January 17, 2012 by galudwig
Philipp Bagus is surely the up-and-coming superstar of Austrian economics. A student of the great Jesus Huerta de Soto, Bagus disagreed with his mentor on one key issue: the Euro. While de Soto had high hopes for the Euro as a liberalizing influence on the socialist old ways of his country Spain (and understandably so, considering Spain’s shockingly recent fascist experiment), the German-born Bagus took the opposite view. In his The Tragedy of the Euro, which is, in my opinion, one of the greatest books in the Austrian tradition to come out in the last few years, he shares his views on the EMU. In a style very reminiscent of Murray Rothbard in What Has Government Done To Our Money (read by Jeff Riggenbach here), Bagus does for the Eurozone and the ECB in particular what Rothbard did for the US and the Fed: he constructs a compelling and well-researched historical narrative of the institutions in question and then explains where it all went wrong from a theoretical perspective based on the insights of austrian economics. And it is glorious. This is the book all Europeans should read to understand the sovereign debt crisis.
It would be too difficult to go into a in-depth review or introduction of the book (and, like always, the people at mises do a much better job than I could ever muster), but I will leave you with what I think is one of the key passages of the book, and the inspiration for the title.
When property rights in money are poorly defined, negative external effects develop. The institutional setup of the Euro, with its poorly defined property rights, has brought it close to collapse and can be called a tragedy of the commons.
His explanation of the institutional setup of the Euro as a tragedy of the commons is brilliant and utterly convincing.
The national government spends more than it receives in taxes. To pay for the difference, i.e., the deficit, the national government prints government bonds. The bonds are sold to the banking system, which in turn takes the bonds to the ECB and pledge them as collateral for loans made through the creation of creating new money. In this way, national governments can practically print money. Their bonds are as good as money as long the ECB accepts them as collateral. As a consequence, the supply of Euros increases. The first receivers of the new money, the national governments running deficits, can still enjoy the old, lower prices. As the new money spreads to other countries, prices are bid up in the whole European Monetary Union (EMU). Later receivers of new money see their buying prices increase before incomes starts to increase. (…)
From a politician’s point of view, incentives in such a system are explosive: “If I, as a campaigning politician, promise gifts to my voters in order to win the election, I can externalize the cost of those promises to the rest of the EMU through inflation—and future tax payers have to pay the debt. Even if the government needs a bailout (a worst-case scenario), it will happen only in the distant, post-election future. Moreover, when the crisis occurs, I will be able to convince voters that I did not cause the crisis. It just fell upon the country in the form of a natural disaster. Or better still, it is the doing of evil speculators. While austere measures, imposed by the EMU or IMF, loom in the future, the next election is just around the corner.” It is easy to see how the typical shortsightedness of democratic politicians combines well with the possibility of externalizing deficit costs to other nations, resulting in explosive debt inflation. (…)
The Euro is not a failure because participating countries have different structures, but rather because it allows for redistribution in favor of countries whose banking systems and governments inflate the money supply faster than others. By deficit spending and printing government bonds, governments can indirectly create money. Government bonds are bought by the banking system. The ECB accepts the bonds as collateral for new loans. Governments convert bonds into new money. Countries that have higher deficits than others can maintain trade deficits and buy goods from exporting states with more balanced budgets. The process resembles a tragedy of the commons. A country benefits from the redistribution process if it inflates faster than other countries do, i.e., if it has higher deficits than others. The incentives create a race to the printing press. The SGP has been found impotent to completely eliminate this race; the Euro system tends toward self explosion.
Apart from one last short quote, I’ll refrain from posting more, do download the book for free and read it, it is truly enlightening.
Expectations are grim. The European Union has become a transfer union. Interest rates that most governments have to pay on their debts remain at a high level. Sovereign debt levels are still on the rise. The future will tell us if the situation was sustainable.