Either there’s parity between M0 and M1 or there isn’t

For a given currency such as the Euro, either there is 1:1 parity between M0 (central bank money) and M1 (commercial bank money) or there isn’t. Actualy many problems would be mitigated if there was no guaranteed parity, i.e. if bank deposits could fall in value when monetary-financial bubbles burst. If in 2008 there had been a haircut on all bank deposits to write off bad debts, that would have been much preferable to austerity as a means of rebalancing. At least it would be so in substance – selling it to the public would have been a challenge.

However, parity or not parity has to be uniform across a currency. If Euro-denominated bank deposits in some Cypriot banks are overvalued and must be cut then all Euro-denominated deposits in the zone must be cut equally, by a smaller amount. That is necessary for a single currency and banking system to work. Otherwise, Cypriot bank money, or Greek, or whoever’s is next is not actually trading 1:1 with German bank money due to risk perception and we don’t really have a single currency. Or more accurately we have single M0 (central bank money and printed notes) but M1 (bank deposits and nearly all inter-bank payments) is already fragmented and exposed to de-facto exchange rate risk. That risk premium is opaque and thus much higher than if it were a properly floating national currency. Greek businesses, and presumably soon Cypriot ones, are unable to pay for imports with Greek-bank M1 (bank money) at parity. Businesses in countries with stricken bank systems are de-facto thrown out of the single currency already.

The Bundesbank hawks can’t have it both ways. Either the Euro is a single currency, which means a Euro in a bank in Cyprus is a Euro in a bank in Italy is a Euro in a bank in Germany so you can use it for payments, or it isn’t. That absolutely means that whetever happens to one Eurozone commercial bank in terms of crisis response has to be collectivized across the zone. Otherwise we don’t have the benefts of a single currency. We just have the penalties and there is no reason that electorates should accept such a flawed construction.

The three-phase crisis cycle

We’re in the third phase of the financial crisis that peaked in 2008. The events of 2007-2009, which are generally called “The Crisis”, were only phase two. The three phases are:

  • Phase One: The bubble. Creation of false assets by financial capital, mostly banks and smaller players in the property market. These assets have a nominal value way in excess of their real earnings potential, and that gap in value is hidden.
  • Phase Two: The stall. Transfer of the deficit of those assets to state balance sheets under emergency conditions. Private insolvency becomes state liability, while the gap between nominal and real wealth remains outstanding and is now visible.
  • Phase Three: The payback. Closing of the gap by a transfer of funds from the public to states. This may be achieved by means such as austerity, taxation, write-off, default, or inflation. These different options hurt or benefit different groups.

We’re in phase three, and the reason we have austerity in most of the west is that austerity is the method capital wants to see used to resolve the gap. Using austerity in the payback phase serves to consolidate the gains that capital made in phase one, such that the whole cycle is a transfer of real funds from the general public to capital. Austerity is the “hard money” way to close the cycle. It’s the only way to close it that refuses to accept nominal losses.

Using inflation (by printing money), taxation of capital gains, debt write-off, or controlled default would allow the valuation gap to close by eroding rather than consolidating the nominal gains made in the bubble phase. These options wouldn’t be clean but they would be fairer and less destructive of the real economy. These options are very unfriendly to capital, so they’re absent from politics. The US Fed is using a small amount of inflation, presumably to reduce damage to the real economy, while the fabulously independent European Central Bank insists on a hard Euro and austerity. The ECB is working as intended, since the whole point of an independent central bank is to avoid taxation of capital in situations like this. On the whole, present monetary policy is strongly in favor of wealth and capital and against social cohesion or development.

Continue reading