On May 7 2012, Jens Weidmann, the president of the Deutsche Bundesbank published an article in the Financial Times titled “Monetary policy is no panacea for Europe’s ills“. From the title one might expect to read a series of well-documented arguments forwarding the thesis point of the article. However in Mr Weidmann article this is not the case. Instead it is a text replete with misleading remarks and quasi-moralistic demands. His suggestions are in fact used to present in a good light the policy of his institution -the Bundesbank- and the overall approach of the German government to the crisis.

I could comment upon each and every paragraph of his article, at the risk of frustrating the reader, but instead of doing so I will only focus on the following pontification of Mr Weidmann, which is enough to destroy his case. As an introductory remark, allow me to say that in truth his article has nothing to do with monetary policy. It rather is a litany of normative statements arguing how prudent central banks have been, how important their independence is and why governments ought to implement austerity measures (emphasis on the quote is mine):

…[T]he funding of banks that are not financially sound or against inadequate collateral would shift substantial risks between national taxpayers. Such implicit transfers are therefore beyond the mandate of the eurozone’s central banks. Rescuing banks using taxpayers’ money is something that can only be decided by national parliaments.

There is much that is wrong with this statement. Above all it reproduces the erroneous rhetoric of “transfers”, implicit or not, with a clear intention to practically suggest that German taxpayers are in one way or another bailing out the banks of the GIIPS. Nothing could be further from the truth. The word “transfers” either implicit or explicit, direct or indirect, is an imposter term when speaking about the operations of the monetary system. What Mr Weidmann, and the other devoted “ordoliberals”, call “transfers” are just the normal, daily operations of any currency union operating under a fiat monetary system.

Refuting the misleading arguments of transfers

One of the necessary elements of a monetary union, such as the eurozone, is that its currency, the euro, must always have the same value regardless of the country in which it is circulating. This means that a 100 euro deposited in a Greek bank must always have the exact same value with an equal amount of euro in a German bank. Though on the face of it this might sound obvious, in fact this is not at all a “natural” feature of the currency. On the contrary there is a very sophisticated payment mechanism in place allowing for the smooth, automatic extension of credit between banks to create this effect. This is what Mr Weidmann falsely calls “implicit transfers”.

To understand why this is the case, one has to realize how a currency is evaluated. We shall consider two simple examples. At first assume that Greece and Germany have their national currencies. Then let’s imagine that in present time 100 drachmas are equal to 100 deutschmarks and we allow the economy to work on its own over time, without any intervention whatsoever. Under these absolute free market conditions the value of each currency is a function of a complex, interweaving web of causes. Some of these are the amount of money in circulation, the demand for it, the conditions in the economy, future expectations, the prevailing interest rates and so on. In short, the value of each currency would ultimately be determined on the market. Understandably if the market considered the deutschmark as a safer currency, because the German economy is more reliable than the Greek, then the deutschmark would be appreciated with respect to the drachma. Hence the initial 100 drachma = 100 deutschmark rate could easily become 200 drachma = 100 deutschmarks. The only way through which their mutual valuation could remain fixed at all times, would be for the central banks of each country to intervene and adapt accordingly to all those factors, by fine tuning their operations. Otherwise the market will scarcely ever treat these currencies as of having an equal value.

The same applies in the eurozone, even though each country uses the same currency. If we were to assume that no interventions from central banks exist, and that the eurozone uses only euro, we would eventually see that a German euro coin would have more (expected) value than a Greek euro coin, exactly because the forces of the market would favor the former rather than the latter, for obvious reasons. For the euro to be of equal value all across the eurozone, the National Central Banks and the ECB need to constantly extend credit to one another to counter the forces of the market and create this equilibrated effect of fixed currency evaluations.

These operations are handled by the TARGET2 payment system. In doing so they ensure that a euro in Greece will always be equal to a euro in Germany, regardless of market conditions.

This payment system becomes even more important and necessary during periods of severe financial stress such as today’s, where banks, operating under the modern fractional reserve banking system, find their selves short of credit because of a dearth in savings, continuous capital flight and due to their inability to access the capital markets at any reasonable price. Their only means of functioning is by resorting to the payment system as outlined above, to finance their daily activities and keep their ATM’s active. The process would thus go as follows: the local bank needs money to carry out a transaction >> it contacts its national central bank, asking for the creation of the respective amount >> the national central bank creates the money necessary for the transaction and sends a claim, through TARGET 2, to the eurosystem.

Such a process is automatic and has nothing to do with transfers of any “real” money, certainly not of taxes. It is a common feature of our modern fiat monetary system, where central banks create money out of thin air (whether that is desirable or not is another issue). As for the actual claims and the potential risk they bear, this can only make sense if the eurozone was to collapse altogether, since member-states are partially exposed to one another via this system. Thus the point of Mr Weidmann, fallacious as it undoubtedly is, seems to be grounded on the assumption that there is a high chance for the eurozone to collapse any time soon. Even though such a possibility can never be ruled out over the medium to long term, the chances of it happening in the short run are minimal.

If we strip away all the technicalities of the above analysis we realize that from a money point of view a monetary union can never be treated as an amalgamation of nation-states, with “transfers” between them.

It is therefore clear that no transfers whatsoever take place in the sense that Mr Weidmann purports to show: as taxes of Germans channeled into (quasi-)bankrupt peripheral banks. To present a regular function of a capitalist, fiat monetary union as “implicit transfers” is flatly wrong and insistence on this terminology is pernicious. There is no particular criterion to base this misleading remark beyond that of short-sighted nationalistic politics.

German banks are among the greatest beneficiaries

Yet this is not the end of Mr Weidmann’s problem, for the above quote also includes another dubious assertion. Namely that “rescuing banks using taxpayers’ money is something that can only be decided by national parliaments”. By presenting this alleged truism, Mr Weidmann fails to realize that if it were to be taken as a universal axiom it would ultimately be to the detriment of the Bundesbank and the German economy.

We know well that German banks are heavily exposed to the eurozone’s periphery. When the ECB used its SMP programme to buy government bonds of peripheral countries, or when it pumped €1 trillion into the european banking system through the two tranches of its LTRO loans, German banks were among the beneficiaries. Either because the governments that owed them money, found the cash to pay them back; or other domestic private banks tried to cover their own liabilities to them, such as Spanish banks who are heavily exposed to the property bubble and who are interwoven with German capital; or the German banks themselves gained direct access to these funds. After all, as the Financial Times reported,more than half of the 800 banks that received the second tranche of the LTRO were German banks, while Deutsche Bank, one of the world’s most leveraged banks, recently capped almost €10 billion from the ECB. In case Mr Weimann did not realized it, all this was never approved by any national parliament, but only by the governing board of the ECB, without any parliamentary scrutiny.

Given that the large German banks are among the ones with the highest leverage ratios in the eurozone, it is natural to expect that they welcome the cheap money from the ECB to raise capital, so as to meet the capital adequacy criteria, by June 30, 2012; or to make some easy profit in the meantime. I really do not think that Mr Weidmann would like this money-printing bonanza to pass from any parliament, because then, German banks could risk running short of funds, with whatever implications this would have on their stability and their sustainability.

By the way allow me to use the words of Mr Weidmann to pose a rhetorical question: does this “funding of banks that are not financially sound or against inadequate collateral” really“shift substantial risks between national taxpayers”? If yes, then the distinction between monetary and fiscal policy is completely obliterated and so the much-vaunted independence of any central bank becomes absurd and meaningless…

Mr Weidmann propounds a series of self-serving arguments, perhaps very useful for the cheerleaders of pseudo-nationalistic yellow papers such as Bild, who are enamored with such oratory and who will delight their selves with “analyzing” the “oracular wisdom” of their Bundesbanker. In truth Mr Weidmann’s article seems as if it was written by the spokesperson of Madame Merkel and not by the president of the Bundesbank, who cares so much about the “independence” of central banks.

I believe it is high time we abandon this hypocritical, polarizing palaver. It serves no one to play the game of “the good, the bad and the ugly” during these times of crisis, where dogmatism can only lead to unpleasant outcomes.

Image credit: L’express

Quo vadis Jens Weidmann? | Protesilaos Stavrou.

For a better perspective let us for argument’s sake put aside all the obstacles that were raised in the last elections and that a coalition of ND-PASOK and some other party forge a government to run the country. The president of ND, Mr Samaras, whose party has secured the most seats in the parliament, has long been delivering promises of renegotiating the memorandum with the troika – the memorandum that he and his party voted in favor of a few months ago to secure the second bailout agreement and the restructuring of the country’s debt under the PSI programme. What can he really ask for? The position of the trio of official lenders is straightforward: meet the fiscal targets or else you will not receive any further financing. What are the strong negotiating points of Mr Samaras to present before the troika so as to entice them to accept his new proposal? What can he say to counter the hard line of the official lenders? In truth nothing, apart from the well-known pointed remarks on the failure of austerity policies, which will nonetheless fall on deaf ears.

The bargaining power of the domino effect

Had this discussion to better negotiate the conditions of the bailout programme been held two years ago, Greece would have been in a more advantageous bargaining position since a disorderly default back then would have inflicted immeasurable loses to all parties involved, both private and public (whether that would be good for the interior is another issue). If we are to strip away all the moral and political objections that could be raised, scrupulous Greek politicians could have asked for much more favorable conditions by presenting a possible default as a threat. For whatever reason they did not try anything like that, preferring instead to slavishly follow every single one of the dictates of the troika, with the ex-Minister of Finance Mr Papakonstantinou trying to convince us at the time that Greece would definitely regain access to the markets by 2012 (this will not happen earlier than 2020 or even later).

For two years the government(s) clung on to a futile programme that could never succeed, for it was chasing chimerical targets, under unrealistic assumptions, without considering the real impact on the economy and society. It is obvious that you cannot reform a country’s economy without considering the microeconomic impact of the incrementalist austerity policies that put all the burden on the average entrepreneur and worker. An economy requires stability and this programme did everything possible to create constant instability and major uncertainty, byrevising the regime every few weeks – grand failure (this holds true even if we accept that the policies themselves are indeed desirable, which is not the case).

Today with most private creditors secured or better capitalized and with everyone in the markets expecting a Greek default, perhaps accompanied by a disorderly exit from the eurozone, there really is no way for any Greek politician to play the “contagion threat”. The risk of contagion coming from Greece has long now been significantly diminished, especially ever since the debt restructuring that transferred most of the debt burden from the shoulders of private creditors on to official creditors (though systemic risk has increased elsewhere in the eurozone). The plain fact is that a Greek default can and will be handled in one way or another, hence no magnificent pressure can be exerted towards that end, if negotiations were to reach such a point.

Note that many politicians still believe that this is a powerful tool in their hands. Especially SYRIZA, the left-wing party that came second in the recent elections, and the Independent Greeks, the moderate patriotic/nationalist party that finished fourth, are of the belief that they can declare the debt illegitimate, refuse to pay it back and thus be in a position to better negotiate with the troika. This view is in present time fallacious for three reasons: (1) it fails to recognize that the systemic risk in the eurozone has shifted from Greece, to Spain and deep in the horizon, France – yes France -, (2) it considers the troika as soulless automatons who will not react accordingly to the measures of the Greek politicians, (3) it underestimates the impact this will have on the legitimacy of Greece both towards its European partners and towards the capital markets for years to come.

The sole reality is that once the Greek politicians start behaving as if all Europeans and the markets are their foes, then the country will be subjected to a silent treatment and will be committed to a diplomatic purgatory, litanies to the contrary notwithstanding. This pseudo-nationalistic inwardness can only harm Greece, especially at this point in time where cooperation with as many forces as possible is the only prudent way of avoiding the chilling effects of economic depression combined with political isolation. Greece needs allies not enemies – and alliances are built through constructive proposals, through tangible, coherent, persuasive and compelling plans; not through absolutist oratory and “we against them” syndromes.

The two scenaria of the failure to renegotiate with the troika

If then a unilateral renegotiation, championed by Mr Samaras et al, is in fact nothing more than a fleeting dream, or the humbuggery of power hungry politicians, what could possibly be the final outcome? Two are the most plausible scenaria, even though in today’s Greece, where populism seems to have obliterated reason, I would hardly be surprised by any other unexpected outcome.

The first scenario argues that the new government will more or less march along the path of its predecessors, implementing the memorandum so as to receive the periodic tranches of loans from the troika. Considering the anti-memordandum oratory however, and how many politicians portrayed their selves as the knights in shining armor who toil against “the markets, the bankers and the creditors”, this would scarcely be accepted by the electorate. Either some like it or not, the fact is that the majority of Greek citizens clearly voted against the current regime of austerity measures and it will be extremely hard to persuade them for more of the same. As such the coalition supporting the troika programme could fall into disarray renewing the round of regime uncertainty that has covered the country over the last months (years), bringing forth the need for new national elections. Given the rigid time frame and the position at which Greece currently stands this could hardly be good news, as a negative reaction from the side of the EU or the IMF or indeed private investors who would otherwise like to invest in Greece, cannot be ruled out.

The second scenario cuts into the nub of the issue: the lack of feasible alternatives mentioned above. Assume that for whatever reason Greece fails to meet the conditions set forth by the troika and the ECB decides to cut funding to the Greek banking system, thus effectively forcing Greece to exit the euro and reconstitute its national currency, the drachma. Should that be the case, only a coherent and detailed plan to introduce the new currency as fast as possible could mitigate the immense shock. The key question therefore is whether any such plan exists? And is it anyhow comprehensive or is it similar to the empty statements we are accustomed to hear these days? To put it bluntly, I suspect that the Greek political system has no idea of what to do, if plan A falls into jeopardy. There is no plan to contain a potential negative outcome of the “renegotiation” of the memorandum, while there is no real strategy to bring about any kind of change to the current regime.

With that said, there is another worrisome sign: the absence of an in depth public debate on the key issues of the present situation. One would expect some kind of well-defined proposals on issues X, Y, Z. Some systematic efforts to identify and combat the root of the problem. In Greece we did not see that. What we saw instead was a competition over who will sound more “patriotic” or “social”, without any interest whatsoever in the actual content of the political palaver. All we witnessed was the cheerleaders of populist political pontification parading before the TV screen, whose arguments cannot be based on any criterion other than myopia.

Thus in May 2012 Greece is once again in complete denial of its self; seemingly unaware of the perils ahead, with no prudent leadership and popular determination to shrewdly navigate through the Scylla and the Charybdis of our time. My final question is: Why didn’t any political power try to establish bridges of communication with other forces in Europe to present a compelling system-wide strategy, which is the only means of actually combating the current approach to the Greek crisis in particular and the eurocrisis in general? To renegotiate you need to have real alternatives and real allies across the EU. Alas the Greek political system has none of the two.

Greece in complete denial: The failure of the political system | Protesilaos Stavrou.

The national elections in Greece on May 6, 2012 brought seven parties in the parliament. The first feeling one gets is that of uncertainty about the future. Five out of the seven parties have a clear anti-austerity, anti-memorandum agenda, while ND, the party with the most seats claims that it wants to “renegotiate” the terms of the bailout programme. Given that no single party has secured a majority of seats in the parliament, a coalition of forces is necessary to form a government. However with the diversity of views now represented in the new parliament, such a coalition will be hard to find, while there can be no safe predictions about a possible government agenda for the time being.

The first observation one can make is that almost 35% of the voters did not turn out to cast their vote. In times like these this can either be interpreted as a sign of disgust and anger towards the political system that brought the country to this position, or as a sign of ignorance, complacency and indifference. I hope it is the former, though I cannot rule out the possibility that the latter holds true.

The second observation, is that the two traditionally dominant parties of the conservative ND and the social-democratic PASOK have suffered major loses in terms of the percentages they enjoyed in previous years, when they could easily secure a majority of seats. Now they have received roughly a third of the votes they used to get. Their bipolarity that governed Greece ever since the fall of the military junta in 1974 is now over. In my view this is a positive sign. The Greek people seem to have realized that the graft and corruption unearthed by these two parties can no longer be tolerated, at least not to the same extent. The next step will be to see the exemplary punishment of all those who were responsible for bringing the country to this position.

The third observation, is that nationalism and populism were rewarded. The neo-nazi party, Golden Dawn, won almost 7% of the share. Though I understand that many of the citizens casted their vote out of anger and despair and that they are not ideologically aligned with the agenda of this party — a programme replete with misplaced beliefs, outright lies, hatred speech and racist shibboleths — I still consider it a disgrace and a scandal for democracy and for the democratically orientated citizens of Greece to have given such power to a clearly undemocratic, totalitarian party. I am much afraid about this rise of extreme nationalism and I dare say that history has offered us highly unpleasant examples of how a totalitarian regime can come out of a parliamentary system. The democratic citizens of this country, regardless of political preferences must remain vigilant and close their ears to the sirens of hatred, xenophobia, europhobia and self-destructive nationalism.

The fourth observation I have to make is the persistent sectarianism that characterizes the Greek left. Apart from the rise of SYRIZA, which became the second party, we see KKE, the communist party not willing to make any kind of compromises to a broader leftist agenda; while on the other hand we witnessed a massive failure of the Ecologists/Greens to find a common programme with the Democratic Left (DEMAR), so that they could both gain out of it. Instead we are seeing a sectarianated left, which has yet to come to its senses about the real situation in the country. Unfortunately many in the broader Greek left have long now fallen into reveries about some promised good life outside the EU or the Euro; and instead of proposing tangible solutions to the dead-end of the troika programme, they insist on unrealistic proposals that will at best create laughter to the European partners and to all those who still put logic above sentiment and ideological delusions. I am much disappointed of the Greek left, for its inability to stand up to the task of being a truly progressive power of reform. I remain reserved nonetheless, to see how SYRIZA will use the substantial share of the vote it won. I wish they do not channel it into the familiar arid oratory of promising everything and offering nothing. We shall soon find out.

The fifth observation is that no coalition government can easily derive out of the existing setting. While theoretically the broader right (ND-Independent Greeks-Golden Dawn) could come up with a coalition, in practice this is impossible for two reasons. Firstly the Independent Greeks are led by Panos Kamenos, an ex-ND deputy who resigned from his former party when ND supported the memorandum with the troika. Kamenos, said after the results of yesterday’s elections that he will not cooperate with “traitors” – he was of course referring to ND. The second reason is that Golden Dawn is clearly anti-EU and they will never agree on a programme that will support the memorandum with the troika or indeed any EU-oriented agenda.

Moreover a ND-PASOK coalition does not secure a majority in the parliament, which means that a third party will have to come in. Theoretically this could be either SYRIZA or DEMAR, but in practice this would scarcely happen, given that SYRIZA and DEMAR are clearly against the memorandum with the troika. This means that a coalition will be hard to find, while its power will be very fragile and could easily break up as soon as the troika demands further budget cuts and other stringent austerity measures – which they will do in two weeks time and then during the summer.

Finally I would like to point out the preposterous law that offers 50 seats out of the total 300 to the first party. This is the most anachronistic, undemocratic law in the books and needs to be removed immediately. If you see the image I included above, you will realize that ND has almost 50 seats more than SYRIZA, when in truth their margin was roughly 2%. Such undemocratic alchemies do not help in bringing all the voices of the people in the parliament, such as those of the Environmentalists/Greens and the Liberals. A truly pluralist system cannot cartelize the parliament.

Given all the above, I believe that there is a lot of uncertainty around Greece. There is a possibility that no government will be formed, which will lead to another election. In the meantime, all this political bungling works to the detriment of the domestic economy, as businesspeople do not know what kind of economic regime they will have to face in the weeks and months ahead. Will publicly owned enterprises be privatized? Will banks be nationalized? Will taxes increase further? Will capital controls be set in place? Will the country exit the eurozone or the EU? These and many other questions along these lines cloud the economic environment. Meanwhile time is running out and if there is no government any time soon, Greece will not receive the next tranche of loans from its trio of lenders, with whatever implications this can have.

The elections have produced a very fluid political setting. I am much worried about the European prospects of the country given that many anti-European sentiments have gained significant exposure. If populism from all sides prevails, then I am afraid that it will have a chilling effect on the country, plunging Greece into chaos and putting it along a perilous path that can only lead into more suffering.

The question we need to answer is whether these elections have signaled the defeat of the austerity policies or whether they have shown that reason has given its way to populism, political fragmentation and a war of all against all? I have no clear-cut answer. I may only wish that logic prevails and everyone stands up to their duty towards the Greek people and the well-meant interests of the country.

Greek elections: The debacle of austerity or of reason? | Protesilaos Stavrou.

I recall that back in September 2011 Mark Rutte, the Dutch Prime Minister, called for an expulsion of Greece from the eurozone, due to the alleged inability of the Greek authorities to comply with the rules of the EU and the demands from its trio of lenders – the “troika” (EU-ECB-IMF). At the time articles where written, tv and radio shows were broadcasted, praising the Dutch premier for his audacity to “finally” break a “taboo”.

Many did not miss the opportunity to use his dictum to reproduce the unreal theory of the unproductive periphery and the industrious center (of the eurozone). They were delighted to “analyze” the hidden meaning of his pontification, so as to obfuscate the systemic nature of the crisis, narrowing it down to a crisis of excessive debt in the periphery.

Mark Rutte always was among the most vociferous and bitterest critics of Greece (not only) for its imbalanced fiscal finances, while he remained among the most fervent detractors of the idea of a system-wide strategy that would deal with the crisis in its totally, arguing instead that fiscal discipline was all that was necessary. This advocate of the austerity-driven, number cabalism that plagues the EU, now sees his government fall apart because of missing the fiscal targets he so trenchantly defended. In ancient Greece this would make for a great play of Tragedy, in which irony would take center stage to pass to the audience the importance of thinking outside the box, of looking into the unseen, otherwise risk falling into a trap of one’s own making.

So what is really the gist of this incident? Certainly not that suddenly the case of Greece and the case of the Netherlands can be compared using a common denominator. But then what lies behind these events?

It is nothing more than the long-standing, well-established argument that the crisis we are dealing with is systemic. Striping away the particularities of each case, there are flaws in the very system overriding each and every facet of the broader crisis. We all know –including Mark Rutte and the other plucky austeritarians who cling on to the country-by-country futilities– that the eurozone, a monetary union, was a flawed venture from the outset (see articles onTARGET2 payment system).

First of all it was a political project for further integration utilizing economic means, in a process of incrementalist steps towards the establishment of a political union. Secondly it formed a currency union with member-states that had not achieved real convergence in terms of productive capacities. Thirdly it lacked essential mechanisms and institutions that could mitigate asymmetric shocks – such as the complete absence of a fiscal union backing the currency, with powers to directly raise revenue and issue (euro-)bonds on its own accord. Fourthly it did not preempt the erratic capital flows in the periphery that resulted in the propping up of all sorts of bubbles, by means of effectively regulating the now-sectarianated European banking system. All this within a context of an EU that has yet to develop aEuropean identity and public sphere, while it still suffers from all sorts of imperfections concerning its governance.

For as long as we try to anxiously conceal the systemic aspect of the crisis, we will witness yet more failures and will have to endure for much longer the inane austerity palaver and the counter-productive, bureaucratic EU bungling that have so far only succeeded in prolonging the chilling effects of the crisis. This is not an apologetic for whatever malignancies may exist in each national economy, nor does it provide any excuse for previous malpractices. On the contrary these are part of the broader problem and need to be taken into consideration, in proportion to their actual impact.

Coming back to the Dutch government, I am convinced that they are indeed very serious with their fiscal finances. Their belief in fiscal discipline is sincere and not some typical humbuggery of political talk. Believing that this is the case, then one can only wonder that if these people who really want to stick to the fiscal targets have failed to do so, could it then be the case that laboring towards satisfying the Maastricht criteria is inherently problematic? Could it be that these chimerical macroeconomic targets require a thorough revision?

The moral of the collapse of the Dutch government is that the austerity nostrums, based upon tissues of misinterpretations on the causes of the crisis and unexamined dogmas; are not a solution to our problem, for they do not treat the source of the disease, but only its symptoms, the imbalanced fiscal finances. The irony of Mark Rutte’s failure together with the shifting of the tectonic plates in European politics, could perhaps provide the impulse for some kind of metapolitical action, that will address the crisis systematically from a supranational, federal so to speak, level. The sure thing is that things cannot -and must not- stay as they are.

Irony and austerity – The fall of the Dutch government | Protesilaos Stavrou.

Throughout many of my writings on monetary affairs one can identify my abhorrence of inflationary policies. One can detect my distaste of the professorial palaver and the humbuggery of political pontification that promote them. My opposition to inflationism takes place on many levels. On the purely academic/economic I find the macroeconomics underpinning these views as inherently flawed and fallacious. False methods and unrealistic assumptions that have been consciously distorting the reality of human action in favor of mathematical conveniency and algebraic manipulation, resulting in those magical arcs and curves that supposedly depict human behavior and the mechanics of the economy. On the political level, I always feel an inclination to commit mayhem whenever inflationary policies are presented as beneficial for the lower parts of the income distribution. Whenever they are embellished with pseudo-socialistic oratory that ostensibly favors the hard-working people who toil against the markets and the speculators.

Let me be clear. My opposition to inflation is rooted in the belief that it only benefits those relatively few who first gain access to the inflationary money; while those who come last pay the entire cost, ending up being worse-off. In that sense this can never be a policy that favors society in general, more so the working class and those groups who are not part of the state apparatus. When I speak against inflation, I oppose vested interests.

To understand why this is the case, see how inflation is brought into being through expansionary monetary policy. A central bank, say the Fed in the US, will step in to buy government bonds or other assets in order to supply extra money into the system. These additional funds will supposedly reach out the real economy, ultimately making everyone better off, in a smooth, equilibrated, proportional way in a seemingly universal expansion. In truth however all that happens is that the open market operations of the central bank, or its “quantitative easing”, result in asset inflation. The prices of stocks, bonds, financial derivatives etc. rise since the extra money is channeled towards that direction for easy and swift profits.

Speculators love inflation and the reason for that is very precise and specific. If I am a speculator who wants to make profit big and fast, I want the price of the financial products at my portfolio to keep rising. If I bought a financial product in present time at 100 I want it to be 100+something in the nearer future so that I may make profit in between the fast exchanges and exploit the expectations of others for even higher prices in the remoter future. As a speculator I have every interest in ensuring that this inflationary process is perpetuated. If by any chance I fail because of the burst of the inflationary bubble, I know that some wise people out there will be eager to bail me out, because I will have become “too big to fail”.

What about the broader society? How does the above process affect them? They are the ones who will experience the later stages of the inflationary process in at least four ways:

1. the misallocation of resources into financial products instead of the real economy, has the effect of diminishing the production of real goods and services, thus reducing employment opportunities, resulting in either unemployment or depressed real wages,
2. the general inflation that will gradually kick in has the effect of reducing real purchasing power and eroding real savings, resulting in an overall impoverishment of the people,
3. when things turn bad, that is when a financial crisis hits, the people will have to pay higher taxes and/or bail out the speculators who lost from the gambling/inflationist bonanza,
4. the rising influence of the speculators undermines democracy and establishes corporatism, since the financiers have greater bargaining power over the government, hence elected politicians tend to favor corporate interest much more than social/democratic needs/demands.

Anyone who has studied economic history knows that those expounding on the “benefits” of inflation were all speculators and greedy financiers, excluding do-gooder groups who are just trapped in fallacious thinking (discussed below). One such figure was John Law (1671-1729), a notorious gambler and banker who openly supported the existence of a central bank with monopoly over the creation of (infinite) paper money. He put his scheme to practice in 1716 as head of the Banque General in France, which soon after became Banque Royale. Law was also made the head of the Mississippi company, a French company operating in the Louisiana region, which allowed him to create the notorious hyper-inflationist Mississippi bubble of 1717-1720. Prices skyrocketed during that bubble, making some individuals “millionaires”–a concept that was unfathomable at the time–at the cost of all those who naively assumed that the increase in prices would continue forever. The inflationary policy of Law favored a tiny minority of people at the expense of all the rest, ironically perhaps, including Law himself. In a similar fashion you will find that today the most fervent supporters of inflationary policies are “market experts” who work for mega-banks such as Goldman Sachs, JP Morgan etc. These corporations were responsible for the crisis in the first place through their pre-2008 over-speculation.

A classification should be made of course between these people and academics. The motives of the latter are profoundly different. Academics of economics are indeed trying to provide feasible solutions to real issues using the scientific method. However their method is inherently wrong. Instead of using my own words to explain why that holds true, I shall use a quote excerpted from a recent article of the perhaps controversial figure, George Soros, which I find absolutely correct.

George Soros says:

Ever since the Crash of 2008 there has been a widespread recognition, both among economists and the general public, that economic theory has failed. But there is no consensus, even among participants in this conference, on the extent of that failure. As a sponsor of INET I am delighted, because it shows that INET is open to a variety of new economic thinking. But I am also the proponent of an alternative interpretation of financial markets and in that capacity I take a different position.

I believe that the failure is more profound than generally recognized. It goes back to the foundations of economic theory. Economics tried to model itself on Newtonian physics. It sought to establish universally and timelessly valid laws governing reality. But economics is a social science and there is a fundamental difference between the natural and social sciences. Social phenomena have thinking participants who base their decisions on imperfect knowledge. That is what economic theory has tried to ignore.

Scientific method needs an independent criterion, by which the truth or validity of its theories can be judged. Natural phenomena constitute such a criterion; social phenomena do not. That is because natural phenomena consist of facts that unfold independently of the scientific statements that relate to them. The facts then serve as objective evidence by which the validity of scientific theories can be judged. That has enabled natural science to produce amazing results.

Social events, by contrast, have thinking participants who have a will of their own. They are not detached observers but engaged decision makers whose decisions greatly influence the course of events. Therefore the events do not constitute an independent criterion by which participants can decide whether their views are valid. In the absence of an independent criterion people have to base their decisions not on knowledge but on an inherently biased and to greater or lesser extent distorted interpretation of reality. Their lack of perfect knowledge or fallibility introduces an element of indeterminacy into the course of events that is absent when the events relate to the behavior of inanimate objects. The resulting uncertainty hinders the social sciences in producing laws similar to Newton’s physics.

These are the main reasons I oppose inflation, especially when I am convinced that there are real alternative solutions. You may draw your own conclusions out of all these thoughts.

Picture credit: Lietaer.com

Why I oppose inflationary policies | Protesilaos Stavrou.

There is this long-standing belief in political thought that society can get rid of interest. That interest is a parasitical cost that we as benevolent human beings can abolish if we intend to. The road to a perfect society or at least to a much better world, inevitably passes through a stage of eliminating all interest payments. Such a view has made itself manifest over the centuries in various ideologies, movements and philosophical doctrines. Not surprisingly perhaps, it started with the ancient Greeks and one of their greatest philosophers, Aristotle. In his proto-economic discussions, which included some correct insights, he made the unfortunate mistake of adding a moralistic dimension to an otherwise real world phenomenon, suggesting that interest was unnatural. Had he escaped from the ancient Greek philosophical moralism, he a genius as he undoubtedly was, could have instead attempted to answer why did interest exist in the first place.

The most recent incarnation of this ancient-old tradition can be found in the calls of several politicians or groups on the European Central Bank to supply credit directly to governments, ideally at 0% interest. They argue that the ECB should help countries combat the crisis, instead of speculating against them. They assess that the independence of the ECB from the plans of member-states is purely wrong, since it deprives governments from essential monetary policy tools that could help in ameliorating the chilling effects of the economic crisis. These views purport to show that the ECB, with the interest it adds on the money it creates, is an institution that only supports the machinations of speculators, greedy bankers and other sinister forces that operate to the detriment of the people.

Plausible as these arguments might sound, they really cannot stand serious analysis. This view of politics in general and economics in particular contains a tangle of fallacies ranging from the utopia of the perfect society that has been plaguing humanity ever since Plato; to the fundamental flaws in economic thinking. There is however a core fallacy. The vein, chimerical belief that there can be a world without interest.

Let us first deconstruct this fundamental error, before proceeding into the discussion on the real world case of the ECB and its role in the eurozone. Those who want to create a world without interest, simply fail to understand the single most important lesson of economics: we live in a world of scarcity. We cannot enjoy infinite amounts of everything at the same time. There are natural limitations that always deprive us from the absolute exploitation of everything that can be found in this world, either tangible or non-tangible. This holds true regardless of the institution of society. That is, regardless of whether we live in a capitalist or communist or any other form of society. No matter what we do we cannot overcome scarcity.

Interest in a world of scarcity

Understanding scarcity is essential to realize why interest exists and to comprehend what it actually is. Interest is the value assigned to goods in the present time against the value of the same goods in future time.

Instead of technical theory, let me offer a more illustrative example. Assume we have a farmer who has a 100 in terms of available resources. He only makes a living out of his farm and he cannot afford to waste any of his scarce resources. Before he puts everything to work, he will have to make a plan over how to best use whatever he has at his disposal in order to make sure that the farm will yield him sufficient food to survive over the year. Moreover he will have to consider setting aside a portion of his resources for future use, while he will also need to deploy some of them to produce beer or wine or some other beverage.

The farmer cannot therefore use his limited resources to produce at the same time maximum food and drink while also saving for the next year. He will eventually have to economize. He will have to make a choice over how to allocate his limited resources in order to satisfy his present and future needs, otherwise risk facing starvation. Suppose now that he decides to use 90 out of the 100 to produce food and drink, while the rest is kept aside for future use.

The fact that he did not use all his resources, since he would have eventually denied himself of any future uses, means that he actually paid an interest of 10 for the utilization in present time of the other 90. In other words he made an arrangement between his present satisfaction and his future satisfaction. The amount he is willing to put aside for his present or future satisfaction is actually the interest he pays for it.

Allow me another example along these lines to forward my argument on the nature of interest. Assume you have in your pocket a 100 euro and you will receive your next salary seven days from now. You thus need to make sure that from today up until next week, you will satisfy all your needs with these limited funds. You will have to arrange the satisfaction of your daily desires in such a way, so that the money is enough to pass the whole week. If you choose to spend all your money on the first day then the interest you are actually paying is the lack of money you will suffer from, for the next 6 days. Though economists would rather call this a “trade-off”, in fact it can be understood as an originary interest payment.

The exact same mechanics exist in the real complex world. The interest rate on a loan reflects the relation between present and future valuations of that loan. In the modern economy, the market interest is of course determined by many other parameters such as the forces of supply and demand, the availability of substitutes, the preferences of individuals, the quantity of available resources, the expectations of investors, the conditions in the economy, the political environment, the prevailing theories etc.

Those anxious to defend their uneconomic theories by obfuscating and concealing this reality, will suggest that all of the above are self-serving arguments of “capitalism”. However such an argument would fail to recognize that interest per se always exists, even in the most primitive of societies, or the most ordinary of daily activities. Originary interest has existed in all hitherto societies. It is not a byproduct of capitalism nor the invention of some people who engage in unbridled speculation and other “parasitic activities”.

Interest always exists in a world of scarcity. It would only cease to exist if we could eliminate scarcity; if we could somehow manage to create a “valhalla”, a “paradise” on earth. For as long as we have not reached such a high level of conscience nor are we ever going to, all talk of eliminating interest is nothing more than a bunch of nonsense, litanies to the opposite notwithstanding.

The costs of infinite money creation by the ECB

The mention to the uninformed view of the world that asserts the elimination of interest is essential to comprehend modern day political discourse concerning the role of the ECB in the eurozone. The agendas of certain populist politicians are replete with such views. I need not refer to particular individuals or parties, since this view is, surprisingly perhaps, found all over the eurozone and beyond. After all focusing on individuals would be misleading, since the problem is far deeper than the occasional beliefs of any single person, which can after all change at any given moment. Stripping away the particularities of each case, the claim that the ECB should give money directly to states at 0% interest has not be clearly thought out. It is based upon a tissue of unexamined principles and deep misunderstandings.

Apart from the egregious fallacy on the nature of interest, such views largely underestimate the implications of such an action, or they completely dismiss them with slight contempt and smugness. In truth a central bank that directly finances governments at 0% creates inflationary pressures, produces perverse incentives and facilitates or encourages the massive misallocation of scarce resources. Let alone the fact that in a monetary union of 17 nation-states such as the eurozone, we will also have to take into account the balance of power and the potential discriminations that can take place, eventually exacerbating all the other economic side-effects.

1. The constraints of inflation

There is this inherently flawed hypothesis that a central bank can create money at no cost. This is reinforced by the fact that modern economies operate under a fiat monetary system. That is a system where “money” is whatever a state edict determines. Thus legal money can only be the euro, and monopoly over the creation of this money is by law conferred to the European Central Bank (and the Eurosystem, but let’s avoid such technicalities). Since “we are the state” under a fiat monetary system, we can just turn on the printing press and create infinite amounts of such money to finally satisfy our needs. In other words, since the ECB is the monopoly for the supply of euro, and since the existing legal corpus enforces the use of euro as the only legal type of money, no one can really limit its operations. In a nutshell, this view fallaciously assumes that a central bank does not face the obstacle of scarcity.

A central bank, the ECB in this case, does face constraints despite the fact that it is the only one who has the power to supply money, euro. The constraint is again the originary interest. The present value of the supplied euros, over their future value, just like in the examples mentioned earlier. The reason for that is that if the ECB creates much more than it should, it will inevitably erode the value of all euros circulating in the economy. This phenomenon is called inflation. To better understand this let us resort to the observation of a little bit of history.

In older epochs, when economies operated under a gold standard or some other form of metallic currency system, the only way for the government to increase the supply of money without importing any additional precious metals, was to debase the currency. Though there have been several methods of carrying out this practice, the idea was to reduce the actual amount of the precious metal found in each coin. Thus make more coins with less valuable metal. For example an easy way was to cut the coins into smaller pieces that would still have the same face value. To better grasp this, it is the same as cutting a one euro coin in half to create two one euro coins — absurd. Wherever that happened, either be the Roman Empire or the mercantilist states of the 16th century onwards, it led to an erosion of the value of the available money (inflation), eventually causing much more harm than the intentioned good. In fact the debasement of currency has in most occasions been inseparably attached to the decline of empires.

A relatively recent though indeed extreme historical demonstration of the mechanics of this “debasement of currency”, now under a fiat monetary system, took place in the Weimar Republic, the German state that was found after the end of WWI. That state was (foolishly) burdened by the Allied forces, the victors, with extravagant war costs, as the Germans were considered the only ones responsible for the cause of the war. In the early 1920′s to pay back their mountains of debt they thought it reasonable to print the corresponding amount of Deutschmarks, naively assuming that there was no cost involved to a central bank printing money to finance government operations and to pay back national debts.

Because of the large-scale “debasement of currency”, the result was a phenomenon called “hyper-inflation”, i.e. extremely high rates of inflation in the domestic economy. At its peak, it caused prices to double every few hours or days. You could sit at a restaurant and by the time you had your meal, the price you would have to pay was twice as much. As soon as you received your salary, you would have to rush to the grocery store to buy whatever you could, before the money in your hand lost its purchasing power. Paper money was soon rendered completely worthless. Instead of being used for payments it only served the purposes of ordinary paper. The very notion of “saving money” became immaterial, since after a few hours it would have no real purchasing power. In an economy without real savings, where inflation runs rampant eating in to everything people produce, only poverty can befall upon society. Indeed this hyper-inflation completely obliterated the savings and the businesses of the middle class, while it literally impoverished most of the German population.

Though the case of the Weimar Republic is indubitably a special case, since it is the most extreme type of inflation, the fundamentals are identical nonetheless. There was a cost to printing money, even though the German central bank had a monopoly over the supply of Deutschmarks and despite the fact that government legislation determined that money as legal – the fiat money. Despite the force of the state, people would not use Deutschmarks since they realized that they had lost their value.

The moral is that a central bank, the ECB in our modern day eurozone, has limits over how much money to create. Of course under a fiat monetary system, a central bank certainly enjoys some discretion to slightly manipulate these constraints, but it definitely cannot defy them. In practical terms though, because “discretion” is often the first step on the road to disaster, the only means of ensuring that these constraints are not violated, is to provide institutional independence to the central bank. This is after all the well-established practice in a democratic state, characterized by the separation of powers.

A failure to set in place the checks and balances found in a democratic system, can indeed lead the whole edifice into jeopardy. If the executive, the government, can control the monetary function, then discretion becomes or can become abusive. Which brings us to the issue of perverse incentives as will be discussed on the section below.

2. The perverse incentives of money creation

A government that can at any time find money out of nowhere to finance its operations has a strong incentive to avoid making tough choices, in favor of carrying out its agenda, even though that will ultimately be detrimental for the economy. In more practical terms a politician will promise everything to his electorate and will pursue all these promises by means of resorting to the printing press of the central bank. All these demands will sound easy to meet once the presumed infinite source of wealth, the “cornucopia”, of the central bank’s printing press can be exploited.

Such power to resort to the central bank, instead of making realistic, though perhaps unpopular, promises and of carrying out pragmatic political plans; provides perverse incentives. Whoever has the honesty to tell people that printing money has a cost and denies making unrealistic promises will simply lose the elections. Once cheap money is offered unconditionally to governments, there is no guarantee whatsoever that it will not happen again. It will eventually be abused. In economic jargon this is also known as a “moral hazard”.

No real reform would ever take place if governments had access to infinite and cheap money. Doing things the easy way to satisfy short-term political opportunism would have been the norm, with whatever implications this would have in avoiding structural reforms, creating inflation, perpetuating corruption, strengthening cronyism etc. After all, one of the reasons the Greek economy and state have proven to be completely unorganized and in many ways counterproductive, has much to do with the cheap money (and foolish voter support) governments enjoyed over the previous decades, first due to the symbiosis between government and national central bank and second due to the cheap credit flowing into Greece after its accession to the eurozone.

For a better perspective, how strong would the deterring effect of a law against corruption be, if the judicial system was controlled exclusively by the government? Is there anyone out there doubting that ministers, officials and public servants would feel less threatened and would therefore be more prone to corruption? And if they could avoid punishment wouldn’t they eventually become involved in corruptive activity? That is why a democratic state needs to separate and diversify powers as much as possible, so that the shrewd can never exploit the loopholes in the system.

The gist is that if perverse incentives are in place, then there are no effective checks and balances in the system, for the sake of avoiding abuses of power. To prevent the ultimate of moral hazards, that of governments exploiting the money printing press with impunity; a central bank must always be institutionally independent, just as all powers are separated in a democratic state (judicial, executive, legislative). A central bank that is dependent on the dictates of any particular government, will eventually be a tool for manipulation and corruption, in the same way that justice would not really exist if judges were forced to interpret the law according to the agenda of the government.

3. The unseen costs

All of the above are enough to kill off any idea of allowing the ECB to provide money directly to states and at a 0% interest. But this is not the end of argument, since one can also speak of the unseen costs involved.

A central bank providing cheap money is offering the incentive to all parties involved to engage in frivolous spending. Governments, banks and businesses will underestimate the potential risks in every venture, while they will plan with less care and precision, since at the back of their mind they will know that they have a money press supporting them with infinite cash. When such a process is set in motion, it can only lead to a gradual but steady misallocation of resources.

The crisis we are now experiencing is a crisis of large-scale malinvestments, resulting from the cheap credit that fled into and sprung from Wall Street eventually giving rise to the bubbles around the world (see also “Money illusion as a solution to the eurocrisis?”). Cheap money facilitates and encourages malinvestments, as was the case with the property bubble in the US or with the purchases of Greek bonds prior to 2008-2009 among many, many others.

Concluding remarks on the money printing delusions

All the aforementioned arguments, when taken together constitute a solid defense against the uneconomic populism of certain politicians and/or economically illiterate groups who preach an interest-free utopia.

Fallacious assumption and belief are pilled on each other to create the multi-illegitimate claim that the ECB should directly finance governments, ideally at 0% interest rate.

Those who are inclined to endorse such ideas, think that they will avoid the suffering of real readjustments. That they will somehow have gain without any pain. They assume that the crisis can ultimately be addressed with the practically cost-free intervention of a central bank, the ECB in this case, without the people having to suffer any losses.

Even if we were to ignore all the above and accept this perverse mode of thinking as correct, we would still find it problematic. If money creation is free of any costs, then why not have a printing press positioned at the central offices of every ministry? Why bother with giving money to the central government which will then have to go through the laborious task of distributing it further? Moreover, why not allow local authorities to create money out of thin air? Wouldn’t that make their efforts easier and improve the daily life of citizens? Ultimately why not supply a money-creating machine to every household so that we can finally enjoy life without the slavery of interest?

Understandably such a rationale is purely wrong from beginning to end. The tragedy is that in times of economic crisis as our own, unrealistic promises of that sort become widely acceptable as they find fervent supporters in the masses of desperate voters.

Uneconomic arguments such as the interest-free financing of the ECB to governments, are fashionable enough, often embellished with triumphant rhetoric, noble values and far-reaching ambitions; yet they are too absurd to stand up to anything like critical thinking and mere reality.

Should the European Central Bank give money to states at 0% interest? | Protesilaos Stavrou.

The underlying principle of this argument, is that the economy suffers from a shortage of “aggregate demand” and therefore it does not operate at its “general equilibrium” as the tidy models of the neoclassical macroeconomists show — yes those same models and theorems that spectacularly failed to predict or prevent the Great Recession; those that glorified the financial engineering of Wall Street together with the perverse regulations of governments which further fueled speculation and malinvestments. The reason we lack sufficient “aggregate demand”, they argue, is because people are hoarding money instead of spending it, due to the fear they have about the general conditions in the market, dominated by the uncertainty of the economic crisis. They maintain that if everybody saves and no one is actually spending, we enter into a “cyclical crisis”, a “downward spiral” where more saving leads to deeper recession. The only way to stop this alleged calamity is by means of inflating the economy through relaxed monetary policy and/or expansionary fiscal policy (“digging ditches” if necessary).

There is much that is wrong with this view, yet it is not without its historical precedent, since it was first developed by the gambler and speculator John Law in the 18th century and has been dominating economic thinking ever since, especially after it was mainstreamed by Lord Keynes through his theory of the “paradox of thrift”. The reasons this hypothesis is dead wrong are two: (1) they treat the previous level of spending as the normal rate, which is inherently misleading since it can consider bubble spending as “normal”, (2) it suffers from the main flaws, errors and misunderstandings of macroeconomics in general that fail to make classification between the various types of “spending”, “investing” etc and thus can overstate or misunderstand the real effects of certain phenomena, such as the fact that they could not treat “investments” in Greek bonds as “malinvestments” –if they could there would be no bubbles and crises.

The supposed hoarding in the eurozone comes from the fact that the GIIPS currently spend much less than they used to spend prior to the crisis. Someone looking at numbers, without any critical intention whatsoever, will identify an indubitable fall, which is reflected, in diminishing GDP, among others. To cling on to the figures themselves is misleading for one needs to question the sustainability of the pre-crisis levels of spending. In other words did we have a massive bubble in the eurozone’s periphery prior to 2008? “Yes absolutely” is the only correct answer, something which is shown in the consumption bubble in Greece or the housing and financial bubbles in Ireland, Spain etc. Thus the pre-crisis spending is “bubble spending”. Using it as a benchmark is understandably a false method.

The plain fact is that the eurozone’s periphery experienced an erratic capital inflow bonanzaover the last years ever since the euro was conceived and finally launched in 2001. The interest rates between the German benchmark and the periphery converged, due to theperverse Basel Accords and the creation of the euro; both of which had the effect, inter alia, of practically treating all sovereign bonds of the eurozone as risk-free. As such Greece suddenly appeared as “Germany” in the bond markets, despite the absence of any real convergence in productive capacities. This process of nominal convergence, or artificial convergence to be more precise, is perfectly depicted in the following chart.

Eurozone interest rate convergence. Source: BBC

With the crisis putting an abrupt end to these abnormal, unsustainable capital flows, the countries that once enjoyed cheap and abundant credit inevitably suffer from a credit contraction and from a consequent downfall in economic activity, which is depicted on the national accounts as stagnant or negative GDP growth.

Claiming that these countries now “spend less” implies that the benchmark is the pre-crisis spending level. But if we were to argue along these lines we would completely obliterate the distinction between normal economic activity and a bubble. The neoclassical inflationists, anxious about the lack of aggregate demand, are in fact trapped in this egregious fallacy, where they see the bubble spending as if it were normal spending and hence they compound one mistake on top of another.

The cheap credit policies that were the single most important cause of the Great Recession in the first place are thought to be the panacea to the effects of the crisis. It is like suggesting that the remedy to a hangover is more alcohol. This is absurd.

Yes, countries like Greece, Portugal etc. suffer immensely, but not from some general “fall in spending”, from a vague lack of “aggregate demand” which will be cured by a money printing press. These countries lack essential productive capacities and require massive spending in particular areas of their economy, not excluding of course the political reforms necessary.

It is not cheap inflationary money that will solve their problem, but real readjustments andreal investments in projects that can yield real benefits, open up real employment positions and profit opportunities and produce real savings. Inflation and its unrealistic macroeconomics are nothing more than a justification to the inane theories of certain academics and of the speculative mania of those who trade money via supercomputers, detached from the conditions in the real economy.

The “money illusion” which is propounded as the remedy to the crisis is nothing more than the manifestation of the delusions and grave fallacies that plague mainstream economic thinking.

Originally posted on www.protesilaos.com

I recently came across a document attempting to offer an overview of the causes of the Great Recession, while underlining the alleged weaknesses, flaws and omissions of the system. After reading its fallacious arguments and unexamined shibboleths I shall make mention to the fundamental problem of economic calculation central planers and their macroeconomics face, by mentioning one assertion of the paper, characteristic to bureaucratic, ideological reasoning; namely that (emphasis mine) “ecosystems are capital assets and the ecosystem services have great economic value… which is not reflected in the market“.

To uphold that ecosystems have great economic value*, one must have conducted some kind of empirical analysis of the market evaluations of ecosystems. In other words one must have used price data of older market evaluations of this particular good or set of goods (the ecosystem) to have a first idea and then develop a mathematical model which will incorporate future expectations as well as other parameters that can influence future market value, in order to reach the conclusion that ecosystems have “great value”.

Assuming that a realistic mathematical model determining future market value exists, which is not and cannot be the case because we can never predict human action, especially in the complex real world; we will have to face the obstacle of data collection. Simply put, what was the market price of ecosystems this morning, yesterday, last week, last month, last year etc? Anyone serious enough, knows that such data cannot be retrieved for it does not exist. The reason being the absence of a market for ecosystems. There is no place where one can sell or buy ecosystems. All that can be found is a series of unrealistic assumptions baked with ideological principles and moralistic concerns, which lead to the conclusion that this given good is economically very valuable.

The plain fact is that in the absence of a market there is no economic value, nor can there ever be any economic calculation outside a price system, as Ludwig von Mises accurately explained in his essay “Economic Calculation In The Socialist Commonwealth“. With this essential flaw in mind, one must be very suspicious of the economic calculations of central planners or ideologues, for they often do not value a good/service on its market price but they determine a “natural value” which is the kind of fundamental error that plagues economic thinking ever since Adam Smith and the classicists.

There is no such thing as a “natural value”. There only are subjective prices and opportunity costs. The market is the place where goods/services are economically evaluated through the forces of supply and demand. If a supplier wants to sell a good she must offer it at a price that consumers will be willing to buy. That price must be above the cost of production and all other costs involved, otherwise the supplier will not sell, for that would mean selling at a loss. If the price cannot cover the costs then the supplier will realize that she must no longer produce that kind of good/service to avoid selling at a permanent loss, which is unsustainable. The consumers determine the price of the good/service through a complex set of motives, tastes and available options or alternatives. The ultimate price they are willing to offer at a given moment in time is the maximum market evaluation of the good/service at that very moment. In a nutshell the forces of the market are those which determine economic value, not the theories of some authority or the values of some ideological group.

This subjectivity of value, which real people who live in the real world know through everyday practice, is in many occasions completely omitted from economic thinking and especially from central planning which is mostly established upon unexamined ideological convictions while it aims at political ends that often contradict economic reality. This should not come as a surprise given the dismal record of centrally planned policies, such as the Common Agricultural Policy of the EU, a perverse and ill advised series of subsidies that has been doing much more harm than good to everyone (also see the related post of Open Europe). In defense of this, some anxious to obfuscate and conceal the fact of inefficiency, might speak of “positive externalities” whereby again they will have to determine economic calculation, otherwise it will be yet another idealistic claim.

It is upon these propounding tissues of egregious fallacies that many policies are established, by some who naively determine value by using misleading signals. Even worse, the deep theoretical and practical misunderstandings are often turned into mathematical symbolism, which then gives birth to elegant mathematical models and those smooth curves we often come across. The answer to this was given by Albert Einstein who said: “as far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.” In other words numbers never lie, but their underpinning hypotheses do. If the logic is wrong and meaningless then all that mathematics can do is conceal the fact and distort reality, by excluding human action and by making brave and unrealistic assumptions to allow for mathematical conveniency.

This methodological flaw is definitely one of the reasons so many policies produce adverse effects and perverse incentives. Moreover it is a clear indication of the failure of central planning and their macroeconomics to deliver definite answers to the challenges of the real world, by failing to make correct economic calculation. As for the ecosystems, there is no doubt that they have great values beyond the sphere of the economy, but to assert that they have “great economic value” constitutes a grave error and is a position that has not been clearly thought out.

*here I am speaking only of economic value, not of value in general

On the Economic calculation of central planners and ideologues | Protesilaos Stavrou.

Following up my last article on European identity and how direct taxation can produce the necessary power impulse towards the creation of a European public sphere, I shall elaborate on the distinction that needs to be drawn between the traditional types of national identity and the new form of conventional, parallel identity that can be developed within the context of European integration.

For a better perspective, references will be made to history and the various emanations of identity as these have appeared in different epochs, in order to illustrate my point that in our times the metaphysical essentialism of the past is useless and thus a more pragmatic approach has to be taken for the construction of a European identity.

Forms of national identity and historical evolution

Nation state building* is commonly accepted by academics as a modern phenomenon, starting from the 17th century onwards, from the Treaty of Westphalia in 1648 establishing the concept of state sovereignty, to the French revolution of 1789 which then fertilized other nationalist movements across Europe. The main elements that characterized the first nations are not always the same, though we can identify linguistic, historical, religious and ethnic bonds between the members of the nation. Despite the specificities of each case there are two main classifications to be made between the forms of historical nationalism, in the nation-state building process. Namely civic nationalism and ethnic nationalism.

The former was the kind of nationalism permeating the population of France during the creation of the First Republic, which suggested that a founding set of principles, a social contract, as Jacques Rousseau described it in his magnum opus “Le Contrat Social”, would be the primary bond of the nation and anyone willing to abide by that constitution, would be henceforth considered a French national. Indeed France as a nation encompassed diverse ethnic groups apart from Franks, such as the Burgundians, the Basques and the Catalans, while the people of Normandy and perhaps Bretagne were also thought to be of Germanic origin. As such, French civic nationalism at the late 18th century was mostly based on a convention between people willing to identify their selves as French, in exchange for a presumed better life, within the newly-founded republic, not excluding the cultural and other ties that might have played an important part in the process. This fundamental belief was repeatedly challenged by the occasional rise of monarchs such as Napoleon Bonaparte, yet the essence of this idea was never drawn out of all the consequent French Republics till this day.

The other type of nationalism, that of ethnic nationalism, could be found in Germany, where the collective bond, the national identity, was the extension of ethnic and cultural ties between the people. It emphasized on the kinship of the people, on their common racial origin, their collective memories and their single destiny, suggesting that the distinction between German and non-German, national and non-national, was a product of nature that could not be denied by any means of human action or institution. This became especially evident in the 18th to 19th centuries when the German strand of the Romantic movement gave a clear ethnocentric, ideological perspective to its literary works, contrary to its more poetic counterparts in France and Great Britain. German ethnic nationalism was epitomized by the kingdom of Prussia, a militarist country that eventually consolidated its rule over other German states, to forge the Second Reich, whose legacy would last till the first decades of the 20th century. German nationalism remained ethnocentric up until the end of WWII, when the leaders of the country realized that the demolished post-war Germany, West Germany at the time, would require a new type of identity to stand in the new world and to combat the mentality that brought so much suffering on the country and the world. They eventually adopted the civic approach, which was open to non-Germans, thus heralding the start of a new era in German and consequent European history.

The role of the intelligentsia

In both cases the well educated elites, the intelligentsia, either be artists or philosophers or jurists and statesmen, played a decisive role in projecting a metaphysical image of the notions that dominated the original nationalist movements, namely “the people”, “the fatherland”, “the state”, “the law” and “the nation”. All these concepts were treated in a near-religious way as if they had an essence of their own, as if they existed independently of the actual conditions in the world or from one another. The “fatherland” or “motherland” was the holy place of “our ancestors” and should always be protected from enemies and defilers. The “state” and/or the “law” was the embodiment of divine providence, blessed by “God” (or Nature for the secularists) and granted its power from the “people” – it therefore was legitimized from both the heavenly powers and the earthly ones. The “nation” was an eternal entity, having survived from all the challenges of history and having produced only great and glorious works in the process. Finally the “people” were the spring of all power and sovereignty and were the present form of the nation, thus they were treated as if they were somewhat holy in substance.

Though infinite examples could be forwarded to demonstrate this metaphysical essentialism, one only needs to pay close attention to the discourse of the time, such as the famous dictum of Robespierre before executing Louis XVI when he said “Louis must die so that the fatherland may live”, whereby the “Fatherland” is treated as if it were a person. So if Louis was to live, the “fatherland” would die? And by death of the fatherland do we mean erosion of the soil, pollution of the air and poisoning of the water? In defense of such parlance one could argue that by the word “fatherland” Robespierre was speaking about the people and about justice and democracy, yet such an argument would have to face the multi-task of proving the zero-sum game between one person, Louis XVI and the “people” as a whole, together with all logical ramifications of this phrase. Of course I am not searching for any definite conclusions along these lines, not do I raise this issue to support either side. This is just mentioned to bring the point of metaphysical essentialism into focus.

In a similar fashion we even today come across phrases such as “the nation/fatherland together with the people and the state have a duty to support the family”, as if all these entities were distinct from one another and as if they were independent “entities” in the first place. Indeed anyone willing to pay close attention to political discourse of earlier epochs, or even of some contemporaries will realize how absurd many statements were/are.

The intelligentsia of each country objectified and deified these notions, through its literary works, giving to them a truly compelling image that eventually permeated the social psyche to stimulate strong sentiments of affection to the nation-state and forge a solid national identity. In parallel, myths and traditions were cultivated, glorifying the deeds of great heroes and kings of the past, which further strengthened the collective memories, feelings and beliefs of the newly-founded nation-states. The idea of a national “character” became a standard, suggesting that nature or the “fatherland” had gifted all people of a given nation certain universal properties of character. Last but not least, the people of the neighboring countries, the “others”, were always depicted as evil forces, sworn to undermine, ravage and destroy the nation at every given opportunity. The intelligentsia of each country played a decisive role in this process of identity building, especially in its initial stages.

After WWII ended and everyone had finally realized how destructive extreme nationalism was, national identities were brought under reconsideration to abandon the anachronistic “we-they” antagonisms and primordial hatreds, in favor of tolerance, cooperation and mutual understanding. The scars of the war, real and mental, individual and collective, provided the fertile ground, allowing for such a transition which understood that there was a better future in a unified rather than deeply divided Europe. In the second half of the 20th century the idea of national identity was not abandoned per se, but was decisively rethought to forever prevent another similar major war in Europe and to be compatible with globalization, international trade and European integration, among others. Nationalism has hitherto lost most of its metaphysical properties, due to this evolution of events.

The lessons to be drawn from history

The evidence overwhelmingly suggests that identity is subjective and dynamic, without however ignoring or degrading the importance of cultural, historical, linguistic and other parameters. It is upon this realization that a European identity can be created. Yet it is essential to learn the lessons of history and to comprehend the fundamental distinction between the kind of identity-building we had in previous centuries, and the type of “banal” nationalism we have been witnessing ever since the end of WWII, which undeniably is not impeding European integration (though European incrementalist decision-making is part of conflicting national agendas, which nonetheless is not the same).

Today we, as societies, are mature enough to no longer have to invent or discover some common “European culture” upon which we shall establish a “European nation”. We no longer need any ruling elite seeking to deify and objectify “holy Europe”, “our fatherland”. Nor do we have to cultivate the existence of sinister outside forces whose presence poses a potent threat to our achievements, just as our ancestors used to think when speaking of their neighboring countries. Such anachronistic beliefs if they exist and even though they might be well-motivated in the case of a European identity, are based on a tissue of unexamined historical facts, deep theoretical misunderstandings and egregious fallacies and must therefore be abandoned.

All we need is to realize that we can identify ourselves as Europeans along conventional lines, in the sense of agreeing on a given set of principles, which will define the fundamental values of being European, such as democracy, individual liberty, human rights, equality, tolerance, solidarity and so on so forth. This can be done by free people, fully conscious that they agree upon a contract, for the sake of establishing a political union that can make their life better. I consider this a conventional identity, one that does not contradict nor override the existing national identities. Such an approach will allow us to circumvent the theoretical and practical impediments towards the formation of a European identity and genuine political integration.

Notwithstanding the temporary difficulties of the economic crisis and the occasionalprotectionist, quasi-nationalist rhetoric, there is infinite potential for a conventional European identity. What we need to do perhaps, is be more conscious about it and become more realistic in our discussions in case we are not, instead of trying to think along the lines of “European nationalism”, for that is, in my view, foolishness of the highest degree.

If we are to speak of a European identity we need to abandon metaphysical essentialism in favor of conventionalism. Once we agree upon this theoretical issue of cardinal importance we can proceed unencumbered into constructing a European identity and we can contemplate on other equally important subjects.

*to avoid any misunderstandings, France and Germany are only used as examples. Similar conditions apply to most, if not all European nations. The use of these two countries is a mere matter of conveniency and should not imply anything.

European identity: From metaphysical essentialism to conventionalism | Protesilaos Stavrou.

Regardless of ideology, we Europeans more or less agree that the current order of the European Union is suboptimal. We all identify numerous flaws and wish to see reforms in many areas either that be the (growing) democratic deficit, or the distance EU institutions, except Parliament perhaps, have from the desires, motives and scrutiny of the citizens; or even the bureaucratic sclerosis in all Community affairs; among many others.

The midpoint of these issues is the fact that the EU is not a state but rather a political UFO that has evolved into its current form through decades of incrementalist integration. Though many steps can be made to improve each of these flaws, it is widely accepted that the establishment of a political union in Europe – a genuine state, regardless of actual form – would have been the single most important step forward. Yet it is undeniably true that a political union cannot be established for as long as the conditions are not mature enough and for as long as crucial prerequisites are completely absent.

Apart from the diplomatic and legal work, two are the necessary elements the EU must have to move towards real political integration: (1) a European public sphere, (2) a European identity. Within the context of this article I shall be elaborating on the concept of a European identity and how that can be gradually brought into being through tax policy.

Before the American revolution, some time in the 1750s, the Americans had established the well-known Bostonian principle of “No taxation without representation”, which basically argued that it was unacceptable to pay taxes to the then Imperial Great Britain, without the Americans having any say over the way their taxes would be used. The Americans were asking for the right to to be represented at the centres of power where their taxes were administered.

By reversing this principle we come up with the idea that people will sooner or later ask for fair representation in the administration of their taxes, for the mere reason that people care for their money as they know they worked hard to get it and are willing to go to any length to ensure their rights over it. This is after all the kind of “social contract” that democracies establish, whereby the state is given the absolute power (sovereignty) to tax its subjects/citizens and in return the citizens have the power to elect their representatives in government so as to control the use of these taxes (among others). In that sense one could go as far as to argue that taxes build states and taxes are the single most important force that forges identity and affection to an authority (of course there are many other ethnic, cultural, historical, linguistic issues, yet this does not change the dynamism of taxation in that sense).

With this in mind one could explain the reason why Europeans are not particularly interested in the EU, since there really isn’t any omnipotent authority in Brussels actually using their taxes. In other words there is no European state or other political entity with the sovereign power to impose taxes on the Europeans. Had there been such an authority, or had there been direct taxation from Brussels, sooner or later citizens would start showing interest in it, to see how their money is spent – to judge whether they are getting a good deal out of taxation. Gradually this interest would identify the democratic and other flaws of the Union and would eventually force Europeans to ask for “Taxation with Representation”. This would then put magnificent pressure for thoroughgoing reform in the institutional order of the EU towards a much more democratic, accessible, transparent and open political union.

For as long as European institutions are seen as the assignees of member-states, people will never show real interest in the EU. After all who would ever feel any sentiment of belongingness to a “Commissioner” or a “High Representative of the EU”? I am not implying anything about the people who currently are in charge of these offices/institutions, I am only saying what every European really feels – that no one actually cares about a detached bureaucracy. To make Europeans care you must make it clear and above board that you are taxing them, that you are getting into their pockets, since that is the “sweetspot” of every individual and direct taxation is the easiest and most effective way to do it. Note though that I am not arguing in favour of more total taxes, but for a redesign of the Community’s “own resources” so that the bulk of them derives directly from the citizens, thus giving a political dimension to the issue.

Taxes build states and create a connection between the sovereign/authority and the people. Once there is such a connection in place there will gradually be more interest from the side of the citizens that will fertilise the ground for a European identity and create a leverage for the radical reformation of the institutional order of the EU, into a truly democratic political entity. This creates a domino effect that will produce public discussions on European politics, thus giving birth to the much-needed European public sphere.

In my view the power of money, of taxation in particular, is significant in forging a European identity. And by identity I am not speaking of a “national identity” that will replace the existing ones – that is both unfeasible and undesirable. I am referring to a parallel identity that will make citizens feel also European, something quite important in the modern and future world.

Finally to illustrate my point, one of the positive aspects of the economic crisis has been the increased interest of citizens in European and cross-country politics. You know why? Because they realised that they are paying for their partners – they understood that their money is involved. Multiply this and visualise what I described above and your get my gist. People care about money and once you tax them you draw their interest, which will eventually produce all the other elements a political union must have. Hence “Taxation with Representation” could be the slogan that will produce the necessary power impulse for reform.

European identity: Taxation with Representation | Protesilaos Stavrou.