Most are aware of the eurozone crisis and the possibility of a Greek exit, but few understand the root cause of the crisis or the dangers of the proposed solution. There is one course of action that will save the euro, solve the inherent problems of the monetary union, and provide the incentives to foster long-term economic growth in Europe. It may also save the global economy.
I recently completed a paper, written for everyone from the layperson to the economist, that thoroughly discusses this topic. This essay is an attempt to summarize the paper's essential takeaways.
An Idea Is Only as Strong as Its Details
To familiarize the reader with the basics, a group of European countries came together in the 1990s to establish a common currency. It was thought that a monetary union could:
- Increase competition among countries by pricing goods and services in the same currency
- Ease travel for citizens and eliminate currency conversion costs
- Lower exchange rate risk, which would boost businesses investment
- Create a strong global currency-an alternative to the US dollar-whereby high demand for this new currency could boost European political leverage
- Provide economic benefit while simultaneously allowing countries to maintain their sovereignty and cultural uniqueness
While this idea sounds compelling and has the best of intentions, it lacks incentives strong enough to deter members from acting irresponsibly. While rules do exist, such as keeping debt below a certain percentage of GDP, union leaders failed to create effective consequences of breaking those rules.
Without deterrents, a country is free to spend frivolously, and the negative impacts can spread to all member nations, including those who are fiscally responsible. A currency union member that spends beyond its means and cannot repay its debt hurts all member nations by:
- Forcing lenders to lose confidence in the euro, which forces interest rates higher, which makes it more expensive for all members to borrow money
- Forcing the global market to lose confidence in the euro, which weakens the euro relative to other currencies, which makes foreign goods more expensive to all eurozone members
- Demanding that fiscally responsible countries use their taxpayer money to provide bailouts for irresponsible countries
A portion of the global population may be angry at Greece for its actions, but one cannot necessarily blame the country's leaders. They were incentivized to remain in power--not to fix the debt problem. Remaining in power required appeasing the Greek people by continuing to supply inflated and unsustainable entitlement benefits. As the saying goes, don't hate the player, hate the game.
Like it or not, well-thought-out rules never expect morality and always expect self-interest.
Incentives, Incentives, Incentives
Real estate is the study of location. Economics is the study of incentives. Behavior can change dramatically when proper incentives are introduced. For example, a retail store manager making a fixed wage expects a certain level of shoplifting. It's reasonable to assume that the average manager would simply report those numbers to the owner rather than actively try to prevent the thievery. Now, take the same manager, at the same store, working the same hours, making the same wage, but offer him or her a bonus, equaling a percentage of the expected loss amount, dependent on his or her ability to prevent thefts. Guess who will be asking for security cameras and a Taser.
Instead of suggesting productive incentives, some pundits have called for unpalatable regulations. They speak of implementing a "central fiscal agent" in the eurozone. This agent, likely a country or a collection of country representatives, would set fiscal policy for the entire region, whereas today, each country controls its own spending. The union is so culturally diverse, however, that each country has specific needs and may feel that fiscal mandates are an intrusion on its sovereignty.
Other pundits, claiming that no effective solutions remain, call for a Greek exit. While they understand that the process would be messy, they do not fully appreciate the collateral damage of such an option.
Secession Has Consequences
To get a glimpse of what may happen prior to and during a Greek secession, one should look to the break-up of the Austro-Hungarian Empire in 1919. It was a disaster as citizens, attempting to protect their money's purchasing power, began smuggling cash across borders to be stamped by banks in stronger economies. It took nearly a decade for these economies to stabilize.
Even though modern economies are almost fully electronic, Greek citizens would desperately try to move their euro currency into other countries' banks. In fact, these movements began over a year ago.
If Greece secedes, then it won't have the ability to repay its debt in euro. As a result, it may convert all debt to new drachma, or it may refuse to pay the debt altogether. Greece refusing to pay its debt could force the failure of some banks whose defaults may cause other banks to fail. This domino effect could spread to the rest of the world, igniting a global economic recession.
In a darker scenario, some countries that weren't repaid may seek to secure Greek assets by force. It is naïve to deny the possibility of such an event. The bottom line is that we have no idea how bad the result may be. As Michael Spencer, Chief Economist at Deutsche Bank, recently stated on NPR, "I think the idea that withdrawing from the euro is an easy thing to do . . . I think that's a fantasy. I think this is not a process that anybody will be able to control."
An Effective Solution Exists
The majority of Europeans want to save the euro but only if it includes rules that incentivize fiscal prudence. A precious metals standard creates those incentives. It acts as a powerful, unbiased, central fiscal agent in a diverse economic region.
The benefits of moving the eurozone to a precious metals standard are summarized below:
- A sound, reliable monetary base would be immune to government inflation
- Since public funding would be acquired by taxes rather than by inflating the money supply, every government request for cash would be well known to the voters. If funds were misappropriated or squandered, then voters would take action.
- Member nations would have sole accountability for their financial conditions. A country's debt would be collateralized by state assets. Default would have no impact on other union members.
- Devaluation of the newly introduced precious metals euro would spark a trade surplus that would drive economic growth. In addition, the high prices of foreign goods would spark innovation across the eurozone.
- As a result of the precious metals standard's benefits, citizens would have far less incentive to move funds abroad than if one or more countries seceded
- Debt and contract renegotiations would be limited to foreign entities
- All the advantages of the euro would be maintained
Keep in mind that some economists oppose a precious metals standard, but I disprove each of their major arguments in my paper.
If eurozone leaders were to decide on a precious metals standard, then they could implement it the following day. While purchasing power of the euro would diminish temporarily, the long-term regional benefits would be clear and compelling. I implore the eurozone to review the facts, review the logic, dismiss the bias, and make the brave decision that would save the euro and perhaps avert a global recession.
We're All In This Together
Globalization continues to unify the world economy, so if the euro collapses and if economic turmoil in Europe ensues, then it will negatively impact the US and the rest of the world.
People, however, shouldn't feel helpless. There are ways, individually, to provide positive impact and protection:
- Educate yourself on the dangers of fiat money. Don't simply know the dangers. Understand the reasons behind them, and don't be intimidated by numbers and economics. Whether you read my paper, read other papers, or watch YouTube tutorials, many people spend a great deal of time clarifying and simplifying complicated topics.
- Make others aware of the problem. The only way to enact structural economic change is for an educated and widespread populace to demand it. Discuss these issues with friends and family, and express your concerns to Members of Congress.
- Keep a minimum amount cash in the bank. Paper money loses about 3% of its purchasing power every year, and it only has value because people believe it has value. That belief may disappear at some point. Hold a variety of assets with inherent value such as real estate, precious metal, and stock in companies that could weather an economic storm.
The euro crisis could affect everyone on Earth, so we should all care how European politicians react. The Swiss government seems to understand this problem more than their neighbors do. Hopefully others will catch on.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I own silver.