THE EURO GOLD STANDARD

Regular readers have often heard me compare the Euro to the gold standard.  In effect, the Euro as a single currency system is restrictive in exactly the same ways that the gold standard was restrictive.  I have referred to this as the “inefficient market irony behind the Euro crisis“.  I haven’t seen the comparison made too often elsewhere until reading the Financial Times the other day.  Edward Chancellor of GMO beautifully describes the restrictions of single currency systems and why they ultimately fail:

“The euro has also failed to meet the expectations of its exponents. Like the gold standard, it lacks a self-equilibrating mechanism. Instead, countries with chronic trade deficits, such as Greece and Portugal, have relied on the recycling of trade surpluses from Germany. Their economies buckled when lending dried up.

Several eurozone members, including Italy and Ireland, have seen their production costs rise relative to Germany. Under a floating exchange rate regime, they would simply devalue. Within the eurozone, however, they are forced into deflation to regain competitiveness.

Having surrendered monetary independence long ago, eurozone members are now losing their fiscal freedom of action. Angela Merkel’s Germany, a top creditor nation and modern scourge of profligacy, plays the role of France in the 1930s.

The burden of the euro is getting heavier. Spain’s unemployment rate has reached Great Depression levels. Ireland is experiencing its severest deflation since the 1930s. Greece and possibly Portugal are on the verge of default. The pain thresholds of the eurozone economies may well be lower than in the 1930s, since debt levels are far higher.

In one respect, the euro is worse than the gold standard. The costs of going off gold turned out to be negligible. Leaving the eurozone may be much harder. Any country that signalled such an intention would most likely spark a run on the banking system and a collapse in government lending. The entire eurozone financial system would also suffer collateral damage. Euro-fetters are proving scarcely less agonising and certainly more binding than the golden variety.”

I couldn’t agree more.  In my opinion, the currency union was founded on false premises and only continues to this day because so much political will has been invested in its success.  Although I believe the Euro is destined to fail I also believe the European politicians will continue to impose a great injustice on their citizens.  Unfortunately, there is no bailout or political will that will help it to succeed and any politician who believes that the Euro should continue to exist does not grasp the economic instability caused by the Euro and is allowing his/her ego to destroy the lives of their citizens via the continued use of a flawed currency system. Ultimately, however, the citizens will awaken to the flaws of their currency system.  They will either force change preemptively or economic downturn will force change upon the Euro area.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Arsene Holmes

    The political will will overide everything for the time being. But this crisis has highlighted the flaws of the system and exposed its limitations.

    I have the feeling that it is going to spur the politicians into action and try to remedy some of the issues in order to fix them.

    Right now the system is too rigid with everyone from day one, having flouted the rules without consequences ( France, Germany, Italy, Greece etc..)

    Now is an opportunity to sit down and work out out to fix it by being more flexible. Maybe a bit like the USA which is a federal system with buffers.

    There is too much at stake. Europe with all its flaws has been a huge success.The main achievement (and not a small one) has been NO WARS. It is the first time in the last few hundred years that there has been such a long period (65 years) without a war in continental Europe.

    It might seem nothing to the young generation but I would qualify it as its biggest achievement.

    I don’t know if the lessons of the Gold standard in the 30’s have been learnt. But we all know how it ended.

    Right now everybody is huffing and puffing but the seriousness of the situation might be the best chance to grab the occasion and do something.

    Don’t write off the euro. It will outlast us but not in its present incarnation

  • Andrew P

    There is too much political will in the Euro to let it go now. Also, as you point out, it is a hell of a lot harder and very messy to get out of. The Europeans have only one choice – full federalization. And they will probably have to face this choice when the ECB does the inevitable bailouts of entire countries.

    Now, they might let Greece go (although I am doubting they will). It is a very special [basket] case, and is also very small. But even if they let Greece go, they won’t let anyone else go. Once the ECB monetizes soverign debt without sterilization, as they inevitably must, I don’t see how the EU can avoid full Federalization – as a purely political matter. How can the Germans be expected to pay for the rest of the EU’s profligacy without a commensurate measure of shared political control? This is the kind of stuff that makes a German voter’s blood boil. And if any national banking systems fail, the only institution that can finance a bailout, or even finance a payoff of the depositors, is the ECB, since it alone prints Euros. After a few large bailouts, how can they avoid Federalization? You can’t argue national soverignty if you are dependent on the ECB. I don’t see any legitimate political arguments that would let them avoid it.

  • Angry MBA

    There is too much political will in the Euro to let it go now.

    Agreed.

    The Europeans have only one choice – full federalization.

    That would be the optimal choice, at least from the standpoint of the currency. But it isn’t the only choice.

    The status quo will work well enough, in that the euro won’t collapse. But the ECB needs to wake up and realize that the euro will never achieve its goals of becoming a top-tier reserve currency if it fails to rationalize its policies, instead of merely acting as a puppet of the Bundesbank.

    One of the primary missions behind the euro was to compete head-on with the dollar, and this crisis makes it clear that this is highly unlikely to happen. The reserve currency of the future will not be coming out of Europe; at best, it will be one piece of a basket chosen by someone else, most likely the PRC.

  • TK7936

    Deflation means you get more for the buck. Its often confused with Hyper deflation where consumption stops because you get it cheaper tomorrow. This doesn’t happen in -1 % per year scenario. Japanese Population is poorer today by numbers but most people have a higher life style. GDP in Germany dropped by 5 % in 2009 but the economical effect on wages, jobless etc was defacto ZERO.
    Nice proof that Banking balances are irrelevant in a countries needs. Problem is these “experts” dont realize that there number base has lost its ability to measure whats important. Deflation is the only way, dont know why the US Economic Blogoshpere is so horrified of something so wonderful. Germany can continue to increase efficiency on resource usage and production capabilities and thereby forcing there neighboring competitors to the same. The effect will be that the Eurozone will become a export region as Germany already is and thereby successfully competing with rising China and co.

  • Angry MBA

    Deflation means you get more for the buck.

    No, it doesn’t. Deflation is defined as falling output.

    With deflation, there are fewer bucks with which to acquire goods. That’s why it’s a bad thing — prices aren’t just falling in a vacuum, but are also pulling down the rest of the economy with it.

    GDP in Germany dropped by 5 % in 2009 but the economical effect on wages, jobless etc was defacto ZERO.

    Under normal conditions, Germany tolerates levels of unemployment that would be unacceptable in the United States. http://www.indexmundi.com/germany/unemployment_rate.html It’s manageable for the population because of social welfare systems, but the rates by US standards are consistently higher — we associate these rates with recession, not prosperity.

    The effect will be that the Eurozone will become a export region as Germany already is

    Germany’s largest export markets are nations in the Eurozone, plus the UK and US. The Germans can maintain a large trade surplus because other nations in Europe are using the same currency to buy German goods. The very thing that gave Greece, etc. a spending bubble is what has given Germany an export bubble.

  • F. Beard

    Deflation def: A decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. opposite of inflation. from http://www.investorwords.com/1376/deflation.html

  • F. Beard

    Deflation means you get more for the buck. TK7936

    P = MV/Y

    Where:

    P = price level
    M = amount of money and credit
    V = velocity of money = average money exchanges per year
    Y = aggregate output

    Price deflation can thus be caused by decreasing M (bad) or decreasing V (bad) or increasing Y (good).

  • TK7936

    @Angry MBA
    “With deflation, there are fewer bucks with which to acquire goods.”

    Not necessarily. It can also mean there are more or better goods to acquire while money supply stays the same or doesn’t grow as fast. And that was the point of my comment -by increasing production through efficiency you essentially make a profit on the consumer side without needing more money. Credit is the opposite of this -interest is defacto a decrease in efficiency to buy goods requiring more credit to compensate and therefor the primary cause of inflation. So the official (Harvard ideologic) definitions are incomplete -at least.

    “Germany’s largest export markets are nations in the Eurozone, plus the UK and US. The Germans can maintain a large trade surplus because other nations in Europe are using the same currency to buy German goods. The very thing that gave Greece, etc. a spending bubble is what has given Germany an export bubble.”

    Debt is merely the side effect of not producing values -debt is a symptom of a invaluable currency. Which is why my prediction for the eurozone to “become more German” is the or a solution -for the eurozone. This will of course take place in symbioses with other production economies like China which is why china already is becoming Germanys largest customer outside the eurozone. For debt is not needed, just the exchange of values, but if you have no value to swap you need debt or simply not buy what you cant afford. The Banks will always offer credit -its there blood but no one is forced to take it to replace ones own non production.

  • Angry MBA

    Not necessarily. It can also mean there are more or better goods to acquire while money supply stays the same or doesn’t grow as fast.

    It’s funny how you deflationists believe that it’s possible to have a sustainable economy in which everyone else’s wages are falling, but that yours aren’t. It’s an absurd belief that makes absolutely no sense from a macro standpoint.

    Inflation is primarily a byproduct of wage growth. In a deflationary economy, wages are falling, output is falling and unemployment is rising.

    Germany is hitting a wall. Like Japan, it has terrible demographics, while it fights to preserve a trade surplus. Like Japan, its domestic companies are looking for opportunities to escape from the high-cost local labor force and set up shop in lower wage markets.

    …which is why china already is becoming Germanys largest customer outside the eurozone.

    Not even close. Germany is a net importer from China, and Germany’s largest customers are the US, members of the Eurozone, and other parts of Europe. As of 2008, Germany’s largest markets were:

    France 9.7%
    US 7.1%
    UK 6.7%
    Netherlands 6.6%
    Italy 6.4%
    Austria 5.4%
    Belgium 5.2%
    Spain 4.4%
    Poland 4%

    Meanwhile, companies such as VW build plants in China, and build cars for the Chinese in China. German automakers would prefer to expand in lower-cost nations such as Portugal, Hungary, South Africa, China and the US, rather than deal with some of the world’s highest wage rates and strongest unions. If German companies are going to do more business in the PRC, they’ll be doing most of it with production from Asia, more so than from Germany.

  • Sigli

    My question is what is wrong with the USG reopening the gold window to buy gold only? If deflation and deficits are the problem then why not offer a premium to market on gold, and promise to buy until deflation goes away? I can’t think of a single reason not to other than our congress is merely useless and incapable of coming up with any real solutions.

    Creditors should like this idea much better than deficit spending. Yes it creates inflation, but the govt. would have something to show for it. If inflation got out of hand then gold would likely go up more and the window could simply reverse policy and suck up the excess liquidity. They’d trade some of the gold acquired for all the dollars sold, then plop the extra into that old treasury known as Knox.

    We need dollar bills. There aren’t enough to go around. Why buy debt through QE, or deficit spend when debt is the problem and the debt cannot be serviced? They could purchase enough gold to stop the deflationary spiral in a week or so. The only hard part would be figuring a price to pay. It’s also an asset that just about everyone considers valid for governments to own, so I don’t think we’d see the common right-left tirades.

    Deficit and deflation hawks, creditors, and debtors all win. Let’s start up the printers tomorrow, fix the liquidity crisis, and fuggettaboutit.

  • Angry MBA

    If deflation and deficits are the problem then why not offer a premium to market on gold, and promise to buy until deflation goes away?

    Because there isn’t a gold standard, so a run on gold doesn’t mean much of anything. There is no particularly good reason for a government to do this in the modern era. It made sense for FDR at that time, when the gold standard was being unwound, but not now.

  • Sigli

    You seem to have entirely missed the purpose. It has nothing to do with the gold standard at all and everything to do with 1. increasing liquidity while 2. not taking on debt or risk assets, to 3. maintaining confidence in the dollar, and 4. appeal to the populace.

    I’m looking at this as a supplement/replacement to QE and not a monetary reformation.

  • Angry MBA

    You seem to have entirely missed the purpose. It has nothing to do with the gold standard at all and everything to do with 1. increasing liquidity while 2. not taking on debt or risk assets, to 3. maintaining confidence in the dollar, and 4. appeal to the populace.

    Buying gold would not increase liquidity. It would truly be a pointless exercise, but for those gold speculators who took the free government money.

  • sigli

    Maybe I need to be a bit more clear: They would print dollars and trade them for gold. It’s not an open market operation/book entry ordeal. It is simply printing dollar bills and trading them for gold at above market values. This increases liquidity by definition.

  • Angry MBA

    It is simply printing dollar bills and trading them for gold at above market values.

    I understood that. And my point remains the same — this would be a pointless exercise.

    It would not increase liquidity, because the money wouldn’t necessarily go toward anything productive. The theory behind stimulus spending is that it feeds the multiplier. An example of that would be infrastructure spending: pay a company to fix a bridge, and it hires workers, who buy burgers at lunchtime and vacations and so on, creating more growth. If that succeeds, the multiplier creates liquidity.

    Giving gold speculators money so that they can go back and buy more gold at the lower market price (arbitrage) or moving the proceeds into another trade, such as oil, would do absolutely nothing to create stimulus, and would most likely have a multiplier effect of less than 1 — it would cost more than it delivered. It accomplishes nothing, except for those few who jump on the government gravy train and take the free money.

  • mike

    Isn’t that essentially what the banks are doing? They are essentially sitting on the nearly interest free loans from the banks or recycling it by buying treasuries. Very little lending being done because the demand side is moribund. Why are banks allow to do this?

  • Angry MBA

    Isn’t that essentially what the banks are doing?

    Different issue. The objectives of shoring up the banks were to prevent them from collapsing (which would have caused a depression) and to indirectly support the equity markets (thus rebuilding retirement savings, etc.), not necessarily to create a stimulus.

    The Fed’s first priority was to repair their balance sheets, not necessarily to see the money lent out. If we want stimulus, it is going to have to come from Congress and fiscal policy (stimulus spending, consumer tax cuts), not from the Fed and monetary policy.

  • TK7936

    “It’s funny how you deflationists believe that it’s possible to have a sustainable economy in which everyone else’s wages are falling, but that yours aren’t. It’s an absurd belief that makes absolutely no sense from a macro standpoint.”

    No, again deflation doesn’t have to imply falling wages it CAN mean increase in efficiency. That was the solution i clearly layed out and its a product of competition which is a product of more production everywhere. But its ok if i made you laugh, i cant understand macro dudes (as you seem to be) more than you can understand production side dudes as i am. Ive given up on trying to convince anybody on the Macro side. Figure it is pseudo science, looking at kidney but ignoring its cells. No offense, just my subjective opinion.
    The rules of quantum physics dont work in classic physics either but that doesn’t mean there wrong.

    “Inflation is primarily a byproduct of wage growth. In a deflationary economy, wages are falling, output is falling and unemployment is rising.”

    Waaaa, this line drives me crazy. Wage growth is a product of inflation not the other way around. Wage increases cant be demanded if there is no inflation to base the demand. And real income is stagnating for 20 years in the US because wage growth is merely compensating higher cost which is mostly a product of compound interest factor on a economy. Basically companies esp. in the US have been making more profits off of real wage stagnation and these profits stored at banks are loaned back to the worker with interest. Economical cannibalism if you ask me, but thats a different topic.

    “Germany is hitting a wall. Like Japan, it has terrible demographics, while it fights to preserve a trade surplus. Like Japan, its domestic companies are looking for opportunities to escape from the high-cost local labor force and set up shop in lower wage markets.”

    Agree on the demographics although Germany is way ahead of Japan on the Problem. Retirement Reforms already initiated in the 90s will add an additional 4 million on to the job market by 2040 through higher retirement entry age while a 10% cut in retirement will ease on the cost. The other 6 million people they will loose can be compensated through a mix of immigration and productivity increase, which is why Germany is doomed to keep pushing the productivity rate and others have to follow. Im not saying this will happen -just that it should because they have no other choice. Japans immigration rate is 1,7%, Germany 12,3 %, the second largest workers immigration country in the world behind the US 12,8 %. So there is potential there to not drop into Japanese Style full stop. Of course they need to use it.

    “…which is why china already is becoming Germany’s largest customer outside the eurozone.

    Not even close. Germany is a net importer from China, and Germany’s largest customers are the US, members of the Eurozone, and other parts of Europe. As of 2008, Germany’s largest markets were:”

    I feel like your not listening, i predicted a future symbioses between EU and China and you give me CURRENT data. If you want to make predictions you have to look at the growth rates of each market they export to and not what the biggest is now. It is clear that China will become the biggest outside EU client in this decade. My opinion was that this will eventually not only work for Germany but for the entire EU.China and Europe could create a superb economical symbioses especially if you speculate on a Russian EU Entry within a few decades leading to a common border with almost every emerging market there is.
    Here is something you might be interested in
    http://www.finfacts.ie/irishfinancenews/article_1019597.shtml

    “Meanwhile, companies such as VW build plants in China, and build cars for the Chinese in China. German automakers would prefer to expand in lower-cost nations such as Portugal, Hungary, South Africa, China and the US, rather than deal with some of the world’s highest wage rates and strongest unions. If German companies are going to do more business in the PRC, they’ll be doing most of it with production from Asia, more so than from Germany.”

    Agree but this is not really a problem, Germany does the same in the USA as in China -you build 75 % of a car in the target market and you still got 25 % for home. In the USA this is based on market factors like the weakening dollar and dollar hegemony on certain products. The Problem with China is its not based on such market sense -its law that you have to produce locally 50% of what you sell locally. (I might be wrong on the 50% might be 75%, i forgot the exact number but the law exists). Given the huge size difference between Germany and China, they do not need or are even capable of producing everything at home, but they will and already have increased production throughout Europe. You have to understand my standpoint from a non German perspective -my solution is to have all economies produce values to exchange between them -it doesn’t matter if Germany is the one who does the production as long as its done in the US and China. US companies SHOULD export more but German companies can export from the US just as well. For the US it shouldn’t be relevant who build stuff in dollars as long as its build.

  • SMIA1948

    Europe does not need political integration to share the euro, anymore than it needs it to share the meter. If the goal is to reduce the real wages of the people of your country, it could just as easily be accomplished by lengthening the second as by devaluing the currency. In either case, people would work longer for the same real compensation. The ECB need to define the value of the euro in terms of gold and then conduct monetary operations by buying and selling assets that have solid value (Greek government bonds would not qualify). Then everyone could stop worrying about the unit of market value and deal with the real problems.

  • sigli

    You’re speculating without providing much other than “because I said so”. Why are you equating liquidity with production anyway? You’re writing like we’re in a normal recession rather than a deleveraging trap.

    I’ll use your own argument: The objective is to shore up America’s balance sheet to prevent us from collapsing, not necessarily to create stimulus.

    Me thinks you’re simply being reactionary without giving this much thought.

  • mpower

    “The Europeans have only one choice – full federalization.”

    I disagree.

    Federalization is not the only choice. Further, those folks looking at federalization as a monetary/currency cure are looking in exactly the WRONG direction. The US model is fraudulent and unsustainable – how could EU politicians possibly justify a deeply flawed federalized system to replace the deeply flawed EMU system?

    Europe is in a unique position to re-assert leadership and long-term stability w/o military coersion. Europe remains a wealthy region. The EMU should be pared-down to a core group of nations (based on solvency). Next, the Euro currency should be linked to gold and made sound/hard. The new gold-backed Euro, supported by a core EU economy that is actually productive (i.e. the PIIGS are OUT), would become the world’s new reserve currency overnight. Europe’s political clout would soar, and europe’s economic future would be stabilized instantly.

    BTW, the american Federal Reserve system is failing – hardly the model that prudent nations would want to emulate. The dollar/Fed only look good in relative comparison to other, flawed fiat currency systems. In the broader sense, the $USD is doomed.

  • Angry MBA

    Me thinks you’re simply being reactionary without giving this much thought.

    I gave it some thought. Your idea won’t work.
    I’ll break it down again:

    -You said it would increase liquidity. I’ve shown how it would not.,
    -You claimed that it would not increase the deficit. I’ve shown you implicitly how it would — the money needed to pay for your scheme would need to be printed and/or borrowed, while there would be no corresponding economic growth created to pay for the resulting debt.
    -It wouldn’t maintain confidence in the dollar, as we aren’t on a gold standard and don’t need to be on a gold standard.
    -As for the alleged appeal to the populace, only those who don’t understand what money is would find this appealing, and policy should not be driven by those who don’t know what they’re talking about.

    So sorry, but you are zero for four on this one. It just doesn’t make sense, on any level, to do what you are proposing. It would increase our debt while not helping the multiplier, so there wouldn’t be any point at all to it. The only people who would benefit would be gold speculators who swap their gold for the above-market price.