What Is Wrong With the Euro (and the Dollar)?

The euro was introduced in 1999 and, a year after it was adopted by a new EU member state, Slovenia, the world’s financial press is unanimous that the new currency has proved a success. George W. Bush’s policies have debased the dollar so severely that the euro, by comparison, seems a tower of strength. While one of the Europe’s original goals, that the euro would replace the dollar as the world’s reserve currency, may not have been achieved, the Financial Times spoke for many in its editorial of 27th December when it welcomed the fact that the euro’s strength means that we now inhabit “a multi-currency world”. This, the paper claimed, will be good for the world because it will encourage the Americans to compete more actively on world markets to keep their currency strong.
Looked at against the price of gold, however, the euro’s record is less impressive. In 2000, an ounce of gold cost about 260 euros. Now it costs over 550 euros. It is true that the collapse in the gold value of the dollar has been even greater (from under $300 in 2000 to over $800 now) but these figure show that euro inflation rate in terms of gold – the supreme reference point of value – has been over 100% in seven years. Much the same is true of property prices: in the five years from 2002 to 2007, property rose by 100% in Spain, by 73% in France, by 71% in Ireland, by 60% in Belgium and by 56% in Greece. All of these countries use the euro yet such explosions in prices are not what we were promised when the euro was introduced in 1999. The European Central Bank is Frankfurt is committed to maintaining inflation at no more than 2%.
That inflation rate, of course, is measured by a “basket” of goods. It is on the basis of this calculation, which includes the prices of hundreds of different things in the economy, that the official inflation figures are calculated. One often has the impression, indeed, that the only thing which never or seldom goes up is the official inflation rate: all the real prices rises in food and the cost of living are “offset” in the official figure by drops in price for commodities which most people never buy. In the United Kingdom, the disconnect between these official statistics and reality is especially Stalinist, because the retail price index does not include the price of property – the normal family’s biggest expense, after tax itself.
The Financial Times’ understanding of the mechanics of currencies bears as much relation to reality as these figures. There is an absolutely ineradicable conviction among London economists that the “market” in world currencies is somehow free because the exchange rate goes up and down. Keynesianism is so deeply entrenched in the British economist’s intellectual DNA that most people have not only forgotten that all the world’s currencies are paper currencies, i.e. state enforced IOUs which are never paid, but also – and worse – they do not even understand the significance of this.
To understand this key point, it is necessary to know and understand only two things. The first is the concept of “legal tender”. When a currency has legal tender, this means that it cannot be refused in payment of a debt. The use of a state currency is therefore forced on the population of a given currency area, by means of the criminal law. To be sure, they may decide to accept payment in other currencies, or goods, but you cannot refuse the dollar if you live in the US or the euro if you live in the euro zone.
The second thing you need to understand is that, before war broke out in 1914, all the world’s major currencies were convertible into gold. The Bank Act passed in France within weeks of war having been declared was sharp and to the point: “Until further notice,” it said, “the Bank of France will no longer reimburse its bank notes in cash.” The French have a good expression to describe this state of affairs, which persists all over the world to this day: “cours forcé”. An inconvertible currency is literally forced onto the population. Prior to 1914, each bank note was a title to a specific quantity of gold. Since the outbreak of war, all currencies have retained their legal tender status (they cannot be refused by debtors) while the state itself never honours its “promise to pay” (in the dishonest words still written on English bank notes).
As a result, paper currencies are themselves nothing but engines for the infinite creation of debt. They are issued by the state as things of value but the state never has to produce anything in return. This means that the state, like its citizens, mortgages the present at the cost of the past. It builds up debt both explicitly, in the form of state deficits, and implicitly, by issuing currencies which are themselves an expression of a debt the state has no intention of ever repaying. Is it any wonder that ordinary citizens accumulate huge amounts of personal debt if the very core of the financial system itself is based on worthless IOUs? Whereas in the olden days, the holder of money (gold) knew that the value of his savings would essentially never go down, today people understand that they must put their savings – and their borrowings too – into other things to prevent their value from evaporating.
This is one of the reasons why the property market has been hyperventilating. The distortions in the property market – which are even now causing the American financial system to creak – are precisely the result of the fact that ordinary people know that it is better to invest in bricks and mortar than in worthless paper currency, whence the scramble to buy houses on ever more precarious loans. More insidiously, indeed, the financial system as a whole needs to generate ever more debt in order for banks to make money: more and more credit has to be pumped into the system to keep the whole pyramid scheme going. The same goes for state monetary policy: states (including a super state like the EU) need to extend the number of people using their paper currency – for instance by extending the euro zone – so that they can issue more of it with impunity.
Because of the debtor mentality inherent in the very notion of a paper currency, inflation is permanently and structurally a feature of paper currency economies. The state issues currency (debt) and expects to make money on it. The amount of goods you can get for the money issued goes down over time (inflation) just as the cost of borrowing money also depends on how long you borrow it for (interest). In other words, debt is at the core of the financial system in a regime of paper currencies, whereas currencies which are convertible into gold are instead titles to a specific good. That is the difference between the two regimes.
It is because paper currencies are the ultimate expression of state power that there is very little chance that they will be abandoned freely. It will need a financial catastrophe for that. But the contrast between a state whose main role in the economy is to uphold the sanctity of contracts (by itself upholding the contract to pay the bearer of its bank notes, on demand, a certain quantity of gold), and a state which controls the supply of the basic oxygen of the economy as a whole – thereby intervening in that economy as actively as in a planned economy – could hardly be greater. It is profoundly to be hoped that, one day, states will go back to their earlier role.

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