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The Euro's Problems

by Larry White September 14th, 2011 5:02 pm

Back in July I posted an excerpt here of a talk I had given on the flaws in the euro. The complete version of my talk on the problems of the euro is now available as an Economic Bulletin from the American Institute for Economic Research.

6 Responses to “The Euro's Problems”

  1. avatar RickDiMare says:

    Larry, my solution to the Euro's problems will probably sound ridiculous to most economists, but I'd like to state it anyway.

    Under George Selgin's post "Advertisements for Myself," I quoted from the 2 pages in "Good Money" where Selgin reports on the actions of Thomas Jefferson regarding the establishment of a U.S. Mint on U.S. soil around 1790, and under the authority of the then new Constitution.

    Essentially, this is what needs to happen on European soil, with the U.S. military overseeing the coin-minting process, and protecting U.S. coin against counterfeiters.

    There is likely to be a psychological barrier at first, because "dollar" to most Europeans will continue to mean the dollar or Euro-dollar they've experienced from the Federal Reserve over the last century, but when they gradually understand that Treasury-Direct U.S. coin ultimately represents the labor of their own local workers, they'll appreciate the economic stability that proceeds from that new basis of value.

    • avatar Martin Brock says:

      Sounds more like imperial banking to me.

      • avatar RickDiMare says:

        Martin, I didn't say anything about banking. That should be left up to the Europeans. Besides, what they have now is imperial "top-down" banking.

        I'm just suggesting use of the U.S. military to assure uniformity of Congress' coin, prevent counterfeiting, maybe control identity theft or fraud issues related to coin transfers, assure safe transport of coin between banks, etc.

        How the various European nations develop their banking systems from my proposed "bottom-up" local-labor-based monetary system is up to them.

  2. avatar Martin Brock says:

    The article is very interesting and raised my awareness of the time inconsistency problem. Thanks. I agree with most of what you say, but I'm disagreeable by nature.

    If we judge optimality from the bottom-up perspective of the ordinary citizens, who want trustworthiness and low transactions costs (rather than from the top-down social-planner perspective of Keynesian macroeconomists who think that devaluation is sometimes a useful tool), the optimal currency area is the entire world—provided that the world currency has a stable purchasing power.

    I like this sentiment, but the optimal currency area is any free association of people choosing to use the same currency. These people could all be within the borders of my home town, or they could be spread across the planet, trading over the internet. Statutory boundaries are economically meaningful only because threatening to shoot people is a viable business model. Borders seem less meaningful now than ever, but threatening to nuke people also seems more powerful than literally threatening to shoot them, so I'm not sure.

    ... the dollar volume of paper currency and deposits in such a system—the stock of money—is geared to the volume of gold.

    When gold is the standard of value, the volume of notes promising gold reflects the volume of credit leveraging gold, and this volume is related to the demand for monetary gold relative to its supply. If the demand for monetary gold is smaller, the equilibrium volume of promissory notes for gold is correspondingly larger. The distinction here between volume of gold and demand for gold seems critical, particularly in a free banking regime in which other standards compete.

    If the supply of gold rises, I expect the demand relative to the supply to fall, all else being equal, leaving the money supply unchanged. More gold implies no increase in the demand for credit. Most borrowers don't want to borrow gold. They want something else. Gold is only a standard of value and medium of exchange.

    But all else is rarely equal. If the demand for monetary gold is volatile, the volume of promissory notes is also volatile, and depending upon the equilibrium level, a small change in demand can imply a large change in the volume of notes. If demand rises, credit leveraging gold unwinds. Creditors must call loans to raise sufficient gold to meet the growing demand. Borrowers required to pay in gold then further increase the demand for gold, leading to a systemic liquidity crisis, a run on the banks.

    Right? That's the story I've always heard. What's wrong with it?

    ... the concentration of gold reserves in central banks.[/quote]
    If most of the gold sits in a few vaults, the systemic problem seems even worse, but ultimately, people are entitled to demand more gold than exists, so people possessing gold are in a very strong position. Right? If they just hold on to their gold, it becomes increasingly valuable as credit unwinds. Debtors must sell things for actual gold, but there's just not enough gold, so a deflationary spiral results, and debtors become insolvent. Maybe this reasoning is flawed, but it's common, and common reasoning is powerful regardless of its flaws. Set me straight here.

    I want free banking but not a gold standard largely for this reason. At least, I don't want an exclusive gold standard. I don't want gold (or anything else) to be an exclusive legal tender.

    The deadweight costs of inflation are the higher transaction costs incurred by people going out of their way to avoid the tax that ongoing loss of purchasing power levies on currency notes ...

    Who holds currency? It's a currency, because I do not hold it. If inflation is less than the ECB's two percent target, inflation imposes little cost of this sort.

    ... and on deposits that pay less than a compensating interest rate.

    Compensation for what? Not investing the resources without a financial intermediary? If I want a bank to secure my deposit, I expect to pay for the service, not to be paid for it. That's what we have now. My real interest rate is negative precisely because my deposit is so secure that I must pay for security rather than earning a risk premium.

  3. avatar Martin Brock says:

    Missing blockquote. Wish I could change it ... A preview would help.

  4. avatar Martin Brock says:

    The article is very interesting and raised my awareness of the time inconsistency problem.

    If we judge optimality from the bottom-up perspective of the ordinary citizens, who want trustworthiness and low transactions costs (rather than from the top-down social-planner perspective of Keynesian macroeconomists who think that devaluation is sometimes a useful tool), the optimal currency area is the entire world—provided that the world currency has a stable purchasing power.

    I like this sentiment, but the optimal currency area is any free association of people choosing to use the same currency. These people could all be within the borders of my home town, or they could be spread across the planet, trading over the internet. Statutory boundaries are economically meaningful only because threatening to shoot people is a viable business model.

    ... the dollar volume of paper currency and deposits in such a system—the stock of money—is geared to the volume of gold.

    When gold is the standard of value, the volume of notes promising gold reflects the volume of credit leveraging gold, and this volume is related to the demand for monetary gold relative to its supply. If the demand for monetary gold is smaller, the equilibrium volume of promissory notes for gold is correspondingly larger. The distinction here between volume of gold and demand for gold seems critical, particularly in a free banking regime in which other standards compete.

    If the supply of gold rises, I expect the demand relative to the supply to fall, all else being equal, leaving the money supply unchanged. More gold implies no increase in the demand for credit. Most borrowers don't want to borrow gold. They want something else. Gold is only a standard of value and medium of exchange.

    If the demand for monetary gold relative to its supply is volatile, the volume of these promissory notes is also volatile, and depending upon the equilibrium level, a small change in demand for gold can imply a large change in the volume of notes. If demand rises, credit leveraging gold unwinds. Creditors must call loans to raise sufficient gold to meet the growing demand. Borrowers required to pay in gold then further increase the demand for gold, leading to a systemic liquidity crisis, a run on the banks.

    Right? That's the story I've always heard. What's wrong with it?

    ... the concentration of gold reserves in central banks.

    If most of the gold is in a few vaults, the systemic problem seems even worse, but ultimately, people are entitled to demand more gold than exists, so people possessing gold are in a very strong position. Right? If they just hold on to their gold, it becomes increasingly valuable as credit unwinds. Debtors must sell things for actual gold, but there's just not enough gold, so a deflationary spiral results, and debtors become insolvent. Maybe this reasoning is flawed, but it's common, and common reasoning is powerful regardless of its flaws. Set me straight here.

    I want free banking but not a gold standard largely for this reason. At least, I don't want an exclusive gold standard. I don't want gold to be an exclusive legal tender.

    The deadweight costs of inflation are the higher transaction costs incurred by people going out of their way to avoid the tax that ongoing loss of purchasing power levies on currency notes ...

    Who holds currency notes? If inflation is less than the ECB's two percent target, inflation imposes little cost of this sort.

    ... and on deposits that pay less than a compensating interest rate.

    Compensation for what? Not investing the resources without a financial intermediary? If I want a bank to secure my deposit, I expect to pay for the service, not to be paid for it. That's what we have now, of course. My real interest rate is negative precisely because my deposit is so secure.

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