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Home > Authors > Detlev Schlichter

Greece Should Return to a Gold Standard

April 9, 2012 by The Gold Standard Institute International

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http://papermoneycollapse.com/2011/06/greece-should-return-to-a-gold-standard/

From:http://papermoneycollapse.com/2011/06/greece-should-return-to-a-gold-standard/

By Detlev Schlichter On June 23, 2011

Gold bar

The New Drachma? (photo by Swiss Banker)Fallacies and Misconceptions about the Greek Crisis

One frequently gets the impression from reading the mainstream media that Greece has a monetary policy problem and not a fiscal problem. This is incorrect. Yet many commentators seem to argue along the following lines: This crisis is due to the straitjacket of the single currency with its one-size-fits-all monetary policy, or at least aggravated by the constraints of this system. Greece would have more “policy options” in dealing with its troubles if it had control of its own national currency.

Then there is, connected to this, an underlying – and not very flattering – notion that the Greeks are somewhat unfit to live and work in a ‘hard money system’, which presumably the euro is. The Greeks, this seems to be the allegation, like borrowing and spending too much. I am paraphrasing here but this is certainly the underlying tone of the narrative. The Germans and Dutch and French can live without the constant aid of conveniently cheap national money – but the Greeks can’t.

This is nonsense, and dangerous nonsense at that. Let’s first look at what Greece’s alleged “options” would look like if the country suddenly had the drachma back. The idea in the mainstream media seems to be that they could have lower rates and an even easier monetary policy than they have today under the ECB, and that such a policy would be suitable to the country as a whole. We have to remember that the ECB is already running an ultra-expansionary monetary policy, that the ECB is already the single biggest owner of Greek government debt, and that the ECB is very generously funding all euro banks (including the Greek banks) under lending programs that allow a lot of toxic waste to be used as collateral. But, I guess, a newly independent drachma-central bank could print even more money, hand that money to the Greek banks and the Greek government to allow them to stagger on, and then have a go at – what’s that pernicious phrase, again? – “inflating the debt away”. Well, good luck – we will debunk this shortly.

But there is another, slightly more sophisticated sounding argument out there. According to this ingenious interpretation, the Greek government is insolvent not because it habitually spends more than it takes in but because the Greek economy is not growing fast enough. If only the Greeks were more competitive and could sell more stuff abroad, then their government could happily continue spending! So again, the problem is with the inappropriately “hard money” of the Eurozone when what is needed is “soft money” — a super-easy monetary framework, in which the currency can be debased and international competitiveness and government solvency be restored with cheap money and low rates.

Euro banknotes

Photo by M. BartoschLuckily, I have never needed the help of any of those debt advisory services for consumers who face personal bankruptcy, so I am not speaking from experience here. Yet, I very much doubt that the first advice these services give to individuals at risk of getting crushed under mountains of credit card debt, is that they should get better jobs so their income rises. Yet, this seems to be the standard advice from mainstream economists for governments. Governments are expected to manipulate the economy via their paper money monopolies in order to generate the economic growth they need in order to sustain their lavish spending. Economic reality has to be made to perform to the demands of state largesse.

Also, I wonder, if soft money is such a great idea, why should we confine it to Greece? Should we then not all ask our central banks to run an even easier policy to “stimulate” growth? Well, most central banks are already trying this without much success. Could it be that there is something fundamentally wrong with fighting a crisis that is the result of too much debt and cheap credit with yet more debt and even cheaper credit?

I am not quite sure what is scarier, the present crisis or the fact that such economic nonsense is widely considered accepted wisdom.

A soft drachma would be of no benefit

But back to Greece. First of all, it should be clear, that a reintroduction of national paper money in Greece and the subsequent debasement of this money would not prevent bankruptcy. It would accelerate it, as the original debt was contracted in euros, and any attempt to repay it in debased “new drachmas” would constitute a default. (Of course, the Eurocracy may try and label it “restructuring” or “re-profiling”, but the rest of us have to live in the real world.) And even if repayment in new and debased drachmas was finally agreed, it would still constitute a massive loss to euro-area lenders such as the reckless German and French banks that foolishly lent to Greek politicians with blissful abandon and that are really the designated beneficiaries of the bailouts. They might as well write-off the Greek euro debt now.

Reality is not optional. The Greek government is bust, which means it cannot and will not repay its debt in anything of material value. Introducing a soft drachma doesn’t change anything.

However, many commentators suggest that even after default and substantial write-downs at the banks and pension funds, Greece should still leave the euro. Why? First of all, there is no need for an exit. The euro is a form of paper money, and paper money is not debt. The euro, just like the dollar, pound and yen, is an irredeemable piece of paper. The governments that issue it promise to exchange these notes for – nothing! The creditworthiness of these states is immaterial. The Eurozone is a currency union, not a credit union or fiscal union. I explained this here.

But I suppose the argument for post-default exit is essentially the one I cited above, namely that a soft national currency is more in character with the Greek’s alleged tendency to financial extravagance. Even if we accepted the distasteful national stereotype behind this, this argument would still be nonsense.

Debasing the currency can never be in the interest of Greek society – or any other society for that matter. Of course, weakening the exchange value of the new drachma would be a temporary shot in the arm to the export industry. As Jamie Whyte explained so lucidly here, and using the UK to illustrate the point, a weak currency is a subsidy to exporters funded by a tax on importers. Debasing the currency never furthers overall prosperity. In terms of access to internationally traded goods and services, the Greek population would get instantly poorer.

Additionally, easy money is a subsidy to the banks and the borrowers, and a de-facto tax on savers, who – contrary to the caricature in the media- do in fact exist in Greece. The recommended soft money policy for Greece would mean that savers lose purchasing power via a combination of artificially low interest rates, international currency depreciation, and rising domestic inflation. But sadly, savers do not count for much in today’s macro-economic debates, which are all geared toward borrowers and dominated by Keynesian ideas of boosting the growth statistics and generating artificial “aggregate demand”. Such a policy bias has far-reaching and long-lasting consequences. Saving and the accumulation of real capital are the backbone of any economy and the only method we have for increasing productivity and thus generating lasting prosperity. It is the savers who put the capital into capitalism.

Currency debasement is never in the national interest

Savers are presently taking their money out of the Greek banks and the Greek economy and, together with the productive elements of society in Portugal and Spain, put their money into real assets overseas (such as property here in London), thus making a mockery of the notion that the adoption of soft national paper monies would be in the national interest. In fact, as the Financial Times reported yesterday, many Greek savers are currently rushing into the eternal form of money, gold, the sale of which is rising sharply in Greece. These people choose the hardest form of money for their savings. They fear bank runs and financial collapse but also exit from the euro and subsequent currency debasement as all of these are damaging to their wealth. They are certainly part of the nation but debasement is certainly not in their interest.

National Bank of Greece in Athens

National Bank of Greece in Athens (Photo by Michalis Famelis)And there is a further problem. Even for the supposed beneficiaries of these policy recommendations – the local export industry, the borrowers, the government and the moochers and freeloaders who cling onto the state like a nasty skin rash– the benefits would be fleeting. They would only last a second or two, then the benefits of currency debasement would turn into disadvantages – and disadvantages for everybody. Savers and creditors, whether domestic or foreign, would demand higher yields for keeping their money in the country or putting new money into it. Gains in the exporting industries would not only be offset by losses in the importing industries but the overall wealth would diminish through higher inflation and reduced capital accumulation. No society has ever enhanced lasting prosperity through a weak currency.

The notion that a debt problem can be solved or alleviated via inflation is a misconception. The cost is only socialized and spread across all holders of the domestic paper money. This policy is not only immoral as it burdens innocent bystanders – people who never contracted for that debt as I explained here – it is also ineffective. The holders of domestic bank deposits and domestic bonds are not simply going to sit tight and let their wealth evaporate. They either get out or demand a risk premium for staying in.

The idea that states that owe money in their own paper currency cannot default is wrong. Once the markets sense that the government or its central bank tries to “inflate the debt away”, the currency and the domestic debt get sold and real interest rates shoot up. This quickly worsens the debt dynamics for domestic borrowers, most importantly the government itself. In the end you get both, hyperinflation and sovereign default, as has happened numerous times before.

The problem is not that the euro was too much of a straitjacket for Greece but that it was too little of a straitjacket. The lenders to Greece probably knew very well that the Greek government was overspending but still funded it generously. Consciously or subconsciously, they must have thought that the euro-area is still a paper money arrangement, and therefore they never expected that the question of sovereign solvency would even arise. They were wrong. They should now take the losses.

The widespread idea that diverse countries cannot share the same currency is evidently wrong. They have done so in a stable and mutually beneficial way under the international gold standard. A proper commodity money system is, of course, a straitjacket for states and banks. As the present crisis shows, such a straitjacket is urgently needed. The excesses of ever-expanding paper money, which the world suffers from today – unsustainable debt levels, weak banks, and distorted asset markets –, are inconceivable under a real gold standard.

Greece is not the only country that will default. It is simply the first. Portugal, Spain and Italy will follow in due course. By then the ECB will have printed trillions of new euros to keep German, French and other banks in business. If the Greeks really wanted a weak currency, they should stay in the euro. The euro – like the dollar, pound and yen – is already on a slippery slope of irreversible decline.

A gold standard for Greece?

But the Greeks are now the first to take the pain. They are the first to hit rock bottom, so they should be the first to be able to rethink the situation and look at other options. As soft money is not in the interest of any society, why not be the first to go for hard money? Money that is harder and more trustworthy than any politicized national fiat money which the authorities can print without limit? Greece should allow the full and painful liquidation of the paper money excesses, it should let the government default, exit the euro and be the first to reintroduce a proper gold standard. This would give the country instantly much needed credibility. It would not only keep Greek savings in the country, it would attract savings from around the world, potentially making the country a magnet for savers everywhere who are increasingly concerned about aggressive monetary policy and are desperately looking for safe places to park their cash.

I have no doubt that the most important economic event of the coming decade will be the demise of the global paper money system. We live in the twilight of the fiat money era. A return to apolitical, international, commodity-based media of exchange is inevitable. Why not start with Greece? The transition would be painful but there are no painless options available anyway.

I am convinced this would be a sensible strategy but I also think it is unlikely. The state and the banks benefitted from the paper money franchise, and they are now addicted to cheap credit and unwillingly to check into rehab. The establishment will continue to fight a return to sound money.

In the meantime, the debasement of paper money continues.

Filed Under: Detlev Schlichter, Gold and Silver, Popular Economics

The Second Crisis of Socialism

March 7, 2012 by The Gold Standard Institute International

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The world is facing the worst financial crisis since at least the 1930s, “if not ever,” the governor of the Bank of England said last week, when he explained to an increasingly sceptical and weary public the bank’s decision to print yet more fiat money and use it to buy yet more government bonds. I doubt that his words or his actions will do much to restore confidence. And they will not mean an end to this crisis.

What type of crisis is this?

This is a financial crisis, for sure. Its root causes are firmly located in money, credit, debt and banking. And I don’t think that the governor was exaggerating when he speculated about its magnitude. This is the Big One.

As we all agree that this is not just another business cycle, the question is what are we dealing with here? How should we define this crisis, and in what context can it best be understood?

This crisis is systemic, not cyclical. It is a crisis of institutions. It is a crisis of policy. It is a crisis of our financial architecture.

When this crisis started in 2007 and intensified throughout 2008, it was often labelled a “crisis of capitalism.” You don’t hear that so often anymore. Granted, there are still the occasional lapses, sadly, even by economists, but the longer the crisis goes on and the longer the spotlight remains on money and banking, the more it dawns on the public just how much the present financial architecture is evidently defined not by the “invisible hand” of the market, but by the controlling hand of the state.

When yet another round of bank “recapitalization” is announced (presumably, at taxpayers’ expense and, thus, driving home the point, once more, that the banks are above the fray of normal and fallible capitalist enterprise)…

…And when the salvation for our debt-laden economy is declared for the umpteenth time to be sought in yet more debt-funded government spending, or in yet another injection of more money created under state monopoly by the central bank and handed to the public as an apparent incentive to take on yet more debt, the public is beginning to wonder if policymakers have not lost the plot, and if we should not fear the “stimulus” more than the unchecked market.

Why are we in this mess?

“Undercapitalized banks” is code for banks that lent too much. How can banks have lent too much – and, obviously, have done so for years, decades even, and have done so the world over in the most enduring and persistent credit binge in history – when they are all under the control of the state central bank, which, in a paper money system, has the monopoly of printing (unlimited) bank reserves and administratively setting short-term interest rates and, thus, controlling lending conditions? Is this not properly called state failure, rather than market failure?

Please remember, the switch from apolitical, inflexible and hard commodity money to limitless paper money under state control was a political decision, not the result of market forces.

And it only came into full bloom with the closing of the gold window by the politician Richard Nixon in 1971. Our financial system is the outcome of political design and popular macroeconomic theory. Both have now revealed to have been self-serving and flawed, not the result of spontaneous human cooperation on markets.

The move to fully elastic fiat money freed both the state and its proteges, the banks, from the golden fetters of inelastic commodity money. Without the straightjacket of a gold standard, the state obtained unrestricted control over the printing press and could engage in “managing” the economy, saving the banks, avoiding or shortening recessions and determining borrowing conditions – and setting them more generously, not least for itself.

After 40 years of government-controlled money, this is the result.

This crisis is the inevitable outcome of the dangerous belief that low interest rates, and investment and lasting prosperity, can be had via the shortcut of money printing – and its twin sisters, artificially low lending rates and never-ending bank credit creation – rather than the time-honoured hard way (and capitalist way) of saving and true capital formation.

This is not a crisis of capitalism. My good friend Brian Micklethwait coined a much better phrase for it: This is the second crisis of socialism. We are witnessing the demise of the paper money standard. 40 years after the global fiat money system was freed of its last link to gold, money everywhere became simply an unchecked territorial monopoly of the state. What we are now finding out is this: The state and the banks need a straightjacket, or they will sooner or later drag us all into a black hole.

Why is this system socialist?There are two ways in which a monetary system can be organized: Either the market chooses what is money, or the state does.

The money of the free market, of capitalism, has always been commodity money that is outside of political control. Wherever the trading public was free to choose, it picked commodities of fairly inelastic supply as monetary assets. Almost all societies, throughout all cultures and civilizations, have come to use precious metals as money.

Commodity money is apolitical money. Nobody can create it at will and use it to fund himself or to manipulate the economy. Crucially, human cooperation via trade does not stop at political borders, and commodity money has always transcended such borders. If gold was money this side of the border, it was usually equally money on the other side, regardless of whose image was printed on it:

By contrast, complete paper money systems that have no link to an underlying commodity are always creations of politics. In such systems, money can be “printed” at essentially no cost and, thus, practically without limit. But not by everybody. Money printing is the privilege of the state and its central bank. Money, in this system, is entirely elastic. But it is political money and closely linked to political authority.

In a paper money world, if you cross a political border you have to swap your money for different money. All the efficiency of today’s 24-hours-a-day, multi-trillion-dollar foreign exchange market, which so easily impresses the untrained observer to whom it may epitomize global capitalism itself, is nothing but the market’s attempt to cope as best as possible with the inefficiency of monetary nationalism and monetary segregation that is the result of every national government wanting its own paper money under its own territorial political control.

To call this system capitalist means depriving the word “capitalism” of its meaning.

In this brave new system of fully elastic fiat money, we put our financial affairs not in the hands of the unfettered market, but in the hands of the state, of politicians and central bankers. This system is properly called a socialist one, not a capitalist one. And this system has failed.

Who are the beneficiaries?

For decades, this system has benefited the state, the banks, the wider financial industry – all of which have grown relative to any other section of society – and those who have assets to be used as collateral for leveraging the balance sheet: real estate, equity portfolios, company stock options. The costs of this system have been spread across the broader public via inflation and the occasional taxpayer bailout. This has been socialism for the rich.

Just like the first crisis of socialism – the collapse of the planned economies under Soviet guidance in 1989 – this crisis, the crisis of government-controlled finance, will also see the overthrow of the present establishment. Although the party leadership is still telling us that they have things under control: Fear not, comrades, with some deficit spending and some astute money printing, tractor production will soon reach targets again.

And just like the collapsing socialist state, the state-paper-money bureaucracy, too, has its true believers. People like Adam Posen, the Bank of England’s quantitative easing enthusiast, who maintains his childlike optimism for and unwavering faith in the power of the printing press. If £200 billion of newly printed money, cleverly placed by the apparatchiks into the coffers of the banks and government, have not solved the crisis, surely, the next £75 billion will. And why stop here? With another £175 billion or £275 billion or £375 billion, everybody in the U.K. should find a nicely paying job again. To people like Posen, the problem with the planned economy is not that it is planned, but that the plan wasn’t bold enough.

Mervyn King, on the other hand, strikes me as a more Gorbachev-like figure, not a nonbeliever, but too sceptical and too smart to be a fully signed-up party member. There is a fascinating interview with him from September of last year that got little attention in financial market circles, presumably, because it was part of a BBC history program on Chinese paper money, rather than on today’s monetary policy. The question asked was this: Are all paper money systems doomed to fail? King answers: No, he thinks, not all of them (although every single one has indeed failed), but he admits that the recent crisis has made him a bit more cautious in his assessment. Maybe the jury on whether paper money could be made to work at all was still out. Remarkable for a central banker, I thought.Regards,


Detlev S. Schlichter (Hampstead, UK) is a writer and Austrian School Economist. Schlichter has a degree in economics and spent nearly 20 years working in international finance, including stints at Merrill Lynch and JP Morgan. He served as a portfolio manager of fixed income portfolios at J.P. Morgan Investment Management and, in 1996, moved to London to work in the global bond team of the company there. In his career, Schlichter has overseen billions in assets for institutional clients around the globe.

Filed Under: Detlev Schlichter, Gold and Silver, Popular Economics

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