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What Good is Money? What Good is ‘Europe?’

Euro crisis | What Good is Money? What Good is ‘Europe?’ All About Alpha

The latest European summit culminated in a seven-page statement by the euro area heads of state or government. Separately, Herman Van Rompuy, President of the European Council, has got letter co-signed by Germany’s Chancellor, Angela Merkel, and France’s President, Nicolas Sarkozy. The two statements have some people thinking of politics, some thinking of diplomacy, and yet others thinking about the nature of money and the lure of gold.

But let’s take things a step at a time. What did the summit do? As Merkozy puts it, We propose that … new rules and commitments should be enshrined in the European Treaties. Alternatively, the Member States whose currency is the Euro will have to go ahead.”

Losing London


Merkozy continues to set out these new commitments as follows:

1) Structural Change

  • Regular summits of euro area heads of state and government (at least twice a year)
  • For the duration of the crisis, monthly meetings
  • A ministerial euro group

2) Preventive Measures
  • A constitutional provision or equivalent legislation within each member state requiring a balanced budget
  • A new common legal framework allowing for faster development of financial regulation, or progress regarding the labor markets or the corporate tax base “and creation of a financial transaction tax
  • Procedural reform
  • Stronger measures to enforce a 3 percent ceiling – i.e. an existing rule that no member state’s budget deficit should exceed 3 percent of its GDP
  • Stronger measures to enforce a separate 60 percent ceiling – i.e. the rule that no member’s total public debt should exceed 60 percent of GDP

3) Crisis resolution
  • A permanent crisis resolution mechanism must be established, and

  • The European Stability Mechanism Treaty should be revised “to make clear that Greece required a unique and exceptional solution.”

The bit about the financial transaction tax, i.e. the Tobin tax, may have been the deal-breaker for Britain’s Prime Minister, David Cameron, who refused to sign on. Nick Goodway in the Evening Standard has rounded up the reactions of London’s financial gurus, including one enthusiast who says of the Prime Minister, “This is the day he won back the City.”

Excessive or Inadequate Efficiency


The Tobin tax as an idea began life in 1972, as the Bretton Woods model was unraveling. James Tobin gave the Janeway Lectures in Princeton, and called for a uniform tax on foreign exchange transactions, a tax just large enough to deter short-term financial round-trip excursions among currencies.

In 1978, James Tobin of Yale University addressed the Eastern Economic Conference on “A Proposal for International Monetary Reform.” He noted that 5 – 7 years (depending on who is counting and how) had passed since the demise of the old Bretton Woods system of fixed exchanges, and said that some economists by 1978 “share[d] the nostalgia of men of affairs for the gold standard or its equivalent, for a fixed anchor for the world’s money, for stability of official parities.”

His view was that the problem was the excessive efficiency of international money markets. Because they are so efficient, he said, capital moves far outpace the necessarily “sluggish” moves of labor and goods. He said that his 1972 proposal had fallen silently “like a stone in a deep well,” but he cast it into the same water again.

From my own quite non-academic point of view, I have to say that I don’t share the intuition that efficiency generates volatility. What does generate volatility is the addiction of governments and national central bankers to issuing their fiat currency in mutual competition, then pulling back at intervals when inflation becomes too much of a threat for politicians to ignore. This bad habit (which a Tobin tax will not change) undermines the money supply’s ability to perform precisely those functions that the textbooks assign to it: measure value, store wealth, facilitate transactions.

Further, observe that no one any longer talks about an excess of efficiency as the reason why a Tobin tax might be a good idea. Rather, Tobin’s argument has been replaced by its contrary: that the currency markets, like other markets, are swung this way and that in the irrational ways of which “behavioral economics” speaks, so the tax will restore efficiency.

Or, in the alternative, the focus is shifted from what the tax will do to the transactions on which it is placed to what the tax will fund. Europe, just now, is very eager to find a painless way of funding the bail-outs of the failed welfare systems of certain of its member nations, so there are unsurprisingly some who have seized upon this.

There are some of us, though, who suspect that those nostalgic “men of affairs” to whom Tobin referred decades ago had the right idea, and that Europe might make good use of its crisis if it leads the rest of the world back to hard (or at least firmed-up) money.


This article was written by Christopher Faille and originally published on AllAboutAlpha under the title What Good is Money? What Good is ‘Europe?’

Tags: Angela Merkel , banking , Brussels , central banks , David Cameron , economic recovery , EU , EU economy , EU treaty , euro , European Central Bank , European Monetary Union , european sovereign debt , european summit , European Union , eurozone , financial crisis , Nicolas Sarkozy , regulation , UK
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