Germany: Winning Europe by Default

Weekly Commentary • Mar 28 2012
Germany: Winning Europe by Default
David McAlvany Posted on March 28, 2012

About this week’s show:

  • “Crises” in the EU propelled the rise of Berlin
  • “Crises” is propelling big government in the U.S.
  • Fixing “Crises” in this way leads to inflation

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, I am talking to you today, as we promised, while you are in Berlin. Of course, that is where the Reichstag is, and that is where so much world history has changed. Even today, with what is going on with the Greek, the Portuguese, and the Spanish problems – the debt of the southern countries versus the ideology of the northern countries – it seems to me like this is a city of crisis. In other words, we had the crisis of World War II, we have had the crisis of World War I, we now have the crisis of the integration and the consolidation of power in Europe. Are you feeling it while you are there?

David: Kevin, I am reminded of the attitude expressed by Rahm Emanuel several years ago, that you should never let a crisis go to waste. There is this idea that government grows in fits and starts, that there is crisis intervention, so to say, and that is when the state apparatus tends to surge. That is what we wanted to look at today, Kevin.

In Berlin, we have consolidation of power through financial obligation. It is becoming more and more the creditor, in what you might describe as a control position, and as the eurozone has come together, much has been ceded voluntarily, and much will likely be given to this idea of a stabilized eurozone. But of course, who will ultimately guarantee this sort of “financial guarantee?” It’s the ECB, the European Central Bank. Who is the real muscle behind the ECB? It’s the German National Bank.

Kevin, there are these voluntary ties which are being made, voluntary commitments and dependencies which have been crafted, and now under stress, countries will have to meet certain conditions in order to continue to receive bailout dollars.

Kevin: David, I think about those conditions that they are now having to meet. This was the fear back in the 1990s, even when they were talking about this in the late 1980s, this unification of Europe, the fear was that countries would give up sovereignty, or be controlled by one entity. The other fear was Germany, which has been the entity of control, really, since the 1870s.

David: Kevin, there is another issue and we have seen this with Spain in recent weeks, and with Holland more recently, and there is the contrast between, “We can’t meet the fiscal expectations of the eurozone,” and now there is a new language which is, “We won’t meet the fiscal expectations of the eurozone.”

Again, there are strings attached, in some instances, and there is not really a quid pro quo, but an assumption of leadership, and perhaps an expectation of payback, and I think it would be good to remember, in the extreme, what happens in these sovereign debt crises. In Newfoundland, many, many decades ago, the debts were impossible to pay back, and the British simply annexed the country. In other words, it became part of Canada. They lost their sovereignty to the British. In that case, it was Newfoundland saying, “We’ll never pay it back, I guess you will have to take the productive capacity and potential tax revenues of the country.” It just became a part of Canada.

Kevin: David, I would like to look at it from a different view. I would like to look at it from the German view for a moment. We have talked about these other countries who were worried about perhaps losing their sovereignty to one entity ruling. But the German people were not unanimously excited about the EU either. This is a country that had been through multiple hyperinflations, at least two hyperinflations in the 20th century, plus several wars. They had seen what happens with the over-expansion or taking on of debt that they cannot pay off and having to print money to get their way out. There was a sacrifice, was there not, when the Germans entered the EU?

David: That’s right. If you recall, for the EMU system to be launched successfully, Germany had to give up the deutschmark. That is a particularly touchy subject, because for a country with a history of hyperinflation, or radical currency mismanagement, going back to the 1919-1924 period under Havenstein, the central banker at the time, to give up its currency was no small sacrifice, because the deutschmark had become something very solid, very trusted, in the wake of that hyperinflation. It took many decades to build security within the monetary system, and they didn’t really want to move away from that.

The transition to the euro caused, initially, a pretty significant rise in prices. Here in Germany, that is not an issue, I suppose, if you are in the upper crust, but for the poor and the middle class, there was, initially, some resentment in terms of what appeared to be price inflation, right at the outset of adopting the euro. I think, often, the primary reason why the Europeans look to, and favor the euro, is that it is convenient. There is ease of convertibility in cross-border transactions, with travel, moving back and forth between countries. It is very easy to forget this in the United States, but with the shrunken geography on the continent, there is much more cause, much more reason, to be going from one country to the next, so the convenience factor is really a useful thing.

Kevin: It is more convenient, David, as you know. Right now you are Germany, but you are probably traveling amongst multiple countries. If you traveled to Belgium, or drop down into France, or go to any other country, each time you would have to change your currency. But there are old tensions, some hard feelings, that go back even to World War II between Greece and Germany. That is part of the issue right now.

David: It is. The deutschmark imprimatur was the legitimizer of the new currency, the euro. There was an integrity that came with the deutschmark, and the euro, by proxy, was legitimized by that solidity, that stability. This is really something, again, that we were saying just a moment ago, that developed in the post World War II period. Not to labor the point on this, but the tensions between Greece and Germany over fiscal stability tend to open an old wound, one that goes back to World War II.

When Germany was occupying Greece, Germany took over the Greek Central Bank and controlled the Greek money supply. At that time, during World War II, the Germans caused a domestic super- or hyper-inflation in Greece. The consequences of that still linger in the minds of the older generation. This idea that Germany is now subjecting the southern states, specifically Greece, to any sort of fiscal or monetary standard, doesn’t sit well. It is not comfortable. It is, I guess you could say, an unwelcome irony.

Kevin: With all the conflicts, as you said, David, in Greece they remember their hyperinflation because of the Germans, the Germans remember their hyperinflations because of the Germans, but let’s face it, the Germans have been the most consistently anti-inflation because of having been burned in the past. Now, we have Angela Merkel, at this point, talking about rewriting the constitution, building more austerity, and more tight controls of all the countries, possibly to avoid the pain of inflation again.

David: And there is this idea that if the ECB, and behind it, the German Central Bank, are going to be sacrificing their balance sheets for the sake of keeping the EU together, and the eurozone together, moving forward in terms of unification, this is really the issue: They are willing to make that sacrifice, but they want to see some controls put in place in terms of the spending of these individual constituent parts or member countries.

Merkel is echoing the Leap 20/20 group out of France. Actually, they are spread across all of Europe. We have had one of their gentlemen on our program before. If you recall, Franck Biancheri was on the program a number of months ago and he suggested that they would be moving in the 2013-2014 time frame, toward a revised EU constitution. That is going to allow for a tighter framework for fiscal accountability. Again, that is all tied to integration.

But there remain some real concerns over whether or not there is actual homogeneity between the northern and southern countries. As we were discussing a few minutes ago, both Spain and Holland are at that juncture where the question is, what language do they use? “We can’t meet fiscal expectations,” or “We won’t meet fiscal expectations,” as in “You can go pound sand. We still are our own country.”

Kevin: David, I think about how you talked about history moving in fits and starts, but it is almost always based on the next crisis. We talked about Europe, the crisis in 1870 when Germany first came together and defeated France. There was a unification of Germany. From 1914-1918 was a crisis in the European realm. From 1939-1945 we had the same type of thing. We see these crisis punctuations.

We also see unity. I don’t want to sound like a conspiracy theorist. I want to throw something out, because people cry out for the government to do something. You talked about a voluntary loss of sovereignty. That’s a huge deal over there, and we see the same thing over here. We have a crisis, government intervention, bank bailouts.

Let me read a quote from Herbert Hoover. He said, “Every collectivist revolution rides in on a Trojan Horse of emergency. It was the tactic of Lenin, Hitler, and Mussolini. In the collectivist sweep over a dozen minor countries in Europe, it was the cry of men striving to get on horseback and ‘emergency’ became the justification of the subsequent steps. This technique of creating emergency,” Hoover said, “is the greatest achievement that demagoguery attains. The invasion of the New Deal collectivism was introduced by the same Trojan Horse.”

When we talked to Otmar Issing, David, and when we have talked to the some of the people who are more involved with this European integration, a little bit of crisis doesn’t seem to bother them, because it seems like it’s moving toward a larger goal of this one collectivist revolution that they have been talking about.

David: Yes, and in fairness to our interview with Otmar Issing, it certainly was not his notion that we should be striving for, or prioritizing some sort of a socialist utopia. What he was after was much more an existential calm in which they could view Europe as a place where the kind of chaos that we saw in World War I and World War II would never be repeated, and that we would create so many ties of an economic nature that we could never consider harming the person who was in that category of “other” – another race, another country, another nationality. There is certainly that motivation.

The question is, do politicians, creating their own personal legacies, hijack that existential motivation and create something new? I do think there are similarities currently, in the ascent of Berlin, to a politically dominant position with that of the United States, in that, propelled to a greater position of control and influence, there has always been, and continues to be, this idea of crisis.

Crisis compresses time – in some sense, you are fast-forwarding to an end game or a conclusion that might have otherwise taken decades, certainly years, to develop, so we have events that speed up, in a given context. In fact, it is this crisis theory that best explains the growth of government, whether it is the U.S. or elsewhere, and Berlin is an interesting case in point.

Kevin: It is interesting, people do subject themselves to almost anything. Look at the conscription in World War I and World War II here in America. Both were very politically unpopular wars and the presidents at the time said that they were going to keep us out of the war. We still ended up in that war because people started to realize there was an emergency, and they said, “Do something,” and what the public would ordinarily not have tolerated, they allowed. The problem is, once you create the mechanism, and I’ve been using war as an example, but look at the depression – how many social programs came into being under FDR and were never reversed?

As a private pilot I am interested in why people sometimes don’t make it to their destination. Oftentimes, it’s because they have this attitude that they’ve got to get there. Pilots call it, “Get-there-itis.” It is sort of the same thing with people, “Okay, let’s just get there. We don’t want to see the Greeks fail. We don’t want to see the American banks fail. Do it at all costs and then we will just reverse things once we get there.”

David: There is this problem with not being able to maintain a sense of calm when tensions are present. If you have a question, you want the answer, and you would even press it to the point of having, and accepting, a wrong answer, rather than waiting and working toward a right answer. Solutions, or resolutions, to tension, are something that crowds tend to demand pretty quickly.

This is tying into that crisis theory, which is, basically, that extraordinary measures are easier to justify, and in fact, are often requested by the general public when circumstances become uncomfortable, or out of control. This is unique because the public would ordinarily not tolerate a rapid intrusion of government into private affairs, whether that is family or business spheres, but there is this idea that if things are coming into chaos, that you just want government to do something.

That is, I think, what we are talking about, Kevin – a further expansion of government in the wake of crisis, again, this intolerance of intrusion in private affairs, is voluntarily suspended, or at least is less forcefully defended, when there is the external pressure of a crisis. In that event, you find that government ratchets up its involvement and rarely gives back the ground that it takes.

We saw that in the FDR administration, we saw that in the Truman administration, we saw that under Lyndon Johnson, and I think that we may actually have that in the Obama administration at present, or certainly in the next four-year period, in which crisis, and the tools to address it, and the people asking for the state apparatus to grow, to fill the gap, to resolve the tension, resolve the crisis, is there, and it is exactly what we are seeing in real time here in Europe.

Kevin: David, I’m not a political expert, but we have talked about the markets for about three decades almost, and one of the things that we do is to look at the growth trajectory, or the shrinkage trajectory, of a particular market. We have talked about gold. The 65-week moving average for gold for the last 10-11 years has been rising. It almost doesn’t matter what the day-to-day ups and downs are, if you just look at the 65-week moving average, it is a steady growth trajectory.

I look at history through the 20th century and now we are in the 21st century, and we are seeing government on a steady growth trajectory. I wonder, though, David, when does that famous quote by Margaret Thatcher come into play, when she said the problem with socialism is that at some point or another, you run out of other peoples’ money? How long can it last, Dave?

David: It seems that you may be accurately making a correlation with the growth of government. As government grows, you have that much more cash required to keep that animal, that leviathan, alive. You certainly have to fuel the growth of government. As you are running the printing presses to do so, you will see that reflected in real goods and services, including gold being priced higher.

So you have said it exactly right, Kevin, governments do tend to be on sort of a steady growth trajectory. Very rarely do you find them taking a step back, but like any beast, to maintain its vitality, it’s going to grow, and crisis is just one of those things that increases the rate of growth dramatically, and people are asking for it. “Do something. Alleviate the pain. Take away the instability. Return us to the status quo, regardless of the cost.” That tends to be where the growth rate accelerates for government.

Kevin: What actually puts a chill in my spine, though, David, is that two Fridays ago, the president put through an executive order reaffirming executive powers over all communication, food, water, transportation, any resources necessary. In other words, dictatorial control, if he needs it. But in the past, that presidential order would be called for when we see everybody yelling, “Do something! It’s a crisis!” But this particular executive order doesn’t even really require a crisis, so are we entering a new dimension of history-making where you basically have tyrannical power whether there is a crisis or not?

David: This is like Bush, and Clinton before him. The executive powers can be exercised in wartime, or in the context of a crisis that is grave enough to initiate war powers, and that could be even the healthy function of the economy. President Obama has affirmed those same powers. It is, as you say, control over communication, control over food and water, control over transportation – any critical resources necessary for the healthy functioning of the economy. If any of those are compromised, then control is in place.

This is where we have to assume that the judiciary is on the side of the people. Unfortunately, at least in U.S. history, we have not found that to be the case. The judiciary usually stands by, and for any number of years, leaves those rules unchallenged. In the FDR administration we didn’t see the judiciary overturn many of the things that FDR put in place in 1933, until 1936. Ultimately, they were found to be unconstitutional, but there was a lag time where private freedoms, individual liberties, were given up for the sake of control, until the judiciary rolled them back.

We can only hope, and I emphasize the word hope, that the judiciary would do something similar, if, as, and when, we saw the executive office overstepping constitutional boundaries.

Kevin: I think sometimes we have to go back and look at what it is that we have lost for this collectivism. I will admit, I am 49 years old, so I have not lived during a period of time where we really had true rule of law, true private property protection, the things that 100 years before, were protected to the last breath of a lot of the legislature, and a lot of the politicians, even, at the time. I think of Grover Cleveland. Even though every politician has to do things that are in their best interest to get re-elected, there were a few things that these guys back then just never did. It was almost a gentleman’s agreement. You don’t go back on the rule of law. You don’t go back on private property.

It seems at this point, you are in Europe right now, and we saw the Greek situation. All they had to do was call it a default, because that is what it was, so that these guys would get paid on their CDSs and the markets would have balanced out a default. Instead, they just confiscated 73% of the value of those bonds from the private holder. They almost put a gun to these people’s heads and said, “Look, this isn’t a default, is it?” And private property rights were out the window. We see the same thing here in America, with the bailouts that we have here. Contrast for me, for a moment, David, the change in the belief systems.  Do people even realize what it is that we are missing at this point?

David: I do think that the enforcement of the collective action clauses and the ISDA’s determination that there was a default there at the tail end is more of a subnote, but it did reaffirm that the contract law is still important, and the financial markets we would see come unwound. We would go through even a greater period of capital deformation if, in fact, we had fully stepped away from the rule of law.

But I think as you look back in time, what you do see is that rule of law, private property rights, and public peace a priority for most politicians. We now have them focusing on the last one instead of the first two – public peace, tranquility, a sense of well-being, rather than private property rights and the rule of law. Those first two tend to be more expendable.

Kevin: David, you had mentioned that the court system was our protection from a government that would redistribute our wealth, and that hasn’t necessarily been protected at this point. In fact, I am going to read a quote from a great book, Crisis and Leviathan, that you put me onto, written by Robert Higgs. One of the things that he talks about is this legal plunder, or redistribution, not paying attention to the rule of law and private property, to maintain public peace.

What we have going on with the Supreme Court right now is that they are hearing arguments about the health bill. It is going to be interesting to see where they land, if they are going to land on redistribution, give everybody health care, or if they are going to actually look at the rule of law and private property rights, and whether it is, indeed, constitutional that they force everyone to buy insurance.

Here is a quote from the Higgs book. “Among the most significant of such adjustments of big government is the Supreme Court’s consistent refusal to protect individual rights from invasion by government officials during national emergencies. Precedents are established each time there is an emergency, and more and more the constitution seems to mean less and less.”

David: There is a lot that hangs in the balance with the determination this week by the Supreme Court as to the constitutionality of the health care bill because it will either tame the tendency of government to grow in leaps and bounds in the next four years, or inspire it. I think that if you give an inch, a yard will surely be taken, in the next four years. Obama will be very emboldened.

I think it is fair to say, Kevin, that at this point, he is the shoo-in. This is an interesting commentary. I got to spend some time with folks that advise in Washington, of various political parties, specifically, in the Republican camp. It is fascinating to know that Romney is considered the person who will win the primaries, by the elite in Washington, though he is the weakest of contenders, almost another John McCain. Romney has outspent his competition, from seven-fold at a minimum, to as much as 55-fold, and still is barely winning. How will he do against the incumbent? The assumption is, “Good luck.” Those in Washington who favor the Republican side of things see Obama as a shoo-in.

Cycle back around to the health care issue and this either emboldens Obama over the next four years, or tempers him even slightly. What we see happen this week may tell us a lot about the next four years – what they look like and what they feel like, and what we experience as citizens who care about private property, who care about private initiative, who care about entrepreneurship, who care about the capital markets, and normal, healthy functioning in those markets.

Kevin: I think we are going to have to wait just a little bit to know what the final decision is, because I think they are thinking that will come out in July sometime, but what you are talking about with Obama – he is already talking to other leaders worldwide in a sort of past tense, as with the quote this week that everyone heard when the mike was on and Obama basically asked Medvedev for some space until after his election. I think he a long-term planner, and eight years is his plan.

David: Kevin, I am here in Germany, sort of the seat of feudalism. Just look at the number of castles that are in the countryside, and you realize that with all the different city states, going back many centuries, this is a place that has practiced what we are likely to experience more and more of in the United States, a loss of freedom, and a loss of individual autonomy. As we live out the New Deal ideal of a mixed economy where there is a command economy, if you will, with those characteristics of capitalism, unfortunately, it sounds like recalling a conversation we have had with others who have described China in just those words – a command economy with characteristics of capitalism, but that is largely what we move toward in this mixed economy where government is growing larger and larger.

Kevin: David, it is interesting that you bring up feudalism. I think of a quote from Alvin Goldner. He said, “Any society that entails the strengthening of the state apparatus by giving unchecked control over the economy and reuniting the political and the economic, is truly a historical regression. In it, there is no more future for the public, or the freedoms that support it, than there was under feudalism.” He is comparing this mixed economy with feudalism, as well.

You are in the land of castles, David. Anytime a person drives through Germany, every few miles you see an old, broken down castle. A lot of people don’t realize that that is a statement of the political economy in Europe, more than it has been in any other type of political system.

David: As we wrap up, I think we should drill down on a particular financial implication, because as we see the public sector growing, the problem is that the private sector simply won’t be able to support the cash flow needs of this monster, and so what you should expect and what you should look for is weakness in the dollar. What you should expect and what you should look for is weakness in the Treasury market. We will be talking not of that, as and when it occurs.

Kevin, the problem is, essentially, there is not enough money. Margaret Thatcher’s old phrase about not enough money to go around – socialism begins to show its weakness when you run out of other people’s money. We are at that tipping point, a tipping point where, as a percentage of the total employed persons in America, as a percentage of gross national product, we are seeing government get to the point where it simply doesn’t work. Just as you can have a demographic winter in which you don’t have enough workers supporting a retired class, you are now talking about the public sector in that same sort of vein, getting to the point where it cannot be supported by private sector taxation.

We will look for the very unfortunate and dire consequences in the dollar Treasury market, and we think that that is really the crisis point of 2013, 2014, within those markets, if not sooner.

Kevin: Which seems to always end in inflation, the printing of money. When you no longer can afford to pay the people through the government, the bread and circuses, you have to print money. I guess this goes right back to our discussion on gold. It is still worth holding on to real gold while the paper goes away, isn’t it?

David: Oh, absolutely. I think that is a very important thing, when you are watching this sort of ratcheting up of government largesse – World War I, World War II, the Korean War, the 1930s and the economic crisis that we saw there – those examples, Kevin. These are periods of stress and strain, both in the currency markets, and the financial markets, in general. There is a time frame in which you simply want to be out of the fray, to re-emerge another day, to re-engage another day, in productive assets, like stocks, and bonds, and real estate.

But in this timeout period, when government grows, and there is regulatory uncertainty and tax uncertainty, that is a period of time when the risks in the marketplace are not justified by the rewards, and people should be moving to the sidelines. Precious metals have been the standard for that going back hundreds of years. Germany is one of those places where you would see that as a historic tradition, that families have always kept a part of their wealth positioned in gold.

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