Saturday, February 18, 2012

Austrian Economics Forum Spring '12 #1--Tragedy of the Euro

We kicked off the latest round of the Austrian Economic Forum at North Carolina State University on January 27th, 2012.  It was well attended and everyone seemed excited to get the semester under way.  This semester is going to be a little different for us in that for each meeting a different Graduate Student will be either presenting his own work or a reading which interests him. 

The first session's reading was selected by Alex Gill.  He picked chapters 8 and 9 in Philipp Bagus' Tragedy of the Euro (2010).

The European Central Bank (ECB) has powers that are slightly different than those of the US Federal Reserve System.  The difference we focused on was the ability of the ECB to expand the money supply. 

The system works by the ECB loaning money to banks, which use national governments' bond as collateral.  Suppose a national government (e.g., Greece) decides that it must spend more than it takes in from tax revenues; it has a budget deficit.  (Hard to imagine I know, but hang in there.)   The Greek Government cannot simply create new money to cover its budgetary shortfall.  So it borrows the money by selling bonds.  The bonds are (either directly or indirectly) purchased by banks.  These banks then go to the ECB and ask for a loan.  The ECB accepts the Greek government bonds as collateral and credits Euros to the banks' accounts.  Where did this money come from?  It comes from a big, black hole of nothingness.  It is simply brought into existence by the recording of Euros in the banks' accounts.

Bagus also illustrated another difference.  The Treaty of Maastricht said that no bail-outs are allowed.  If a government overexpands and cannot meet its spending "obligations" then that's its own problem.  The national governments were allowed deficits of no more than 3% of GDP and Total Debt to not be greater than 60% of GDP.  Clearly, politicians care little about such restrictions.  

Today's situation reminds me of the addage that if you borrow $1 million from your banker and cannot pay if back, you are in trouble.  However, if you borrow $1 billion from your banker and cannot pay it back, then he is in trouble! 

No one who agreed to the treaty should have been under any illusion that these clauses would have been tossed aside in the midst of a crisis.  Austrian (or any decent economic) insight into the incentives of a crisis should have led one to this conclusion.  Bagus takes a slightly different approach to this analysis.
Bagus argues that the Euro Zone is analagous to the Tragedy of the Commons.  Since each country can run a deficit, and then monetize it, they will exploit the "common" value of the currency before others can.  Some g
overnments spend more than their revenue and cover the deficit spending with bonds.  The governments that run deficits are able to exploit the "commons."  The value of the common resource, the Euro, is diminished for the rest of the users of the Euro. 

The analogy is a bit of a stretch.  The problem with the commons analogy is that "the commons" are unowned resources.  When a fisherman catches a fish, he is privatizing it for his own use.  The "Tragedy" is that the resource is overused and depleted.  The problem with this analogy is that all of the money is always owned by someone.  There is not some unowned resource, a pool of value, that then gets exploited when the Greek government runs a deficit.  I see what Bagus is trying to do, which is argue that the first to print new money is the winner.  But if this is the case, why not just make the standard Austrian non-neutral money argument and be done with it?  I think that making the argument on the grounds of non-neutral money is better because it is direct.  However, perhaps, Bagus' approach opens Austrian insights and arguments to an audience that otherwise would reject the Austrians out-of-hand. 

A conclusion that falls out of this analysis is that Greece will not reduce its deficit.  It has no incentive t0 do so.  It has been benefitting from the monetary might (stability) of other countries, such as Germany.  As a result, the Germans are upset with the Greek.  (See Chapter 9)  Will it lead to the collapse of the common market, balkanization, or even war?  Unfortunately, that is a question that cannot be answered.


There is another point on theory that I think needs to be addressed. I think that Bagus is conflating the property rights argument in money production with that of some right to a value of money. In Chapter 8, Bagus contends that money production has external effects, and that the costs and benefits to money production are skewed due to these external effects. So far so good.

However, now he states, "Private gold money with clearly defined property rights was replaced by public fiat money. This money monopoly itself implies a violation of property rights." (p. 79) Hmmm… The problem is that in one sense this is true, but there is a second sense where it is not true. In the first sense, when we switch to a fiat money system, I can no longer demand gold in exchange for my labor services. Thus, this law violates my ability to freely contract on my own terms. However, the negative externality of the loss of value of the gold-in-my-pocket due to demonetization is not a violation of property rights. Nor is it a violation of property rights when there is monetary expansion that leads to a loss in purchasing power for the dollars-in-my-pocket. As my friends who deny intellectual property rights are fond of pointing out, there is no right to the value of anything. All value is subjective.

I think that Bagus is leaning toward the second sense when he says, "By giving fiat money a privileged position and by monopolizing its production, property rights in money are not defended and the costs of money production are partially forced upon other actors." (p. 79)

It would have been better if Bagus stuck to the traditional Hoppean/Rothbardian property rights argument that says that fractional reserve banking assigns the right of the same dollar to two different individuals. but he doesn’t. Instead, Bagus goes after Selgin and White, in footnote #8, for missing the property rights argument. He states that they “do not see any property rights violation in the issuance of fiduciary media.” Then, in addition to citing Hoppe, Hülsmann and Block, he cites entirety of the nearly 900 page book Money, Bank Credit, and Economic Cycles by Jesús Huerta de Soto. Why relegate such an important, and unproven, assertion to a footnote? The way I see it, expanding the money supply, even if it is 100% pure fiat money, is not a violation of my property rights. To claim otherwise means that I have a right to the value of my money, which is simply untrue.

Regardless, I think that the property rights argument is weak and a better case against fiat money and a central bank can be made on pure economic grounds.

Next, I want to address Bagus’ discussion of the "quality" of money, pages 79-80. This line of reasoning makes sense when a country is on a pure commodity standard, but makes little sense when we are talking about fiat money, which is only exchange value. If he simply means seigniorage, then okay, why not just say that? But if he is making a larger assertion, he needs to come out and say what he means and then differentiate it from seigniorage. Especially puzzling are statements like, “In contrast to fiat paper situations, where an increase in the supply of money dilutes the quality of the currency, there is no dilution in the quality of the currency by gold mining.” (p. 80.) He is using “quality” to mean “purchasing power” the first time, but means “percentage of content” in the second. Puzzling and troubling, indeed.

Finally, Bagus misses the big reason there is a check on the overexpansion of the money supply (beyond extent of the money multiplier) in a free banking system. The threat of bankruptcy in a free banking system does not have to come from a bank trying to drive a competitor into the ground. (See pages 83-84.) As Rothbard demonstrates in The Mystery of Banking (Chapter 8, page 114+), we can suppose that all economic actors are fully wanting fractional reserve banking to expand as much as they can. The check on bank expansion comes from the fact that some people have deposits at different banks. Suppose that I bank at Bank A and you bank at Bank B. When I get a check from you, I will deposit that check in my bank so I can access the funds. When I do so, Bank A asks Bank B for the money. That's the check against infinite bank expansion. Bank B had better have the money available for my bank and me or it will go out-of-business. The check is not because a bank might be trying to drive its competitor out of business, instead the check comes from the fact that I want to access my money from my bank.

Overall, it was a good discussion and a good beginning to another semester of thoughtful Austrian Economic Analysis. The next session will cover the idea of using artificial intelligence as an analogue for economic theorizing. The session that follows that will cover The Calculus of Consent by Buchanan and Tullock.


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