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Germany, the Euro and the Gold Standard
Raymond Richman, 11/2/2011

[This is reprinted from this blog on February 26, 2010. It is just as true today as it was then. Click here to read the original.]

Many commentators believe that dysfunctional Greece is the cause of Greece’s pending bankruptcy and many believe that dysfunctional USA is the cause of the USA’s pending bankruptcy. Time has run out for Greece and is running out for the USA. But the U.S. is more fortunate than Greece; its bonds are payable in U.S. dollars, issued as needed by its central bank, the Federal Reserve System. Poor Greece, its debt is payable in euros which are printed by the European central bank whose policies require Germany’s approval. And Germany does not approve profligacy.

The cause of Greece’s problems is alleged to be financial profligacy but its immediate cause is really its chronic trade deficit with Germany and the European community which causes it to run out of euros. The cause of the USA’s problem is alleged to be financial profligacy but its immediate cause is its chronic trade deficits with China, Japan, Germany, and OPEC  which flood the world with dollars which the world hoards as reserves or sends to the U.S. in return for U.S. Treasury bonds and other U.S. financial assets. Unfortunately, this is not sustainable .

The Asian Tigers got into trouble like Greece when the bubble caused by inflows of foreign capital burst in the late 1990s and their debts unfortunately were denominated in U.S. dollars which they did not have and could not get. They are no longer in trouble because they all have trade surpluses with the U.S. This gives them plenty of dollar reserves to pay any debts they may have payable in dollars.

Greece could get out of trouble, too. All it needs to do is have a favorable balance of trade with the members of the European Union. Its profligacy unfortunately makes it difficult if not impossible to prevent an imbalance of trade. Indeed, it would not have gotten into trouble if its trade had been in balance. Every country’s slogan has to be “Balanced Trade,” or it will inevitably bite the dust. Growth and stability, not profligacy is the answer.

That is the way the gold standard used to work. Countries got into trouble when they ran out of gold to pay their foreign debts when due. And why did they run out of gold? Because their profligacy caused them to run continual trade deficits that had to be paid for in gold. A number of years ago, Prof. Milton Friedman, one of my mentors, predicted that the euro could not be sustained any more than the gold standard could be maintained. He recognized that a condition of its longevity was that each member had to earn as many euros or as much foreign exchange that could be converted into euros as it spent. Not necessarily every year, but the deficit could not go on indefinitely.

After WWII, the U.S. was generous in helping its former enemies recover. The world was on a gold exchange standard basically in the 1970s when the U.S. faced the possibility that a continued outflow of gold would empty Fort Knox. So the world was forced to adopt a system of flexible exchange rates, in which, as it happened, the dollar became the world’s standard. It worked fine as long as the U.S. maintained its economic growth and stability.

The creation of the euro imitated the gold standard, or perhaps, the gold-exchange standard with the German mark imitating gold. The problem was that Germany, until overtaken by China during the last decade, was the country with the world’s largest chronic trade surpluses. For all practical purposes it was inevitable that member countries would run out of marks – excuse me, I mean euros. Greece is the first to teeter on the brink of bankruptcy but Spain, Portugal, Ireland, and Italy are having difficulties and are not far behind. Germany employs commercial policies at home that are mercantilistic. That is good if it wants to subjugate Europe – it is genuine lebensraum. But it is more likely to cause a break-up of the European Union than make Europe a satellite of Germany.

For the euro to survive, Germany must bring its European trade into balance. For the U.S. to survive it likewise must balance its trade with its trade partners with whom it has been experiencing chronic trade deficits for decades. Printing dollars while the dollar is the world’s exchange standard can enable it to survive but it is not sustainable. China, Germany, Japan, and the OPEC cartel are going to have to bring their trade into reasonable balance with the U.S. or, what comes to the same thing, the U.S. has to end its profligacy, restore growth and stability, and has to bring its trade into balance with these countries. It may have to use barriers to imports [such as scaled tariffs] which are authorized by the rules of the World Trade Organization to countries experiencing chronic trade deficits.

Perhaps, Greece should put a tariff on its imports from Germany! Poor Greece!

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Comment by jim, 11/5/2011: What's a good book to read about the history and logic of "export led growth" aka mercantilism (I have access to a university library). I've heard that the Japanese were coached by the German Kaiser at the turn of the 20th century, that the Asian Tigers copied the Japanese, and then the Chinese jumped on the same bandwagon. I've never understood why these countries keep such large piles of reserves. Up to a point it makes sense, but the only reason for foreign reserves I can see is as a buffer against fluctuations in capital flows and the purchase of exports. R. Taggart Murphy has made the case that Japan's reserves became a negative for Japan in the 1980s, yet they continued to pile up. China could improve the standard of living of its citizens if they spent some of those reserves--this would also take some of the pressure off the yuan. Why don't they do it?

Response to this comment by Howard Richman, 11/7/2011:
The best book to read is our own book: Trading Away Our Future.

Comment by harpat949, 11/8/2011:

Almost all the financial ills of the world are rooted in credit. It seems like people do not heed shakespear 'Neither a borrower nor a lender be for loan oft loses both itself and friend and borrowing dulls the edge of husbandary'. Germany and Europe deserve what they get for loaning money to Greece and encouraging their profligate ways. I think they are more to be blamed than Greece.

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]