The current economic situation is challenging because it is bringing up issues that are outside the range of experience of either the present, or the most recent previous, generation of politicians.
One would have to back to the 1930s to find politicians who actually had real life experience of the sort of problems weface today
In the 1930s, there was
1.) a collapse of confidence, in and between, banks, which paralysed the economy.
2.) There was a gold standard (currencies had a fixed exchange rate with gold and the supply of gold was limited) which, like the euro, precludedcountries using the standard from devaluing or printing money asways on inflating debts awayand thusmaking savers pay forthe mistakes of debtors.
3.) There was also a slowdown in the rate at which people spent money (“velocity” is the economicterm for this),and that meantthere was less bang for eachbuckthat wasprinted.
All these things are happening today, 80 years later.
NO RELIABLEMEASURE OF VALUE ON WHICH TO BASE BANKING DECISIONS
The advantage of the gold standard was that it provided a fixed measure of value. And a banking system needs a fixed measure of value, which each bank can hold, and which provides it with a guide as to how much it can lend.
Since 1971, when the US ceased to exchange dollars for gold at a fixed rate of exchange, the world has lackeda fixed measure of value on which to found its banking systems.It has had to improvise.
In theabsence ofgold, sovereign debts of Governments were pushed into assuminggold’sroleasa fixed measure ofvalue , on the assumption that Governments always repaid their debts at face value, and if a bank held enough Government bonds ,it was thus , by definition,a sound bank.
GOVERNMENTDEBT A POOR SUBSTITUTE
The difficulty was that , unlike gold, there isno natural limit on theamount ofGovernment debt.Indeed the United States, and other Governments, issued large amounts of debt to people, like the Japanese and Chinese , who wanted to save for the rainy day and were prepared to buy the debt at ridiculously favourable prices to the borrower.That, in turn,led to an over expansion of the US and other western economies on the basis of credit fuelled by an oversupply of Government bonds.
Now the very clever people in the bond markets have discovered, to their amazement, that Government bonds are not as good as gold afterall. If you have too much of a good thing, it is not good any more.Here is how their eyes were opened.
THE THINGS THAT SPOOKED THE TRADERS, WHO HAD NO SENSE OF HISTORY
Political parties threatened to, deliberately and unnecessarily , default onGovernment debts to make a political point. This happened in the US recently.
Some Governments produced deceptive public accounts to allow them to issue more debt than they can afford to service.This happened in Greece.Governmentsgenerally, and many businesses, simplyborrowed too much,at artificially low interestrates .
The fact that none of the highly educated people in the rating agencies, banks, and accounting firms did not see the risk thatsucherrors might be made , andprice therisk such errors into the interest rate they charged on Government bonds,was a result ofthe“tunnel visioned”specialisation,that passes for education in many our leading universities nowadays.
We paid a price for thefact that economics courses focussed insufficientlyon economichistory andfinance wastaughtas if it wasa branch of mathematical engineering,rather thansomething inherently under the influence ofpsychology and politics
All this critique is fine as far as it goes.But is there a solution?
HOW A EURO BOND MIGHTSOLVE THE PROBLEM
I think we will only get our economies going again, if we can restore belief in a fixed measure of value ,that can perform the role that gold performed in the past, andwhich sovereign bondsperformed until recently.
That is where the proposal for a euro bond could be helpful.It could be a lot more than a short term fix.
Suppose all the euro area Governments could agree that they would all mutually guarantee the repayment of anewcollective euro bond,and that in additionitwould have first call on (say) a fixed share of all VAT receipts.Suppose then that this guaranteedeuro bondcould onlybe issued by a euro area Governmentin limited circumstances eg.
1,) that their budget law , and five year projections,had been approved in advance by the European Commission and
2.) the eurobondcould only be issuedcover a limitedproportion of their total borrowing, as long as their overall debt/GDP ratio was more than (say) 40%.
This would have a number of advantages.
It would guarantee a minimum borrowing capacity to all euro area states.
It would, however, penalize countries who had debt /GDP ratios over 40%, because they would be forcedto borrow commerciallyand pay higher rates of interest on theextra borrowing, which would be a strong incentive to them toget their debt level down as quickly as possible to40% or below.
Because it would be guaranteed by all euro area Governments, and have a prior call on VAT receipts,the new euro bond would have real credibility globally, as well as within the EU.
Banks who held such new euro bonds would now have something of real and certainvalue, on the basis ofwhich they could confidently basetheir lendingdecisions. In that way, credit would start flowing again, jobs would be created and permanent structural damage to our economies avoided.
If this happened, Europe, rather than being the world’s economic problem, could be the provider of part of the world’s economicsolution.