The Poetry of the Euro

Harold James


PRINCETON – The purpose of creating a common currency has been largely and surprisingly forgotten in crisis-torn Europe. Instead, there seem to be more pressing concerns: gloomy speculation about the eurozone’s impending collapse and desperate attempts to find institutional fixes to its extensive governance problems.

But the euro was not just the outcome of an idiosyncratic quest to reduce the wear on pockets stuffed with odd national coins, or to facilitate intra-European trade. The bold European experiment reflected a new attitude about what money should do, as well as how it should be managed. In opting for a “pureform of money, created by a central bank independent of national authority, Europeans self-consciously flew in the face of what had become the dominant monetary tradition.

In the twentieth century, the creation of moneypaper money – was usually thought to be the domain of the state. Money could be issued because governments had the power to define the unit of account in which taxes should be paid. This tradition went back well before paper, or fiat, currencies. For many centuries, even while metallic money circulated, the task of defining units of accountlivres tournois, marks, gulden, florins, or dollars – remained a task of the state (or of those with political power).

Abuse of this role, with governments addressing excessive debt by inflating it away, was deeply destructive of political order in the first half of the twentieth century. After World War II, the liberal politicians most committed to European federalism saw this point clearly. The economist, central-bank governor, finance minister, and president of the Italian Republic, Luigi Einaudi, pleaded the case in the immediate aftermath of the war: “If the European federation takes away from the individual states the power of running public works through the printing press, and limits them to expenses that are financed solely by taxes and voluntary loans, it will by that act alone have accomplished a great work.”

But monetary abuse is no less dangerous in political systems with multi-layered authority, and in the past often led to the breakup of federal states. That is because inflation is not a benign cure for economic ills, in which beneficent and stimulatory effects are spread equally over the entire region under the inflationary monetary authority. Making inflation depends on the central bank’s decision to monetize specific debt instruments.

After all, the monetary authority never decides simply to convert every obligation into money. Instead, it decides that some industries, banks, or political authorities need to be sustained for the general good.

Those industries, banks, and political authorities that are not so privileged are inevitably resentful, and view the central bank’s actions as an abuse of power. In federal systems, in particular, those businesses and political authorities far removed from the center are most likely to be excluded from the monetary stimulus and hence are inclined to be resentful.

Hyperinflation in Germany in the 1920’s fanned separatism in Bavaria, the Rhineland, and Saxony, because these remote areas thought that Germany’s central bank and central government in Berlin were discriminating against them. The separatists were politically radical – on the left in Saxony, and on the far right in Bavaria and the Rhineland.

There are also more recent cases of the same effect. In late-1980’s Yugoslavia, as the socialist regime disintegrated, the monetary authorities in Belgrade were inevitably closest to Serbian politicians such as Slobodan Milošević and to Serbian business interests. As a result, the Croats and Slovenes wanted out of the federation. In the Soviet Union, inflation appeared as an instrument of Moscow bureaucrats, and there, too, more remote areas sought to break away.

The makers of modern Europe saw that unstable and politically abused money would be a European nightmare, and lead to destructive national animosities and antagonisms. They were supported by the twentieth century’s two most influential economists, Friedrich von Hayek and John Maynard Keynes.

Hayek was the most consistent critic of state-produced money. His proposal, competitive currencies produced by “free banking” in which numerous private authorities would issue their own money, was more radical than the solution adopted by Europeans in the 1990’s. But the Hayekian element of a money-issuing authority that was extensively protected against political pressures, and consequently against political opprobrium, was a key part of the European Union’s Maastricht Treaty. Keynes, too, in planning for the postwar order, proposed a synthetic global currency that would guarantee stability and prevent deflation.

The vision of central-bank independence as a necessary part of the constitution of a sound and stable political order was not simply a European construct in the 1990’s. It was also reflected in legislative changes affecting other central banks, and in central bankers’ growing prestige.

That view is now seriously challenged. In the aftermath of the worst financial crisis since WWII, central banks are once again being called on to monetize securities issued by some debtors, but not others. That task of selecting between debtors is highly political, and poisons the idea of monetary stability.

Jean-Claude Trichet, until recently the president of the European Central Bank, liked to claim that money was like poetry, before adding that both give a sense of stability. That unusual but accurate formulation is reminiscent of General August Neidhardt von Gneisenau’s famous reply to the Prussian King, who dismissed as “nothing more than poetryvon Gneisenau’s patriotic concerns in the early nineteenth century. “Religion, prayer, love of one’s ruler, love of the fatherland, what are these but poetry?” von Gneisenau asked. “Upon poetry is founded the security of the throne.”

Stable money, too, is the foundation of political order. We should not allow ourselves to be so overwhelmed by today’s crisis that we forget that.

Harold James is Professor of History and International Affairs at Princeton University and Professor of History at the European University Institute, Florence. He is the author of The Creation and Destruction of Value: The Globalization Cycle.

December 6, 2011 10:58 pm

Merkozy failed to save the eurozone

By Martin Wolf

Two heads, it is said, are better than one. In the case of the meeting between Angela Merkel, Germany’s chancellor, and Nicolas Sarkozy, the French president, that was not the case. If the conclusions give cover to a decision by the European Central Bank to intervene still more in public debt markets, it might offer some relief. But, like the Bourbons, the leaders seem to have learnt nothing and forgotten nothing.

What was agreed? The decisions seem to include: not compelling private bondholders to take losses on eurozone bail-outs, though voluntary restructuring remains possible; greater likelihood, though no automaticity, of sanctions on countries that fail to stay within the limits on budget deficits; inserting a balanced budget requirement into the domestic legislation of members; introduction of the European Stability Mechanism – the permanent rescue instrument – in June 2012, instead of June 2013; and monthly meetings of the European heads of state and governments, during the crisis, to oversee policy co-ordination.


Gone, then, is forcedprivate sector involvement” in rescheduling of debt, which will delight the ECB. Gone are automatic sanctions on fiscalsinners” and review of breaches of fiscal rules by the European Court of Justice. This will delight France, which also obtained agreement that an intergovernmental accord among eurozone members might take the place of a new European Union treaty. Germany did not leave quite empty-handed: it managed to rule outeurobonds” – joint issuance of sovereign debtonce again. But it does not seem to have got much.

Might this agreement encourage the ECB to intervene more heavily in markets for sovereign debt? Mario Draghi, its new president, told the European parliament last week that an agreement to bind governments on public finances would be “the most important element to start restoring credibility” with financial markets. “Other elements might follow, but the sequencing matters,” he added. The fiscal and reform measures announced by the technocratic government in Rome may help give the ECB the green light for thoseother elements”. Markets have responded, in hope: Spain’s 10-year bonds were down to 5.2 per cent, and Italy’s to 6.3 per cent, on Monday. But Standard & Poor’s decided to put the eurozone on negative watch. Fragility remains the watchword.

The summit on Friday is a huge moment. What we have heard from Mr Sarkozy and Ms Merkel does not create confidence. The problem is that Germany – the eurozone’s hegemon has a plan, but that plan is also something of a blunder. The good news is that eurozone opposition will prevent its full application. The bad news is that nothing better seems to be on offer.

The German faith is that fiscal malfeasance is the origin of the crisis. It has good reason to believe this. If it accepted the truth, it would have to admit that it played a large part in the unhappy outcome.
Take a look at the average fiscal deficits of 12 significant (or at least revealing) eurozone members from 1999 to 2007, inclusive. Every country, except Greece, fell below the famous 3 per cent of gross domestic product limit. Focusing on this criterion would have missed all today’s crisis-hit members, except Greece. Moreover, the four worst exemplars, after Greece, were Italy and then France, Germany and Austria. Meanwhile, Ireland, Estonia, Spain and Belgium had good performances over these years. After the crisis, the picture changed, with huge (and unexpected) deteriorations in the fiscal positions of Ireland, Portugal and Spain (though not Italy). In all, however, fiscal deficits were useless as indicators of looming crises.

Now consider public debt. Relying on that criterion would have picked up Greece, Italy, Belgium and Portugal. But Estonia, Ireland and Spain had vastly better public debt positions than Germany. Indeed, on the basis of its deficit and debt performance, pre-crisis Germany even looked vulnerable. Again, after the crisis, the picture transformed swiftly. Ireland’s story is amazing: in just five years it will suffer a 93 percentage point jump in the ratio of its net public debt to GDP.

Now consider average current account deficits over 1999-2007. On this measure, the most vulnerable countries were Estonia, Portugal, Greece, Spain, Ireland and Italy. So we have a useful indicator, at last. This, then, is a balance of payments crisis. In 2008, private financing of external imbalances suffered “sudden stops”: private credit was cut off.
Ever since, official sources have been engaged as financiers. The European System of Central Banks has played a huge role as lender of last resort to the banks, as Hans-Werner Sinn of Munich’s Ifo Institute argues.

If the most powerful country in the eurozone refuses to recognise the nature of the crisis, the eurozone has no chance of either remedying it or preventing a recurrence. Yes, the ECB might paper over the cracks. In the short run, such intervention is even indispensable, since time is needed for external adjustments. Ultimately, however, external adjustment is crucial. That is far more important than fiscal austerity.

In the absence of external adjustment, the fiscal cuts imposed on fragile members will just cause prolonged and deep recessions. Once the role of external adjustment is recognised, the core issue becomes not fiscal austerity but needed shifts in competitiveness. If one rules out exits, this requires a buoyant eurozone economy, higher inflation and vigorous credit expansion in surplus countries. All of this now seems inconceivable. That is why markets are right to be so cautious.

The failure to recognise that a currency union is vulnerable to balance of payments crises, in the absence of fiscal and financial integration, makes a recurrence almost certain. Worse, focusing on fiscal austerity guarantees that the response to crises will be fiercely pro-cyclical, as we see so clearly.

Maybe, the porridge agreed in Paris will allow the ECB to act. Maybe, that will also bring a period of peace, though I doubt it.
Yet the eurozone is still looking for effective longer-term remedies. I am not sorry that Germany failed to obtain yet more automatic and harsher fiscal disciplines, since that demand is built on a failure to recognise what actually went wrong. This is, at its bottom, a balance of payments crisis.
Resolving payments crises inside a large, closed economy requires huge adjustments, on both sides. That is truth. All else is commentary.
Copyright The Financial Times Limited 2011.

Europe’s pain must be widely shared

Raghuram Rajan

December 6, 2011

Any proposed resolution to the European crisis over the next few days will have to be economically viable as well as politically palatable to both the rescuers and the rescued if it is to restore confidence to the sovereign bond markets. This means paying attention not just to the technical details but also to how it is presented.

There is growing consensus about the key elements of any resolution. Italy and Spain will have to come up with credible medium term programmes that will not just boost their fiscal health, but also improve their ability to grow their way out of trouble.

While any plan will involve pain for the citizenry, the markets must also deem the pain politically tolerable, at least relative to the alternatives. It is important that the plan be seen as domestically devised, although voters will have no illusions about the external and market pressures that have forced action. At the same time, the plan’s credibility could be bolstered by an external agency, such as the International Monetary Fund, if it evaluates the plan for consistency with the country’s goals, and monitors implementation.

Some institution – either the IMF or the European Financial Stability Facility with funding from countries or the European Central Bank – has to stand ready to fund borrowing by Italy, Spain, and any other potentially distressed countries over the next year or two. There is an important detail here which has largely been papered over in public discussions. If this funding is senior and therefore higher priority to private debt – as IMF funding typically is – it will be harder for these countries to regain access to markets. For the more a country borrows in the short term from official sources, the further back in line it will push private creditors, making them susceptible to larger haircuts if the country eventually does default.

Private markets need to be convinced both that there is a low probability of default and that there is some additional loss-bearing capacity in the new funding so that outstanding or rolled over private debt does not have to bear the entire loss if there is a default. This may seem unfair. After all, why should the taxpayer accept a loss when they are saving the private sector’s bacon by providing new funding?

In the best of worlds, distressed countries would default as soon as private markets stopped funding them, and they would impose the losses on private bondholders. In the world we live in though, if the view is that Italy and Spain are solvent, or are too big to fail, then official funding should be structured so that it gives these countries their best chance.

Does this mean that official funding should be junior to private debt in a restructuring? Probably not, for that will require substantially more loss-bearing capacity from the official sector for any given amount of fundingcapacity that is probably not available. Of greater public concern, official funding, if junior, will then be providing a greater cushion to private creditors and thus bailing them out to an even greater extent.
The simplest solution is that official funding should be treated no different from private debtbest achieved if official sources buy country bonds as they are issued (possibly at a predetermined yield) and agree to be treated on par with private creditors in a restructuring. As the country regains market confidence, the official funding can be reduced, and eventually the bonds sold back to the markets.

The key point is that official funding must be have loss-bearing capacity. If the IMF is the organisation through which funding is channelled to the countries, and if its funding is to be treated on par with private debt, it will need a guarantee from the EFSF, or the eurozone that it will be indemnified in any restructuring. Of course, the community of nations that compose the IMF may be willing to accept some burden sharing once a sufficient buffer provided by the eurozone is eaten through, but that cannot be taken for granted.

If the first two elements of the plan are in place, there should be little need for the third – an ECB willing to buy bonds in the secondary market in order to narrow spreads, and provide further confidence. Indeed, if the ECB intends to claim priority status for any bonds it buys, it is probably best that it buy very little. Of course, the ECB will have to continue to provide support to banks until confidence about their holdings returns.

There is, however, one more element that is needed to assure markets that the resolution is politically viable. Citizens across Europe, whether in rescued countries or rescuing countries, will be paying for years for a mess that no one feels they are responsible for. Banks may not all have voluntarily loaded up on distressed government bondssome were pressured by supervisors, others by governments – but many have made unwise bets. If they are seen as profiting unduly from the rescue, even as they return to their bad old ways of paying for non-performance, they will undermine political support for the rescue, and perhaps even for capitalism.

So a final element of the package ought to be a monitored pledge by the banks in the eurozone that they will not unload bonds as the official sector steps in, that they will be circumspect about bonuses till economies start growing strongly again and that they will raise capital over time instead of continuing to deleverage – if this hurts equity holders, they should think of this as burden sharing. Cries that this is not capitalism should be met with the retort: “neither are bail-outs!”.

The writer is professor of finance at the University of Chicago’s Booth School

The Great Western Crackup

December 6th, 2011

By Peter Schiff, CEO of Euro Pacific Precious Metals

From World War II until very recently, the West – specifically Europe and the United States – was on a course for greater centralization, greater integration, and greater economic intervention. But this consensus is breaking down. In Europe, the euro has gone from steadily adding new members to now facing the prospect of having its weaker members quit. In America, the US Congressional Supercommittee has now officially failed in its mandate to bring even meager cuts to the bleeding US deficit.

This is the beginning of the end. Both the EU and US are politically paralyzed, seeming only to be able to make compromises that involve more spending, more debt, and more central planning. The results are all too predictable to free-market thinkers: bailouts leading to moral hazard, low interest rates leading to ballooning debt, and eventually a cascade of systemic failures leading to more bailouts.

This was confirmed yet again last Wednesday when central bankers on both sides of the Atlantic announced a coordinated tidal wave of new money to bailout the Western banking system yet again. Now, the only money you can trust is the gold and silver in your pocket.


The poison of Keynesianism has left the politicians unable to even listen to free-market solutions. Personally, I have found it nearly impossible to find a Keynesian professor or official to debate me – even though (or perhaps because) I have a track record of accurate economic predictions. You would think at least one of them would want to tell me why I’m wrong to offer some excuses for their failure to predict the dot-com bubble, the housing bubble, or anything that has come after that.

This is just an illustration of what we, as investors and citizens, are facing. The halls of power, the media, and academia are completely closed off from reality. They’re clutching their theories and hoping that they don’t end up having to work for a living like the rest of us.

I have repeatedly stated that the fact that Germany has been resistant to printing more euros is the main argument in favor of the euro. Of course, the mainstream consensus is the opposite. The same people who pushed for entitlement programs that Western nations couldn’t afford are now arguing that the EU must use the power of the printing press to “helpbankrupt Greece, Italy, Spain, and others. Really, this is just a secret tax on those who chose to save for a rainy day, and it will lead the euro on the road to ruin just like the US dollar.

If Greece, Italy, et al, can’t stomach the austerity that comes with staying in the euro, they should withdraw and see how the bond markets treat them without the implicit backing of Northern Europe. Either way, they must be made to face the market consequences of their previous spending.

Unfortunately, with this past Tuesday’s announcement that the EU would provide another $10.7 billion bailout to Greece and Wednesday’s bank bailout announcement, there is no sign that Europe’s politicians are going to allow market forces to play out. Instead, repeated bailouts will ensure that other ailing economies, like Italy or Portugal, do not make the necessary cuts in time to avoid needing their own bailouts. And no one, save perhaps China, can afford to bail out the likes of Italy.

Thus, like pulling off a bandaid, the politicians have made the euro crisis more painful by drawing it out. This means more risk and more volatility for investors, causing them to abandon the supranational currency in droves..

Abandoning the euro looks like a wise course of action, but it becomes extremely unwise when you buy dollars instead. Remember, my concern with Europe is that they have started down a path that may lead them to the sorry state of the US. If you’re worried that your refrigerator doesn’t get as cold as it used to, you don’t move your perishables to another fridge that won’t even turn on!

In other words, the current status of the dollar is the nightmare scenario for the euro: no significant member-states are thriving, bailouts are assumed and given without significant debate, and the money supply is growing rapidly to cover the debts. At worst, the EU could be facing a rump euro comprised of the healthier Northern economies or years of debt monetization to try to “save” the PIIGS. But the US has already spent decades monetizing its debt and is now facing a ‘game over scenario.

Remember, the EU might be going along with the latest bank bailout scheme, but the US Fed spearheaded it and the swaps are denominated in dollars.

The failure of the Congressional Supercommittee shows how laughable Washington – and, by extension, the dollar – has become. The Federal Reserve is frantically buying Treasuries at auction to make up for wilting demand from foreign creditors, such that it may soon hold 20% of all outstanding Treasury debt. Meanwhile, the Supercommittee failed in its meager mandate to slow the growth of new spending by $100 billion a year, barely a dent in an annual deficit that runs over $1 trillion a yearnot to mention the $15 trillion in debt already accumulated. The failure caused ratings agency Fitch to downgrade its outlook on US credit, potentially joining S&P soon in stripping the US of its AAA.

Perhaps the analysts at Fitch realize that if the Fed were to stop buying Treasuries, say because consumer prices started rising too quickly to ignore, then rising interest rates would add additional trillions to the debt problem, making default inevitable. Or maybe they’re starting to realize that getting paid back the whole coupon in worthless dollars is just another form of default.

In short, the US is going to be mired in economic depression for the foreseeable future, with no reform efforts likely, and so the Fed will continue printing as much as it can to paper over the problem. This is tremendously bearish for the dollar, even more so than a euro facing the loss of a few weak member-states.


The knee-jerk buying of US dollars, which has sent metals prices on a roller coaster this fall, represents pure market manipulation by the Fed. Private buyers and foreign governments were selling dollars and Treasuries before this recent market action sent confusing signals. We saw a short rally, but on last Wednesday’s bank bailout news, dollar selling resumed in earnest. Overall, the trend remains: the Fed will continue to buy a greater and greater share of US debt until all the new money it’s printing sends inflation into the double digits.

So, in a world where the two major reserve currencies are both faltering, which asset is going to become the new foundation for international trade and personal savings?

A look at history sees periods of monetary debasement and market mania followed by a return to more fundamental values. Every successful civilization in history has relied on sound money to grow, always in the form of precious metals. With globalization, we live in a world where investors don’t have to live with their governments’ bad choices.

Allocating a portion of your portfolio to precious metals means being able to sit on the sidelines and laugh at the comedy of the sovereign debt crisis. It means that when new dollars or euros are printed, your metals simply go up in price.

That is the ultimate resolution to this crisis. More banks, institutions, and individual investors will simply withdraw from the fiat money system and rely on precious metals as their reserve asset. As they do so, the fiat system will be all the weaker for the those left behind. After this period of uncertainty, a new consensus is sure to form, and the 24% run up this year alone indicates that gold may play a central role.
Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices.