The European Union and the Price System May, 2012 Pablo
Paniagua
The second World War
(WWII) brought out the most terrible side of humankind in Western civilizations
along with the most vicious and brutal war of all times. In addition, WWII
brought Western civilizations to quarrel and to manifestly ravage each other.
We can say far worst things about the cruelty of the war, but if there is
anything positive that it may have brought, it was undoubtedly the urgent need
for younger Europeans after the war to create a common understanding and a call
to unify European values and ethics. This attempt for unification and the
necessity to leave the substantial war burden behind brought the first attempts
to create a political and economical effort for a common European view.
The need for unification
was first reflected politically in 1958 with the establishment of the European
Coal and Steel Community (ECSC) and the European Economic Community (EEC). Soon
after these two milestones several other treaties and pacts were signed,
developing the homogenization and understanding of European nations. In 1985
the Schengen agreement led towards the association of open boarder and passport
control, leading to the creation of the European flag one year later. Soon after the collapse of the iron curtain
and the fall of the Berlin Wall in 1989, Europeans could then talk seriously
about a unification system. Germany was considered a key figure, politically
and economically speaking, towards a real reconciliation among the “old
adversaries of the war”.
Once the WWII “old foe”
endorsed the cause for unification, the European Union (EU) was formally
established when the Maastricht treaty came into force in 1993. Six years later
the euro currency was introduced and the European Central Bank was finally able
to fully operate. In 2002, euro notes and coins replaced national currencies in
12 states, replacing the old European currency system and bringing to life one
of the biggest political and economical rational planning of the XX century.
Let us understand two
very significant elements: the first is the human need to create, at whatever
cost, a sense of association for understandable humanitarian reasons. This urge
for a single and unified moral human system, excelled by the desire to leave
the dreadful past behind, resulted in facing the future collectively as
“Europeans”. Undermining old detestations and divisions that were, after all,
the basic cause for endless wars ever since, was obviously a novel and a very
natural reaction among Europeans. The second significant element is political.
Politicians saw the unification as the greatest opportunity for the whole
continent and themselves to stand in the globalized competitive world as a
super power and as a relevant political and economical actor. Contemporarily,
it was a manner to prove the world that European leaders would not “get it
wrong” another time. Europe and their leaders after all had allowed on their
own soil: two world wars, terrible colonization systems and the biggest
systemized mass production human assassination of all times. Ultimately the
“Union” was the best way to point out the progressiveness and competitiveness
of the new “race” of European leaders to the world.
Various other national
factors also played in favor of the Unification for politicians. To mention a
couple: the policies aimed to ensure free movement for Europeans, goods,
services, capital and investments, and several reforms in education, common policies
in trade, agriculture, fisheries and regional development. These were signs of
good politics and national progress and in this way politicians proved their
“efficiency” and willingness of reforms to their own people. The reforms gave
nations a sense of prosperity and confidence towards the beginning of the 90s.
Presently, Europe is indeed the biggest economic entity and also one of the
biggest trading networks.
All of this positive
progress and the possibility for European politicians to stand out in the world
were very big incentives to seize the opportunity to thrust the unification
forward as fast as possible post the fall of the Berlin Wall. Unfortunately
these superior dreams and excellent humanitarian intentions, combined with the
urgency and the rush for politicians to get a hold on this political
opportunity, blinded not only politicians but the society as a whole. They saw
the EU as a global expression of reconciliation, as well as a new dawn for
Western civilizations. Contemporarily the EU invigorated the counterfeit notion
of successful coordination and international, political and economic planning.
Sadly in the process,
Europe neglected several social and economic issues, which in the long run
resulted in being excessively important and essential for the union’s future.
If we discard the spontaneous social order and economic fundamentals of
markets, these neglects may lead directly towards the very denial of any
possible logical existence of a unified European dream. These fundamentals were
clearly underlined by Professor Mises and Professor Hayek more than 60 years
ago; they referred to the distribution of knowledge by a heterogeneous and
extended price system mechanism. This system allows spontaneous social
coordination and dispersion of relevant information towards an efficient
allocation of wealth. Unmistakably we have seen these fundamental social orders
completely neglected. The denial and impediment of the spontaneous price system
has been exposed under a unified EU monetary system throughout the last couple
of decades; but we were unable to foresee and fully understand its
consequences.
During the end of the
1990s, with the beginning of the Maastricht agreement, government bond’s
interest rates among countries started to converge. Countries within the
agreement and also those out of it were experiencing an increasingly convergent
towards the value of German bond’s interest rates. This process of convergence
could be seen as a sort of “harmonization” of government’s interest rates, mainly
induced by the single currency program (see Figure 1). Countries that were not
part of the EU in 1993 were already working their ways to inclusion. This
created feelings of safety and homogenization of political and economic
behavior throughout European countries.
Investors thought that
this convergence may lead to a German flare for European competitiveness and
monetary behavior within the Union. This sensation of monetary protection and
diligence of being under the German Umbrella created a sense of fortification,
lowering risk perception among entrepreneurs and governments. With this
psychological effect, investors lowered their inflation expectations for all
European countries. This process was undertaken on the false belief that the
now heterogeneous countries so diverse such as Italy or Portugal will now
behave more like the Bundesbank (the German central bank).
The low interest rates
throughout Europe permitted countries to enlarge their deficits in the 90s.
These interest rates gave them long-term possibilities to accumulate massive
government debt for extended periods of time. This entire process was being
conducted and hidden under the single currency, the homogenization of interest
rates and the feeling of security under a single controlling “inflation hawk”,
the European Central Bank. These variables severely affected the heterogeneous
and affluent price mechanism that was working before the introduction of the
single euro currency. The previous system was one in which each single currency
reflected relevant information about each country’s competitiveness (or lack of
it) and political risk.
The new single currency
system obscured relevant information about the current health and state of the
European economies, as well as their lack of competitiveness. This insufficient
information misled investors and affected the entire process of European wealth
allocation. Therefore what we observe in Figure 1 is more than just a
convergence of rates between 1999 and 2008; it is the central political intervention
of the division of knowledge and the narrowing spectrum of the price mechanism,
which dampened the possibility to reveal relevant information in order to make
efficient capital and wealth allocation. The fundamental intrusion of the price
system by a collective currency could have led nowhere else than a resource
misallocation crisis.
As we notice, one of the
most crucial problems of modern societies is the competent allocation of
resources. Professor Hayek stated that this could only be achieved by the
spontaneous distribution of knowledge and information by singular individual
actions and not by unification, harmonization of information and central
planning. The complex system of actions either from individuals or European
governments translates into economy through prices, including exchange rates.
This complex price mechanism gives the right signals to investors and
entrepreneurs as to where to allocate their capital and wealth. Under this
spontaneous system, heterogeneity is essential. It is only thanks to different
views and the subjectivity of actions that prices can reflect real and relevant
information. As Figure 1 explicitly shows, this was undoubtedly abandoned in
the single currency system.
To put it into Professor
Hayek’s words, “Knowledge of the circumstances of which we must make use, never
exits in concentrated or integrated form, but solely as the dispersed bits of
incomplete and frequently contradictory process”. We noticeably recognize then
that although the feeling of unification and the need to overcome the
sufferings of the war are good intentions, the system required for a successful
complex society and a market based price system needs to be based in the
distribution of heterogeneous facts and not in the centralization of them.
To believe that we can
achieve prosperity by putting at disposal of a central authority “all the
knowledge” to be used to rule and plan the future of European societies as
their monetary policies, is just solely pretence of knowledge and abuse of reason.
The solution that Professor Hayek provides to this conundrum is the proper use
of individual knowledge throughout decentralization. “We need decentralization
because only thus can we assure that the knowledge of the particular and
relevant circumstances of time and place will be promptly used”.
It is through knowledge
dispersion and decentralization of information among European countries that
the relevant facts such as competitiveness, productivity and government debts
are reflected in currency prices and interest rates of the sovereign debt. In
this way, prices coordinate the separate actions of individuals and thereafter
the order of heterogeneous nations. The price system is then the only relevant
organization system that sustains the whole idea of the division of knowledge
in a complex society. Obviously centralization and a single currency are
totally counterintuitive and against the natural order of societies. Currency
unification will then be obvious in continuous conflict of communicating relevant
information among investors. Therefore the new counterintuitive system will
lead to systematic clashes and further misallocations.
In a nutshell, The
European Union as a monetary system was just a political system and a human
collective dream. It had immense economic and social repercussions, which
central planners failed to foresee. Central knowledge under unification
discards the basic and fundamental individual knowledge dispersion in
society. Once again the insights of
Professor Hayek might enlighten us to see how humans throughout history have
undervalued the price mechanism: “The price system is only one of those
spontaneous formations that human has discovered and learn to partially use,
after we stumble upon it without fully understanding it”. Hence we can
recognize that is not a product of human reason nor planning, and every attempt
to rationally replicate it is futile. Ultimately it seems that once more
society has forgotten the benefits of spontaneous order and price relevance
without human design. European politics had discarded what Professor Hayek
brilliantly realized. And so political dreams, arrogance of knowledge, and
power for extended control have damaged the Open Society.
*Edited by Vicki Finn
Figure 1: Interest
rates on 10-year Government Bonds for 7 European Countries
Source: FTI Consulting and BBC news.
Sources
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F.A.
Hayek, Individualism and Economic Order, “Economics
and Knowledge”, the University of Chicago Press 1948.
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F.A.
Hayek, Law Legislation and Liberty, Vol2 “The Mirage of Social Justice”, “The market Order of Catallaxy”, The
University of Chicago Press 1976.
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F.A.
Hayek, The Counter Revolution of Science, Studies on the Abuse of Reason, “Scientism and the Study of Society”, The
Free Press 1952.
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Martin
J. Dedman, “The Origins and Development of the European Union 1945-2008: A History of European Integration,
Routledge 2009
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Philipp
Bagus, The Eurozone: A Moral-Hazard Morass, Mises Daily, Ludwig von Mises
Institute 2012.
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