Euro-zone Debt Crisis, Where Would We Be Without Rules?

By: Adrian_Ash

"Where would be if we didn't have rules?"
"FRANCE!"
"And where would we be if we had too many rules?"
"GERMANY!"
  – UK comedian Al Murray, the (very British) Pub Landlord

"The GREAT DEPRESSION was caused by the Gold Standard," reckons NYU professor and professional media star, Nouriel Roubini.

Like pretty much everyone else, Roubini thinks the Gold Standard's tiresome rules brought about that cataclysm. Those manacles meant having to swap paper for bullion every time investors and savers got jumpy about the size of your deficit, your debt or your money-printing.

Really, what an idea! So 80 years later, the Gold Standard is deader than punk. Yet here we are in another depression again.

What's caused this catastrophe if gold was to blame before?

"First, it is Europe itself that is in crisis. Not finance. Not the economy. Europe. Its culture. Its genius. Its unconscious conscience. Its immemorial and its memory. All that makes up its bases and its origins. Its heart, that beats more and more faintly. Its soul. Its common and hidden grammar. The distinction, that it invented, between law and right. Or between man and citizen. The articulation, that is its own, of multiple forms of the Multiple and of the unique name of the One..."

There's more of this – much, much more – from French "superman and prophet" (© Vanity Fair) Bernard Henri Lévy. A "vain, pontificating dandy" according to the professional pie-thrower who's been attacking Lévy's enormous hair since the mid-80s, the nouveau philosophe "[has] no equivalent in the United States," according to his biog' on the Huffington Post. Which is lucky for the US. Because in France, Lévy "is accorded the kind of adulation that most countries reserve for their rock stars," says the UK's Guardian.

Scarier still, he's best-friends-forever with French president Nicholas Sarkozy. Most scary of all, Lévy would in fact make a clear and sensible point, if only he swapped the word "Europe" for "money" above. Deflation is a "deterioration of the monetary standard" just as much as inflation, as sometime Reagan advisor and WSJ editor Jude Wanniski noted in 1982. No less disastrous for everything built on the grammar, culture and genius of money than its apparent opposite, deflation is "characterized by falling prices". And as money rises in value, "it affects more and more debtors in global Dollar contracts" – the Dollar still being money today, and the only cash that counts in a panic.

Research shared with BullionVault today shows that, in 8 out of 10 of the best weeks for equities since 2007, the Dollar fell on the currency market. It rose in each of the worst 10 weeks for stocks. You might have noticed this mechanism gutting your portfolio again this month, as well. But what of the Dollar's sometime challenger for reserve currency status?

"The Euro represents the mutual confidence at the heart of our community," declared Wim Duisenberg, then-president of the European Central Bank, when accepting the Charlemagne Prize on behalf of, well, on behalf of the Euro currency itself, in 2002.

"It is the first currency that has not only severed its link to gold, but also its link to the nation-state. It is not backed by the durability of the metal or by the authority of the state."

Lacking those two legal attributes – attributes held by pretty much all money ever until the mid-20th century – the Euro did have rules, however. "In order for [monetary union] to function smoothly," as the European Council still says today (just above a warning that "this page is under revision"), "member states must avoid excessive budgetary deficits. Under the provisions of the Stability and Growth Pact, they agree to respect two criteria:

"A deficit-to-GDP ratio of 3% and a debt-to-GDP ratio of 60%."

Now, if everyone had stuck to those rules, perhaps the Euro would have avoided this crisis. (Not adding the debt of your entire banking sector to the deficit, as Ireland did in 2008, would have helped too.) But nobody kept to 3-and-60, because those rules were just rules, and they were there to be broken.

"If a Member State exceeds the deficit ceiling, the excessive deficit procedure (EDP) is triggered at EU level. This entails several steps – including the possibility of sanctions – to encourage the Member State concerned to take measures to rectify the situation."

Tough talk! The "possibility" of sanctions would "encourage" miscreants to "take measures", or so the Growth & Stability Pact pretended. Yet as we wrote a year ago, nearly 12 months to the day, the "ghost of the Mark" (as Nobel-winning economist and 'father of the Euro' himself Robert Mundell called it) saw the Euro's strict rules – learnt and applied during 50 years of Teutonic discipline – over-run at every turn.

• The European Central Bank's own target for money-supply growth first became merely a "reference value", and then it was ignored outright. Set at 4.5% per year to start, it hit well over 12% at the height of the banking bubble in 2006-7;
• Luxembourg aside, all member states have long since breached the Eurozone's government deficit and debt ceilings – Germany included;
• Barred by its founding treaty from financing government deficits directly, the ECB first bailed-out commercial banks by lending to them against government bonds put up as collateral, and then threw the whole thing over by agreeing to buy and hold government bonds outright – the weaker, the better, of course.

There has been resistance, of course. But it was awful late in coming. German ECB member Axel Weber stood down in February 2011, proclaiming discomfort at the majority of his central-bank colleagues voting to buy government bonds to shore up Athens, Dublin and Lisbon. Yet this was over nine months after the first Greek deficit crisis, and a mere eight years after Germany and France breached the 3-and-60 rules themselves. Where were his principles when breaking the rules didn't matter?

Six months after Weber, the ECB's chief economist Jürgen Stark also made a principled stand, announcing that he would leave his post, two years early, in December. Why? Because "If the central bank starts to finance governments, it decreases the incentive for governments to address the root causes of the crisis," as Starck told an interviewer last week.

"It is not so much that bond purchases will lead to inflation at this particular moment. The ECB regularly draws down the liquidity again; it later soaks up the money spent. What is important and problematic is that the interest rate on government bonds is affected by the purchase of bonds and thus has a fiscal effect."

Buying bonds, in short, means that the independent ECB policy wonks "influence the conditions under which governments can borrow," says Stark. "This is absolutely not our job." Given that everyone knows the rules are being broken, of course, "There is an open discussion about extending our mission," says the ECB man. "This not only affects our independence, it threatens it.

"Principles apply...Rules are there to give direction, especially in times of crisis."

How brave, insightful and utterly naïve! Tilting at windmills, Stark misses the one true lesson of the Great Depression's Gold Standard just as badly as Nouriel Roubini does. Hasn't anyone got a library card these days?

"The advantage of gold, in theory, is that it affords a safeguard against the dishonesty of Governments," writes British philosopher Bertrand Russell in a dusty tome from 1935. "This would be all very well if there were any way of forcing Governments to adhere to gold in a crisis, but in fact they abandon gold whenever it suits them to do so."

Replace the word "gold" with the words "Europe's Growth & Stability Pact", and you'd think it was the end of November 2011. And just like the Euro's would-be saviors today – or at least, just like those world-improvers who don't believe rules should get in the way – Russell thought the only solution to mankind's economic problems was "an international Government". That way, tiresome democracy would be made irrelevant as expert technicians did the best for all in all possible ways.

Now voters in Greece, Ireland, Portugal, Spain and most plainly Italy have shown they can't handle democracy – not in a rules-based currency system. Time and again they have voted for people and policies which now make the rules aimed at defending the State's independence impossible. Little wonder their sovereignty's now vanishing, along with the rules.

By Adrian Ash
BullionVault.com

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Formerly City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2011

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