By Nathan Tankus, a member of Occupy Wall Street Alternative Banking working group. He is also deeply involved in the heterodox economics community and plans to have a PhD in economics before the decade is done. Cross posted with View From the Metropole.
In accounts of American economic history, the early days of banking are typically described as chaotic, contradictory and many decisions are depicted as awful, stupid mistakes. That period certainly included all these things, but looking at Europe now, one can’t help but feel that many back then (especially the elites) understood money better and were much better pragmatists. The point about pragmatism is especially important: you can only make realistic decisions if you know how things actually work. In this sense, the Euro is the ultimate idealist project. Its designers took a vision (some would say a religion), compared their vision to the functioning of an entire continent and attempted to chop off the parts of the continent and different societies that didn’t fit the template. I would call it a Procrustean bed, but to be fair to him, I bet he only mutilated a few dozen people, not an entire continent.
What is the theory that justified the Eurozone? It is a geographic extension of these assertions by Adam Smith in the Wealth of Nations:
It is the necessary, though very slow and gradual consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another.
Later on he extends this point to an analysis of money:
But when barter ceases, and money has become the common instrument of commerce, every particular commodity is more frequently exchanged for money than for any other commodity.
Notice he says that barter “ceases”. The implicit assumption here, which has been extended and made explicit since Smith wrote these words, is that people “naturally” move towards exchanging what they produce for a particular commodity (Smith obviously was thinking of gold and silver), which would then be money. In short, Smith proposed that money develops to reduce the cost of transactions between people. It’s an interesting theory but, as David Graeber has described at some length in his book Debt: The First 5000 Years, , it’s one with no historical foundation. A policymaker, working under the view that these assumptions are correct, would have a very difficult time coming up with and implementing pragmatic solutions to financial (and fiscal) crises.
Modern economists took the obvious next step in this theory in that they applied it to geography. Named Optimal Currency Area (OCA) theory, it suggests that how large a “currency area” is and which locations are in that currency should be determined by what will reduce transaction costs between firms and individuals the most. In some ways this view is more incoherent then Adam Smith’s view. Smith had a labor theory of value so he thought the value of the unit of account (gold and silver in Smith’s mind) would vary with the rising or falling labor time it took to produce it. But OCA theorists never suggested tying these currencies to a particular commodity. They seemed to think everyone would just say “oh wow, they said my costs will be less if I use those pieces of paper and electronic spreadsheets so I’m going to do that now!”
So what would give this money that isn’t tied to any particular commodity, value? Ironically, later in the Wealth of Nations, Smith provides an alternative mechanism for money receiving value.
A prince who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind might thereby give a certain value to this paper money, even though the term of its final discharge and redemption should depend altogether upon the will of the prince.
Long time readers of Naked Capitalism will recognize this as the view of Neo-Chartalists, primarily based out of University of Missouri, Kansas City and who blog at New Economic Perspectives (and often on this blog too). The reason that a whole “area” (what normal people call a country) shares a unit of account is ultimately because people try to acquire whatever they can pay their taxes in. Rather then the need for a medium of exchange automatically generating a “natural” unit of account, an artificial unit of account is imposed through taxation. It becomes a medium of exchange when people try to acquire the money they need to pay taxes by selling whatever they have (for most people, it ends up being their ability to work). In Graeber’s book, he hypothesizes that this really started historically as a means for a king or government to get the local population to give up goods and services to their armies.
Luckily for the countries on the Euro, these economists didn’t suggest eliminating all taxes. Unfortunately for those countries (or more accurately, their average citizens) , they didn’t propose any way to finance budget deficits. As a result, once they hit their first bump in the road, in this case a financial crisis, they had no mechanism of dealing with these problems except imposing harsh austerity, which doesn’t ultimately solve the problem as unemployment insurance rises and tax revenues fall further as people’s incomes fall. To stop these automatic stabilizers from providing higher levels of expenditure in bad times, these nations would have to repeal nearly the entire welfare state and reintroduce poll taxes. Then they would just drive some people into insolvency, which may still cause budget deficits. Even in the face of rising political opposition, the policy elites to seem determined try. As a result, some contend that the real aim of the Euro project is to dismantle Europe’s social safety nets.
Ironically, the proof that OCA theorists marshaled to “prove” a monetary union between various different states is beneficial, was the United States! To someone who knows anything about our financial system after the Revolutionary war, that’s comical. First, it’s true the constitution banned states from printing paper money and minting coins (which is how they financed their budget previously), but they didn’t actually switch to some central currency. That doesn’t really start to happen until Lincoln issued “Greenbacks” during the civil war. Instead, they chartered banks whose notes were acceptable in payment of state taxes. The states financed most of their spending out of the dividends they got from owning a percentage of their chartered banks, and later out of taxing their capital. The notes of the First and Second Bank of the United States were acceptable in payment of federal taxes and to purchase public lands. Both banks could even make loans directly to states with the authorization of Congress! This system certainly was designed to help certain interests, but at least they knew how to take a few golden eggs without killing the goose.
The Euro would be a much more workable system of the European Parliament had taxing authority over all of Europe and each country kept its own currency. But then, why would Europe need or want such a system? Each generation of politicians in Europe seem to think that they can get what they want through the Euro while trying to keep this jerry-rigged system operational (or at least the appearance of operational) for the time being. Indeed, its designers were well aware that there were fundamental gaps in its architecture, and anticipated that they would be addressed in future crises. While the future is now, but there doesn’t seem to be a pragmatic set of politicians in sight to implement these measures. That might prove to have been their most fatal, idealistic assumption of all.