8: Are the Euro’s Trials Telling Us Something about the Cult of Bigness?
There were simple, inexpensive tests requiring no more than a pencil and a scrap of paper to prove that under the reigning ideology, the euro would not fly. In our first-year high-school algebra, we learned that to solve a problem with two independent variables you need two equations. Applied to economic policy-making this translates into:
you need as many independent policies as there are independent problems.
It follows at once that to run a union of 11 countries ranging from highly industrialised countries such as Germany and France to emerging ones like Greece and Portugal, you need an abundance of policy variables. For each country has more than a single problem. Germany itself is the product of a recent unification of Western Germany with Eastern Germany which has came through two generations of Communist rule.
No amount of idealistic fervour or greed for markets could help the statesmen over such a road bump.
On the other hand, ever since the first stirrings of European unification shortly after the war, the international financial institutions have been reworked in just the opposite direction to what was needed for making the Euro union feasible.
The central goal of the men who originally conceived the notion of a European Union, was to make impossible the recurrence of Franco-German wars. But financial ground rules of the union were determined by an institution that embodied the very spirit that led to World War II—the Bank for International Settlements (BIS). Set up as a purely technical clearing house for the transfer problems of German World War I reparations—Germany had finally been allowed to pay them in its own currency. The BIS would look after the bond issues for their transfer into hard currency. By the time it opened its doors in 1930, that program was already bankrupt. The Wall St. crash had occurred.
Yet because it was a strictly technical agency, BIS proved itself a useful clubhouse for central bankers. There they could meet and discuss bringing back the world to solid bankerly virtues. Nobody connected with a government is to this day welcome at their monthly sessions. When Hitler marched into Prague before the outbreak of WWII, the BIS tripped over itself in its eagerness to hand over to him the gold reserves the Czechoslovak government had left with it. Because of this, and other alleged pro-Nazi activities during the war, Resolution 5 was adopted at Bretton Woods calling for the earliest possible liquidation of the BIS. That caused the BIS to cultivate the lowest of profiles, and that commended it still further for what the international banking community had in mind.
For having contributed so richly to bringing on the Depression, bankers were in the 4oghouse throughout thirties. Ceilings had been set on interest rates, severe restrictions imposed on what banks could invest in. Under this forced cure, the banks had by the 1 950s recovered their liquidity, and were overcome with nostalgia for the fleshpots of yore. Over the ensuing decades, one by one, the restrictions imposed on Wall St. under Roosevelt, were unstitched. The Bretton Woods Institutions—the IMF and the World Bank—came under the influence of the BIS.
During the sixties the institutions of social security were set up, a significant portion of the world’s population was resettled. The infrastructures to catch up with 15 years of depression and war required an immense amount of public investment. There was an immense backlog of technology to bring in. Urbanisation took over on all continents. All this called for an unprecedented amount of public investment. But public investment was not recognised as such. Most of it was written off in the year that it was made. That required more taxation than was strictly necessary. Inevitably that showed up in an upward price ramp.
However, any upward inching of the price level was taken for "inflation" whether there was an excess of demand over supply, or whether it merely reflected the deeper layer of taxation in all prices. As society and the economy grew more pluralistic economic theory was reduced to a Simple Simon level. Alternatives to raising interest rates as a means of curbing "inflation" were stricken out of the textbooks. Reserves against deposits held by banks that could be moved up to counter inflationary pressures as an alternative to higher interest rates were legislated into disuse or abolished altogether. By the early 1 980s interest rates had been pushed up into the 20% range, with a real interest rate on interbank loans as high as 9%. Buzzwords were devised in series, always a new one when the previous had outlived its usefulness, but all designed to support the dogma that high interest rates and enough unemployment will cure just about anything.
No matter what the momentary slogan might be, the common purpose was to advance the revenue of moneyed interests at the expense of debtors.
And that brings us to the European Union and the growing disparity between its problems and the policy tools allowed its constituent governments under its constitution. Their annual budgetary deficits are capped at 3% of the budget, their debt at 60% of their GDP. That threw out of the window all that had been learned during the Depression, the War and the immediate two postwar decades about anticyclical budgeting—with heavy government investments in infrastructure to take up serious slack in the private sector. No distinction was made between public investment and current spending. That set the stage for the euro’s current woes.
To begin with we must recognise that currency strength or weakness is always relative to other currencies. Today the standard of comparison is the American dollar. Here the United States has two immense advantages. "The first is how little foreign currency the US government and its agencies hold $32.2 billion at the end of 1999 or 3.7% of the dollar reserves held by foreign official institutions—down from 18% in 1900. That equals less than one-tenth of one percent of total foreign holdings of US financial assets. A developing country sporting so slender a ratio would be deemed woefully uncreditworthy." By year end 1999 foreign central banks and other foreign entities had invested $881 billion of reserve balances in US financial assets-a loan equivalent of 9.5% of US GDP.1
But there is a far less well-known factor in this situation. In 1996, the US Bureau of Economic Analysis of the Department of Commerce quietly introduced some capital budgeting, i.e. stopped writing off government investments in physical capital in a single year. Carried back to 1959, that added roughly one trillion dollars to the national savings. That is about 12% of the GDP. Along with the net foreign exchange balance discussed in the preceding paragraph, these two items amount to over 20% of the GDP. Recognising such assets where there was only a hole in the previous accountancy, would have an immense significance for the credit rating of any country. That affects bond ratings and interest rates across the board. Fiddling with debt and savings statistics thus engineers a transfusion of wealth from the producing to the moneyed classes. Bad official accountancy, even though it may serve private interests well, has its crushing costs. On top of that, policy dogma hammered into the heads of the public eventually eats the wits even of the propagandists. They end up unable to grasp the most obvious relationships.
Thus The Wall Street Journal (6/10) informed us: "The European Central Bank unexpectedly lifted its key interest rate a quarter-percentage point to 4.75%, but signalled that this seventh increase since November might be the last for awhile."
"The ECB explained yesterday’s move by citing the inflation threat posed by high oil prices and a weak euro.
High oil prices are certainly a special concern for the ECB, accentuated by drop of around 30% since the euro was launched at the beginning of 1999. But high interest rates affect everything in the economy and society at large. Focussing on any single goal rules out curiosity about what might move up prices. The press has reported the shortage of refining capacity, the lack of available crude sources at every stage of discovery and development. Moreover, what limited capacity there might be for bringing further oil products onto the market will be blocked by higher interest rates. When the suggestion is made to combat inflationary pressures by raising the rate of the reserves that banks have or had to hold against their deposits, the reply of central banks is that would be a tax on the financial industries. But never do we hear that higher interest rates will not only be a tax on all producers and consumers on behalf of lending institutions, but will increase rather than ease the oil shortage. People who will pay through the nose for their heating oil this winter, will also see their mortgage rates and taxes go up. Clearly there is a disconnect here as serious as a neurological disturbance.
Nor does the damage end there. The more problems you ignore in applying a single-factor remedy, the more new problems you spawn. Those higher interest rates will reinforce the effect of the higher oil prices in depressing the economy and pushing the deficit of the constituent euro countries
beyond the permitted 3% of the GDP. That will probably lead to slashing further social services just when unemployment is likely to climb. An economy so troubled is hardly likely to attract investment, so the euro could fall further. With all road bumps to the movement of capital banned that could cause a massive flight of investment to the US.
And as though these internal problems do not give the Euro union enough balls to keep in the air with one hand—the other being tied by dogma—there are those of transatlantic origin. The United States has not had a positive balance of trade with the rest of the world in thirty years. To finance this growing trade deficit, foreign ownership of American assets has grown from $191 billion in 1976 to a current value of$8.65 trillion, exceeding the foreign assets held by US citizens by $1.47 trillion.
To keep this influx of capital which not only finances US prosperity but keeps the limping Wall St. miracle afloat, requires from the Fed not only adroitness, but a good chunk of luck. And of course, keeping the foreign funds coming in depends on ongoing performance by Wall St. The role of the US dollar as the world’s primary reserve currency helps immensely in this. With every foreign currency that collapses, the demand for US dollars increases. That strengthens the US currency, and that automatically weakens the euro. However, it can have adverse effects on American corporations dependent on these markets though they are refining their buy-out scavenging skills to high virtuosity.
Even the saints were not expected to produce more than a single miracle at a time, but to sustain the unsustainable in our globalised, deregulated world will require a baker’s dozen going simultaneously. It is the deregulation of financial flows that heightens the risk to screeching levels. We wonder when the commentators will discover the Tinbergen counting rule. When they do, perhaps one of them can patent it for a dot-coin and lease it out to Washington’s policy gurus.
Any gambler who played the market the way our central banks do, would long since have lost his shirt.
—Jane DArista in FOMC Alert, reproduced in Economic Reform, Sep.2000.