What is Europe’s Big Financial Problem?
“The sole use of money is to circulate consumable goods” – Adam Smith, The Wealth of Nations, p. 370
With the health of Europe’s economy increasingly in question, a great deal of ink is being spilled as to its causes. Most unfortunate and wrongheaded is the growing view that the creation of a common currency – the euro – is behind the continent’s troubles.
The above thinking speaks to a most basic, and fundamental misunderstanding of the role of money in any economy. Simply put, money is a measuring rod meant to attach value to the goods we exchange. Absent money we could still barter, but the existence of currencies means that the baker can exchange the monetary product of his labor with the winemaker who may not want bread in exchange for his wine; the money used to facilitate the exchange ideally stable in value so that the trade renders both sides as equal as possible.
That’s the purpose of the euro. Not a commodity, it is merely a concept of value meant to increase trade among European producers. The problem, of course, is that many in the commentariat don’t properly understand what the purpose of money is, and this has led them to make misguided statements that reveal in living color their misunderstanding.
Notable in this regard is National Review’s excellent editor, Rich Lowry. Commenting on the euro last week in theNew York Post, Lowry confidently suggested that its creation was “based on one of the world’s most foolhardy delusions”, that “you can have a common currency without a common country.”
What Lowry ignores is that while the U.S. was founded with a common federal government strictly limited by the Constitution, the different states in the union were meant and expected to be different much as the countries in Europe are. A common currency would in no way be problematic given those differences.
Lowry argues otherwise. He writes that the “euro foundered on differences of national cultures and interests”, then attempts to bolster his point with a quote from the Daily Telegraph’s currency challenged economics writer Ambrose Evans-Pritchard who, in bashing the euro himself informed Lowry’s point of view with his observation that “These countries were thrown together into monetary union by high-handed politicians before there was any meaningful convergence of productivity, growth patterns, wage bargaining, inflation proclivities, legal systems, or sensitivity to interest rates.”
What Lowry misses is that what he and Evans-Pritchard describe fairly well is the United States. Indeed, no one would mistake the productivity, culture and growth patterns of West Virginia, Mississippi and Louisiana for those of New York, California or Washington State. All different states with different growth rates, taxation and industry, the various states in the Union were all advantaged by a common currency that particularly until 1971 – but beyond that too – achieved its sole purpose which was and is the exchange of products for products.
Imagine otherwise, as in imagine if Lowry, or Evans-Pritchard, or Lowry’s other informant Matthew Lynn were charged with designing a currency system for the U.S. Judging by their views expressed about Europe, they’d have all 50 states issue different currencies to account for the various differences that they incorrectly claim are at the heart of Europe’s troubles.
Of course if they got their way, the rich country that the U.S. remains would be far less so. It’s bad enough that the floating dollar (when Nixon severed the dollar’s link to gold he robbed it of its most important property: its largely stable value) forces so many wise minds into facilitator roles in finance, but imagine how many more productive minds we’d lose if there were 50 U.S. currencies floating against each other, not to mention the periodic economy-retarding devaluations that Lowry oddly seems to view as a cure for Greece’s troubles.
Though the collection of individuals that is the U.S. economy struggles today, the existence of a common currency is a certain benefit that reduces the existing pain. So while the weak dollar weighs on our economic fortunes (more on the dollar later) more than any other policy, we at least have a common currency, as does much of Europe, thank goodness.
As for the Greek government’s fiscal struggles, there Lowry falls into the facile and clichéd trap whereby he suggests that its problems have somehow infected Spain and Italy; “contagion” the word frequently used by the bright minds of the commentariat. What Lowry can’t explain is why one government’s insolvency would somehow spread to other governments. He can’t because what he argues is logically unrealistic.
More realistically, when Greece was bailed out, it wasn’t a country that’s been in arrears to creditors for half its modern existence being bailed out, rather it was the banks with exposure to its debt. Lowry might find himself in a difficult situation there given the nominally free market National Review’s endorsement of TARP and the various U.S. bank bailouts, but if conservatives would stick to basic principles that elevate both success and failure, Greece would have defaulted, some banks with improper exposure would have happily gone under, and a wasteful government would have been starved of capital to the benefit of private sector interests in the same country.
Returning to “contagion”, Italy and Spain find themselves facing default today precisely because the banks with exposure to Greek debt were bailed out implicitly through a bailout of the country. Absent this most economy-sapping of moves by the IMF and various governments, Italy and Spain would have seen clearly that there would be no relief coming their way, and fear of default would have forced them to get their fiscal houses in order much earlier. In short, the “contagion” that Lowry refers to is the logical result of governments messing with natural market forces, and in doing so, authoring much worse problems (Italy and Spain, once again) down the line.
As for how euro-countries such as Greece and Portugal reached their present predicament, Lowry suggests that the euro “made it possible for countries like Greece and Portugal to borrow at essentially the same low rates as Germany under the illusion that they were just as safe.” No sourcing for that comment either, and with good reason.
Indeed, investors aren’t stupid, and they were well aware of the spending/default differences of countries within the eurozone. For Lowry to argue that illusion took hold is for him to presume that investment in debt is something anyone can do; investors blindly buying euro debt with no regard to the problems that were/are apparently obvious to Lowry.
In truth, the “illusion” that he describes is in fact a dollar/euro illusion; specifically the false belief within the commentariat that the euro’s rise versus the dollar was a signal of strength for the modern European currency concept. In reality, when measured against the objective constant that is gold, the euro has been in freefall much of the last several years; this collapse in the value of the paper currency obscured by the dollar’s even greater weakness against the yellow metal.
If the opposite had occurred, as in if the ECB hadn’t mimicked the U.S. Treasury’s mistake that destroyed the Bush presidency, and promises to do the same to Obama’s, Greece, Portugal, Italy, and Spain (France too?) aren’t in the trouble they’re in. Not by a long shot.
They’re not because as this column repeats all too frequently, when investors commit capital to the very growth concepts whose taxable success ultimately fills the coffers of wasteful governments, they’re buying future income streams. There’s no company formation, no job creation and very little growth without investment, and the devaluation that Lowry sees as the cure for Greece’s ills is what restrains Europe’s growth at present, and is what has its governments that have overspent in such trouble.
In buying and exposing themselves to euro-denominated government debt investors weren’t casting a blind eye to Greece’s fiscal history, instead they made a bad bet on the soundness of the euro itself. Once again, if the ECB doesn’t devalue alongside the U.S., investment in Europe today is much stronger, and with it investors are protected on the way to growth rates that would have Europe’s governments – including Greece – in much better fiscal shape.
To the above, most commentators – including perhaps Lowry – would respond that a strong currency would be death for countries such as Greece owing to the widely held, and incorrect belief that strong currencies restrain exports. The obvious answer to this falsehood is Japan, a country whose currency crushed the economy-sapping weak dollar in the ‘70s on the way to skyrocketing exports to a country that made the same currency mistakes as it’s making today four decades ago.
What the devaluationists always miss is that there are cruel ramifications to the cheapening of currencies. Indeed, not only does inflation drive up the cost of imports necessary to produce finished goods, so does it increase the cost of shipping goods, not to mention the rising wage demands from employees who see their paychecks shrinking. Most importantly, devaluations reduce the value of the income streams that attract investors to begin with, and the result is slower growth.
In a rare bit of sanity in era sadly devoid of it, just this week Nestle Chairman Peter Brabeck made the essential point as it applies to the rising Swiss franc that the latter isn’t the problem, but the dollar is. He’s right. The franc isn’t too strong (in gold terms it’s the opposite), but with the dollar weak other currencies including the euro are declining too, with predictable results.
Looking at the euro, a currency meant to facilitate exchange could never be Europe’s problem anymore than a common U.S. currency across fifty different states could be ours. Instead, the euro problem is a function of dollar weakness, and the ECB choosing to follow us into devaluationist hell.
To reverse the continent’s decline, the ECB would ideally strengthen the euro in concert with the dollar assuming the fanciful notion that the U.S. Treasury might get serious about arresting the greenback’s fall. Absent that, a stronger euro on its own is essential, and if it’s deemed credible by the markets, a stronger euro will attract the necessary investment to the eurozone that will soon enough erase the fiscal struggles of various overextended governments.