WEBVTT NOTE Eliminating Monetary Externalities 1 00:00:00.000 --> 00:00:09.000 Okay, one of the great benefits for me of being a director of this conference is to introduce the various lecturers, distinguished lecturers. 2 00:00:09.000 --> 00:00:17.000 Our first is Philip Baggis. He's a former Mises Fellow and Professor of Economics in the University Ray Juan Carlos in Madrid. 3 00:00:17.000 --> 00:00:27.000 He's the Assistant Editor of the Procesos de Marketo, Market Processes, a Spanish and English bilingual journal edited by Jesus Huerta de Soto. 4 00:00:27.000 --> 00:00:32.160 Soto, he has published articles in the Journal of Business Ethics, American Journal of Economics 5 00:00:32.160 --> 00:00:36.440 and Sociology, Independent Review, the Quarterly Journal of Austrian Economics, the Review 6 00:00:36.440 --> 00:00:41.760 of Austrian Economics, New Perspectives on Political Economy, the Journal of Libertarian 7 00:00:41.760 --> 00:00:45.640 Studies and other scholarly outlets. 8 00:00:45.640 --> 00:00:50.400 He's also the author, as you heard this morning, of two wonderful books. 9 00:00:50.400 --> 00:00:55.640 He will address us today on Eliminating Monetary Externalities. 10 00:00:55.640 --> 00:01:02.640 I introduce Dr. Baggis. 11 00:01:05.280 --> 00:01:10.400 Thank you, Joe. Good morning again. 12 00:01:10.400 --> 00:01:12.480 Well, let me first express my, 13 00:01:12.480 --> 00:01:17.040 the deep honor that I feel delivering the Rothbard Memorial Lecture 2011. 14 00:01:17.040 --> 00:01:20.680 It certainly is the greatest honor that I have received 15 00:01:20.680 --> 00:01:23.400 in my young career. 16 00:01:23.400 --> 00:01:32.600 Even though I don't think I'm so young anymore, when I was interviewed for Mises.org's 17 00:01:32.600 --> 00:01:39.800 Frequency Spotlight, one of the comments were, he looks like 13. 18 00:01:39.800 --> 00:01:45.800 I can tell you, appearances are deceiving sometimes. 19 00:01:45.800 --> 00:01:51.880 And of course I thought, now you have a problem, because who will take a 13-year-old seriously? 20 00:01:51.880 --> 00:01:52.880 What shall I do? 21 00:01:52.880 --> 00:02:09.880 Jeff Tucker also wrote in the description of my books, a young scholar, Philip Vargas, who predicted all things that would happen with the Euro correctly. 22 00:02:09.880 --> 00:02:21.880 Well, not 13, it's 30 and counting. But then I thought, maybe Philip, you have problems that other people would like to have. 23 00:02:21.880 --> 00:02:29.880 Anyway, I will try to make good use of this lecture, something that Rothbard would be proud of. 24 00:02:29.880 --> 00:02:38.880 I owe him a lot. It was through his Ethics of Liberty that I discovered all the implications of my libertarian genes. 25 00:02:38.880 --> 00:02:49.520 His clear economic and political prose was very inspiring for me and I owe him another one that I talked about earlier. 26 00:02:49.520 --> 00:02:56.240 I first wanted to call my book The Case Against the Euro in honor of Rothbard's grades, The Case Against the Fed. 27 00:02:56.240 --> 00:03:01.760 So I feel a bit sorry that I eventually did not do so, but I will try to make up for it. 28 00:03:01.760 --> 00:03:05.200 Finally I decided to call the book The Tragedy of the Euro. 29 00:03:05.200 --> 00:03:12.320 and not only for the reason that the Euro has proved to be a tragedy for liberty in Europe 30 00:03:12.320 --> 00:03:19.640 and will be so in the future, but also because the main argument or maybe the main argument 31 00:03:19.640 --> 00:03:24.440 of the book is that it is a tragedy of the commons. 32 00:03:24.440 --> 00:03:32.860 And this concept, the tragedy of the commons, made me think on the subject of monetary externalities. 33 00:03:32.860 --> 00:03:37.940 And there's not much written on monetary externalities in the Austrian School. We have Walter de Soto 34 00:03:37.940 --> 00:03:43.300 who claims that fractional reserve banking is a tragedy of the commons, which implies 35 00:03:43.300 --> 00:03:53.300 negative externalities from money. But there's not much else. There's not even much on externalities 36 00:03:53.300 --> 00:04:00.620 as such in the Austrian School. Rothbard, for example, he dedicates only roughly half 37 00:04:00.620 --> 00:04:09.620 There is half a page in Man Economy and State on externalities, even though he uses a slightly different terminology. 38 00:04:09.620 --> 00:04:17.620 He calls negative externalities external diseconomies or external costs, a term which he doesn't define explicitly. 39 00:04:17.620 --> 00:04:25.620 He just states, quote, but cases of external diseconomy all turn out to be instances of failure of government, 40 00:04:25.620 --> 00:04:30.820 Enforcing Agency Adequately to Enforce Individual Property Rights 41 00:04:30.820 --> 00:04:35.020 And then he gives us the typical example of air pollution. 42 00:04:35.020 --> 00:04:38.780 For further information, he refers to Mises's quote 43 00:04:38.780 --> 00:04:40.540 on external diseconomies. 44 00:04:40.540 --> 00:04:43.860 The only good discussion by an economist 45 00:04:43.860 --> 00:04:50.020 is the excellent one in Mises's Human Action, page 650 to 53. 46 00:04:50.020 --> 00:04:55.380 So even Mises has only three pages on externalities. 47 00:04:55.380 --> 00:05:02.380 So I would like to go into more detail today. 48 00:05:02.380 --> 00:05:12.380 I will first try to reconstruct externality analysis and then apply it to money, analyze different layers of it in money, 49 00:05:12.380 --> 00:05:18.380 and then propose several reforms to eliminate some or all of these externalities. 50 00:05:18.380 --> 00:05:24.380 I hope you're now ready for my 30 years of accumulated wisdoms to come to you now. 51 00:05:27.380 --> 00:05:29.380 Well, the mainstream definition. 52 00:05:29.380 --> 00:05:36.380 Orthodox textbooks often define the externalities as uncompensated effects of actions on third parties, 53 00:05:36.380 --> 00:05:41.380 on bystanders not participating in a particular action or exchange. 54 00:05:41.380 --> 00:05:46.980 Triple examples are someone smoking next to you in a restaurant as a negative externality 55 00:05:46.980 --> 00:05:53.660 or a neighbour planting flowers in his garden that look nice as a positive externality. 56 00:05:53.660 --> 00:06:00.100 And then the literature goes on to distinguish between psychic, pecuniary and technological 57 00:06:00.100 --> 00:06:03.160 or real externalities. 58 00:06:03.160 --> 00:06:15.800 Pecuniary externalities are internal feelings that a particular action invokes on third-parties. 59 00:06:15.800 --> 00:06:22.920 Such a feeling would be the nice view that the beautiful neighbor's garden provokes. 60 00:06:22.920 --> 00:06:27.440 Pecuniary externalities result when actions affect third-parties indirectly through the 61 00:06:27.440 --> 00:06:28.920 price system. 62 00:06:28.920 --> 00:06:36.160 So when a new restaurant opens in a neighborhood, it tends to have a negative pecuniary effect 63 00:06:36.160 --> 00:06:37.800 on competing restaurants. 64 00:06:37.800 --> 00:06:45.960 Finally, real or technological externalities are defined as the direct effects that actions 65 00:06:45.960 --> 00:06:52.120 of some firms have on the physical output of other firms affecting its production function. 66 00:06:52.120 --> 00:06:58.280 The typical case is a factory that pollutes a farmer's field, so the physical crop production 67 00:06:58.280 --> 00:07:07.720 of the Farmer is Humped, so we can see a physical destruction of the property of a third person. 68 00:07:07.720 --> 00:07:14.600 Unfortunately this mainstream taxonomy of externalities is very problematic and not 69 00:07:14.600 --> 00:07:20.800 very useful to analyze problems of the real world. First the definition of externalities 70 00:07:20.800 --> 00:07:24.760 seems to be too broad. 71 00:07:24.760 --> 00:07:28.160 Any action may have psychic, pecuniary, 72 00:07:28.160 --> 00:07:32.160 or technological externalities. 73 00:07:32.160 --> 00:07:33.360 So psychic externalities. 74 00:07:33.360 --> 00:07:35.800 The planting of the flowers by the neighbor 75 00:07:35.800 --> 00:07:39.400 may have negative or positive externalities 76 00:07:39.400 --> 00:07:40.760 on all bypasses. 77 00:07:40.760 --> 00:07:42.160 Negative, because people might be 78 00:07:42.160 --> 00:07:45.680 allergic against flowers, would be a negative. 79 00:07:45.680 --> 00:07:48.520 If the neighbor puts a photo of his beautiful garden 80 00:07:48.520 --> 00:08:00.920 In other words, any action that is known to third parties may affect their well-being. 81 00:08:00.920 --> 00:08:08.720 Regarding pecuniary externalities in a society with a high division of labour, a consumer 82 00:08:08.720 --> 00:08:15.020 buying chewing gum in China may have a pecuniary externality on all other producers worldwide 83 00:08:15.020 --> 00:08:21.380 because the money that is spent on chewing gum cannot be spent on other goods. 84 00:08:21.380 --> 00:08:27.460 And regarding technological externalities, implementing scarce resources in an investment 85 00:08:27.460 --> 00:08:35.700 project affects the production function of all other firms directly, may affect it directly. 86 00:08:35.700 --> 00:08:41.900 If I convince a famous singer to sing at my charity event for free, of course the same 87 00:08:41.900 --> 00:08:53.900 As such, the definition of externalities, the mainstream definition, seems to be too broad to be useful as an analytical tool. 88 00:08:53.900 --> 00:09:07.900 Second, the distinction between technological, pecuniary and psychic externalities seems to suggest that they are both objective and subjective externalities. 89 00:09:07.900 --> 00:09:19.900 Yet externalities are only relevant for actors if they affect the subjective well-being of individuals. It is not the objective changes that are relevant, but the subjective perception of them. 90 00:09:19.900 --> 00:09:26.900 So there is no clear-cut distinction between real pecuniary and psychic externalities. 91 00:09:26.900 --> 00:09:34.900 Also, technological and pecuniary externalities affect the subjective well-being of third parties. 92 00:09:34.900 --> 00:09:40.900 Let's take the typical example of technological externality, the pollution of a farmer's field. 93 00:09:40.900 --> 00:09:48.900 When a farmer produces fewer crops due to the pollution, his well-being is affected subjectively. 94 00:09:48.900 --> 00:09:56.900 If he wanted to produce fewer crops to increase prices, he might actually welcome the pollution. 95 00:09:56.900 --> 00:10:02.900 Also, pecuniary externalities are relevant to actors only if they affect their subjective well-being. 96 00:10:02.900 --> 00:10:11.900 It's not the higher or lower monetary income as such that is important to actors but their subjective valuation of these changes. 97 00:10:11.900 --> 00:10:20.900 This leads us then to the question, why distinguish between technological, pecuniary and psychic externalities if all affect the subjective being in the end? 98 00:10:20.900 --> 00:10:25.900 Why not only refer to psychic externalities? 99 00:10:25.900 --> 00:10:28.900 This leads us to the third critique. 100 00:10:28.900 --> 00:10:34.900 All externalities are psychic or subjective and individually experienced by actors. 101 00:10:36.900 --> 00:10:44.900 Therefore, the mainstream classification is flawed and, most importantly, puts aside and does not mention 102 00:10:44.900 --> 00:10:50.900 and thereby hides the true and only meaningful distinctive characteristic of externalities, 103 00:10:50.900 --> 00:10:54.900 which is the poor definition and defence of property rights. 104 00:10:58.900 --> 00:11:06.900 The poor definition and defence of private property rights is objectively discernible from the outside. 105 00:11:06.900 --> 00:11:15.900 In fact, if other effects resulting from actions that respect private property rights are relatively uninteresting, 106 00:11:15.900 --> 00:11:22.900 because all actions may have effects on third parties in the sense that they may affect their subjective well-being, 107 00:11:22.900 --> 00:11:32.900 But actions that do violate private property rights and inflict damages on the property or health of third parties pose important theoretical questions. 108 00:11:32.900 --> 00:11:40.900 Those actions may be called irresponsible as they do not account for the effects resulting from the ill-defended property rights. 109 00:11:40.900 --> 00:11:47.660 Consequently, I, in line with the Austrian analysis, will define externalities as effects 110 00:11:47.660 --> 00:11:53.660 of actions that affect third parties and that do not respect private property rights. 111 00:11:53.660 --> 00:11:56.600 It's in line with Mises. 112 00:11:56.600 --> 00:12:00.780 For him, positive and negative externalities, or what he calls them external benefits and 113 00:12:00.780 --> 00:12:08.060 costs, occur when a proprietor does not assume the full advantages or disadvantages of employing 114 00:12:08.060 --> 00:12:14.420 and Property because of ill-defined or defended property rights. 115 00:12:14.420 --> 00:12:23.420 So here we have, and they often generate perverse incentives harming third parties, which we 116 00:12:23.420 --> 00:12:25.140 will see later. 117 00:12:25.140 --> 00:12:33.940 Here is a table where we have positive and negative effects on third parties in the first 118 00:12:33.940 --> 00:12:38.940 The first row are where property rights are respected and the second row are where they are not. 119 00:12:38.940 --> 00:12:45.940 So where property rights are respected and they have positive effects, the example would be savings and investment. 120 00:12:45.940 --> 00:12:54.940 There is capital accumulation, productivity, rises of labour also and wages tend to increase. 121 00:12:54.940 --> 00:13:02.940 So there is a positive effect on a third party, which is the worker, whose real wage tends to increase. 122 00:13:02.940 --> 00:13:13.940 A typical example would be a divorce. A couple splits up, so it might have a positive effect on someone who was waiting for one of those two. 123 00:13:13.940 --> 00:13:29.940 Or a typical example is also a lighthouse. It's for all people that want to find their way, even if they didn't pay for it, it shows the way. 124 00:13:29.940 --> 00:13:32.740 In fact, no violation of property rights. 125 00:13:32.740 --> 00:13:35.020 Then negative effects. 126 00:13:35.020 --> 00:13:38.100 Here, where property rights are respected, 127 00:13:38.100 --> 00:13:40.700 a boycott, for example, I could convince someone not 128 00:13:40.700 --> 00:13:45.420 to go to McDonald's, negative effect for McDonald's, 129 00:13:45.420 --> 00:13:47.900 but no property right violation. 130 00:13:47.900 --> 00:13:51.740 On the other hand, we see that anything 131 00:13:51.740 --> 00:13:57.780 may be, in any case, the divorce may have a negative effect 132 00:13:57.780 --> 00:14:12.780 Another example would be gold production in a 100% gold standard that prices increase, but there's no violation of property rights. 133 00:14:12.780 --> 00:14:21.780 There's no go to the ill-defended or ill-defined property rights. 134 00:14:21.780 --> 00:14:33.780 A positive effect. A tyrannicide. Someone kills a tyrant, so for many subjects that will have positive effects. 135 00:14:33.780 --> 00:14:43.780 Another example would be someone kills your competitor in any market. It may have a positive effect on you. 136 00:14:43.780 --> 00:14:46.900 Property Rights Violated. 137 00:14:46.900 --> 00:14:51.220 Another example that shows that one action can 138 00:14:51.220 --> 00:14:52.900 have positive or negative externalities 139 00:14:52.900 --> 00:14:55.340 would be air pollution. 140 00:14:55.340 --> 00:14:57.500 I have a house with white walls. 141 00:14:57.500 --> 00:14:58.580 Then there's air pollution. 142 00:14:58.580 --> 00:14:59.820 They get dark. 143 00:14:59.820 --> 00:15:03.100 I contract painters to paint it white again. 144 00:15:03.100 --> 00:15:08.300 Positive effects on the painters caused by ill-defined property 145 00:15:08.300 --> 00:15:09.300 rights. 146 00:15:09.300 --> 00:15:12.180 And we see that this is also an example 147 00:15:12.180 --> 00:15:17.260 for negative externalities because I have to pay the painters, for me it's a negative 148 00:15:17.260 --> 00:15:22.980 externality. Another example would be of a negative externality violated property rights, 149 00:15:22.980 --> 00:15:29.980 a wealth tax, reduces capital accumulation, tends to reduce productivity, wages tend to 150 00:15:29.980 --> 00:15:36.420 be lower than otherwise, a negative effect on third parties or public roads that suddenly 151 00:15:36.420 --> 00:15:40.580 Emigration Without Invitation is possible. 152 00:15:40.580 --> 00:15:43.060 So what is there in the circle? 153 00:15:43.060 --> 00:15:47.540 This is what I define as negative externality, 154 00:15:47.540 --> 00:15:50.380 because there's a negative effect on third parties 155 00:15:50.380 --> 00:15:54.380 and property rights are violated. 156 00:15:54.380 --> 00:15:58.700 I might add that ironically, the mainstream analysis has 157 00:15:58.700 --> 00:16:03.980 used positive effects that do not violate private property 158 00:16:03.980 --> 00:16:09.980 to justify property rights violations, which may then exert negative externalities. 159 00:16:09.980 --> 00:16:20.980 The lighthouse example, it has positive effects on third parties, they call them free riders that did not pay for the lighthouse. 160 00:16:20.980 --> 00:16:32.980 So they say it's justified to tax these people who use violence, violate private property rights and build a lighthouse with public money. 161 00:16:32.980 --> 00:16:37.980 which could then have true negative externalities. 162 00:16:37.980 --> 00:16:44.980 So now let's see if we can apply this concept to money. 163 00:16:44.980 --> 00:16:50.980 Of course, government manipulation of money affects its purchasing power. 164 00:16:50.980 --> 00:16:59.980 However, most manipulation of government does not affect the physical integrity of a fired paper note. 165 00:16:59.980 --> 00:17:11.020 paper note. So from the mainstream point of view there is no technological or real externality. 166 00:17:11.020 --> 00:17:18.660 Maybe even Rothbard would not consider it as a negative externality. He points out in his 167 00:17:18.660 --> 00:17:25.180 discussion of external cost that in a free society no one owns the value of a property. 168 00:17:25.180 --> 00:17:33.260 So no one owns the value of one's cash balance. Nevertheless, a criminal action may reduce 169 00:17:33.260 --> 00:17:38.300 the value of your property. So there can be violations in property rights in the monetary 170 00:17:38.300 --> 00:17:44.700 sphere that affect the value of cash balances and therefore constitute negative externalities. 171 00:17:44.700 --> 00:17:52.060 Here one must not forget that it is the services of a good that makes it valuable for an actor. 172 00:17:52.060 --> 00:17:56.660 And when property rights to money are not defended, the services it provides are affected 173 00:17:56.660 --> 00:17:59.180 negatively. 174 00:17:59.180 --> 00:18:05.100 Pioneers of this approach are Hoppe, 94, or Hoppe-Hülsmann & Bloch, 98, and Walter Soto, 175 00:18:05.100 --> 00:18:12.560 98, that refer to negative externalities resulting from property rights violations in money. 176 00:18:12.560 --> 00:18:17.840 And my suspicion is that the distinction between the value of the property and the physical 177 00:18:17.840 --> 00:18:23.040 Property explains why these externalities resulting from meddling with property rights 178 00:18:23.040 --> 00:18:27.200 and money are sometimes neglected. 179 00:18:27.200 --> 00:18:31.480 I might add that even Rothbard might agree that there can be negative externalities from 180 00:18:31.480 --> 00:18:37.040 meddling with money because he himself points repeatedly to the service a good provides 181 00:18:37.040 --> 00:18:40.000 in contrast to the physical content. 182 00:18:40.000 --> 00:18:47.180 As a matter of fact, tangible goods are valued not so much for their physical content as 183 00:18:47.180 --> 00:18:53.300 As for their services to the user, whether he is a consumer or producer, the actor values 184 00:18:53.300 --> 00:18:59.140 the bread for its services in providing nourishment, the house for its services in providing shelter, 185 00:18:59.140 --> 00:19:03.420 the machine for its service producing a lower-order good. 186 00:19:03.420 --> 00:19:08.060 In the last analysis tangible commodities are also valued for their services and thus 187 00:19:08.060 --> 00:19:12.260 on the same plane as intangible personal services. 188 00:19:12.260 --> 00:19:16.060 Economics therefore is not a science that deals particularly with material good or material 189 00:19:16.060 --> 00:19:22.920 Welfare. It deals in general with the action of men to satisfy their desires." The same 190 00:19:22.920 --> 00:19:29.020 is true for money. What are the services of money? Well, money is valued mainly for its 191 00:19:29.020 --> 00:19:34.580 services as a medium of exchange and the store of value. People demand to hold money in their 192 00:19:34.580 --> 00:19:41.220 cash balances because they thereby reduce the uncertainty of the future. As Rothbard 193 00:19:41.220 --> 00:19:52.220 The desire to keep a cash balance stems from fundamental uncertainty as to the right time for making purchases, whether of capital or consumer goods. 194 00:19:52.220 --> 00:20:02.220 Also important are a basic uncertainty about the individual's own future value scale and the desire to keep cash on hand to satisfy any changes that might occur. 195 00:20:02.220 --> 00:20:13.220 The service of money of course depends on its purchasing power and here money is special as the service it provides depends on its demand and supply. 196 00:20:13.220 --> 00:20:20.220 The higher the demand for money, the higher the services it provides tends to be as its purchasing power is built up. 197 00:20:20.220 --> 00:20:25.220 The higher the supply, the lower the services a given unit provides tend to be. 198 00:20:25.220 --> 00:20:32.620 The lower the quality of money the lower the services a given unit provides tend to be. 199 00:20:32.620 --> 00:20:39.340 What is also special of money is that its services may be affected even though the physical 200 00:20:39.340 --> 00:20:45.660 integrity of it is not affected, even though the physical integrity of the existing dollar 201 00:20:45.660 --> 00:20:57.420 Another note in your wallet is not affected, it's the services it provides may be affected. 202 00:20:57.420 --> 00:21:04.380 So let's look for the negative externalities in our present monetary system. 203 00:21:04.380 --> 00:21:09.780 In a gold standard, the production of base money or money proper respects private property 204 00:21:09.780 --> 00:21:10.780 rights. 205 00:21:10.780 --> 00:21:14.780 The gold money producers assume the full costs of money production. 206 00:21:14.780 --> 00:21:21.780 Even though prices tend to increase due to the money production, there is no violation of property rights or ill-defined property rights. 207 00:21:21.780 --> 00:21:26.780 No one has to accept the newly minted coins. People are free to use alternative currencies. 208 00:21:26.780 --> 00:21:30.780 Consequently, there are no negative externalities. 209 00:21:30.780 --> 00:21:35.780 In our modern monetary system, however, base money production implies negative externalities, 210 00:21:35.780 --> 00:21:43.140 is added as it is not free and competitive. There's a money monopoly which implies a privilege 211 00:21:43.140 --> 00:21:49.520 violating property rights as no one is allowed to use his own property to produce base money. 212 00:21:49.520 --> 00:21:57.300 And this privilege is normally combined with legal tender laws which present a violation 213 00:21:57.300 --> 00:22:02.460 of the freedom of contract and thereby also property rights. People cannot use their property 214 00:22:02.460 --> 00:22:08.260 in the way they want but must accept the legal tender in exchanges. 215 00:22:08.260 --> 00:22:14.980 As the property rights are violated, negative externalities may evolve consisting in what? 216 00:22:14.980 --> 00:22:20.260 When the monopolist produces more base money, prices are bitten up and the price increase 217 00:22:20.260 --> 00:22:22.260 harms third parties. 218 00:22:22.260 --> 00:22:28.380 Damage is inflicted on the purchasing power of money through a violation of property rights. 219 00:22:28.380 --> 00:22:35.180 Money head rents fewer services than it otherwise would have yielded, and it is these reduced 220 00:22:35.180 --> 00:22:44.580 services that present the negative externalities, in the same way as it is in the case of pollution 221 00:22:44.580 --> 00:22:47.060 of a farmer's field. 222 00:22:47.060 --> 00:22:54.500 The pollution yield leads to less services in the form of a lower crop and providing 223 00:22:54.500 --> 00:23:01.820 Less Nourishment, and the money producer, the Centre Bank, does not assume therefore 224 00:23:01.820 --> 00:23:07.220 all costs of his action and will try to maximise his income out of the money production at 225 00:23:07.220 --> 00:23:14.060 the same time attempting to avoid a breakdown of the monetary system, leading to a redistribution 226 00:23:14.060 --> 00:23:17.700 in his favour. 227 00:23:17.700 --> 00:23:23.220 This was about the production of the negative externalities due to the production of base 228 00:23:23.220 --> 00:23:24.220 money. 229 00:23:24.220 --> 00:23:29.580 Let's go to the negative externalities due to the production of fiduciary media in the 230 00:23:29.580 --> 00:23:32.860 fractional reserve banking system. 231 00:23:32.860 --> 00:23:38.300 Another area where property rights today are ill-defined and defended is in banking. 232 00:23:38.300 --> 00:23:43.840 In a deposit contract, the depositor entrusts to the depository a good to guard, protect 233 00:23:43.840 --> 00:23:46.260 and return on demand. 234 00:23:46.260 --> 00:23:53.780 So the fundamental purpose of a deposit contract is to maintain the full availability of the 235 00:23:53.780 --> 00:23:59.780 deposited good, which implies the obligation of custody and safekeeping of the good deposited. 236 00:23:59.780 --> 00:24:07.140 The bank's duty is to hold 100% reserves on these deposits. Consequently, it's both a privilege 237 00:24:07.140 --> 00:24:12.100 and a violation of private property rights if banks are allowed to expand credit and 238 00:24:12.100 --> 00:24:14.100 and hold fractional reserves. 239 00:24:16.100 --> 00:24:20.100 Governments have granted the privilege to banks to hold fractional reserves. 240 00:24:20.100 --> 00:24:25.100 In other words, they have not defended the property rights of depositors. 241 00:24:25.100 --> 00:24:29.100 Banks can exploit the purchasing power of deposits entrusted to them, 242 00:24:29.100 --> 00:24:32.100 and the results are negative externalities. 243 00:24:32.100 --> 00:24:36.100 The creation of fiduciary media leads to upward pressure on prices. 244 00:24:36.100 --> 00:24:39.100 The services from money held are reduced. 245 00:24:39.100 --> 00:24:45.780 Existing depositors lose purchasing power as the privileged banks have created new money. 246 00:24:45.780 --> 00:24:52.100 Another externality of fractional reserve banking and production of fiduciary media 247 00:24:52.100 --> 00:24:58.020 is that the quality of money is reduced. The quality of money is its capacity to fulfil 248 00:24:58.020 --> 00:25:08.420 its functions as a medium of exchange, store of value and unit of account. 249 00:25:08.420 --> 00:25:13.740 By credit expansion, the reserve ratio of deposits is reduced. Banks expand credits 250 00:25:13.740 --> 00:25:20.700 to grant loans for long-term investment projects. As a result, the average quality of assets 251 00:25:20.700 --> 00:25:25.500 that might be used to redeem deposits falls because banks acquire illiquid assets with 252 00:25:25.500 --> 00:25:31.980 the newly created money. Therefore, the money becomes a worse store of value. The quality 253 00:25:31.980 --> 00:25:37.780 of money is reduced. Another negative externality is that credit expansion also distorts relative 254 00:25:37.780 --> 00:25:54.340 One may make the argument that in the case of our present fractional reserve banking 255 00:25:54.340 --> 00:26:00.940 system we are not faced with ill-defended property rights, but rather with ill-defined 256 00:26:00.940 --> 00:26:07.220 property rights. In fact, it may not be clear for many parties involved if they deal with 257 00:26:07.220 --> 00:26:10.220 with a deposit contract. 258 00:26:10.220 --> 00:26:16.060 Probably many depositors want a complete availability of their money, which is characteristic of 259 00:26:16.060 --> 00:26:17.580 a deposit contract. 260 00:26:17.580 --> 00:26:23.040 However, banks tend to regard the deposited money as loans granted to them. 261 00:26:23.040 --> 00:26:27.700 So it's not clear who really owns the deposited money. 262 00:26:27.700 --> 00:26:31.980 And bankers fail to make clear whether they have been authorized or not by the depositor 263 00:26:31.980 --> 00:26:34.100 to use the money. 264 00:26:34.100 --> 00:26:41.740 states what Soto states, quote, to fail to clarify or fully specify these details indicates 265 00:26:41.740 --> 00:26:47.980 a remarkable ambiguity on the part of bankers and in the event that adverse legal consequences 266 00:26:47.980 --> 00:26:54.660 result, their weight should fall on the banker's shoulders and not on those of the contracting 267 00:26:54.660 --> 00:27:00.580 party, who with good faith enter into the contract believing its essential purpose or 268 00:27:00.580 --> 00:27:07.380 are of course to be the simple custody or self-keeping of the money deposited, end quote. 269 00:27:07.380 --> 00:27:12.580 So it's not clear in our present fractional reserve banking system what kind of contract 270 00:27:12.580 --> 00:27:18.300 is entered into, whether it is a loan or deposit. Without clear and unambiguous contracts property 271 00:27:18.300 --> 00:27:23.300 rights are ill-defined, resulting in negative externalities. 272 00:27:23.300 --> 00:27:29.300 Thus, we may interpret modern fractional reserve banking in basically two ways. First, we may 273 00:27:29.300 --> 00:27:36.100 We may regard deposits as ill-defended, because banks have the privilege to use genuine deposits. 274 00:27:36.100 --> 00:27:42.060 Second, we may regard the property rights of demand deposits as ill-defined, because 275 00:27:42.060 --> 00:27:44.500 it's not clear what kind of contract is actually being signed. 276 00:27:44.500 --> 00:27:52.220 With both interpretations, modern fractional reserve banking system leads to negative externalities. 277 00:27:52.220 --> 00:27:58.300 And here we are faced with a special case of negative externalities, namely a tragedy 278 00:27:58.300 --> 00:28:02.740 A Tragedy of the Commons, a term coined by Gerrit Harden. 279 00:28:02.740 --> 00:28:05.940 A Tragedy of the Commons is defined by two aspects. 280 00:28:05.940 --> 00:28:13.100 There's a rivalrous use of the resource and there's non-excludability in the access of the resource. 281 00:28:13.100 --> 00:28:16.780 That is, many people can exploit it. 282 00:28:16.780 --> 00:28:22.900 A Tragedy of the Commons occurs in the case of unowned or common property resources. 283 00:28:22.900 --> 00:28:27.380 Mises calls this as an extreme instance of negative externalities 284 00:28:27.380 --> 00:28:34.420 Because not only one actor, but several actors can exploit a resource due to ill-defined or ill-defended property rights. 285 00:28:34.420 --> 00:28:38.140 A typical example is the harvesting of fish in the ocean. 286 00:28:38.140 --> 00:28:44.020 As property rights on fish stocks are not defined, anyone can harvest the fish, reducing the stock. 287 00:28:44.020 --> 00:28:47.700 All fishermen bear the cost, the burden of the reduced stock of fish, 288 00:28:47.700 --> 00:28:52.460 while the advantage of fishing is fully absorbed by the individual fishermen. 289 00:28:52.460 --> 00:28:55.700 Thus there is an incentive to fish as many fish as possible, because otherwise other 290 00:28:55.700 --> 00:28:58.300 fishermen may deplete the stock. 291 00:28:58.300 --> 00:29:04.660 A tragedy of the commons thereby leads to a tendency towards a destruction of the common 292 00:29:04.660 --> 00:29:07.580 property resource. 293 00:29:07.580 --> 00:29:13.460 And we can apply the concept of the tragedy of the commons to banking, state-wide risotto. 294 00:29:13.460 --> 00:29:17.340 Fractional reserve banks can exploit the common property resource, that is the deposits of 295 00:29:17.340 --> 00:29:19.420 their depositors. 296 00:29:19.420 --> 00:29:28.500 Any bank that expands credit reaps the full benefit of the money creation, yet it does 297 00:29:28.500 --> 00:29:33.860 not assume the full costs, which are borne by all money users and also by other fractional 298 00:29:33.860 --> 00:29:40.300 reserve banks, because banks see the possibility to benefit from credit expansion reduced as 299 00:29:40.300 --> 00:29:42.060 the purchasing power of money falls. 300 00:29:42.060 --> 00:29:48.300 Thus, there is an incentive to exploit the commons as fast as possible, because otherwise 301 00:29:48.300 --> 00:29:51.500 and of course other banks will exploit it via credit expansion. 302 00:29:53.100 --> 00:29:58.900 Nevertheless, competition and the interbank clearing mechanism is a check on the exploitation of the deposits. 303 00:29:59.700 --> 00:30:02.900 Fractional reserve banking therefore is no pure tragedy of the commons. 304 00:30:03.300 --> 00:30:08.100 A pure tragedy of commons has virtually no limits on the exploitation of the common resource. 305 00:30:11.100 --> 00:30:12.300 It works like this. 306 00:30:12.500 --> 00:30:17.900 A bank that expands credit faster than other banks will lose reserves to the more conservative banks 307 00:30:18.300 --> 00:30:22.300 and it might fall into severe liquidity and ultimately solvency problems. 308 00:30:22.900 --> 00:30:25.900 Only when all banks expand in the same rhythm, 309 00:30:26.180 --> 00:30:30.180 there are no reserve losses due to the clearing mechanism. 310 00:30:30.660 --> 00:30:34.660 Thus, there is an incentive for banks to collude and coordinate credit expansion. 311 00:30:35.260 --> 00:30:39.260 And banks have traditionally pushed for the institutionalization 312 00:30:39.260 --> 00:30:43.260 of the coordination of credit expansion through the interaction of central banks. 313 00:30:43.260 --> 00:30:46.260 Because the central bank can coordinate the credit expansion of the banking system, 314 00:30:46.260 --> 00:30:50.420 can prevent reserve losses and ensure a controlled exploitation of the commons. 315 00:30:50.540 --> 00:30:55.620 The central bank, by regulating the exploitation of the deposits of the commons, 316 00:30:55.740 --> 00:31:00.140 may prevent the total destruction of the resource and the purchasing power of money. 317 00:31:00.260 --> 00:31:06.740 The treasury of the commons thus is alleviated and converted into what people call 318 00:31:06.860 --> 00:31:11.500 a managed commons. The regulation of the banking industry prevents the immediate 319 00:31:11.500 --> 00:31:24.500 and the destruction of the resource by imposing certain quotas and rules on its explanation in the same way that governments impose certain quotas on fish, on the exploitation of fish stocks in the ocean. 320 00:31:29.500 --> 00:31:35.500 Well, we have another layer in the euro system of externalities. 321 00:31:35.500 --> 00:31:44.420 It's a tragedy in the monetization of government debts. This tragedy is unique for the Eurozone 322 00:31:44.420 --> 00:31:49.260 because several independent governments can use one banking system to finance the debts 323 00:31:49.260 --> 00:31:54.140 by increasing the money supply. 324 00:31:54.140 --> 00:32:00.580 How do governments monetize their debts? Traditionally, there have been two instruments by which central 325 00:32:00.580 --> 00:32:06.460 Central Banks monetize government debt. One is that central banks buy government bonds 326 00:32:06.460 --> 00:32:11.300 from the banking system. The other is that they accept government bonds as collateral 327 00:32:11.300 --> 00:32:13.580 for new loans to the banking system. 328 00:32:13.580 --> 00:32:20.580 Let's assume here's an example. The government spends more than it receives in taxes. For 329 00:32:21.860 --> 00:32:27.420 the difference, it prints some nice-looking government bonds which are bought by the banking 330 00:32:27.420 --> 00:32:34.740 Banking System. The banking system in the Euro system may use these bonds as collateral 331 00:32:34.740 --> 00:32:42.540 to get new loans from the ECB. So the banking system gets new reserves and can expand credits 332 00:32:42.540 --> 00:32:52.180 on top of these reserves. This is, of course, a deficit that does not hurt very much because 333 00:32:52.180 --> 00:32:56.060 what happens at the end of the year is that the government pays the interest on the bonds 334 00:32:56.060 --> 00:33:00.860 to the banking system, which they are the owner of the bonds, and of course the banking 335 00:33:00.860 --> 00:33:04.820 system has to pay interest on the loans it receives from the ECB. 336 00:33:04.820 --> 00:33:06.660 The ECB at the end of the year, what does it do? 337 00:33:06.660 --> 00:33:10.800 It returns the profits to government. 338 00:33:10.800 --> 00:33:17.500 So here to see a little bit quantitatively how much it is, how many government bonds 339 00:33:17.500 --> 00:33:20.300 are owned by the banking system in Europe? 340 00:33:20.300 --> 00:33:24.300 Well, 25, recently almost 30 percent. 341 00:33:28.300 --> 00:33:31.300 The second way is the way that does the Fed. 342 00:33:31.300 --> 00:33:34.300 We have the same here, a deficit, bonds are issued, 343 00:33:34.300 --> 00:33:37.300 bought with money from the banking system, 344 00:33:37.300 --> 00:33:40.300 and here the Fed buys the bonds outright 345 00:33:40.300 --> 00:33:45.300 and gives new reserves to the banks that can expand credits on top of it. 346 00:33:45.300 --> 00:33:47.300 Base money increases. 347 00:33:47.300 --> 00:34:04.300 And here we have, here the interest is paid directly to the FED, because the FED is the legal owner of the bonds, it has bought it, and the FED returns the profits to the government, that the debt does not hurt. 348 00:34:04.300 --> 00:34:21.300 The difference between the two methods is mainly legal. In the case of the outright purchase, like the FED does, the central bank owns the bonds and increases the base money until it sells the bonds back to the banking system. 349 00:34:21.300 --> 00:34:35.300 In the case of collateralised lending, like the ECB does, the central bank holds the bonds as collateral and increases base money until it stops rolling over these loans. 350 00:34:35.300 --> 00:34:40.300 In both cases central banks effectively monetise government debt. 351 00:34:40.300 --> 00:34:50.300 They increase base money to hold the government bonds outright or as collateral, thus indirectly financing the government's deficit. 352 00:34:50.300 --> 00:34:58.300 In addition to this outright monetization of government bonds, there is an indirect monetization occurring within the financial system. 353 00:34:58.300 --> 00:35:04.300 Market participants know that central banks buy government bonds and accept them as preferred collateral. 354 00:35:04.300 --> 00:35:09.300 Banks buy the bonds, ensuring a liquid market and pushing down yields. 355 00:35:09.300 --> 00:35:14.300 Knowing that there is a liquid market in government bonds and a high demand by banks, 356 00:35:14.300 --> 00:35:19.300 investment funds, pension funds, insurers and private investors buy government bonds. 357 00:35:19.300 --> 00:35:22.900 Government bonds become very liquid and almost as good as base money. 358 00:35:22.900 --> 00:35:26.900 They stand as a reserve to be converted into base money if necessary. 359 00:35:26.900 --> 00:35:34.900 As a consequence, new money created through credit expansion often ends up buying liquid government bonds, indirectly monetizing the debt. 360 00:35:34.900 --> 00:35:38.900 So, let's imagine the following example. 361 00:35:38.900 --> 00:35:40.900 The government has a deficit again. 362 00:35:40.900 --> 00:35:43.900 The banking system buys the bonds. 363 00:35:43.900 --> 00:35:47.900 It pledges them as collateral for new reserves to the banking system. 364 00:35:47.900 --> 00:35:53.780 But we have seen the banking system only holds 30% of the government bonds. 365 00:35:53.780 --> 00:35:57.540 Where's the rest of the government bonds when it's not in the banking system? 366 00:35:57.540 --> 00:36:02.540 Well, China has some, but there's also another one. 367 00:36:02.540 --> 00:36:05.020 We have seen that the reserves have now increased. 368 00:36:05.020 --> 00:36:07.140 Banks hold new reserves. 369 00:36:07.140 --> 00:36:08.820 They have received new reserves. 370 00:36:08.820 --> 00:36:11.020 That means they can expand credit. 371 00:36:11.020 --> 00:36:20.260 They may give a loan, grant a loan to the constructor that starts constructing a project 372 00:36:20.260 --> 00:36:22.180 and pays his workers. 373 00:36:22.180 --> 00:36:25.380 The new money flows to the workers, what do the workers, what part of the money they may 374 00:36:25.380 --> 00:36:32.420 save and invest in investment fund and the investment fund buys government bonds because 375 00:36:32.420 --> 00:36:34.220 they are very liquid. 376 00:36:34.220 --> 00:36:40.260 So here we see that indirectly the new money creation, a big part of the money creation 377 00:36:40.260 --> 00:36:46.340 may end up buying government bonds because of the preferential treatment by the central 378 00:36:46.340 --> 00:36:52.340 bank, because of the direct monetisation that is going on. 379 00:36:52.340 --> 00:37:02.300 Well, now, in the euro system, the European Monetary Union, several governments may use 380 00:37:02.300 --> 00:37:10.820 that describe direct and indirect mechanisms to finance expenditures and please voters. 381 00:37:10.820 --> 00:37:13.140 Any government in the Euro system may do the following. 382 00:37:13.140 --> 00:37:17.060 It may issue bonds to pay for its deficit. 383 00:37:17.060 --> 00:37:20.620 The fractional reserve banks buy these bonds and use them as collateral to receive loans 384 00:37:20.620 --> 00:37:23.140 from the ECB. 385 00:37:23.140 --> 00:37:27.060 The new resource may then be used to expand credit on top. 386 00:37:27.060 --> 00:37:32.140 And the tragedy of the commons develops because any government may use the banks and the ECB 387 00:37:32.140 --> 00:37:38.340 There exists actually an incentive to have higher deficits and print relatively more government 388 00:37:38.340 --> 00:37:43.460 bonds than other governments because printing bonds becomes almost analogous to printing 389 00:37:43.460 --> 00:37:50.580 money. The governments that print bonds faster than other governments profit as they receive 390 00:37:50.580 --> 00:37:55.500 relatively more new money. So there's a redistribution from the slower printing governments with 391 00:37:55.500 --> 00:38:00.500 lower deficits to the faster printing governments with higher deficits. So the redistribution 392 00:38:00.500 --> 00:38:08.500 The European Union system of the national governments, part of the advantages and disadvantages are transferred to the general population in the respective countries. 393 00:38:09.500 --> 00:38:25.500 Take the example of Greece. Important parts of the Greek economy are not competitive as prevailing wage rates and other factor prices, yet prices are maintained high by government spending. 394 00:38:25.500 --> 00:38:32.060 The Greek government maintains high deficits to pay unemployed public workers, high pensions 395 00:38:32.060 --> 00:38:33.820 and other social expenditures. 396 00:38:33.820 --> 00:38:39.340 Thereby, the wages of many Greeks are raised above the free market level. 397 00:38:39.340 --> 00:38:44.380 Greeks use then the income to import goods and services from abroad, whereas they are 398 00:38:44.380 --> 00:38:45.380 cheaper. 399 00:38:45.380 --> 00:38:48.620 A trade deficit is thereby maintained by the government deficit. 400 00:38:48.620 --> 00:38:52.360 In order to pay for these deficits, the Greek government prints bonds that are then purchased 401 00:38:52.360 --> 00:38:58.400 by the banking system in order to use them to obtain funds from the ECB or the Euro system. 402 00:38:58.400 --> 00:39:04.380 New money is created and tends to bid up prices. While the purchasing power of the Euro affects 403 00:39:04.380 --> 00:39:10.920 all users of the currency, the costs are shared by all users of the currency, the printing 404 00:39:10.920 --> 00:39:14.720 of the Greek government bonds benefits primarily the Greek government and special interest 405 00:39:14.720 --> 00:39:20.920 groups that receive income from it. Is it a negative externality? Yes, because the Euro 406 00:39:20.920 --> 00:39:25.920 If the Euro is a legal tender fiat money, it represents an infringement on property rights. 407 00:39:26.920 --> 00:39:35.920 The printing of government bonds therefore leads to negative externalities in the form of a lower purchasing power of the Euro imposed on all other users of the currency. 408 00:39:37.920 --> 00:39:40.920 Imagine the following case to visualize the redistribution. 409 00:39:41.920 --> 00:39:49.920 The government prints bonds, which are bought by the banking system, which uses it to get base money and expand credit on top of it. 410 00:39:50.920 --> 00:40:07.920 The Government uses the money to pay a public servant. The public servant buys a German car. Prices of German cars tend to rise. The money supply increases. Prices go up while goods flow towards Greece and slowly the money spreads throughout the Eurozone. 411 00:40:07.920 --> 00:40:15.920 The purchasing power of the Euro has fallen. There is a redistribution in favour of the first receivers of the new money, the Greek Government and its public servant. 412 00:40:15.920 --> 00:40:21.920 Other people faced with the rising prices of German cars are the losers in this redistribution. 413 00:40:22.920 --> 00:40:26.920 Of course, not only the Greek government may use this mechanism for its own advantage 414 00:40:26.920 --> 00:40:31.920 and that of the Greek population, but the other governments of the Eurozone may do so as well. 415 00:40:32.920 --> 00:40:35.920 And the government is on the winning side of the redistribution scheme 416 00:40:35.920 --> 00:40:38.920 if it prints government bonds faster than other governments. 417 00:40:38.920 --> 00:40:47.640 Take the example that Germany prints its government bonds at a pace of 3% of GDP, but the rest 418 00:40:47.640 --> 00:40:53.200 of the governments print these bonds at a pace of 10% of GDP. 419 00:40:53.200 --> 00:40:57.720 So let's assume that the purchasing power of the euro falls 8% per year. 420 00:40:57.720 --> 00:41:03.880 Then prices rise faster than the German government prints its bonds. 421 00:41:03.880 --> 00:41:10.880 Even though the German government deficit spending is at 3% of GDP, real government spending 422 00:41:12.000 --> 00:41:17.920 may actually fall. So the incentives resemble a tragedy of the commons. The incentive is 423 00:41:17.920 --> 00:41:23.240 to print faster than your peers. In fact the system resembles a system where several actors 424 00:41:23.240 --> 00:41:30.240 have access to a commonly owned printing press. While the analogy is close, there are some 425 00:41:30.240 --> 00:41:35.240 There are some differences. It's not a pure tragedy of the commons. There are some limits. 426 00:41:35.240 --> 00:41:39.240 Otherwise, obviously the euro would have disappeared already in hyperinflation. 427 00:41:39.240 --> 00:41:45.240 So what are the limitations of it? Well, governments cannot print euros directly. 428 00:41:45.240 --> 00:41:49.240 They can only print bonds. And banks may not buy these bonds. 429 00:41:49.240 --> 00:41:52.240 And the ECB may not accept these bonds as collateral. 430 00:41:52.240 --> 00:41:55.240 And resulting from this, there are some differences. 431 00:41:55.240 --> 00:41:59.240 And there's the Stability and Growth Pact, which I will talk about later. 432 00:42:00.240 --> 00:42:10.200 So, why might it not happen that the banks buy the bonds and the ECB would not accept 433 00:42:10.200 --> 00:42:16.320 it as collateral? Why would the monetisation not work? Well, first, collateralised lending 434 00:42:16.320 --> 00:42:21.720 with government bonds may be unattractive for banks. If the interest rate offered for 435 00:42:21.720 --> 00:42:27.520 the government bonds is lower than the interest rate banks must pay for loans from the ECB, 436 00:42:27.520 --> 00:42:29.400 Banking will be unattractive. 437 00:42:29.400 --> 00:42:35.520 Second, governments may default on their bonds and the default risk may deter banks from 438 00:42:35.520 --> 00:42:39.560 purchasing the bonds. 439 00:42:39.560 --> 00:42:45.120 In the Eurozone, however, the default risk was and still is reduced by implicit bailout 440 00:42:45.120 --> 00:42:47.920 guarantees. 441 00:42:47.920 --> 00:42:49.840 The Euro is a political project. 442 00:42:49.840 --> 00:42:52.440 That is all what my book is all about. 443 00:42:52.440 --> 00:42:58.440 Thus we see the importance of the combination of politics and the monetary setup. 444 00:42:58.440 --> 00:43:05.440 The euro is conceived as a further step towards the unavoidable political integration of the European Union. 445 00:43:05.440 --> 00:43:12.440 Politicians imply that there can only be progress via more political integration. 446 00:43:12.440 --> 00:43:21.440 Any regress would imply a defeat of European politicians and put into doubt the whole project of the EU, 447 00:43:21.440 --> 00:43:25.280 and the whole project of the socialist vision for the EU. 448 00:43:25.880 --> 00:43:32.480 Consequently, a default of a member state that might force a country to exit the Eurozone 449 00:43:32.480 --> 00:43:37.240 would not only be regarded as a failure of the Euro, but also of the greater project 450 00:43:37.240 --> 00:43:43.280 of the European Union, the European super-state, and thus market participants for a long time 451 00:43:43.280 --> 00:43:47.880 regarded a default as politically next to impossible. 452 00:43:47.880 --> 00:43:52.440 The expectation was that in the worst case, the fiscally stronger member states would 453 00:43:52.440 --> 00:43:57.040 support the weaker ones. Countries such as Germany or the Netherlands would guarantee 454 00:43:57.040 --> 00:44:03.880 the bonds of the Mediterranean nations and prevent a default. Now we know market expectations 455 00:44:03.880 --> 00:44:09.400 were accurate. The implicit guarantees have become explicit. Greece and Ireland were bailed 456 00:44:09.400 --> 00:44:15.400 out in 2011 by the rest of the Eurozone. 457 00:44:15.400 --> 00:44:24.600 Third, banks are faced with a liquidity risk in the scheme where they use CCB to refinance 458 00:44:24.600 --> 00:44:27.960 themselves and pledge government bonds as collateral. 459 00:44:27.960 --> 00:44:29.400 Why? 460 00:44:29.400 --> 00:44:33.080 Because the term of government bonds in most cases is longer than the term of the loans 461 00:44:33.080 --> 00:44:34.760 granted by the ECB. 462 00:44:34.760 --> 00:44:39.120 I am a bank and I have a Greek government bond that is 10 years long. 463 00:44:39.120 --> 00:44:51.120 I pledged as collateral to get a three weeks loan from the ECB, so after three weeks I have to do the same again and roll over until we get to the ten years. 464 00:44:51.120 --> 00:45:02.120 There's consequently a risk that the rating of the bond is reduced over the lifetime and that the ECB stops accepting them as collateral in the lending operations. 465 00:45:02.120 --> 00:45:12.120 The risk of such rollover problems is, however, reduced because the ratings of the government bonds are supported by the formerly implicit, now explicit bailout guarantee. 466 00:45:12.120 --> 00:45:17.120 The political willingness to save the euro project supports the ratings. 467 00:45:17.120 --> 00:45:26.120 The liquidity risk is also expressed by the risk of a change in the interest rates or in the value of the government bonds. 468 00:45:26.120 --> 00:45:34.680 First, the ECB might refuse to accept certain government bonds as collateral, and of course 469 00:45:34.680 --> 00:45:42.280 the ECB requires a minimum rating by rating agencies for bonds to be acceptable as collateral. 470 00:45:42.280 --> 00:45:46.600 Before the financial crisis, the minimum rating was A minus. 471 00:45:46.600 --> 00:45:54.680 In order to support the banking system during a period of falling ratings, the ECB reduced 472 00:45:54.680 --> 00:46:03.520 It's minimum rating to BBB-minus, but it always said it will only be for one year. 473 00:46:03.520 --> 00:46:08.320 This implies if government bonds would fall below the minimum rating, they would cease 474 00:46:08.320 --> 00:46:10.200 to be acceptable as collateral. 475 00:46:10.200 --> 00:46:15.600 However, we have seen the danger of this to happen is not really high either because the 476 00:46:15.600 --> 00:46:21.320 ECB tends to be accommodative, and it has been in respect to its collateral rules for 477 00:46:21.320 --> 00:46:22.320 government bonds. 478 00:46:22.320 --> 00:46:26.240 As I said, it wanted to cease the reduction of the minimum rating after one year, but 479 00:46:26.240 --> 00:46:35.980 when it saw that the rating of the Greek government would not achieve an A minus, it extended 480 00:46:35.980 --> 00:46:38.540 the rule for another year. 481 00:46:38.540 --> 00:46:44.380 And the ECB also stated that it would not apply special rules to a single country. 482 00:46:44.380 --> 00:46:49.480 But then the Greek government, it appeared that it would not even achieve a BVB minus, 483 00:46:49.480 --> 00:46:56.800 So the ECB then announced it would accept Greek debt no matter what, even if rated junk, 484 00:46:56.800 --> 00:46:59.880 which has already occurred. 485 00:46:59.880 --> 00:47:04.480 So a precedent was set and governments from now on can expect that collateral rules will 486 00:47:04.480 --> 00:47:08.400 be changed to support the deficits and the ECB to be accommodative. 487 00:47:08.400 --> 00:47:13.040 The ECB is just an instrument, has become an instrument of politics. 488 00:47:13.040 --> 00:47:26.040 The truth is, the ECB applies haircuts. When a bank offers 1,000 euros as collateral to receive a loan from the ECB, it won't receive 1,000 but less because of a haircut. 489 00:47:29.040 --> 00:47:36.040 And lastly, and this is the biggest danger, the ECB might not play the game. It might not be accommodative to all demands for new loans. 490 00:47:37.040 --> 00:47:42.040 So the banks may offer more government bonds as collateral than the ECB makes available. 491 00:47:43.040 --> 00:47:57.040 However, the ECB can be expected to be accommodative, as it has been in the past, for political reasons, for the will to continue the political project of the Euro, which reduces the risk for banks. 492 00:47:57.040 --> 00:48:09.040 So, despite these frictions that I discussed, the possibility to indirectly finance government deficits through the ECB constitutes a traditional tragedy of the commons, 493 00:48:09.040 --> 00:48:15.040 And the problems of the set-up were known in the beginning, even though to my knowledge no one has called it before a tragedy of the commons. 494 00:48:15.040 --> 00:48:31.040 Thus, to restrict these perverse incentives, Germany and other relatively hard currency countries enacted the Stability and Growth Pact. 495 00:48:31.040 --> 00:48:37.040 The Stability and Growth Pact intended to limit the debts and deficits of member states. 496 00:48:37.040 --> 00:48:47.040 According to the Stability and Growth Pact, government debts shall be below 60% of GDP and deficits below 3% of GDP. 497 00:48:48.040 --> 00:49:00.040 Thus, the Stability and Growth Pact acts as a managed commons because it imposes quotas on the exploitation of the common resource, the purchasing power of the common currency. 498 00:49:00.040 --> 00:49:12.040 Of course the incentive is to exploit the quota to the maximum, that is to have a 3% of GDP deficit. 499 00:49:12.040 --> 00:49:18.040 This is the incentive if the quota is really enforced. However, the Stability and Growth Pact was never enforced. 500 00:49:18.040 --> 00:49:29.040 It utterly failed because governments themselves decided on the very sanctions that they would have to enforce upon themselves. 501 00:49:29.040 --> 00:49:44.040 It's like a system that resembles a cartel, where cartel members promise not to exceed a quota of 3% of GDP deficit, and thus the services of the exploited resource, the purchasing power of money, is kept from falling fast. 502 00:49:44.040 --> 00:49:53.040 Yet the cartel is not enforceable, and the incentive for members is to exceed the quota to benefit on cost of members fulfilling the quota. 503 00:49:53.040 --> 00:50:04.040 In fact, in 2010, all Eurozone governments had a deficit higher than 3% of GDP. 504 00:50:04.040 --> 00:50:10.040 So, you have seen there are three layers in the Eurozone of negative externalities. 505 00:50:10.040 --> 00:50:14.040 One is the production of base money, property rights not defended. 506 00:50:14.040 --> 00:50:18.040 Then production of fiduciary media, property rights not defended either. 507 00:50:18.040 --> 00:50:25.520 either and then there's a tragedy of the commons also in the monetisation of government debt. 508 00:50:25.520 --> 00:50:31.520 And of course, how do we eliminate these negative externalities? Well, simply by defending and 509 00:50:31.520 --> 00:50:39.080 defining well private property rights. Of course, the more of the externalities that 510 00:50:39.080 --> 00:50:44.640 we do eliminate, the higher will the resistance of the privileged class of the current system 511 00:50:44.640 --> 00:50:51.880 with the political class and banks and big business. 512 00:50:51.880 --> 00:50:57.240 So let's look at the different options that there are. 513 00:50:57.240 --> 00:51:04.600 This is a table where we have the negative externalities on the top. 514 00:51:04.600 --> 00:51:09.760 On the right is the external negative externalities due to the base money production. 515 00:51:09.760 --> 00:51:13.920 Then we have the tragedy of the commons due to the production of fiduciary media by the 516 00:51:13.920 --> 00:51:21.920 The Frictionary Reserve Banking System and then the Euro area specific tragedy in the monetization of government deficits. 517 00:51:21.920 --> 00:51:33.920 And then they have the monetary setups. In the current Euro system, the externalities are high, negative externalities are high for all three. 518 00:51:33.920 --> 00:51:40.920 A reform would be to enforce a stability and growth pact, for example with automatic sanctions. 519 00:51:40.920 --> 00:51:45.920 Any government that exceeds the 3% government deficit gets an automatic sanction. 520 00:51:45.920 --> 00:51:52.920 So this would limit the tragedy of the commerce in the monetisation of government deficits. 521 00:51:52.920 --> 00:51:57.920 However, Germany and the EU Commission proposed automatic sanctions, 522 00:51:57.920 --> 00:52:04.920 but even this modest reform seems not to be possible because there is resistance from other governments 523 00:52:04.920 --> 00:52:12.920 against this limit, putting limits to the possibility to monetize the debt. 524 00:52:12.920 --> 00:52:22.920 Another reform similar is the monetary growth rule by Milton Friedman. 525 00:52:22.920 --> 00:52:28.920 There we would limit the negative externalities from base money production. 526 00:52:28.920 --> 00:52:32.920 For example, if you say the central bank can only increase base money 5% per year, 527 00:52:32.920 --> 00:52:56.600 A system of national currencies that is returning to the Deutschmarks, the Lira, the Francfonds, 528 00:52:56.600 --> 00:53:01.440 this would of course eliminate the tragedy of the commons and the monetisation of government 529 00:53:01.440 --> 00:53:05.120 depth through the Euro system, because the Euro system would cease to exist. 530 00:53:05.120 --> 00:53:07.480 So there's none. 531 00:53:07.480 --> 00:53:10.640 The tragedy of the government's intervention of the Fiducia media would remain and also 532 00:53:10.640 --> 00:53:18.680 for each government could still use its own central bank to produce basement and monetize 533 00:53:18.680 --> 00:53:21.560 its debt. 534 00:53:21.560 --> 00:53:29.360 The next system would be fractional reserve free banking to abolish central bank, abolish 535 00:53:29.360 --> 00:53:35.680 legal tender laws, of course there would be no tragedy of the commons into monetization 536 00:53:35.680 --> 00:53:41.040 anymore and no external effects of monopolistic based money production because anyone could 537 00:53:41.040 --> 00:53:52.760 produce, would produce currencies that would end through the clearing mechanism, the tragedy 538 00:53:52.760 --> 00:53:57.740 of the commons of the fractional reserve banking system would eliminate, eliminate it. And lastly 539 00:53:57.740 --> 00:54:04.740 Eliminating all negative externalities would be clearly to restore property rights, to 540 00:54:04.740 --> 00:54:11.820 defend property rights 100%, define well property rights in money. That is to return or to go 541 00:54:11.820 --> 00:54:19.620 to a 100% commodity standard. There would be no tragedy of the commons in monetisation, 542 00:54:19.620 --> 00:54:22.620 nor by fiduciary media nor by base money. 543 00:54:24.620 --> 00:54:30.620 So, to conclude, we are faced with several layers of negative externalities in money 544 00:54:30.620 --> 00:54:33.620 due to ill-defined and ill-defended property rights. 545 00:54:33.620 --> 00:54:36.620 We have a tragedy of the Commons and fractional reserve banking 546 00:54:36.620 --> 00:54:40.620 and the production of fiduciary media and of the monetisation in government debt in Europe. 547 00:54:42.620 --> 00:54:48.620 And we can group monetary reforms and systems according to the extent that they eliminate 548 00:54:48.620 --> 00:54:55.700 They eliminate these negative externalities and perversion samples. 549 00:54:55.700 --> 00:55:03.260 Only a 100% commodity standard would restore property rights fully and eliminate all negative 550 00:55:03.260 --> 00:55:04.260 externalities. 551 00:55:04.260 --> 00:55:11.600 Let's hope that we can go to the system without or before a total collapse of our current 552 00:55:11.600 --> 00:55:14.560 monetary system. 553 00:55:14.560 --> 00:55:19.100 For this to happen, we have to win the battle of ideas. 554 00:55:19.100 --> 00:55:20.100 Good luck to all.