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Italy and the euro: On the edge (economist.com)
141 points by llambda on July 15, 2011 | hide | past | web | favorite | 105 comments

>They cannot agree on who should bear the cost of today’s crisis: should it be creditors (through a write-down), debtors (through austerity) or the Germans (through transfers to the south)?

In theory it should, of course, be the creditors. You buy an asset (govt bonds), you're implicitly and knowingly shouldering a risk of default. The institutions that bought these assets should have known what they were buying. Caveat Emptor.

Of course in practice you need to ask what the wider implications of default are. Greece _should_ be allowed to default. Absurd austerity budgets are penalising the average Greek whilst minimising the bottom line impact to (arguably wealthy and powerful) European banks. It's no wonder they're pissed. The short-sharp shock of a Greek default will be over in no time. Rolling debt and refinancing terms etc etc is likely to make things worse in the long term.

But of course Italy is different, given the size of the economy. The impact of a default is likely to be far, far wider than a write-down to the creditors. But to be honest I think this worry over contagion is being over-blown. Markets often over-react. It only takes a single hedge-fund these days to move a market - even a big one like Italy debt. It's probably just Bluecrest or Moore selling the market :)

>In theory it should, of course, be the creditors. You buy an asset (govt bonds), you're implicitly and knowingly shouldering a risk of default. The institutions that bought these assets should have known what they were buying. Caveat Emptor.

Indeed. But the reason why you try to avoid a default (or the prospect of one) is that you want to continue to borrow money to finance your deficit spending. Otherwise you get the worst of both worlds: forced austerity and creditors that want nothing to do with you without high interest rates.

Yes, absolutely. I was going to add an edit to this effect. Damned if they do, damned if they don't. Anyway the running of these deficits _does_ need to be curbed. It's clear that Greece has been pretty terrible at collecting taxes and managing it's finances. Even now with "Austerity" the UK is still spending £4 for every £3 it earns. Austerity just means "slow the increase in debt". In fact it's prob not even a first-order change, but second order: slow the rate of increase!

Edit: don't know why you've been dv'd, your point is absolutely relevant.

It's not as simple as that. Greece is in a hole largely because tax evasion is the national sport. The "average Greek" should bear the brunt of it. He or she owes decades of back taxes anyway... The premium Greece will have to pay on it's debts won't go away with dropping out of the Euro.

Except that the loans in question were made to the Greek government, not the average Greek. The creditors should have taken into account the Greek government's inability to collect proper taxes.

Let's be honest, tax evasion is pretty much a national pastime in the US too -- the difference is that here the IRS will come after you if you cross the line.

Yes, whereas it's systemic in Greece - the government will call off tax inspectors in an election year!

The only way forwards I see is for the Germans to take over the collection of Greek taxes, and to control Greece's spending too, at least for a generation.

I highly doubt that will happen unless Germany wants to try turning Greece into a police state because the people will not stand for that.

Yes well that was the problem - Greeks are happy to vote for high government spending, they even vote for high taxes - they just don't pay them.

I think we'll also see them sell their half of Cyprus to Turkey too, for a few billion Euros, once the austerity starts to bite. And the Germans have their eye on a few of the Greek islands too.

Sorry, WTF ?

The Republic of Cyprus is a sovereign state, it's not part of Greece.

Then they won't mind relinquishing their claim on it, then! And British peacekeepers can withdraw at last.

What, essentially, you just said:

"US Treasury Bonds downgraded because of the Deficit Cap row? OK, so the Americans can just sell their half of Canada to France."

This Cyprus diversion of yours was just wrong to the point of surrealism. Let it go.

It was only recently that Greece stopped openly calling for enosis, enjoining Cypriots to overthrow their own government if necessary. They've been quieter about that crap over the last couple of decades, but Greece still clings to the territorial dispute to justify its overgrown military. It is quite accurate to say that Greece hasn't yet let go of Cyprus, and that doing so would save it considerable money.

To my knowledge, the U.S. has never encouraged Canadians to overthrow their government, nor do they use Canada as an excuse to justify an expensive cold war against, say, France.


Canada hasn't been turned into a warzone in recent history by France and the US arguing over who owns it.

The UN mission, UNFICYP is multinational, and talks about withdrawal are serious. The British bases there have nothing to do with peacekeeping.

It is not just the tax dodging though. The greek people are, at least in Europe, known for being lazy and many of them are in government positions where they get paid a lot but don't work a lot. That they dodge taxes on top of that is just icing on the cake.

The other issue is that Greece couldn't keep up with exports in terms of cost with other EU member states. It isn't able to keep up with other high export countries for the same goods.

All Greeks I've met that had a government job made it a point of pride of how little they worked and how they spent their days openly in leisure or working a second job on government time. The private sector employees envied and cajoled them. It was surreal. Maybe it was the alcohol.

This is a real problem, as far as civil services are concerned. If you want to go to some service to do some work, their opening hours are frequently 10am-1pm. It's ridiculous, and really makes things hard for the public. I'm not familiar with any service that stays open to the public after 2pm, post offices, hospitals, whatever.

Meanwhile, employees in the private sector work 11-13 hour days, 6 (sometimes 7) days a week, so calling Greeks lazy is unfair. Most of my friends are amazed and envious when I tell them I don't work on Saturdays.

I've heard that kind of boasting from Americans working at dysfunctional large corporations also. Get people over beers and they'll tell you about how in all of last month, what they did is played 5000 games of Bejeweled Blitz, made 3 bullshit Powerpoint presentations, attended a few bullshit meetings, and carefully tweaked their .vimrc while pretending to work. It seems to be the sort of culture that crops up when people are in dysfunctional settings and cynical about whether their job is actually doing anybody any good; kind of a coping-mechanism I guess.

Of course telling creditors to suck it up is a great way of guaranteeing that you'll never see a red cent from them - or their buddies - again.

Pissing off your creditors is like pissing off a business partner - you do so at your own risk; the more powerful the partner, the larger the fall out.

Who knows, maybe Greece is about to get as much money as they can from the EU in order to default after? What would happen in this case?

I believe that the money lent to Greece is just being funneled back to banks to pay their existing debt obligations. The so called bailout for Greece is really a bailout for banks. Everyone knows Greece will never pay back these loans. The hope of the ECB is that a Greek default can be pushed long enough into the future so that when it does default the banks will be in better financial shape. The fear is that right now the banking system can't handle a Greek default.

Yes, this could be an explanation. But why would the Greek government provide the money to the banks? I mean they could invest the money (that they've got from EU and IWF) in infrastructure and economy and then declare default. If I understand it well Argentina was as well helped by IWF, but in the end they defaulted - and it seems like it was the right step. So I do not really understand what is the EU's interest to absolutely safe Greece from default? They are pumping more and more money at a time where many voices say that Greece will not be able to pay back. Even George Soros thinks: "A Greek default may be inevitable but it need not be disorderly" (http://www.cnbc.com/id/43720940).

So if you could explain, why is it important for the banking system to be able to handle a Greek default? I mean throughout the financial crisis everybody is saying that it is absolutely important to save the banking system - every politician repeats this like a parrot. But why? Most of the middle/lower class population in Europe does not have spare money in a bank account but in contrary has debts for housing or other stuff. And I would guess that this is by far more than 80% of population. These people would not necessarily suffer from banks collapsing, but they are suffering from the economic cuts that the governments are doing everywhere in order to save banks - who are actually responsible because they did not mitigate the risk and triggered the subprime crisis.

So if you have a good explanation, please share with me.

The interests of the ruling elite of Greece do not coincide with the interests of the average Greek. Greece is part of the EU and it's leaders are part of a ruling social group within this context. How they view things is differently than how the average Greek views things. Or how you and I view things.

The Greek government has bond payments to make and needs money to make those payments. The funds recently released by the ECB are for Greece with the understanding that it is just going to take the money and pay make the bond payment. The ECB wants Greece to sell assets. There is money to be made by for foreign companies buying national assets of Greece. The ruling elite stand to make money from this as well. The average Greek stands to lose big time. Hence the demonstrations.

Greece should default. It should leave the euro. Its government should not exist to serve the interests of the banking elite.

That's only part of the picture. You could just as accurately say that the government should not exist to serve the interests of the unions. Taming the banks would not make Greece's problems go away, nor would aligning the interests of the Average Greek with those of the elites.

The population of Average Greeks doesn't maintain economic productivity sufficient for any kind of significant export economy.

The population of Average Greeks doesn't pay enough taxes to finance the government at even a basic level, never mind the more luxuriant indulgences like a bloated military.

To the extent that it's unionised, the population of Average Greeks values job security for themselves above overall employment and economic solvency.

You are right that the average Greek will be on the losing side of any sales of national assets. But from the looks of things, the average Greek is unwilling to consider the structural improvements that that are the viable alternative.

You've hit one of the biggest issues on the head and that is the greek do not pay enough taxes yet each time they are more than willing to vote for tax increases and increases of social services made available to them.

One of the things that the greece government has to do is cut back on those social services and ACTUALLY start collecting taxes it is owed to make up for that debt.

The greek people are unhappy to cut social services and are not willing to pay taxes... that doesn't work.

Fully agree.

"Most of the middle/lower class population in Europe does not have spare money in a bank account but in contrary has debts for housing or other stuff."

Actually, unlike their government, most Greek households do not have high debts:

"Greek consumers are relatively frugal, with household debt equal to just 61% of GDP, compared the American household debt of 95.7% of GDP"


Most people in EU invest their money in real estate or some other hard value. But contrary to US, most people do not handle their economics for the retirement by themselves - this is handled by the governments. So there is really not much to lose if some banks will go bankrupt. It would finally clean up the whole mess. Looking at the figures above I ask myself why Americans did bake the US government to bail out the banks - seems they should have even less interest?

The American people wrote in large numbers to their representatives to not bail the banks back when. If you remember, the bill was not passed first time around.

It probably would have been much worse though had it not passed second time around. Tremendously long cues like the British bank Northern Rock worse.

The problem as I see it, and the article briefly hinted at this is illiquidity. Western Europe is extremely rich (in terms of capital stock) but has a relatively low income (in terms of capital flow) and extremely low income growth. Without structural reforms (improving infrastructure, decreasing frictions in the labor market, reducing entitlements to incentive work, etc) you cannot increase income or income growth levels.

But, by increasing public claims on private wealth and opening the country up to foreign direct investment (read: selling the Sistine Chapel to China to rent) you can tap the capital stock. This should be increasingly seen as a way out for wealthy yet cash-poor Euro countries.

Without structural improvements in the US it will also be the only way forward 30 or 40 years for now. Be prepared for a "Sponsored by India" sticker on the Washington Monument.

That's interesting. It immediately made me think of the way Chicago sold off its parking meter system in 2009(?) to a private company for a fraction of what it's worth. The deal is so bad for the city, I almost have to believe it was corrupt.

I suspect sales of national assets are unlikely to tap their full value, subject as they are to corruption and to the likelihood that the sellers are over a barrel.

That was unfortunate. But another side of the issue in Chicago was that the city blew through the cash in record time. Even if the meters had been sold off at an above market price, the disfunction in the local government would have resulted in the squandering of the proceeds.

From your well made point I infer that we should make a dispassionate evaluation of the value of public assets during good times so that they won't be sold for a song during bad times.

Things usually go, "No we will not sell off pieces of our nation" (during good economic times) so nobody actually evaluates the options for doing so --> "We need cash now!" And we become subject to market forces when leveraging public assets.

Some large Amercian cities -- San Fran comes to mind, Chicago maybe just as much -- are microcosms of countries like Greece. Enormous government payrolls locked up in union contracts, massive social regimes from which a large part of the population either draws upon or derives job security, and a corrupt and labyrinthine tax system.

Not really. San Francisco and Chicago are governed just as badly as some third-world kleptocracies, but those cities fortunately have relatively little general obligation debt (proportionally much less than Greece). Eventually they will probably declare bankruptcy and repudiate their ridiculous union contracts.

The lesson I take from it is that we shouldn't sell off public assets, because their long-term ownership is likely to provide more value to the public than the one-time money from a sale does, especially given the high likelihood that the one-time proceeds will be squandered by politicians. Better to keep the meters, and allow meter revenues to trickle in a little bit every year, rather than receive and waste 99 years of meter money in a lump sum.

Your explanation is a silly mix of right-wing tropes.

You think it's going to be China that buys the Sistine Chapel, or India that purchases the Washington Monument?

No, it will be crony capitalist groups (formulated by the banksters and politically connected) that do so. The fact that these groups may be involved with some sovereign wealth fund of a BRIC or other country is incidental.

Then they'll rent it out at obscene prices and gouge the public further.

Hmm, well I didn't think this needed clarifying but the internet is notoriously bad at transmitting humor (or maybe I am). But I was being facetious with respect to the examples I gave.

By capturing private wealth, what will most likely happen are taxes on existing wealth (national property taxes, increases in the estate tax, etc.). National debt is uncollateralized and will always be this way, so sovereign debt holders will never have claim to the physical assets of a nation. It is country themselves that can change laws to appropriate private wealth. Constitutions and laws vary in the extent to which this is allowed. There is the notion of an unconstitutional level of taxation in the US.

As for the rest of your ideological rant.


I enjoy the Economist because they cover topics well and will tell you their sources as well. (which both validates that they have sources and you can evaluate the base information they are using for their article). That being said, this particular event, or series of events, will change the European Union profoundly.

As with most political enterprises, the EU is a compromise. Much like the original Articles of Confederation [1] it took a very touchy situation (pretty much independent political nation-state entities) and attempted to craft a framework around how they might co-operate politically, financially, and militarily.

Early criticism of what was produced was once called 'a bus where every passenger has their own steering wheel' by a Swiss delegate. We can see the literal effects of that as participating countries, have their wheels apparently turned 45 degrees to the direction of travel. If enough countries do that the bus can, and will drive off the road. (ok that's enough torturing of that analogy!)

Europe remembers what it was like to be dominated by Germany involuntarily. One of the sub-themes of the original EU discussions had very real tension about effectively handing over the soverignty to the 'big' economic powers (France, Britain, and Germany). So there were a number of checks and balances in the final treaties that provide very real limits on what the EU can do (mostly they left in the ways to 'help' and took out most of the ways to 'discipline'). That compromise may ulitmately be untenable and the events of the next few years will test those compromises to the breaking point.

I predict several things will be true after this crisis that are not true now. One, I think there will either be a way for the EU to expell a member or to put it under 'federal' control. Second there will be a trans-EU judiciary system which allows for injecting change (either through impeachment, imprisonment, or both) into member states leadership. If such a system existed it would have allowed the joint-EU leadership to demand (and get) corrective action on destructive behavior.

Those changes will effectively mean handing national soverignty over to a central authority. And either the Europeans will be able to swallow that change, or the EU will disintegrate back into independent nations.

It may be that they reach a compromise somehow, but my expectations that the EU will survive unchanged are low.

[1] https://secure.wikimedia.org/wikipedia/en/wiki/Articles_of_C...

The 13 colonies fought a war against a common enemy (Britain) for a relatively short time and did not suffer greatly (compare with Ireland).

Europe countries have been at war with each other on and of (mostly on) at least for a thousand years and while Poland and Russia suffered far more, very few have forgotten what happened to Rotterdam, London and the occupied cities in France.

The horror of the first world war broke one of the most militarized countries in the world (laugh at France all you want, but it was Napoleon who fought Russia). France has never been the same since. It was only a few months ago that they allowed a (tiny) German military base in France.

My maternal grandparents where children during the occupation and was thrown out of their house by the Nazies. To this day they still hate them.

Don't forget the historial rivalries between the UK and France either, though they don't hate each other nearly as much as the French hates the Germans.

Europe is a cross section of old scars and grievances and relative recent wounds that haven't healed all that much; Even the old scars can easily be ripped open.

Europe will never go for what you suggest.

I've lived or spent extensive periods of time in most big European countries (Germany, UK, France, Spain), and there isn't much hate between them anymore. Maybe in the 70+ age bracket you will find some. Then you maybe have some mild distaste from 50-70 year olds, indifference at 35-50 and some appreciation from young people. If you compare German, French and British opinions of each other with their opinions of Turks, North Africans, and Indians respectively it's not even a contest.

That doesn't mean that anyone's going happily hand over their sovereignty, but the picture you are painting of Europe does not fit with my experience at all.

I completely agree with your assessment.

The worst case outcome I can imagine is that the EU will dissolve, the Euro will be abandoned, and Europe will return to its previous state of decline in terms of competitiveness in the world economic stages. China and India will fill the gap and except for the self supporting economies the rest of Europe will slide into a long and deep depression.

That will be followed by a lot of externalized accusations of conspiracies and general hatred ultimately leading to an insurrection which results in the loss of soverignty for between 1/3 and 1/2 of the current nations.

One 'law' that I've never seen fail is 'Nature abhors a vacuum.' and when the EU collapses, it will create a very, very large vacuum.

It will be far more likely to have some kind of laws as tomjen3 suggests. We can't allow individual countries to jeopardize the Euro. With the worst case that one country will abandon the Euro (although I don't see that happening any time soon)

The EU will not dissolve, that's just crazy talk. The EU is something _totally_ different than the Euro, not all members of the EU even have Euro's.. Saying that the EU will dissolve is almost as unlikely as saying that the US will dissolve.. although countries in the EU are of course much more individual than states, we work together on so many levels that it would just be nuts.

The French hate the Germans? So, what makes you believe that crazy nonsense? Wow. How far removed from reality are you?

Can you really see those smaller countries go for that type of language tho? The Irish, Greeks, and Italians (among others) aren't ones to cede anything resembling autonomy.

It would seem the most likely course would simply be the unraveling of many of the treaties that created the EU in the first place.

Italians have always been euro-enthusiastic and I don't think they would object to transfer more powers to the EU.

I don't think bigger countries would go for it either; a referendum in France to hand over any sort of sovereignty to the EU would fail by massive margins.

>I predict several things will be true after this crisis that are not true now. One, I think there will either be a way for the EU to expell a member or to put it under 'federal' control. Second there will be a trans-EU judiciary system which allows for injecting change (either through impeachment, imprisonment, or both) into member states leadership. If such a system existed it would have allowed the joint-EU leadership to demand (and get) corrective action on destructive behavior.

I cannot conceive of a country ever allowing others to have impeachment/imprisonment powers over their head of state. This prediction makes absolutely zero sense to me. Much more likely, we may see some member countries leave the union over the next several years.

At some point, we will have to realize that debts are a bad thing. No one can spend money he does not own without paying the consequences. The Euro seems to be exacerbating this race towards a tipping point.

It seems that some kind of serious crash is inevitable. But it is yet to be seen whether Europe (and the world) will come out of this united or in flames.

As people are pointing out in replies, debts are bad is probably not the right answer. However, debts are much more dangerous than our current analyses are telling us does seem like an inevitable correction. Debt calculations based on smooth probability distributions underestimate Black Swans, and the evidence of this has been pretty clear for a while, it's just that if you give our highly intelligent financial analysts five to ten years of clear sailing, they'll talk themselves into forgetting it again. For various reasons, this is probably not a solvable problem. (Mostly because, during the periods of clear sailing, underestimating risk means you make more money, and over time simple greed will cause more people to do that, until... kaboom. In a way the problem is that we don't have enough crises.)

This has always been my perception.

I think that the market forces an underestimation of risk as the only viable long-term strategy (ironically).

If I can run my finance house on a "I will blow up on a once-every-5-year event" I will outgrow a business running on "I will blow up on a once-every-50-year event". So I outcompete my competitors and acquire them or steal their best employees with high salary etc.

Basically, short-termism seems to be the optimal solution in the game theory of risk management.

(Of course, the real problem is the frequency of such events is poorly understood. What happens is that a finance house pursues a 'more profitable' course without perhaps fully understanding their increased exposure. See Taleb, sub-prime crash etc)

Debt is a mechanism for moving risk around - risk-averse parties (the people taking the loan) selling risk to risk-seeking parties (the lender). You're buying money now and paying interest, providing return, against which there's a chance it doesn't get paid back.

As such, there's actually not much of a difference between debt, insurance, and synthetic derivatives such as credit default swaps. (Modern debt and insurance practice both originate from the shipping industry.)

Of course, if you believe the world's a better place without corporate finance, you're entitled to think so, but we'll have to disagree.

Debt is a mechanism for moving risk around

Much more fundamentally, it is a mechanism for moving things around -- tangible capital like tools and buildings. Interest is in part a payment for risk of default, but it is also payment for use of capital (the debtor gets to use it, the creditor gives up his ability to use it). There would still be interest even if there were no risk at all.

Good point!

I tend to think of the time value of money, loosely speaking "opportunity cost", as a sort of risk (the risk that you needed the money right now to go do something else with it), but that's a pretty idiosyncratic way to think about it, really.

Am I allowed to think that the world would be a better place without implicitly and explicitly publicly backed private corporate finance?

Just want to make sure that'd be OK.

I don’t think you can have a stable financial system without a government that is willing and able to step in when things go pear-shaped.

(You might say “if the government weren’t doing that, then lenders would be more careful with their money and things wouldn’t go pear-shaped”, but the string of crashes in the late 19th and early 20th centuries, before the Federal Reserve was created, suggests otherwise.)

The argument isn't that if only the government keeps out there will be no pears, but that if the government keeps out the following recoveries will be faster and those responsible for the crash will take a hit financially, so hopefully someone learns a lesson or two.

From 1869 to 1918, the per-capita GDP increases from $4600 to $12000 -- a time constant of 1.95% per year. From 1918 to 2011, the per-capita GDP increases from $12000 to $47300 -- a time constant of 1.47% per year. That is, the pre-Fed period experienced 32% faster growth over-all, or at least that's what it looks like, to me. Feel free to contest my analysis.

http://www.wolframalpha.com/input/?i=log%2812000+%2F+4600%29... -- first time period. Per-capita GDP starts at $4600 and ends at $12000 over 49 years.

http://www.wolframalpha.com/input/?i=log%2847300+%2F+12000%2... -- second time period. Per-capita GDP starts at $12000 and end at $47300 over 93 years.

That certainly is the consensus, isn't it?

Of course, depressions didn't become Great until our friends at the Fed got involved. Maybe another twenty years of flat to down real growth will change some minds. Although, the Japanese show no signs of changing course.


Who can claim to understand humans, let alone economics?

That is a very interesting thought. Thank you for mentioning it!

From a purely accounting perspective, debt and money are just two sides of the same coin. Every financial asset you own, whether it is paper money or a number in a bank account, is somebody else's liability.

With this in mind, it is clear that blanket statements like "debts are a bad thing" are useless. Bad with respect to what?

For example, when citizens save some amount of their income in government bonds to have some buffer to protect them against future individual troubles, then can you honestly say that this debt is a bad thing?

The problem of the Eurozone is that there is no fiscally sovereign government which can safely (and in a politically legitimised fashion) carry an unlimited amount of debt.

> Every financial asset you own, whether it is paper money or a number in a bank account, is somebody else's liability.

Gold is a form of money with no counterparty risk; if I own gold it's nobody's liability.

One complication is that some central bankers and governments try to suppress gold being used as money through enforcement of fiat money monopolies at gunpoint...

Edit: I am incorrect in saying gold is a financial asset.

Gold is a natural resource, so it's not really a financial asset. Coins containing gold are liabilities of the issuing government just like any other type of coin.

I hope you do not seriously believe that the reason gold is not used for trade is that governments suppress it. The fact is that using gold is actually extremely impractical compared to modern forms of payment.

The use of gold in trade in the past developed naturally because sufficiently stable fiat money systems did not exist. However, once such fiat money systems do exist, they are simply better and there is no reason left to use gold as a medium of exchange (outside of goldbugdom).

I do believe governments and central banks would like to suppress its use, though I wouldn't claim that's the only reason it isn't used in transactions today. It's in their interests to suppress its use because it's one way to spend more than they take in as revenue by issuing new currency. I think we're seeing the results of that globally today.

As to gold being impractical for use in everyday transactions, I don't think that's true anymore. You can look at companies like Goldmoney for a real world example of what is possible. Any trusted third party can hold the physical gold, while allowing electronic transactions of said gold in whatever increments, without any physical exchange taking place. In fact, this is generally how the dollar worked before it went off the gold standard.

I'm not sure why you think fiat money is better. The history of fiat money has been one of short lifespans and dramatic failures, while gold's history of use as money spans over 6,000 years.


Would it? Gold has gone up nearly an order of magnitude in a decade. Has this caused your computers cost to go up dramatically? Are there industrial alternatives to gold? Would stability of the value of your currency be worth an increase in the cost of consumer electronics?

I know no right thinking person, especially with an elite education, would consider a gold standard.

All the more reason to consider it carefully.

Where are you getting your information? Gold in 2000 was about $400 inflation-adjusted dollars. Gold in 2010 is a little over $1500. That's not even close to an order of magnitude.

However, if you know that there are about 140,000 tons of gold in existence and somewhere around $9(M2) trillion in US money supply in existence, you do the math on how much gold would be worth.

The main point of my post was that this is such an obvious point that is not addressed, meaning that even the idea of moving to a gold standard is not well-thought out. Poor analysis is enough for me to dismiss the idea without a second thought -- only idiots play roulette with a nation's entire money supply.

I've done the math and invested accordingly.

I'm being a bit hyperbolic, but $2000 gold is around the corner, and the bottom in the early 2000's was well under $400, depending on the market you look at. The move in gold has been hyperbolic. Have you seen that pass through to consumer electronics? Are there alternatives to gold for these industrial uses?

I agree entirely that only idiots play roulette with the nations's entire money supply, which is precisely why we should take the roulette wheel out of the hands of the money printers at the privately owned Federal Reserve.

In your scheme, you are simply trading assets that are reflected by a liability of the organisation that runs the system, so you are not actually using gold for everyday transactions. It's the same as the difference between using gold itself and a gold-backed currency.

As to the question of what is better, my answer to that is two-fold.

First of all, history paints a misleading picture of the strength of gold-backed currencies. After all, when things go seriously wrong economically under gold-backed currencies, ending convertibility is usually one of the first things that governments do. Then the final death of the currency happens after it has become a fiat currency, but of course the failure is ultimately one of a gold-backed currency. Generally, whether a currency fails is not related to whether it is fiat or gold-backed anyway (such as with the failure of the Weimar mark, which happened to be fiat money; but both the move away from gold convertibility and the hyperinflation were caused by the First World War).

Second, while it is obvious that fiat money can be rejected totally, and gold will always retain at least some minimum value based on its use in jewellery and industrial production, this is not a useful measure to decide which system is better.

I claim that the real measure should be: How well does the economy fare, how well does it serve society, under a modern fiat money system vs. older systems.

Here, there is a great amount of evidence in favour of modern fiat money arrangements. Compare the cycle of booms and busts in the 19th century with the relative calm of the second half of the 20th century. In fact, that period was so calm that economists even claimed that the business cycle had been tamed! (They called it the Great Moderation.) Of course, this was hubris as the current crisis has demonstrated, but it should give you a taste of just how successful the combination of modern central banking with fiat money has been.

(I do not think this calmness was purely due to using fiat money, but I would claim that using fiat money certainly helped. The correlation is obvious, one can debate over the causal link of course.)

For one, we use gold in a whole lot of things (like the computer you're typing this on). A gold standard would cause a massive increase in the price of gold, crippling those uses.

I hope you do not seriously believe that the reason gold is not used for trade is that governments suppress it.

Exchange of gold is subject to capital gains tax; exchange of the US dollar is not. It is clearly suppressed as a currency.

(As would any other attempt at private commodity currency, nothing unique about metals).

The fact is that using gold is actually extremely impractical compared to modern forms of payment. [...] However, once such fiat money systems do exist, they are simply better and there is no reason left to use gold as a medium of exchange.

I do not follow your reasoning at all. Are you perhaps confusing paper money (exchange of documents certifying ownership of wealth instead of physical goods, as a logistic convenience), with fiat money (ability of a state actor to create money and force its creditors to accept it as payment of debt, as a variation of its power to impose taxes)?

There's nothing inconsistent between gold and paper money -- in fact the US dollar was at one point both at the same time, paper bills backed by gold. You have a dollar bill, you have gold; you want it in your physical possession, you trade in your dollar bill and the US redeems your gold. But for convenience you trade in paper bills.




You have a dollar bill, you have gold; you want it in your physical possession, you trade in your dollar bill and the US redeems your gold. But for convenience you trade in paper bills.

How is that inherently better than fiat money? You are essentially trusting that the government will provide you with the gold on demand. The government could overprint & not actually have enough in reserves to cover all gold requests.

Additionally silver/gold certificates were redeemable for silver or gold dollars. The world gold market started making these coins worth more than the face value. You started to get speculators who would cash in & then sell the gold for more than the currency was worth. This also happened to Britain with their gold standard. Not to mention the overhead required to maintain & store large volumes of gold as well as punching out expensive gold coins.

I can see the nice concept of having a currency independent of government, but when you boil it down, money is all about trust. Even if we were on a world gold standard we would have to have faith that gold will keep a stable value & that other players in the market are being truthful about their reserves.

Yes, you are right that I was looking at gold vs. fiat money without considering gold-backed paper money. I was in a biased frame of mind because the GGP was saying that with gold, there is no corresponding liability. With paper money you have such a corresponding liability, whether gold-backed or not.

About the US tax system, which I don't know too well: what about exchange of foreign currencies? Are they subject to capital gains or some other form of tax? Does the capital gains tax actually apply if you use gold for payment, and not just if you sell the gold in exchange for US$?

On the GP's point, isn't a gold certificate a debt instrument? If you use a gold certificate for convenience, then you are introducing counterparty risk.

Most people are willing to pay a few cents on the dollar (whether that rears its head as actual risk of theft, risk of default or risk of inflation, or as insurance against those possibilities) in order to be able to trade things with other people.

The modern economy is very good about keeping its costs stable and low, while steadily increasing the speed and ease with which we complete transactions. I'd say that's a pretty good thing.

Can you outline the qualities that an ideal form of money should have?

Would, among those qualities, you list the ability of a privately owned bank to create as much of it as it sees fit?

Can you think of a way that shortcomings of physical gold coins could be overcome given the technologies available to us today?

So a bank being able to create an unlimited amount of currency is bad, obviously, but limiting your currency growth to how fast you can mine gold out of the ground isn't much better.

Let's take a very simple example. Say there are two people on an island. The first can build boats, the latter can fish. There is no currency. What should happen?

Case 1: No transaction. Both die. Case 2: The first builds a boat (boats are very resource intensive!) and gives it to the second. The second fishes and has fish. The first dies because he has no fish. Case 3: The first agrees to build a boat and rent it to the second in return for part of the first's weekly catch for the next 10 years.

To support Case 3, you basically need contract law. But the contract in question is very inflexible. Does the boat maker enter into similar contracts to cover his needs for clothes, etc? Ideally the boat maker could just sell the fisherman the boat and use the money to buy fish or clothes or anything. So you need currency.

The key question is: how much currency do you need?

Obviously, you need enough to be able to serve as a proxy for the goods and services in your economy and promises thereof. The Fed may not be great at estimating that amount, but pegging it at how quickly you can mine gold out of the ground doesn't make any sense either.

Would miners pull gold out of the ground more quickly (and start more projects) if the price of gold increased?

Would new entrants in the market attempt to find more efficient ways to extract gold?

Would alternatives to gold as a currency arise?

I'm not convinced that a gold standard would be perfect. I am quite convinced that the current private exponential issuance of debt-based fiat currency by a money printing madman is insane.

I really don't know. I just don't think that our academic betters know either, despite their pretenses. I tend to think that any idea that our friends in economics dismiss is worth considering carefully, given how wrong they've been in the last decade plus.

The U.S. grew at its fastest rate under a hard money gold standard, with heavily restricted immigration and almost no government, financed with tariffs, of all things. Does that mean we should adopt those policies? I dunno man. I do know we were industrializing at the time and, hey, look at that, there was a literally unbelievable explosion of goods, services and promises thereof.

So I try to keep an open mind on this stuff.

Only exacerbated because the ECB is not a central bank in the traditional sense. Traditionally, the central bank (or a related institution) would just print up money to make up for the shortfall. The logic of modern politics leads inevitably to the printing press.

Now, the only way the Germans would have agreed to an ECB would have been a bank at least as strong (and printing-averse) as the Bundesbank. So the so-called 'stability pact' was signed in order to placate them (max 3% of GDP deficits and max 60% debt to GDP ratio, working toward zero deficits at some point).

What happened was the Euro states continued or increased their spending, producing deficits even during the great boom years right before the collapse. Today, the Stability Pact is a dead letter and members (the PIIGS in particular) are trapped without an ability to print themselves out of trouble. Of course, the ECB has been issuing a lot of new money, but just to rescue the major banks, the governments are on their own.

This isn't to say that it's a good idea to print oneself out of debt, but governments find it the easiest thing to do. The crisis would not exist if expenses could have been scaled down as easily as they have been increased. It's better in the end to have a strong currency and balanced budgets, but balanced without low expenditures, not high taxes.

People who make arguments against debt are ignoring a great deal of historical information. A person, or a nation, can clearly spend money on stupid things, but that doesn't mean that debt is bad. Many businesses take on debt to grow, or at least they seek a credit line to cushion themselves against variations in income.

The argument for debt goes like this: in the future "we" will be wealthier, so why don't we borrow against our future income to make the investments that will ensure that, in fact, in the future we will be wealthier.

"We" can refer to a person, business, or nation.

The careful and strategic use of debt has been used to build great empires. A quote:


"Chart 2 tells, in stark detail, the story of the British Empire. It was built on the National Debt. Throughout the 18th century the National Debt grew and grew, from nothing at the end of the 17th century to about 60 percent of GDP by the end of the War of Spanish Succession in 1715."

To win World War II, the USA drove up debt to 100% of GDP, a level much higher than what it faces today.

To finance business, an interesting difference has developed between the English speaking nations (I mean those who inherit their legal codes from English Common Law) and those nations of continental Europe. In the English speaking nations, it became common, by the 1800s, to finance growth by offering equity for sale at public auction. The continental nations developed along different lines -- banks played a larger role. In Germany, most firms operate with higher levels of debt that what would seem normal in English speaking nations.

To get an understanding of the importance of debt, and its history, I'd suggest you read Fernand Braudel:


As he points out, debt and civilization tend to go hand in hand. Debt was illegal in many European nations during the Dark Ages. Nations in the Mideast and India all had flourishing markets in debt, and flourishing trade, while Europe was sunk in poverty. When Europe revived and began to expand again, it helped itself along with the revival of credit, and credit markets. By the time the 1600s came around, Amsterdam was able to offer the world the full range of modern financial instruments: put and short and forward contracts, options of every kind (save for the exotic derivatives of recent vintage).

There is no civilization without debt, no advanced commerce without debt, no growth without debt. The wheels of commerce are greased with credit.

>"Throughout the 18th century the National Debt grew and grew, from nothing at the end of the 17th century to about 60 percent of GDP by the end of the War of Spanish Succession in 1715."

That's a fifteen-year period, not throughout the 18th century, and for that entire period, England was at war. It's absolutely true: debts help win wars. This isn't surprising: war is one of those times when there's a good argument for borrowing against the future, because the alternative is annihilation. On the other hand, during most periods of peace, historically, debt as a percent of GDP has fallen.


The thing is we don't have any more wars worth fighting. Maybe in twenty years the precarious situation of "the largest economy in the world is totalitarian [i.e. China]" will boil over, but that definitely isn't happening any time soon. These days, we just accrue debt for no reason, or to fight a war on nothing (drugs, terror, cancer, tobacco).

Debt by country:


Growth by country:


(I wanted to say something about this but I'm having trouble distinguishing between five identical shades of green)

Yes, debt makes sense when talking of investment. However, borrowing is a bad choice when you are just trying to pay operating expenses. This is the dilema: nations have shifted from borrowing for investment purposes, to borrowing to keep the lights on.

Precisely! Taking out a loan to pay for college should be seen as a good thing. Taking out payday loans to cover living expenses should be seen as a bad thing.

The Braudel book looks really fascinating. Is it understandable on its own, without having read volumes one and two?

It's understandable on its own.

That said, all the volumes are pretty wonderful. Braudel is my favorite historian--materialism without nutty Marxism.

Is there some concept of money that doesn't (almost) directly link money to debt? (so money wouldn't be completely worthless without debt)

While the demand for most moderen currency is based around Taxes and Debt you can also link them to a wide range of real or vertual goods. AKA gold in an MMO or Mooncakes in china. (http://marketplace.publicradio.org/display/web/2010/09/21/a-...)

Edit: Bit coin is an interesting experement with the idea that simply because something is finite it has value based around the idea that at some point people might want it. Even the most simplistic analysis suggests the market will quickly become prone to bubbles but what's intresting is how it will recover after a major crash.

PS: I don't know why people ignore the link between Taxes and Money but try paying your taxes in gold bullion and see how far you get.

Yes, commodity money. A commodity has intrinsic value; so if you use commodities as money (medium of exchange, store of value...), you have money with intrinsic worth.

Supposedly it's the original money, since it arises spontaneously in a barter system. Suppose you have a matching problem in a barter system (I want X from A, and A wants Y, but I only have Z...) The way to solve it is with a series of intermediate barters which cancel out, whose only purpose is to coordinate exchanges (I first give Z to B in exchange for Y, which I then trade for X with A). Some commodities are better at being intermediates than others: they have to be persistent, subdividable, popular (so it's easy to find counterparties who want it). So you have several commodities which end up universally used as exchange.

The problem with commodity money is without other supporting infrastructure you have no way to denominate commitments of future obligations (at least at a macroeconomic level). You can introduce contracts with respect to commodities that can be traded (eg: a contract for 100 pork bellies to be delivered in 1 year) but then you still get into modern finance.

That looks more like a feature of private/competing currencies than commodity currencies. If a commodity money is backed by a state, it shouldn't act differently from fiat money (assuming its price is stable enough to act as a useful "unit of account", which for a weighted basket of commodities shouldn't be difficult. If the commodity basket is the particular one specified by the CPI, then its real value will be a constant by definition!) You wouldn't trade in pork bellies, but convenient "dollars" with a well-understood and stable value, pegged to a fixed ratio of a commodity (X pork bellies). E.g. historically, 1 USD was defined as 1.505 grams gold (1900-1933). And most transactions wouldn't involve physical delivery of a commodity, just paper bills.

You have a good point that if there are multiple currencies (say they are privatized), then there could be major confusion as to how to denominate debts, which currencies are acceptable payment, people being confused by different units and fluctuating exchange rates, etc. Like dealing with international currencies, except everywhere.


It was called the gold standard. It worked quite well for a very long time.

No respectable academic economist takes it seriously.

Which is why you should.

You don't need fancy academics to see why the gold standard was a bad idea.

You need money to function as a proxy for the economy. Every time grows up and enters the workforce, you need to add money to the economy to be able to serve as a proxy for his or her labor. As population and economic activity grows exponentially, you need to add exponentially increasing amounts of money to the economy just to avoid deflation.

Now, explain to me how we could've sustainably kept mining exponentially increasing amounts of gold out of the ground?

Why do you need to add money?

Can you name an industry in which the much-feared deflation has occurred in the last fifty years? How has that industry done in terms of wealth creation?

Why do you think that the economy isn't capable of adding money if necessary? Are there any historical examples of the opposite occurring?

Why do you think that exponential growth makes sense in a finite world?

Keep an open mind: the banks would prefer that you didn't.

All of that is true if you don't consider inflation and the money supply. Then stuff gets complicated.

More dangerous than debt is a political system which accepts broke countries into a monetary union when these countries just downright faked their economic statistics and noone did any due-diligence or found out only until years later when it was too late.

On related news, US and the dollar: On the edge

It is also very possible that the average Greek or whatever country person is not responsible for the country's problems.

What we have here is a communications breakdown. So anyone from those countries themselves want to explain what went wrong, when and where?

The image on the article is very creative!

The economist likes to predict the end of the euro every six months or so.

Newsflash: countries have armies, banks do not. Guess who will ultimately prevail?

"Newsflash: countries have armies..."

All the Red horses and all the Red men could not put Soviet economy together again.

It did provide a really intense story plot, though. http://en.wikipedia.org/wiki/Red_Storm_Rising

If you'd actually read the economist over the past year and a half (i.e. acute phase of euro crisis) you'd know the paper has been a staunch critic of the reactive measures taken by the various parties trying to save the EU and that the paper has not predicted a time frame in which the euro will end; it's only cautioned that current policies are not solving anything and that the crisis will continue to worsen until either it's comprehensively solved or leads to a dramatic breakup of at least part of the currency union.

Newsflash: Banks have been prevailing since they were created. Tanks and Guns are nothing against the power of credit.

Look who has the biggest armies in Europe. (Hint: it isn't the countries who look likely to default).

actually greece has a pretty big and modern army for its size

Except the conflict is not "countries vs. banks". Big banks and governments are essentially the same entities, and this has been the case throughout history.

Historically, financial crises and disputes haven't often lead to armed conflict.

Italy is nowhere like Greece.

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