Philipp Bagus (“PB”), author of The Tragedy of the Euro, was interviewed by the Mises Institute (“MI”) about recent developments in Switzerland and the European Monetary Union. Excerpts from that interview follow.
I (“AA”) understand most of what Mr. Bagus said in that interview, but there are parts that seem almost incomprehensible to me. Because Mr. Bagus’ meanings are not always clear to me, some (maybe all) of my comments should be taken with salt.
Still, my “discussion” with Mr. Bagus might offer grounds for several items of interesting and vaguely-related conjecture:
“MI: Why do you describe the euro as a sinking ship?
“PB: The euro is badly designed. . . .”
AA: I doubt that it’s possible to have a “well designed” fiat currency that could last more than a few decades. I doubt that any economics spin-meister could ever overcome the fatal flaw that seems inherent in all fiat currencies: the presumption that, unlike individuals and even major corporations, governments will always be able to repay their debts simply by raising taxes on their people. Based on that presumption, governments are entitled to borrow beyond their ability to repay–and grow–almost without limit. Eventually, the government grows larger than the private sector can support, and causes a national recession, depression or even collapse.
PB: “In the EU, there is one central banking system that can be used by a wide variety of governments to finance themselves. This is the tragedy of the euro: governments can finance their deficits indirectly through the central bank as their debts are pledged as collateral for loans to the banking system. Or they can be directly purchased by the central bank.”
AA: In a rational world, assets (actual, tangible payments) can be “pledged as collateral” but debts (intangible promises to pay) cannot.
In our brave new world of fiat currencies, not only government debts, but virtually all debts (promises to pay) can be treated as collateral (assets, actual payments).
It’s not entirely irrational to treat all debts as if they were legitimate “assets”. Still, debts (mere promises to pay) are not “assets” in the sense of actual payments. Debts are, at best, a lower class of “expected” assets whose value is always in doubt because the “promises to pay” may not be kept if the debtor dies, becomes bankrupt, or absconds and refuses to pay. The debt can even be destroyed by a currency collapse, national bankruptcy or war.
Those who treat debts as assets are counting their chickens before they’re paid.
• If it’s not completely crazy to treat debts as assets, there are limits.
It’s not unreasonable to treat some debt as a asset, so long as the debtor is actually capable of keeping his promise to repay. But once you reach a point where the debt exceeds the debtor’s capacity to repay, you’ve entered an economic “twilight zone” that’s irrational and often even incomprehensible.
Sooner or later, reason and reality must prevail. Sooner or later, the debtors must admit that they can’t pay. When that happens, institutions and individuals who relied on the debtors’ irrational promises to pay will be bankrupted.
Institutions based on irrational promises include: 1) debt-based monetary systems; 2) fiat currencies; 3) savings stored in the form or paper or digital currencies and debt-instruments; and 4) economies based on debt-based, fiat currencies. When the collective promises to repay exceed the institutions’ capacity to do so, the institutions must suffer a “correction” (“haircut”) wherein masses of debt will be repudiated. These repudiations can be felt as an economic decline, recession, depression or even collapse.
PB: “The effect of this policy [allowing government to finance themselves] is to externalize the costs of this monetization of the deficits on all users of the euro . . . . There is therefore an incentive in the euro countries to make deficits and accumulate debt, while externalizing costs on foreigners.”
AA: Mr. Bagus’ statement implies that western governments believe they can grow wealthy by “making deficits” and “accumulating debt”. For them, debt is wealth. Are governments merely mad to believe such monetary insanity? Are they criminals bent on profiting from fiat currency at public expense? Or, is their real intent to pretend to believe such nonsense in order to better control the public?
If more government debt created more wealth and more prosperity, then it should follow that we could all become fabulously wealthy if we quit our private sector jobs, stopped producing things like food, homes and cars—and just went to work for the government producing nothing. Then government could grow, go deeper into debt and all of us non-productive government employees could live like kings, feasting on food we didn’t grow, living in palaces that we didn’t build, and riding around in Cadillacs that we didn’t build or pay for.
The idea that we could prosper in a debt-based monetary system reminds me of the “big lie”—a propaganda technique advocated by the Nazis. Hitler intentionally told lies so “colossal” that no one would believe that someone else “could have the impudence to distort the truth so infamously.”
In other words, if you tell a lie that’s big enough, often enough, the people won’t dare to doubt it and will come to believe.
That propaganda technique may work for a while, but it’s ultimately nuts.1
That technique has certainly worked on Americans who don’t understand the concepts of fiat currency and debt-based monetary systems. Americans have been so conditioned to think of Federal Reserve Notes (debt-based, fiat “dollars”) as “money,” that it’s almost impossible for 99.9% of Americans to even imagine that those green pieces of paper in their wallets are only “currency” and evidence of debt rather than wealth.
Instead, Americans believe that our government officials understand such things, and if the government supports the “big lie” that debt-based, fiat dollar is “money,” then it must be true (surely, government wouldn’t lie about such things, right?).
If you try to explain to most Americans that the debt-based, fiat dollar is a “big lie” and an irrational concept that’s deceived the entire world, they’ll look at you as if you are the crazy one.
So long as people have sufficient confidence in the “big lie” of fiat dollars, the currency system will seem to work. But when the truth finally emerges (as it must), the lie of debt-based, fiat currencies will spiral down the toilet like a rocket-propelled . . . umm, . . . something.
• “MI: Could [the fiat monetary system] lead to the downfall of the euro?
“PB: It has already led to an enormous debt for most countries. Add to that the expansionary monetary policy of the European Central Bank, which is always coming up with new tricks that put more money in circulation, such as their recently-announced quantitative easing.”
AA: “Expansionary monetary policy,” putting “more money in circulation,” and “quantitative easing” all mean the same thing: inflating the currency. By printing more euros, the ECB tries to cause inflation which allows debtors (primarily the governments of the EU) to repay their “enormous debts” with inflated and “cheaper” euros. In the EU’s “expansionary monetary policy” we see evidence that the ECB is determined to cause inflation—or, conversely, to prevent deflation.
We’re left to wonder if governments fail to cause inflation, and deflation become predominant, will that deflation (which causes debtors to repay debts with “more expensive” euros), drive so many EU governments into illiquidity, insolvency and bankruptcy that the EU disintegrates?
One big question is whether inflation is merely advantageous to the function of any debt-based, fiat currencies (like the euro and dollar)－or is an absolute requirement? Without inflation must all debt-based, fiat currencies fail?
• Did the Federal Reserve, and later, the ECB create a “business model” for “selling” their fiat currencies to the world? Did those business models presume that economic growth would continue and their fiat currencies could function properly so long as there was 2% inflation in their domestic or global economies? Does the “business model” for fiat currencies fail if inflation falls below 2% or, worse, turns into deflation?
I certainly don’t know if central banks have a “business model” for implementing fiat currencies—but it seems logical to suppose they do.
Let’s suppose those business models were based on the presumption that inflation would always to run about 2% per year. If that presumption failed and the world slipped into deflation, then the fiat-currency business model would fail, sovereign governments would default on their debts, their paper wealth would disappear, and their fiat currencies would become as worthless as Zimbabwean dollars.
If there’s a “business model” for selling fiat currencies to the world, I’ll bet that model will only work within a fairly narrow range of economic conditions. Too much inflation might collapse the model; too much deflation will collapse the model.
Let’s suppose that the range within which the fiat-currency business models can function is as narrow as I suspect. If so, the viability of those business models and fiat currencies will depend on the governments and central bankers of the world to exert sufficient control to keep national and global economies within operating range for their fiat currencies. That control would inevitably translate into lost freedoms and lost prosperity for ordinary people. Ultimately, in order to defy economic reality and thereby sustain their fiat currencies, governments and central banks would be forced to advocate and impose some sort of national and/or global “police state(s)”.
Get that? This speculation implies that fascism and the modern police state might be precipitated by a financial breakdown of the “business models” for a nation’s fiat-currency. If so, an early sign of the collapse of a nation’s fiat currency could be the rise of an increasingly tyrannical government and a domestic police state.
• In the final analysis, all fiat currencies are irrational because they treat debt as wealth and a promise to pay as a payment. That lie is bigger than anything Hitler ever imagined.
Nevertheless, it’s “officially” presumed that the deeper you go into debt, the richer you become. That presumption works for a while and may even seem brilliant to those who understand how to exploit fiat currencies. But, inevitably, virtually all debt iss destined to shed the pretense of wealth and be suddenly seen as not only “debt,” but unpayable debt. At that point, the debt-based, fiat monetary system should collapse.
I can’t yet prove it, but I’m increasingly convinced that deflation is deadly to debt-based, fiat currencies.
If that’s true, and if we’re entering a prolonged period of economic deflation, the world should be approaching the demise of all debt-based, fiat currencies.
Implication? Hang onto your gold. When the fiat fails, all that may remain is gold.
• “MI: How long will the paper money system last?
“PB: If I knew that I could be very rich. It depends greatly on the monetary policy. And the financial and political elites will try to save the system because they benefit from it. They could try to reset the system. What is clear is that the debt held by so many states cannot grow much more. It is unlikely that you can pay back this debt through growth. Most countries are in a monetary trap. When interest rates rise, the states are bankrupt because they cannot pay the interest.”
AA: Not exactly.
When interest rates rise during a period of inflation, those rising interest rates aren’t necessarily fatal to the borrower or the economy.
During periods of inflation, the currency loses value (purchasing power), and borrowers can repay their debts with “cheaper dollars”. That makes it easier to borrow and nominally repay your debts.
For example, if I borrowed $100,000 and the inflation rate was 10%, when I repaid the $100,000 it would only have $90,000 value/purchasing-power. Thanks to inflation, I (the borrower) would profit by $10,000 on that loan.
Even if the government raised the interest rate to 5%, I would still profit by $5,000 on my $100,000 loan.
During a period of inflation, so long as interest rates don’t exceed the inflation rate, the borrower can repay his debts with “cheaper dollars”. Rising interest rates aren’t good for borrowers, but in the context of inflation, they’re not necessarily ruinous.
However, during a period of deflation, the fiat currency gains value (purchasing power) and becomes “more expensive”. If I borrowed $100,000 during a period of 10% deflation, when I repayed the $100,000, it would have a purchasing power of $110,000. Thanks to 10% deflation, the lender would gain $10,000 on the loan and I (the borrower) would lose $10,000 in purchasing power. That loss would make it harder for me to repay my debt, would predispose me to default on the loan and might even push me into bankruptcy.
If the bank raised interest rates during a period of deflation by, say, 5%–that 5% would be added to the 10% deflation to make my loss 15% of the purchasing power of my original loss. During a period of deflation, any increase in interest rates would increase the probability that borrowers would default on their loans and perhaps slip into bankruptcy.
Thus, Mr. Bagus’ contention that “When interest rates rise, the states are bankrupt because they cannot pay the interest,” isn’t necessarily true during a period of inflation, but tends to be irrefutable during any period of deflation.
Based on the antagonistic relationship between deflation and fiat currency, we can infer that whenever a central bank holds the interest rate near zero (as the Federal Reserve has done since the onset of the Great Recession), that’s evidence that the bank fears that the economy is near, or already in, a period of deflation.
More, if a bank offered negative interest rates on customers’ deposits, those negative rates could be evidence that the bank believes the currency is already deflating and likely to continue doing so for some time into the future.
Incidentally, the central bank of Denmark and the ECB have already begun to offer negative interest rates on their loans.
• Mr. Bagus observed that rising interest rates could prevent governments from repaying the interest on their debts. His observation implies that even if a government is so broke that it can’t currently repay, and will never be able to repay, the principal that it borrowed, the illusion of government solvency can still be sustained so long as the government is at least able to repay the interest on the debt.
If so, a final sign of a government’s collapse should be its failure to repay even the interest on its debt.
Japan, the US and EU have tried to hold interest rates down to nearly zero. Their determination to do so may be because:
1) They believe we’re in or near a period of deflation;
2) They’re already so overly indebted and near insolvency that if interest rates rise, they won’t even be able to repay the interest in their debts;
3) Once a government can’t even repay the interest on its national debt, the underlying debts (government securities) will be repudiated, the value of paper-debt instruments like government bonds, pension funds, bank accounts, etc. will collapse; and,
4) Their national economies may do the same.
• Fed Chairperson Janet Yellen has implied that the Fed will raise interest rates this coming summer (A.D. 2015). Whether or not interest rates are raised significantly this summer will be a test to see if our government is, or is not, so insolvent it can’t pay the interest on the national debt.
If the US government is so insolvent that it’s already unable to repay much more than near-zero interest on its debts, then Janet Yellen won’t raise interest rates next summer. Oh, she might raise interest rates by 0.1% or some other miniscule amount as a symbolic gesture—but there’ll be no significant rise in interest rates until the government becomes solvent (if it ever does) or deflation is replaced by inflation.
On the other hand, if the US government is still generally solvent, the Federal Reserve may raise interest rates by 0.5%, 1.0% perhaps even 2% before the end of this year.
But if interest rates remain near zero for the rest of A.D. 2015, that’ll be good evidence that the US government is bankrupt and not only unable to repay the principle on its loans, but even unable to repay a reasonable rate of interest.
That evidence would imply that government bonds are fundamentally worthless and perhaps precipitate an economic collapse.
• I’ve seen estimates that attribute 40% of the US GDP to government.
Is government (like some of our largest financial institutions) “too big to fail”? If so, and if the government were bankrupt, who would be left to bail it out?
What would happen to the US economy if the government were officially, openly and undeniably bankrupt?
Does the Fed’s near-zero interest rate policy imply that that’s already the case?
1 Maybe it’s worse than “nuts”.
The current monetary system reminds me of Revelation 18:21 & 23 which describe the fall of Babylon:
“And a mighty angel took up a stone like a great millstone, and cast it into the sea, saying, Thus with violence shall that great city Babylon be thrown down, and shall be found no more at all. . . . for thy merchants were the great men of the earth; for by thy sorceries were all nations deceived.”
Given the importance of “merchants” in that verse, we can presume that End-Time Babylon’s “sorceries” are “commercial” in nature. Could it be that Babylon’s “sorceries” include whatever tricks and propaganda used to fool the people of the world into having faith in fiat currencies and debt-based monetary systems? Haven’t all the nations of the world been deceived into believing that debt is wealth, currency is money, and promises to pay are payments?
Could the End-Times destruction of “Babylon” correspond to the failure of the world’s fiat-currency “sorcery”?