Embrace Default!

Painting by Eugene Delacroix La Liberté guidant le peuple

Eugene Delacroix La Liberté guidant le peuple

There is a myth circulating, and I am not sure whether it has its origin in sloppy thinking or devious manipulation. It is this: sovereign default in the euro-area is the biggest threat to the euro’s survival.

Really? Why?

The euro is a form of paper money, just as the dollar, the pound and the yen is paper money. Paper money is backed by – nothing. It is an irredeemable piece of paper. It is not as if you could take your paper money to the central bank and demand to get something material in exchange for it -such as gold.

The solvency of the states that print paper money and make it legal tender is completely irrelevant for paper money’s use as a medium of exchange. The risk to a paper currency’s continuous acceptance in trade is over-issuance of the paper money, not sovereign insolvency.

Historically, paper monies died – and sooner or later they all died – not because the government went bust but because the government went bust and did not want to acknowledge that it was bust. It wanted to keep on operating. It wanted to keep on spending. It wanted to keep on bestowing privileges on those whose services or support it needed. So it kept on printing money. That has always been the reason for paper money’s ultimate demise. And it will be the reason for the demise of the euro.

And the dollar.

And the pound.

An honest government that declares itself insolvent when it is insolvent, and that declares its banks insolvent when they are insolvent, is no threat to the survival of its money. A government that does ‘whatever it takes’ to save its banks and bond investors, and keep on spending, is a massive threat to its paper money.

Not insolvency of states and banks is the biggest risk to the euro. Keeping states and banks going by printing euros is the risk to the euro. Whether the ECB hikes on Thursday or not is irrelevant. The ECB will not be allowed under any circumstances to meaningfully tighten monetary policy, to drain liquidity from the system and – to shrink its balance sheet. Its balance sheet has to keep growing. And those of other central banks as well.

Picture of ECB President Jean Claude Trichet

J.C. Trichet, money printer, photo by Jebulon

Why? Here is why. The ECB keeps rates low and keeps on printing euros to keep the banks in business. The ECB also keeps rates low and keeps on printing euros to keep various states in business. And the states are kept in business so that the banks – which are fractional-reserve banks and lend money by creating money, of which they lend a lot to the state – are kept in business so that they — keep on lending money to the state.

This will continue until the euro is worthless. Ditto for the dollar, ditto for the pound. When the public fully wakes up to it things can unravel quickly.


The Irish government is bailing out its banks -again.

How many banks does Ireland need?

How big should the Irish banking sector be? And is that a question for politics or the market?

There was a time when people believed that every country needed its own shoe industry, and its own car industry, and its own ……..(fill in a sector of your choice) industry. Then there was the time of subsidizing the coal and steel industry, of keeping these industries – against market forces – in an inflated size at the expense of the taxpayer. Today, no self-respecting journalist at the Wall Street Journal or the Financial Times would argue that the coal- and steel industry should be “re-capitalized” by the state. Why is it that this is precisely what everybody is suggesting we do with the banks?

Is banking the last domain of acceptable mercantilism in financial journalism?

“The Spanish government has to re-capitalize its banks.” “The Irish government has to recapitalize its banks.”

After the credit-boom the banking sector is too big. The boom is over. The banks have over-lent. There is overcapacity in banking. In capitalism, shrinking occurs via corporate failure. Not in banking, apparently. Banks get re-capitalized. And they get life-support from the central bank. Zero rates and debt monetization. Quantitative easing.

Either you have capitalism or you have  – - a lender of last resort.


Photo of Angela Merkel

A. Merkel, Photo by World Economic Forum

The real dividing line through Europe is not the one between the Germans and the Irish. It is the one between the net payers to the government and the net receivers of funds from the government. The former group is the productive sector. The latter group is the political sector.

The political sector includes all political representatives and public sector employees, all receivers of state transfers (from prison inmates to welfare recipients) and those who lend to the political sector (bankers, bond investors) and who thus expect to get repaid – not out of uncertain market income earned by capitalist enterprise but – out of tax revenue.

Because the political sector – even to the extent that it does something that would be desired and thus voluntarily funded in a stateless society – does not subject itself to the discipline of the market, its size is not the result of voluntary interaction with paying customers but of — well, politics. Its size depends on how many resources it can obtain – via taxation, borrowing or money printing – from the productive sector.

So, this is how it really works: The German government (political sector) wants the productive sector in Ireland to pay more tax to bail out the Irish government (political sector) and the Irish banks (political sector). This should also save the German banks (political sector), which stupidly lent exuberantly to the Irish government and the Irish banks. Or, as a bailout was now required, the German productive sector will have to come up with the resources to pay for the bailout of the Irish state and banks (political sector) that the German government (political sector) has generously arranged in support of -ultimately – the German banks (political sector). For Ireland or Irish, you may insert Portugal and Portuguese.

Do you begin to see who is going to be the net payer in this ‘grand bargain’ and who is the net receiver in it?

The productive sector in Ireland, Germany, Portugal, Greece is keeping the political sector in all these countries alive, is paying for the mistakes of the political sector and is funding its growth. Because the political sector is always growing. In all these countries. But the resources must come from the productive sector. Everywhere.

Productive sectors in Europe, unite! Unite and embrace default! The default of sovereign states and their lenders. For default is the only way – painful though it might be – to finally cut off the bloodstream to an ever-growing political sector! It is the only way to teach bankers and bond-investors – who rather give savings to the government than to capitalist enterprise – a lesson! The whole thing is palpably overstretched anyway. The entire system is built on thin ice! Let’s not pretend this can go on.

Friedrich Nietzsche

Friedrich Nietzsche

O my brothers, am I then cruel? But I say: to what is falling one should give a further push! (Friedrich Nietzsche, Thus Spoke Zarathustra).




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  1. says

    When I made pretty much this exact point when I was a speaker before a quite friendly ‘free market’ crowd at the Adam Smith Institute in London last year: “Sovereign Defaults… the sooner the better”… and it was clear that most people there looked at me like I had taken leave of my senses :-)

    I wonder how such remarks would be received today?

  2. Archie Dean says

    “Paper money is backed by – nothing”.

    ……….excepting force of course, which is very persuasive indeed when applied.

    At one level, the attacks on Iraq,Libya and shortly, in all likelihood, Iran, surely have much to do with the American State seeking to remove, where possible, the threat of oil being priced in anything other than dollars. At another level entirely is the confiscation of assets and subsequent prosecution of Bernard von NotHaus as a result of his ‘Libery Dollar’ experiment, and at still another level we have the myriad legal tender laws that underpin the control of the means of exchange within countries the world over.

    As you imply, the simple fact of the matter is that ownership and contol of the means of exchange is the key to State power. Without it, the State as currently constituted is lost. Thus whilst I have considerable sympathy with your views in respect of sovereign default – it just isn’t going to happen anytime soon – you can bank on it!!


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