I recently spent a very enjoyable 5 days travelling around the Low Countries of Northern Europe with a friend of mine. We drove through abandoned border posts, and used one currency across 5 borders – quite amazing! Our language skills were not always up to the challenge, but we got by. Conversation naturally turned to how the region had changed as a result of the EU and the euro.
He’s blogged some of his ideas from the holiday at his blog Questioning and Answering and also in a follow up post. I won’t look at pro/anti EU arguments, but rather focus on the euro, which is very relevant to the theme of this blog.
The euro has significant benefits – economically speaking, the primary benefit is that of reduced transaction costs across borders. Rather than swapping your Francs for Marks, you can pay your neighbour in euros. This helps to increase trade between nations, to the benefit of all in the eurozone. The other key benefit (stemming originally from free trade, but encouraged by the adoption of the euro) is peace. As Frederick Bastiat of broken window fame once said,
“When goods do not cross borders, soldiers will.”
But the euro suffers from the same problem as the pound, the dollar, the yen – in fact any other fiat currency. And the European Central Bank (ECB) has the same flaws as the Bank of England or the Fed. The central bank is able to increase the money supply without any limit, and can set interest rates outside of the market price. I discussed in an earlier piece why this is harmful, but I’d like to quote the Cobden Centre’s Sean Corrigan on this:
Even without that, this fixation with reducing long rates is a futile one. No less than 320 years ago, Sir Dudley North already knew better than Ben Bernanke that to assume that low interest rates are a cause, rather than an effect, of prosperity is to put the cart very much before the horse.
In his 1691 ‘Discourses Upon Trade’, he argued that:-
These things consider’d, it will be found, that as plenty makes cheapness in other things, as Corn, Wool, etc. when they come to Market in greater Quantities than there are Buyers to deal for, the Price will fall; so if there be more Lenders than Borrowers, Interest will also fall; wherefore it is not low Interest makes Trade, but Trade increasing, the Stock of the Nation makes Interest low.
It is said, that in Holland Interest is lower than in England. I answer, It is; because their Stock is greater than ours. I cannot hear that they ever made a law to restrain [it]…
To have a central bank decide interest rates is effectively to ignore reality and to artificially agree on a price for borrowing money – rather than relying upon the actual amount of loanable funds that are available from savings. The euro zone gives us a very helpful picture of the dangers of this. Two nations on the “periphery”, Ireland and Spain, had very significant housing booms, followed by massive busts. France and Germany’s housing sector was less volatile. Why was this? Simply that these economies are not the same – France and Germany have a greater proportion renting than buying homes, and so the lower interest rates did not set off such a large house bubble. Centrally set interest rates take no account of the highly heterogenous nature of the European economy. Similar effects were seen in the US – again a highly diverse economy.
So what would I propose? Well, ending the ECB would be a start, but returning to national fiat currencies is hardly much of an improvement. Each currency would still be subject to inflation, as is always the case with fiat currencies, and the same boom-bust process would take place, just as it did in the US and UK with national central banks. Even the Bundesbank, often praised for it’s (relatively) sound money policies, still suffers from the same knowledge problem as any central bank. Prices on the market are not something we can “know” and then set by fiat day by day. Instead, they are formed by consumers, traders, investors, and others, buying and selling, making exchanges. Likewise, the market interest rate would be set in the same way.
The solution then is neither a European wide single currency, nor national currencies, but rather the complete denationalisation of money, and allowing the market to provide money. Back in the days of the gold standard, European nations fixed their currencies as a certain weight of gold. Trading was then easy – you just paid your neighbours in gold – you didn’t need to exchange a pound for a franc. A pound or franc was just the name for a certain weight of gold. There were fixed exchange rates and no need for a bureau de change! Governments abandoned this standard in order to pay for the carnage of the First World War, so rather than trusting governments to maintain such a standard, it’s best to get government out of the way altogether.
In Britain, we tend to have a adverse reaction to the Euro, as many of see joining it as a surrender of our sovereignty (which is quite true, as Greece is now finding out). But the motivations of the euro-creators are really quite irrelevant. If the Bank of England can’t set interest rates appropriately for a country of 60 million, what hope is there that the ECB can get it right for 300 million? The euro is simply another fiat currency – the only question is whether the dollar or euro will fall first – both are in serious crisis, and both stem from the same underlying causes.
For further reading, I recommend Philip Bagus’ Tragedy of the Euro, available for free from the Mises Institute.