Europe’s future is coming into focus: hyperinflation

Hyperinflation In Hungary

Photo by Mizerak Istvan

As you know, my expectations were low to begin with. I did not expect the EU summit on the debt crisis to provide a solution. There is no solution. The situation is beyond repair and the crisis will continue to unravel.

What struck me most when reading the first responses to the EU summit was this: most of what you get from the mainstream media pundits or from the financial economists on Wall Street or in the City of London not only misses the relevant points, it usually gets things completely the wrong way round. What these analysts suggest is good policy and needs to be done is almost always bad policy and should be avoided under any circumstances.

Let’s go through the salient points:

1. Write-down of Greek debt to 50%

“Private sector involvement,” aptly abbreviated PIS, is one of those dreadful, perverted phrases that conceal more than they explain. The private sector here means of course the banks that were stupid enough to give billions of euros to Greek politicians.

We all know what happens under capitalism to lenders who give money to borrowers who end up being unable to pay: they lose their money. That is how it should be. That’ll teach them and hopefully make them more prudent lenders in the future. Alas, this is Europe, so there is no capitalism, and you can negotiate your losses with the political class and agree on the ‘appropriate’ haircut. In July, a 20 percent write-off was agreed, now this was upped to 50. Either number is entirely arbitrary.

The positively Orwellian phrase “private sector involvement” makes it sound as if these poor banks were just innocent bystanders – and respectable members of the private sector for that matter – who got dragged into this unfortunate business at no fault of their own.

For how much should the ‘private’ sector be ‘involved’? Well, I would say for exactly as much as it chose to involve itself in the first place by voluntarily lending money to the Greek government. I mean, have the risk managers and credit analysts at the likes of Credit Agricole and Societe Generale ever been to Athens and inspected the bottomless pit in which their loans were dumped? Or have they from the start assumed that the German taxpayer or the ECB would cover their losses?

Of course, a haircut of 50 percent, as now agreed in Brussels, is better than the ridiculous 20 percent, or so, ‘agreed’ in July. But looking at Greece’s dire financial situation the haircut should be at least 60 percent, or maybe 90, or 100. As I said here and here, there is no reason for the Greek citizens of this and future generations to suffer endlessly because of the corruption of their past governments and the stupidity of their bankers. Embrace default! Just stop paying, go bankrupt, shrink your government, role up your sleeves and start from scratch. After a complete and proper default the state will not get loans easily again, which coincidentally is an additional bonus of a complete government default, it keeps your future politicians honest. That would be the free-market solution. But again we are in Europe.

An even bigger haircut, one decided not by political horse-trading but by the market and Greece’s true ability to pay, would be more helpful for the Greeks and would conveniently discipline the bankers. Why is it not considered? Well, the politicians don’t like it because it would shut much of the government bond market down and make it difficult or impossible for them to keep running deficits of their own, and also because the banks have skilfully booby-trapped the entire financial system with explosive CDS (credit default swaps) that get triggered if the “private sector involvement” gets too big. The bankers resemble increasingly financial terrorists: If you don’t bail us out we blow the whole place up!

Bottom-line: A haircut of 50 percent is better than 20 but it is still too little for Greece, and the whole idea that the ‘private’ sector negotiates losses with the politicians doesn’t bode well for the future.

2. Fiscal coordination.

Nothing specific was agreed at the summit but this is where we are going, and the mainstream economists are cheering for it.

For years now we have heard this in endless macroeconomic research pamphlets and newspaper editorials: There can be no monetary union without a fiscal union. This is, of course, utter nonsense. Complete rubbish. And it doesn’t get any more right by repeating it at nauseam.


The money of capitalism

The money of capitalism, of the free market and global trade, has always been gold (or silver, but I will refer to gold here). A gold standard is the oldest and best currency union imaginable, and I would argue, the only one workable. Under a gold standard various countries and their governments use the same currency, gold. There is no central bank and no printing press. Governments have to make do with the income they generate from taxing their local population. In such a system, the state has to live, just like any other entity in society, within its means. Apparently, this is a truly fantastical notion for today’s politicians and mainstream economists. Under a gold standard, the state may also borrow from the market but it is clear to the lenders that they assume full risk of default. There is no lender of last resort. This is a powerful constraint on government largesse.

The Greek crisis was a good test to see how closely the European fiat money union could resemble the workings of a proper gold standard. In theory at least, and as intended by the original designs for EMU, there should have been no bailout and the whole mess should have been a local affair between the Greek government and its lenders, just as it would be under a gold standard.

All this nonsense about the falling apart of the euro was, of course, needless scaremongering, albeit politically motivated. When a government defaults under a gold standard, there is no reason why any other government should give up gold as a currency. Had the no-bailout provision been adhered to, there would equally have been no reason why a Greek default should have affected the acceptance and the usability of the euro in any of the other countries, nor for the Greeks themselves. A currency union does not require a fiscal union. Quod erat demonstrandum.

But EMU is no gold standard, and it already failed its first test of whether it could even be a currency union of some discipline. The gold standard was abandoned globally precisely so that governments would not have to live within their means. The euro is political paper money, fiat money, and issued to allow persistent fiscal irresponsibility, as is any other paper currency. Central banks have always been created to fund the state and the banks. The ECB is no different.

Printed money

Photographer Graeme Weatherston.

This is the global picture in 2011: After 40 years of complete paper money, public debt around the world has reached such momentous dimensions that the major central banks are now increasingly funding the state directly. This is what is happening in the U.S., the UK and increasingly the eurozone, and it is either accepted with suspicious equanimity or enthusiastically supported by bank economists and the inflationistas in the mainstream media. The trend is the same pretty much everywhere. It is only that within the eurozone it is less clear which government has first call on the printing press. In other paper money economies this can be done more straightforwardly.

To assume that some form of institutional framework for fiscal coordination will discipline the European governments and reduce the desire for ongoing central bank debt monetization is at least naïve, if not outright stupid. All governments in Europe are fiscally irresponsible, even the German one. In the run-up to EMU Germany imposed the Maastricht criteria on her European partners. Anyone remember the 60 percent debt to GDP limit? Laughable. Today Germany is at 83 percent and rising, which may look relatively prudent if compared to Belgium or Greece, but if Germany has to pay up on its already agreed upon commitments under the European Financial Stability Fund, she will go above 90 percent in one giant leap, roughly where Ireland was when her creditors said ‘no mas’! Germany may have the lowest unemployment rate in twenty years and, last year, had the highest GDP growth in twenty years, but she is still running deficits, accumulating debt every year, just like anybody else in Europe.

On a long enough time line, everywhere is Greece!

Bottom-line: We will see a plethora of treaty changes, top-level EU summits and other pointless boondoggles. All to no avail. To assume that governments will not collectively resort to the printing press and that they will instead discipline one another when all of them are long-standing, habitual and incorrigible fiscal offenders, is beyond ridiculous! If you believe it, call me, I may have something I want to sell you!

3. ‘Unlimited firepower’ courtesy of the central bank

I guess you might argue that it could have been worse. Merkel could have given in to demands by Sarkozy to use the ECB straight away to leverage the EUR440 billion bailout fund. Seems like she didn’t, and Sarkozy will have to go, hat in hand, to the Chinese and see if they have some change to spare. However, this is not a long-term solution and once Italy and Spain are in trouble, the bailout fund will be depleted.

Super Mario (photo by IMF/Stephen Jaffe)

One of the most shocking aspects of this crisis is how acceptable it has become for the mainstream economists and the pundits in the media to point towards the ‘unlimited resources’ of the ECB. True, a fiat money central bank can print unlimited amounts of paper and electronic money to bailout everybody, the government, the banks, the pension funds, etc. It is just that such a policy used to be advocated only by suicidal cranks, as it is a sure recipe for complete currency annihilation. Today, established and supposedly highly regarded economists point out the importance of ‘keeping the ECB engaged’ because only the ECB has the ‘unlimited’ resources to underwrite the boundless fiscal profligacy of modern democratic governments and their vote-buying political elites, and to underwrite the gargantuan debt pile.

As the hysterical calls by the inflationistas for a bold ECB policy get ever shriller, Mario Draghi, the new money-printer-in-chief for Europe, has already signalled his support for the ECB’s debt monetization policy, that is, ongoing buying of depressed and ultimately worthless government bonds with the help of the euro-printing press.

Anyone who has any savings stored in the euro-area should be extremely concerned about what is going on here, and in particular about the tone of the debate. When the mainstream speaks of ‘unlimited’ resources of the ECB, they do in fact mean unlimited. The creation of new euro-currency units will be without ANY LIMIT. And the remaining inflation will also be without limit.

Bottom-line: On the face of it, the German position has won: deeper haircuts and no use of the ECB for leveraging the EFSF for now. But where is the money for the larger EFSF going to come from? Italy and Spain will remain under pressure. Nobody has the money to save them or to recapitalize the banks again when the big deficit countries lose access to the market and fail. The ECB is not off the hook. Resorting to the printing press has become a global policy theme for the past three years, and sadly such thinking is now part of the mainstream. The balance sheet of the ECB will not shrink, it will grow. There is no exit strategy. Pressure for further and accelerated monetization of debt, of budget deficits and bank balance sheets will continue and intensify. The endgame will be inflation.



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  1. JP says

    Wonderful piece. Economics is not such a difficult discipline to understand if it is presented in a honest forthright manner. Thanks!

    • says

      What Trichet is saying is the following: The ECB is buying the bonds of struggling governments with one hand, injecting new money into the system as a result, and with the other hand the ECB is simultaneously draining the equivalent amount of money from the system somewhere else. Thus, this is not QE in the sense that the ECB is not employing bond buying as a means to expand market liquidity, such as the Fed and the BoE are doing. Instead, this is simply an operation to manipulate specific market prices – propping up the prices of certain government bonds. It doesn’t have a direct impact on broader monetary aggregates and thus, according to monetarist orthodoxy, on inflation. Here we have another illustration of the idiocy of the mainstream discussion of monetary policy: It seems that any activity by the central bank can only be criticized if it leads to an imminent rise in inflation. The central bankers expect to get away with all sorts of interventions and market manipulations, and expect to remain above reproach as long as they can argue that their actions do not generate inflation. As if an instant rise in the price level were the only negative effect of anything the central bank could ever do! Even if Trichet’s statement were correct, and I don’t think it is, this policy would still have substantial negative consequences: The ECB picks specific market prices and ‘corrects’ them via targeted money injections. This is a policy of price fixing and thus persistent resource misallocation, and over time it will generate massive imbalances. It should be condemned for this reason alone. Additionally, the ECB is indirectly funding the operations of the chosen governments by providing artificial demand for their bonds at lower yields. Once these governments have become dependent on this type of central bank support the ECB will not ween them off it easily. The ECB will find it difficult to tighten policy at any point in the future because a very large group of entities depends on support from the central bank. This is one of the biggest dangers of present central bank support around the world. These central bankers are digging themselves an ever deeper hole, and they won’t get out of it when they need to. Therefore, I would argue that,even if Trichet’s statement were correct this policy would still deserve to be condemned.
      But I also believe that Trichet’s statement is, at a minimum, misleading. Where exactly does the ECB drain the money from to offset the money-injection from the bond-buying program? From Greek, Portuguese, Spanish and Italian banks, which rely on extensive and growing liquidity support from the ECB? The ECB has been keeping many of these banks in business through massive liquidity provisions. I don’t see the ECB draining any liquidity. To my knowledge the ECB has been expanding liquidity provision to the banking system. There can be no doubt that, on trend, the ECB’s balance sheet has been expanding, not contracting. It may be true that whenever the ECB buys Italian bonds somebody else within the central bank may sell some other assets to sterilize the monetary impact, only for a third person somewhere else in the ECB to point out a few seconds later that there is urgent need for more liquidity for some Spanish or Greek banks. The bond-buying program itself may be run in a liquidity-neutral fashion. In aggregate, however, the ECB is providing generous liquidity to a substantial number of entities.

  2. Tom says

    Interestingly enough though, I have seen articles in the past days stating enormous pressure from both the majority of the German population and the German politicians (who seem to have been whipped into submission by the German population) to exit the Eurozone if the ECB is used to monetize debt, including buying Italian bonds.

    It seems that the German public is more intelligent than the rest of the world, most probably because they vividly remember what happened during Weimar Germany in the ’20s.

    My belief is that there is a very high probability that the German population will revolt if the ECB continues with its operation of printing money – the ECB is viewed with incredible suspicion by the German population – and Germany will then break away from the Euro and start using a newly printed and new version of the Deutsche Mark.

    The question is then, what will happen to the rest of Europe? Given that the European banks and governments (including the non-Eurozone ones such as the UK one) are related to each other, will the rest of Europe’s banking system crumble? When it crumbles, will China’s bankrupt banking system, which according to Casey Research is in even worse shape than Europe’s or the US’ banking system, crumble too? What about Japan? The US’ banking system would then have to follow suit, and all of this is therefore a huge domino effect.

    If the banking system of almost the entire world collapses, who is going to bail it out?

    My point is, given the sentiment of the German population, will they be the trigger that finally pushes the world into collapsing its entire savings that are in paper money, given furthermore the fact that the reserve currency of the entire world is nothing more than the US dollar?

    The German population will never under any circumstances accept the inflation that printing money would bring (for the very simple and truthful fact that they are afraid that the debt monetization by the ECB will spiral out of control), given that they still remember that not too long ago their nation crumbled through hyperinflation when it was called Weimar Germany.

    Therefore, the world increasingly seems like a huge house of cards that is about to blow up, exactly the minute that the German population decides to stop using the euro.

    These are going to be dangerous times, which is why I hope that Ron Paul is elected – he will be able to represent and educate the whole world about peace and prosperity during these times of desperate need.

    • says

      Tom, you make some interesting points. I sometimes wonder how good a judge I am when it comes to my fellow countrymen. I left Germany 15 years ago and I am not following debates in Germany very closely but I think I have an idea of what is going on. But even for me it is sometimes difficult to figure out the German psyche. I think you are right that there is a tremendous suspicion among the German public regarding the EMU project. The German public is adamantly against further bailouts of other countries, and I think they are almost equally fed up with bailing out their own banks. Concern about the ECB’s bond buying programme is more acute in Germany than in many other countries, and the average German is, on the margin, a more active gold buyer than the average Frenchman, from what I know. You are also right that any breakup of EMU would most probably be the result of relatively strong countries (Germany, Netherlands, Finland) leaving to protect their money and wealth rather than relative weak ones leaving to resort back to devaluation and inflationism. Again, the portrayal of breakup risk is often wrong in the mainstream media. However, there are some important buts. 1) On the European level, a lot has already been implemented against the wishes and legitimate concerns of the German public. The political establishment is strongly in favor of European centralism and institution-building, from which they benefit much more than the average German. At what inflation-rate or what size of ECB’s bond buying programme will the German public revolt? At 10 percent CPI? 15? It amazes me how much monetary lunacy has already been implemented in the UK and, to some degree, now even in Switzerland without any protest from the public. Where is the pain threshold? 2) The political implications of quitting the EU would be massive. Would a German government get a clear mandate to take such a decisive step and accept the political fallout? If so, would 10 percent inflation be enough to trigger it? Or would inflation have to be even higher and then probably already be spinning out of control? 3) The European banking system and government finances are a house of cards. When inflation shoots up and people rush out of the euro, maybe even in growing anticipation of a German exit, then things could unravel quickly. Things could collapse before the Germans had a chance to leave. 4) I have long been frustrated with the deeply rooted belief among many average Germans in state power and their equally strong skepticism towards the market. Sadly, when the crisis gets worse, I fear that the Germans will prove quite tolerant of many heavy-handed market interventions and aggressive state action, including capital controls, taxes on financial transactions, and the like. Maybe I am a bit too pessimistic in my assessment of my fellow Germans. I certainly hope so. But I am not confident that public support for the principles of the free market will be strong.

      • Deft says

        “But I am not confident that public support for the principles of the free market will be strong.”

        Unfortunately this is the truth, because people do not understand what free markets are. The question is, how is it (or is it even) possible to educate *enough* people about free markets when all the mass sources of reference (politics, media etc.) misappropriately say the current market system is free and its failure is because of this?

      • Tom says

        Detlev, I want to respond but first I would need to read Man, Economy, and State with Power and Market by Rothbard, Capital in Disequilibrium by Lewin, Ethics of Liberty by Rothbard, and Building Blocks for Liberty by Block!

        I would then talk about how capital is a metaphysical asset that starts with knowledge, that we are in an environment where paper currencies are being perceived as being worth less and less daily (not by a select few investors, but by the very public at large, especially in Germany), that this situation is spiralling out of control, that the world is bankrupt after all, that the German public will reflexively lash out against statism and politicians alike, and that gold bullion coins and bars are by their very nature the capital that is most worth owning after knowledge, given the fact that after knowledge, they are the most resistant to chaos.

        But all of this would take me some time – hopefully one day I will be able to make such a post! :)

    • says

      “The German population will never under any circumstances accept the inflation that printing money would bring”

      And what can the German population do against this? Lets not be naive and believe that democracy gives people influence on government decisions. The system does what it needs to do to survive, until the bitter end. My impression is that the German population is already overwhelmingly against these bailouts. Whoever I talk to in Germany, they all seem to be outraged by it. And yet there are hardly any critics in the Bundestag. The Germans also didn’t like the Euro in the first place. But that did not prevent the politicians from implementing it. They moaned a lot, but in the end took the pill. Since voting cannot change this, the only way of getting their will would be a real revolution like a German spring. I don’t see that happening. Most Germans are on the paylist of the state, and lets be honest, they love the state.

      Its like with the EU referendum in Britain. Most people are for it, but they never going to get it.

      • Tom says

        If politicians don’t want to be lynched, then they will start acting as the population demands. I don’t like populism, it is after all what brings dictators to power. But what I like is when populism becomes anti-statism, so that true prosperity can be pursued. I believe that we are on the verge of this, albeit in a very chaotic way. As the situation spirals out of control given the bankruptcy of the world and the paper money system, the population will exponentially become anti-statist – the natural characteristic of capitalism.

    • says

      ricardo once mentioned that these are the bithnpairs of fiscal union in eu. i wonder to what extent these punctuated crises are being used to prep the populace for this, given how invested the political class is to the unified euro. my bet is that euro as we see it know will split. germany + one or two. then the rest. these would possibly extend monetary union into fiscal union. what would germany + france gdp be as a % of us? germany + france + netherlands vs us? this is about an eco unit competitive in clout with us.

  3. David Payne says

    Mr Schlichter

    So we can now update the good senator and say: a trillion here, a trillion there and pretty soon you’re talking serious money.

    David Payne

  4. Ray says

    For years now we have heard… There can be no monetary union without a fiscal union. This is, of course, utter nonsense.

    I’m so glad you said that. I was beginning think I was missing something.

    • John Campbell says

      It certainly is nonsense but not only is the European ruling class pursuing fiscal union. Their ultimate goal is political union.

      Thanks to reading Detlev’s book, I have plunged into Austrian economics and Libertarian thought. I am now reading The Tragedy of the Euro by Phillip Bagus, which is a fascinating account of how this train wreck got started with the motivations and political machinations behind it.

      Economics has simply become the handmaiden of politics and political power for the ruling classes. The barbarians are not at the gate, but inside the castle.

      • Tom says

        Let’s not forget that it is the people that bring the barbarians to power – not the barbarians themselves. This has been the rule since human kind existed.

        Let’s blame the people, and not the ruling class. In a fascist state, it is perceived that the ruling class has the power of force, and that the people are subjugated through force. This is in effect not true, given that it is the people that are the true wielders of the force of the ruling class.

        Communism failed because it was perceived that statism would bring power to the people, and that the ruling class would therefore no longer exist.

        The only way that anti-statism can be brought to the forefront is through a natural and organic manner – which can only mean continuous education, as natural as the one that lets us relate to everything.

        • John Campbell says

          Good reminder Tom – you are correct. One thing I love about this site and Detlev’s book, among very many, is that Detlev does not spend time criticizing people. He is criticizing ideas and the actions that result from those ideas. Blame is not useful, but understanding the reasons and explanations behind human action is essential.

          In fact as I read and learn more about the Austro-Libertarian perspective, I am struck by the high regard for ideas in the context of civil discourse. It is such a refreshing change from most of the media and most of the internet.

          I have found my home here for politics and economics and yes Tom, education is the only way to spread these ideas.

          • Tom says

            In addition to the books that I listed in my other comment, be sure to read “Against Intellectual Property” by Kinsella (he is an Austrian Economist who makes the very important distinction between property which can be enforced and property which cannot be enforced – physical property and intellectual property – in that the free market works as the organizer of scarce resources, and that anything intellectual is by its very nature not scarce, and thus not an enforceable property, implying in other words that properties which can be enforced can only apply to scarce resources), “Man, Economy, and Liberty” by Block and Rockwell, and “Murray N. Rothbard In Memoriam” by Rockwell.

            Murray Rothbard and Ron Paul are for me the greatest Austrian Economists, because they are able to emphasize the border between political action and economics – which is education. There is a lot to learn from them.

  5. letmethink says

    Great piece – thank you.

    Is it just me or is anyone else wondering whether Portugal, Italy, Spain . . . . are thinking at this moment “what do I have to do to get 50% of my bank debts ‘written down’”??

  6. John Campbell says

    Detlev, if we agree that money is broken worldwide and the system is unravelling, what are the implications for different countries regarding their gold stocks?

    My brother pointed out that United States has kept it’s large gold reserves, while other countries have much less. Who has the gold and how might it affect the winners and losers in the nearer future before monetary sanity returns?

    • says

      John, apologies for the late response. I think this is an interesting point. Maybe I will cover it more extensively in a future blog. Here are just some initial thoughts: We should not simply look at the size of official gold reserves but need to look at them relative to the outstanding amount of paper and deposit money. Allegedly, the US Treasury sits on 260 million ounces of gold. I say ‘allegedly’ because the gold holdings have not been audited in a long time, which gives rise to all sorts of conspiracy theories. But let’s not go there. Those 260 million ounces have today a market value of roughly $450 billion. The monetary base and bank reserves are currently $2,656 billion, M1 is $2,133 billion, and M2 is $9,578 billion. If the US wanted to return to a gold standard today, the first question would be what part of its paper money infrastructure should be covered with official gold reserves? If it is just the monetary base, then the paper dollar would have to be devalued relative to gold by a factor of about 6, meaning the gold price would have to go from $1,720 (or so) today to $10,320. But there would then still be a lot of uncovered paper money around. The paper dollar would have to be devalued much more to cover M2, of course. Depending on the relationship between the respective paper money supply and official gold reserves, this operation would look different in different countries, but in theory, in each country it is simply an administrative exercise. I have not done these calculations but my sense is that this would look less dramatic in Germany and Switzerland than in the UK, where Gordon Brown sold most gold reserves at the bottom of the market in 1999- one of his many legacies to the British public! But again, this is a guess on my part. I have not yet done the math.
      However, this is ultimately an academic exercise. My question is: does it really matter? None of these governments want to go back to gold. They love their fiat money systems. It gives them control over the economy and the power to create cheap credit. In the US, bank reserves, M1 and M2 will not stay where they are now. They will continue to grow, and grow a lot. Same in other countries. We will see the creation of much more fiat money. I think it is more likely that the whole system will collapse in hyperinflation, in which all that M1 and M2 money is going to be wiped out anyway, and that we then get a new start based on gold money. Hopefully, this will then be an entirely private system. At the start of that system there would be more gold in some countries than in others, as per Richard’s statistic below (although we would then have to add formerly official gold reserves with private gold holdings, and in a new and private monetary system the two would combine to form the basis of the new money supply) but that is just a snap shot at the birth of this new system. Gold is international money, and gold ownership would quickly spread around the world. Under a proper gold standard all that US gold would not stay in the US for long. As I explain in my book, how much gold a gold-backed system is based upon is ultimately of minor importance.

      • John Campbell says

        Thank you Detlev – that certainly puts the situation in perspective! Fort Knox cannot ride to the rescue. And you are so right about the political will for strong, commodity based money – there is none.

  7. Pat says

    What happens if the Germans decide enough is enough. They realize they can’t save Europe or they’ll destroy themselves. Then they pull out of Europe.

  8. Sani Musa says

    Hi Detlev,
    I read your interesting response to John.Lik you rightly mentioned:The paper dollar would have to be devalued much more to cover M2, Do you think it is possible to do so? I asked this question because i believe, most governments like their fiat money for several reasons; especially economic benefits.


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