A right-wing euro rescue

Published in Business Spectator (Melbourne), 6 September 2012

Founded in 1947 by distinguished economists such as Friedrich Hayek, Milton Friedman and Ludwig von Mises, the Mont Pelerin Society has long been a forum for critics of big government, defenders of the free market and believers in individual liberty.

As the society’s general meeting in currently being held in Prague (hosted by Vaclav Klaus, the fiercely euro sceptical Czech president), it was clear that the euro crisis would be a dominant theme during the week-long conference. But you would not have expected to find the most passionate supporter of the euro currency among these arch-libertarians and capitalists.

As if to confirm that no two classical liberals ever share the same beliefs, Spanish economist Jesús Huerta de Soto delivered a fervent plea to keep European Monetary Union alive. It was a more determined defence of the euro than anything ever voiced by Europe’s political class. But it was based on a completely different logic.

De Soto is certainly not a believer in the European superstate. Nor does he trust the wisdom of the ever growing EU bureaucracy. The economics professor from Madrid’s Rey Juan Carlos University is as free market minded as economists come. And precisely because of his anti-government attitude he supports European monetary integration and wants to keep it at all costs.

At first this sounds like a paradox. How could the most top-down economic policy ever designed by European leaders gets a seal of approval from a radical liberal economist? President Klaus, who chaired de Soto’s session, could hardly believe his ears.

But de Soto was entirely serious, and his argument goes something like this. For his whole professional life as a Spanish economist, he has advocated economic reforms for his home country. He saw that Spain needed product and labour market reforms; that the power of trade unions had to be curtailed; that the size of government needed to be reduced and government bureaucracies had to shrink. And though these reforms may have been obvious to economists like him, they were never implemented … until the euro crisis came along.

Under the pressure of the crisis, and as the price Spain had to pay for European assistance, Spanish governments have embarked on the most far-reaching economic reforms the country has ever seen.

A balanced budget clause has been inserted into the constitution; additional government projects put on hold; the public payroll slashed; the retirement age increased; unemployment benefits were cut; the government budget was reduced by 15 per cent; and a number of product markets were deregulated.

To sum it up: The euro crisis has forced the implementation of policies that are a liberal economist’s dream – and policies that would have never been feasible without the pressure the euro crisis provided.

De Soto even went further. While most Spaniards would blame the Germans for their current problems, he praised them for insisting on the harsh austerity programs. “We should all forget what terrible things they have done in the past and be grateful to them for forcing us to reform,” he told the conference.

In de Soto’s ideal world, a gold standard would keep government spending under control as governments could not just print money to balance their books. As a second best solution, he sees a regime of fixed exchange rates exerting discipline on deficit prone countries.

But if you can’t have a gold standard or fixed exchange rates, the euro is the next best thing, he argued. If it had not been for the euro, de Soto said, governments in Europe’s crisis countries would have already started to monetise their problems away in their national currencies: they would have just printed the money they needed. Indeed, that’s what they had done all those decades prior to the euro’s introduction – which he sees as precisely the reason for not tackling any of Spain’s reform needs before the euro crisis.

Under the ECB’s regime, and with those few remaining Bundesbank hawks watching, there are limits to such easy money policies. Hadn’t the GFC years demonstrated clearly that the ECB was much more restrained in its monetary policy than both the Federal Reserve and the Bank of England?, de Soto asked.

As he was delivering his speech with the passion of a Pentecostal revivalist, jaws were dropping in the audience. President Klaus was not the only one visibly irritated by what de Soto proposed. Klaus drily commented that his experience of EU summits did not suggest to him that this was how the euro crisis would play out.

Indeed, doubts about de Soto’s euro optimism are warranted.

What de Soto assumes will happen in the euro crisis may turn out to be little more than wishful thinking. As ECB president Mario Draghi prepares to launch his ‘bazooka’, and as hawks like Bundesbank president Jens Weidmann are few and isolated on the ECB board, the ECB may eventually resort to policies once favoured by the Banco de España.

De Soto’s dreaded debt monetisation would then happen, but not just in Spain but for the whole eurozone. Once this is done and yields on periphery debt are reduced to what the ECB deems an acceptable level, all reform pressure on the Spanish government would have evaporated. But in addition, it would have created inflationary pressure for the eurozone.

In effect, the ECB would not have turned the rest of Europe more German. Rather I would have turned all of Europe into Spain.

That’s the main problem with de Soto’s line of argument. A gold standard would undoubtedly put a limit to government spending. It may also prevent the development of big trade imbalances as balance of payments would need to be settled in gold. But the euro is not gold.

Unlike the euro, you cannot print gold when you need more of it. And when you can settle your balance of payments with dubious central bank transactions (Target 2), the disciplining effect of gold on a country’s external economic relations does not exist either.

As much as one can understand why liberal economists would like to use the euro as a catalyst for economic reforms, it may result in the precise opposite. But if there is one place where a little liberal daydreaming is allowed, it is the general meeting of the Mont Pelerin Society.

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