl ationary expectations was caused by the prestige of the newly created European Central Bank as a copy of the Bundesbank. Risk premiums were reduced artifi cially due to the expected support by stronger nations. The result was an artifi cial boom. Asset price bubbles such as a housing bubble in Spain developed. The newly created money was primarily injected in the countries of the periphery where it fi nanced overconsumption and malinvestments, mainly in an overextended automobile and construction sector. At the same time, the credit expansion also helped to fi nance and expand unsustainable welfare states. In 2007, the microeconomic eff ects that reverse any artifi cial boom fi nanced by credit expansion and not by genuine real savings started to show up. Prices of means of production such xi xii The TRAGEDY of the EURO as commodities and wages rose. Interest rates also climbed due to infl ationary pressure that made central banks reduce their expansionary stands. Finally, consumer goods prices started to rise relative to the prices off ered 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. The fi nancial sector came under pressure as mortgages had been securitized, ending up directly or indirectly on balance sheets of fi nancial institutions. The pressures culminated in the collapse of the investment bank Lehman Brothers, which led to a full-fl edged panic in fi nancial markets. Instead of le ing market forces run their course, govern- ments unfortunately intervened with the necessary adjustment process. It is this unfortunate intervention that not only pre- vented a faster and more thorough recovery, but also pro- duced, as a side eff ect, the so vereign debt crisis of spring 2010. Governments tried to prop up the over extended sectors, increasing their spending. They paid subsidies 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. Moreover, govern ments supported the fi nancial sector directly by giving guarantees on their liabilities, nationalizing banks, buying their assets 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 in- creased. Corporate taxes that had been infl ated artifi cially in sectors like banking, construction, and car manufacturing dur- ing the boom were almost completely wiped out. With falling revenues and in creasing expenditures governments´ defi cits and debts soared, as a direct consequence of governments´ responses to the crisis caused by a boom that was not sustained by real savings. The case of Spain is paradigmatic. The Spanish government subsidized the car industry, the construction sector, and the banking industry, which had been expanding heavily during Foreword xiii the credit expansion of the boom. At the same time a very infl exible labor market caused offi cial unemployment rates to rise to twenty percent. The resulting public defi cit began to frighten markets and fellow EU member states, which fi nally pressured the government to announce some timid austerity measures in order to be able to keep borrowing. In this regard, the single currency showed one of its “advantages.” Without the Euro, the Spanish government would have most certainly devalued its currency as it did in 1993, printing money to reduce its defi cit. This 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 devaluating, the govern- ment could have continued its spending without 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 after pressure by the Commission and member states like Germany. Thus, it is possible that the second scenario for the future as mentioned by Philipp Bagus in the present book will play out. The 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 reforms in order to comply with the Stability and Growth Pact. Pressured 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 govern ment has to substitute a fall in “aggregate demand” by increasing its spending. Thus, the US engages in defi cit spending and extremely expansive monetary policies to “jump start”
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