L. Neil Smith's
Number 303, January 23, 2005

"I am very serious about this offer."

The Euros are coming,
the Euros are coming!

by Patrick K. Martin

Exclusive to TLE

I the past few months I have watched with increasing alarm, the fall of the US dollar in currency markets. Now sure, we've all seen fluctuations before, the Fed as well as normal market forces change the 'value' of the dollar all the time, but this time is different, this time the US dollar is on the verge of being replaced as the world's currency of choice.

For several years now certain OPEC countries, the USSR... sorry, Russia, and a number of other countries and groups have seen the dominance of the US dollar as a symbol of America's dominance over too much of the world. The dollar is the reserve currency of a majority of the planet, as well as being the best choice for individuals who wish to protect their savings and are unable to obtain gold or silver or other real stores of value. Now, however, there is a new currency to challenge the dollars position as the world's number one currency, the Euro.

For those of you who haven't been paying attention, the Euro (€) is a fiat currency issued by the European Central Bank (ECB) to replace the individual currencies of almost all of the countries in the European Union (EU). The idea behind this is to reduce trade barriers, stabilize prices, and of course, expand the political control of the EU on its member states by eliminating their ability to control monetary policies. Given the mess that many European countries have traditionally made of their monetary systems, this might not be all bad. The issue which concerns us though, is the EU's attempt to increase the world wide usage of the Euro. The EU would very much like to see the Euro become the reserve currency of choice around the world.

To understand the situation, you need to understand that money, like any commodity, responds to the law of supply and demand. Large supplies of money reduce the value of its individual units (relative to the supply of goods and services available) while lower supplies increase it. When prices rise due to lower supplies of money it's called Monetary Deflation, when they fall its Monetary Inflation. While people who lack an understanding of basic economics decry one or the other of these, both inflation and deflation have benefits, but each benefit different groups. Deflation (rising prices) benefit producers and creditors because producers get more money for their goods and services, while creditors receive more value from the money they have loaned out. Inflation (falling prices) benefits consumers and debtors, as consumers pay less for more goods and debtors pay less to their creditors in terms of what the money will buy.

In a market economy both inflation and deflation will work to correct themselves. In deflationary times, producers will produce more which increases supply and reduces prices, while creditors will have to lower interest rates (the cost of barrowed money) to get more people to barrow. During inflation creditors raise interest rates and producers will reduce production to increase prices. However, when it is the increase or decrease in the supply of money which causes the problem, normal market forces have less effect. With monetary inflation or deflation, what you need to alter is the supply of money. If the supply problem is due to say, foreign trade surplus (dollars flowing in from abroad temporarily increasing the supply) the market can and will correct it. If the problem is not market based, and instead is the result of someone (i.e. the government) producing too much money, then the market is being distorted and will most likely be unable to correct the problem.

I know most of the people here would use this as an excuse to demand the use of gold or other 'hard' money to eliminate the problem, but it won't. Gold and other 'hard' money currencies are automatically deflationary because you cannot increase the supply of gold as fast as the supply of goods and services, which drives up prices. If you could increase the supply at will it would cease to be 'hard' money because its value would be so low that it would have no value as a commodity, which is the whole point of 'hard' money in the first place, having value independent of its value as 'money'. While paper currency which is backed (i.e. convertible on demand) by gold or other commodities is little better than fiat money simply because those who issue it can manipulate its value by changing the conversion rate or eliminating convertibility altogether. I only mention this to head off arguments which have little to do with the subject at hand, so let's drop it for now.

One obvious way to reduce economic disruption due to the over or under supply of money is simply to print or otherwise supply more or less depending on what the market is doing. Good idea, but in practice the market works so fast that by the time you can get the money in or out of the economy the trend you are reacting to is over and, nine times out of ten, your action is disruptive to the trend which is following the one you were trying to do something about. Needless to say you will end up with wild fluctuations in supply and demand caused by the constant over or under supply of money.

Another answer is simply to keep the money supply constantly expanding at a rate lower than the supply of goods and services, which is what happens with gold. This is fine, if your supply of goods and services expand at an increasing rate, as was the case in the 19th century. A constantly increasing supply of goods decreases the cost of individual items which will counteract the rising value of the money. When your economy can no longer absorb the constantly increasing supply of goods, or when some factor, like war, interferes with production, the system breaks down because producers can't or won't keep producing and deflation reasserts itself, as happened after World War I.

Money is the life's blood of any economy above the direct barter level. Money allows us to shift energy from where it's at to where it's needed. If you want to do so quickly you need a large supply of money, but too large a supply will reduce its value, which brings us to another issue, circulation. Money available to buy goods and services is money in circulation, and this is different from the absolute supply. If you can keep the money in existence, but keep it out of the market, you increase the value of the money relative to the goods and services it will buy, but not too much as the money held out of circulation might come back in quickly if conditions change.

One of the most obvious ways to keep money out of circulation is savings. If you keep your money locked in a safe, or bury it in the backyard, you still have it but it is not chasing goods and services. Banks do something similar by keeping a high reserve rate. The way banks work is, they take the money you deposit and loan it out at interest. Obviously they can't loan out every penny as you might come back for it, so they keep a fraction of all their deposits in the vault to be able to pay off those who will come back and take the money out, this fraction is called the reserve rate. Higher reserve rates will keep more money out of circulation, but it also means the bank will make less money in interest because it will loan out less money. The bank therefore will try to keep its reserve rate low in order to make more money on loans. Since interest rates will go up in times of inflation (lower prices due to oversupply of money), banks want to lend more then, but higher interest rates are designed to get money out of the economy, thus the short-term benefit of the bank acts against the long-term interests of the economy in reducing inflation. Of course the opposite happens when deflation occurs, interest rates fall in an attempt to get more money into the economy and lower prices, but the banks make less money on loans.

National currency reserves are much like savings in that a country keeps large supplies of money on hand but out of circulation. This keeps the value of the currency higher because it's not out chasing goods and services, but its available if the value of the currency gets too high. In the case of the US dollar it's not just our government that keeps large supplies of dollars, but dozens of other countries as well. They keep US dollars because more people and countries will take dollars than any other currency. If their currency falls, they can use dollars to buy up large chunks of their own currency to reduce the supply and increase its value, or use it to pay debts to countries where the dollar is more valuable.

The fact that so many countries keep dollars in reserve is like the worlds biggest no interest loan. Tens of billions of dollars are kept in existence but out of circulation, vastly increasing the value of the dollar. Additionally, the value of the dollar causes millions of individuals to hoard dollars as a means of protecting their savings from price fluctuations caused by their own countries monetary policies. The value of the dollars international use to Americans is not to be underestimated. The value of the dollars international use provides a massive benefit to you and I, and the loss of its position would bring with it a commensurate level of pain.

If the dollar were to be replaced in its position as the reserve currency of choice its value would plummet. All those dollars suddenly released to chase goods and services would cause prices to skyrocket, consumption would plummet, savings (what little Americans have) would vanish, and shortly thereafter, so would the dollar. If you think that last is an exaggeration think again. The dollar is not, contrary to popular belief, a fiat currency, it's much worse than that, because the US dollar is a bank credit. Every dollar represents a debt to the Federal Reserve banks which loaned it to us in the first place.

Every dollar in existence is a debt, both in the fact that we are (at least theoretically) expected to pay it back as well as paying a percentage of the value of each dollar, each year as interest. In fact, the only 'value' the dollar has is the Federal Reserve banks agreement to accept them in payment of debt. If foreign banks refused to accept dollars, how long could domestic banks continue to do so? If the Fed did keep accepting dollars, it would only be a matter of months before the entire federal budget was consumed in a vain attempt to pay the interest on the debt, then what? The government has no capacity to increase the supply of dollars except by barrowing more money, so the US could not attempt to inflate its way out of the problem, and if the government attempted to issue fiat money of its own, the banks would not accept it. Likewise, repudiating the debt would collapse the banks as their existence is utterly dependant upon their ability to use the government's tax collectors to refill their coffers.

The Euro supporters think that all this would be to the good. The elimination of the dollar would allow the Euro to become the world's currency. Skyrocketing prices for US goods would open markets for European goods, and European banks would replace American banks as the lenders to the world. Lastly, with the American economy in shambles, American military power and political prestige would effectively disappear, leaving the EU, Russia, China, and others free to step into the power vacuum left behind.

The problem with the plan is that it simply will not work. If the US goes down it will drag the rest of the world down with it. Consider the effect if all US government securities suddenly became valueless. Billions of dollars worth of value, in the hands of individuals, institutions and governments around the world would simply disappear. If US consumers can no longer absorb the products of countries like China, can Europe and Russia take up the slack? Or will the economies of those countries simply contract? If the later, who will by the goods from Europe and Russia? Can other countries absorb the oil America sucks up every year? Or will OPEC countries see their number one export plummet in value? Who will invest in oil companies if the price collapses? We cannot forget the degree to which stock markets around the world are interdependent either. If US markets collapse the effects will not be limited to the US.

One other issue is the Euro itself. The Euro is not a currency in the conventional sense, but rather an exchange coupon. The Euro has no value in and of itself (the ECB makes a lot of noise about the Euro being backed by gold, but this is just a smokescreen, as it is not convertible), but rather it is worth a fixed amount of each Euro countries currency, that is to say that X amount of Deutschmarks, Y amount of Lira, and Z amount of Francs all equal one Euro. This fixed exchange rate system utterly depends on each country maintaining a fixed level of debt, equity, and inflation. If they cannot, they must go to the ECB with hat in hand, of course this tends to increase the ECB's control over those countries that do so, which is of course the point. The EU is working to create a Europe which looks like the United States, with a powerful central government ruling a number of politically weak internal states and the ECB, and the Euro is a big part of that program.

All of which means the Euro is worth nothing! No gold, no Marks, no Lira, no nothing. It's not even a claim against the labor of taxpayers in Europe as the dollar is a claim against us. If the EU fails to claim power over the individual states of Europe the Euro will never be anything but a promise backed up by hot-air.

Unfortunately, the plan to replace the dollar with the Euro appears to be working. People all over the world, from Chinese factory workers to Russian drug-dealers are getting rid of their dollars and getting on the Euro bandwagon. Cuba has announced that dollars are no longer welcome in Cuba and Euros should be used instead. Oil producing countries are reducing dollar holdings in favor of Euros. China is considering revaluation of the Yuan which is currently pegged to the dollar. All of which is lowering the exchange rate on the dollar and increasing the Euro, which will tend to accelerate the process.

Can this process be halted? Sure it can. America just needs to stop barrowing money from the Fed and find a process by which this perpetual cycle of debt can be eliminated without shattering the economy. Our foreign rivals around the world can wake up and realize that America's economy is currently driving the global economy and if America falls we will drag them down with us. Working together America and the world can cease clubbing each other to death and usher in a new era of cooperation which will raise the standards of living for everyone everywhere. The sprit of laissez-faire capitalism can be engendered around the world and freedom will spread like wildfire...

Or we can continue as we are, with each nation seeing only the presumed benefits to their countries or coalitions and refusing to accept the reality of the harm that will be done. America can keep buying luxury and ease at the cost of a mortgage on the lives of its children and grand-children. Politicians can keep buying votes on credit with nothing but a hope to delay repayment beyond their terms...

I think you get the idea.

If you think the millennium is at hand then I suggest you continue to eat, drink, and be marry. However, those who think that business will continue as usual until the house of cards we've built collapses should begin to prepare. Get your hands on gold and silver (the metal, not some piece of paper that someone says will turn into it one demand), food, guns, ammunition, tools and the other things you won't have any money to buy. Get rid of your debt, fast! Sell, payoff, whatever, but get rid of other people's claims against your money and labor. Act now, as tomorrow may be too late.

(P.S. for those who are serious students of economics, yes I know much of this is oversimplified, but I stand by its basic truth and the conclusions thereof)


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