This is sub-chapter #15, of Chapter #4, Economics (Three-Quarters of the way there), of my ongoing rewrite and open editing process Random Rationality: A Rational Guide to an Irrational World. Would greatly appreciate any feedback, corrections, criticisms, and comments. If you want the full PDF of the book, then you can download it by clicking here—if you provide constructive criticisms in return, and live in the US, UK, or EU, then I’ll ship you a paperback copy of the book free of charge when it’s published. If you wish to read the previous chapters in one convenient place online, follow this link.
EUROPE’S ACHILLES HEEL
The Euro, the official currency of the European Monetary Union (EMU) has been in place since 1999, and up until 2008/09 was functioning pretty smoothly. Countries that participated in the EMU (seventeen countries out of twenty-seven countries in the European Union) saw their overall GDP during that decade rise, everybody got along, and politicians were celebrating their grand experiment in unification and big government.
Of course, this wasn’t because bigger government is better, but because economically weaker parts of the EU, like Greece and Portugal were able to borrow more money with the ‘apparent’ credit of Germany, allowing for debt-based growth, which is always short-lived. Another factor was in part the removal of congestion and barriers between the EMU nations that facilitated the exchange of goods. There were no more borders and the free flow of goods and people was accelerated, saving huge amounts of time and money.
That party came to a close during the Global Financial Crisis and a fundamental flaw was exposed. To understand the flaw, first we need to understand the EMU.
As part of the makeup of the EMU, national governments keep their national sovereignty, but allow an open border policy with other EU nations and give up their sovereignty to print new money. That last point is the crux of the flaw. You have seventeen nations that make up the EMU that must all use the centrally issued Euro.
Now, the manner in which a central bank sets the price of money, aka the interest rate, goes much like this: The central bank (CB) takes into account the fiscal habits of the nation’s people, and enacts policies that can have the greatest benefit to the economy for the well-being of all, in relation to those spending habits. They do this by setting the price of money (the interest rate).
For example, a nation of savers would have a low-interest rate, and a nation of spenders would have a high interest rate—a drastic simplification, but for the purposes of this example, fitting and easier to digest.
Digging a little deeper: a nation of savers would create excess capital; which can be used to create new businesses, industries, and jobs. Access to new capital from the CB would not be as necessary, and when it would be, the resulting inflation would be manageable growing with economic expansion in the process creating prosperity by naturally increasing as required by the new jobs and businesses brought into existence with the money multiplier effect—win-win for everybody. Another way to look at it is, the low-interest rate is an indicator that the necessary sacrifice and thrift have been achieved that shows that long-term investments can be funded with minimal risk by borrowing; hence the price of money is cheap (low-interest rates).
On the other hand, a nation of spenders could not have such a low price of money as spenders in such an environment would spend beyond their means and create lots of private debt, and pay off that existing debt with new loans and more debt—which is what our governments are currently doing, ramming it into your skull for the forty-fourth time (it’s simple mathematics that is cannot go on forever). In a low-interest environment, this creates a vicious cycle that creates lots of inflation and economic pain for everyone, without increasing the jobs and business that go with it, as it does in a nation of savers, so inflation spins out of control and everyone who hasn’t diversified into commodities (and even they often get the short-end of the stick due to reactive government policies) are worse off. It is in this scenario where totalitarianism usually arises; such was the case with Hitler in the aftermath of the Weimar Hyperinflation. So a nation of spenders would need a higher central bank interest rate to disincentive new loans and the money creation that goes with it.
Here we come to the crux of the problem. There are seventeen countries together in this economic union; countries like Germany, a nation of productive savers who couldn’t imagine life without work, and whom work until the age of sixty-five before retirement. And at the opposite end of the spectrum is a country like Greece, a nation of spenders, some of who retire at fifty, and the majority at sixty, the lowest rate in Europe. Yet both have access to the same line of credit from the European Central Bank, and nobody saw this disaster coming, why? The subprime mortgage in the US that triggered the Global Financial Crisis was due in part, to giving anyone and everyone interest-free loans without even bothering to do credit checks or even see paperwork. Many argued that it was immoral or unfair to not provide such credit, but is it unfair and immoral now that the entire nation (perhaps even world) is worse off?
This caused huge distortions and misallocations of capital, which can’t now be paved over with the current round of bailout after bailout after European Central Bank bailout (not that it stops them from trying), but a problem can’t begin to be solved without solving the underlying cause that begot it.
This gaping, foundational crack in the base of the EU isn’t even being looked at. Brussels is just throwing money at it, hoping it disappears (which it won’t and cannot), essentially trying to solve the problem by doing the same thing that the problem caused in the first place, a misallocation of capital that is only being magnified by these suit-wearing monkeys, further misallocating current savings, and creating future debt burdens in the name of keeping the status quo.
The solution is, or would have been, to charge a variable interest to the varying countries that make up the monetary union depending on the macro-economic behaviors of their people. That is, what would an individual central bank in each of the countries set its interest rates at, so that, to the best of its ability, prices remain stable and the economy remains strong? Then charge that interest rate to each country. Sure, they will cry foul and whine like babies as politicians have a habit of doing, but so what? Let them bitch and cry until their cheeks turn coarse, and eventually they will swallow it up or they’ll end up in their own currency, which may just happen anyway with the current system.
Is it fairer that the now richer, more prudent countries that produced excess capital now have to essentially give free money to these countries whose politicians and people had the foresight of five-year olds at a candy store? It’s fairer to get what you have shown the world you are responsible with. Anything more puts the wellbeing of other people into irresponsible hands, which potential outcomes worse than people or nations making do with what they have. Anything else simply perverts and distorts incentives without the necessary financial intelligence (learned slowly and surely), which all too often, creates more problems than what one (person, country, or supra-bloc) began with, except now they have less wealth with which to deal with the problem, not to mention that it only renews calls for the cycle to begin anew, which again, all too often, historically at least, ends up in totalitarianism. (With the internet-connected world we live in today, this scenario is extremely unlikely but it is enough that economic well-being is so connected to livelihood, quality of life, and cost of living that to embark on such a path regardless of the social cost is utter folly.)
On an individual level, you have to earn other people’s trust before you can be trusted with their friendship, babysitting their child, or taking a loan. The same should be true on an international level, but politicians are the most self-serving people on this planet and they think they deserve everything because we have put them on a pedestal.
Perhaps the monetary union would never have gotten off the ground in the first place, as such legislation required unanimous support from all countries involved. The poorer countries, always wishing to spend beyond their means, would have struck it down immediately. But that would’ve been the first warning sign.
An equal-across-the-board interest rate might seem fair to the socialist-leaning tendencies of the left-dominated societies of Europe, but remember in the real world, life isn’t fair. A wolf isn’t guaranteed a rabbit to eat, the slowest antelope will be eaten, and injured birds are met with the fatal clasp of a cat’s fang.
The only institution we are equal under (or should be, since in practice its fuzzy) is the law. Whether poor or rich, we are to be treated equally in justice. But try going to a bank for a loan with bad credit. You can’t, and for good reason; the likelihood of you paying it back is slim, and the bank, a vital component in society, loses money that than can’t be loaned to a business to build a bakery, a clinic, or an apartment complex that would otherwise increase economic activity, prosperity, and quality of life.
The advancement of society comes only when capital, created in excess [savings], is used to create new businesses, investments, jobs, and the consumption of more products. It may come for a while under such liberal make-believe equality, but that doesn’t last long, and the economic reality of such decisions eventually rears its ugly head and we, the people, usually suffer.
Everything comes down to economics, one-way or the other, whether you acknowledge, understand it, or don’t. Everybody will one day reap the fruit of their economic decisions and if not, then the burden falls to the next generation, much as it is being done so today.
Governments can only temporarily alter this balance, and only to our detriment (by borrowing from the future). This is a big reason communism doesn’t work, as capital is squandered and we are too shortsighted to work for the common good while subsisting on beets.
“It’s a European Union of economic failure, of mass unemployment and of low growth.” ~ Nigel Farage (Politician)