"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Wednesday, December 1, 2010

The Euro: Après moi le déluge

(This is a continuation of my Part III of my Fiat Evolution Series.  Due to my schedule I did not post the final part of that essay, and to be honest, I am still torn as to recent developments and my view of the Euro's ultimate fate. The best I can do is describe the two paths the EU faces)

The expression "Après moi le déluge" has been attributed to the King of France, Louis XV.  I think it is an appropriate expression to describe the possible breakup of the EU due to a failure of the Euro.  The expression, loosely translated, means: "After me, the flood."  Louis XV was a fiscal disaster, and he knew it.  The Treasury was in a shambles, and it has been said that the expression: "Après moi le déluge" was uttered by him to describe the day of reckoning that awaited France.  Fifteen years after his death, the French Revolution broke out, and his  successor and grandson, Louis XVI met his fate with the guillotine.

I make this analogy because at the beginning of Louis XV's reign, he was very popular.  Debt splurges often have that consequence, the times are great.  Consumption increases, people work, money flows.  But then, there is always a day of reckoning.  I have written about this in the past:  That the Euro, based on debt, allowed for extreme imbalances in consumption and trade surpluses to develop.  Lifestyles in the periphery nations improved, and the economies of nations such as Germany became models for the world to follow.

But it was illusory, as all debt based pyramid schemes are.  And now we find ourselves with extreme debt levels in violation of the Maastricht treaty - across the board, and extreme trade imbalances that hinder any rebalancing or growth.

So what does that mean for the Euro's evolution?  In the beginning of this series I mentioned that the EU wants the Euro to "act like gold."  That is, they wanted to control its creation through controlling governments' debts, they mark to market their gold holdings quarterly, and they put in place strict deficit guidelines.  This is in marked contrast to the US Dollar fiat policy.

As we are seeing now, Euro stewarship was a failure.  However, I hold the Banks more accountable than the governments.  Banks always control money through their decisions to lend.  That is what Banks do - it is their business to measure risk and lend accordingly.  Well, they failed to measure risk accurately.  All of them.  And now, due to the Banks' pivotal role in the monetary system, the Banks will not pay the price of rampant irresponsible lending, the people will.  And loss of sovereignty will follow.

These are not national bailouts.  They are Bank bailouts.  Let's be clear about that.  Just as in the US, QE2 is a masked Bank bailout as well.

And so, the Euro faces two paths:

Path One - Austerity

This is the path that has been taken to date.  It is a return to fiscal responsibility, and a return to make the Euro what it was intended to be: a strong reserve currency challenging the dollar and unifying Europe.  But will austerity succeed?  Will making the Euro act like gold, in a competing for devaluation fiat world, keep the Euro alive?  I'm afraid not.

Beneath the title of this blog is a quote by Austrian economist Ludwig von Mises:

"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved." - Ludwig von Mises

What von Mises describes are two scenarios that follow a period of extreme credit growth.  The EU, with austerity, is following the first approach, the US with QE2, is following the second path.  The first leads to immediate depression, the second to ultimate currency collapse.  Those are the choices, those are the two corresponding outcomes.

Austerity will be a political failure.  Why?  Because austerity ultimately socializes irresponsible bank and government losses on the people.  And not just any people, but the "little" people the most.  These are the people that protest and riot.  The political repercussions can not be underestimated.  And like the aftermath of Louis XV's reign, there will be an uprising when the "little" people feel the pain.  I'm not saying it will be as extreme as the French Revolution - and I hope not.  But the real concern here is that the anger of the populace will lead to the disintegration of the EU, and thus, the end of the Euro.

The economic repercussions of the end of the Euro would be catastrophic.  All sovereign debt markets will be suspect.  Interest rates would skyrocket, and economies, faced with flat or minimal gdp growth can not handle high interest rates.  It's a basic question of mathematics.  How can a country successfully manage it's debts if the interest rate on its bonds post Euro is 9-12%, but its GDP is .5-2%?

Path Two - The EU follows the US Fiat Model.

As I described in Part I, the US has revolutionized (in a bad way) fiat money.  With QE and trillion dollar deficits as far as the eye can see, money creation has been taken to a new level - without the limitations of risk measurement that the private banking sector faces.

But in order to do this, the EU needs a central Treasury to work with the ECB, and what follows, is an EU wide income tax, just as the US has.  See Part I on why the Fed was created at the same time as the Federal Income Tax.  Is Europe politically ready for such integration?  And how long can such a fictitious monetary system last?  A commentator on this blog, Dave Narby posted a quote from Greg Hunter:

"If a country could simply buy its own debt with zero downside, I say we should have been doing this all along."

Makes sense, right?  But what happens when every country on earth, as surely they will, follows suit?  The entire global financial system will end in a crack up boom as governments compete to placate the needs of their oligarchs and general populations.  You think there is a currency war now, well, Fiat in extremis, done globally, would be the WWIII of currency wars.  Gold would be in the six figures in no time!

But there is one more final path.  Well, not exactly a fiat evolutionary path, as it replaces the Euro and changes the Euro area.  It's the disintegration, or possibly splitting up of Europe.  Disintegration as a policy is highly unlikely.  No one wants to end the EU.  But a splitting up of the EU into two currency zones would be something I would not rule out.


The central thesis of this blog is that fiat money will be replaced by gold, in some form, after a period of chaotic defaults and geopolitical conflict.  Currencies and Credit will face so much distrust that the market and governments will be forced to rely on gold, as it is not manipulated, and is not someone else's liability. I wanted to describe the final evolution of fiat before the system ends.  These are the days that policymakers globally, are scrambling and implementing policies ad hoc to stop the debt dam from bursting.  From what I am seeing.  No real solutions have been implemented that address the underlying causes of this global financial crisis, only  temporary band-aids that delay the inevitable.

Think about it.  Since this crisis began in 2008, multiple explanations have been given as to how it came about:

First, many said "No one could have predicted this."  And then, it was blamed on greedy subprime homeowners, and so it was "contained."  Also blamed were consumption motivated credit card users.  Well, that didn't last long.  So it was the greedy banks and the derivatives market.  Which morphed into bad fiscal policies enacted by irresponsible nations like Greece.  And now under attack, are the pensions promised to seniors.  If we constantly change who to blame, do we really understand what is going on?

Has anyone in government or central banking addressed the underlying issue - that all debt based monetary systems, due to the exponential growth of interest, ultimately end?   I wrote this yesterday on a message board from Market-Talk, a very good greek financial blog, as part of a debate.  I repeat it here, sorry for the poor grammar, as it was written in haste:
People do not understand what money is. Money is created through debt. Debt needs to be created for money to be created.
It is basic double-entry book keeping. Anyone that has taken an accounting course should understand this concept.
In double entry book-keeping, one entity’s debt is another’s asset. For example, let’s look at the relationship between Germany and Greece. German Banks lent money to Greece. Therefore, Greece has a liability, that is, they owe money to German Banks, and German Banks have an asset - they own a Greek debt that pays them interest.
If you forgive the debt, you destroy the asset. The two co-exist. Now how healthy are German Banks? French Banks? Can they handle a debt write down of Greece? of Ireland? What about Spain? In the end, who is really getting bailed out in Greece?
European banks are a mess. I remember watching Jim Cramer on CNBC in the US. He was explaining how he worked a desk in Wall Street and how they bundled debt. He said when a debt salesperson had trouble selling bonds, they would say: “Sell it to the Germans, those idiots will buy anything.”
That’s what happens to countries that amass a large trade surplus at the expense of everyone else. They accumulate so much money, all they can do with it is buy the risky debts of their trading partners. Look at China, how much US garbage debt do they own? Suckers!
But if you look at the big picture, debt accumulates because of interest. Whereas in the example above, say Greece received 100 million Euros from a German Bank. Well, 100 Euros were created. But you know what? That German bank wants 100 Euros plus 5.5% per year interest back.
So in a debt based system, the amount of debt in the system always outgrows the amount of money available to service that debt. 
No monetary system is permanent. The current monetary system began in 1971 when the US went off the gold standard. The post WWII monetary system called Bretton Woods ended when the US effectively defaulted on its gold obligations. Yes, the US has recently defaulted.
The current system arose from that default. The current system is 100% debt based. That means money is not convertible and can expand exponentially - far larger than the value of underlying assets in the system.
If all monetary systems have an end due to the exponential growth of credit in the system, then I submit that the current 100% debt based monetary system we have today will also end. But its end will be the most catastrophic of all as it relies on credit more than any other monetary system that existed before.
It’s not a Greek thing. It’s not even an EU thing anymore. It’s basic mathematics. It’s a pyramid scheme that has reached its apex.
Game over

So long as governments ignore the real causes of the crisis, the unfortunate train wreck will continue.


Dave Narby said...

Excellent stuff.

I do hope you'll post the last part of your essay, even if you have to do it with a disclaimer/rewrite!

Misthos said...

Dave, yesterday's news that the Fed has lent over 3 Trillion to the world's banking system has only confirmed my worst fears. It's a grand fiction - much worse than I suspected. It looks like the entire global economy is on life support.

By the way, I know you follow FOFOA regularly - I haven't read some of his recent material lately. What do you think about ANOTHER/FOAs views on the Euro? Recent events have me thinking otherwise.

Dave Narby said...

Good question, and I have no real idea whether the Euro will survive, but I'll take a stab at it. BTW, you should check this fellow FOFOA fan's blog out: http://barondayne.blogspot.com/ There's been some discussion regarding the Euro over there.

Seems like they could split the EU into responsible/irresponsible nations. Irresponsible nations can re-issue their own currency and devalue against the Euro.

For sure the EU banks are going to have to be reined in, and their governments will need to contract.

I think ultimately the Euro will survive as it's just too useful. I don't think that it will survive without some fairly dramatic changes, however.

Nick said...

Hi Misthos, Dave,

I also agree that the "Euro" will survive - just not it its current form. I think that only a "new" (nordic) Euro can support A/FOA's writings, should they come true. What is still puzzling me in such a scenario, however, is Germany's gold that is kept in the US, as I think Misthos has already mentioned.

Nevertheless, as most people seem to be completely unaware of what's going on unfortunately, I'm afraid that this situation can last for quite a while.

Misthos, keep the posts coming!

Dave Narby said...

Misthos, Nick,

From http://www.safehaven.com/article/5205/why-the-global-financial-system-is-about-to-collapse

Dig it:

"Remonetization has two prerequisites. One is a free public market in one or more monetizable commodities - such as gold and silver. The other is an unstable and mismanaged official currency - such as the US dollar.

In theory, reversing either of these factors could prevent remonetization. In practice this is probably impossible.

Before a remonetization event, the austerity measures necessary to fix the dollar are politically unlikely. Afterward they would be too late."

Replace Dollar with Euro, and there's our answer. Now, do they want to take the hard choice?

Misthos said...

Dave and Nick:

Regarding the Euro - the only thing I am certain of is that it will not survive as it is today. The numbers just don't add up, unless of course, Europe becomes more centralized - it creates a central treasury and taxing authority like the US.

But can that happen? How many EU citizens identify themselves as "French" or "German" or "Greek," and how many just say "I'm European?"

In the US, people are Americans first, and then they are Texans, Californians, etc... And so, it is easier for the US Federal Gov't to overtax California and undertax, say, Mississippi. It's all America.

Germany's success is tied to a large extent, to the "irresponsible" nations. Remember, the EU does the vast majority of its trade within the EU. 2/3 to 3/4 of German exports are to EU countries. Thus, wealth and debt are but two sides of the same coin. You cannot have wealthy member states without indebted member states. Greece's debt is France's and Germany's wealth. Wipe out Greek debt, and you wipe out German and French wealth.

Here's the problem - many of those debts won't be paid. And thus much of that wealth will cease to exist.

Dave - I'm reading the link on remonetization.