Eliminating Monetary Externalities

0:00Okay, one of the great benefits for me of being a director of this conference is to introduce the various lecturers, distinguished lecturers. Our first is Philip Baggis. He's a former Mises Fellow and Professor of Economics in the University Ray Juan Carlos in Madrid. He's the Assistant Editor of the Procesos de Marketo, Market Processes, a Spanish and English bilingual journal edited by Jesus Huerta de Soto. Soto, he has published articles in the Journal of Business Ethics, American Journal of Economics and Sociology, Independent Review, the Quarterly Journal of Austrian Economics, the Review of Austrian Economics, New Perspectives on Political Economy, the Journal of Libertarian Studies and other scholarly outlets.

0:45He's also the author, as you heard this morning, of two wonderful books. He will address us today on Eliminating Monetary Externalities. I introduce Dr. Baggis. Thank you, Joe. Good morning again. Well, let me first express my, the deep honor that I feel delivering the Rothbard Memorial Lecture 2011. It certainly is the greatest honor that I have received in my young career. Even though I don't think I'm so young anymore, when I was interviewed for Mises.org's Frequency Spotlight, one of the comments were, he looks like 13.

1:39I can tell you, appearances are deceiving sometimes. And of course I thought, now you have a problem, because who will take a 13-year-old seriously? What shall I do? 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. Well, not 13, it's 30 and counting. But then I thought, maybe Philip, you have problems that other people would like to have. Anyway, I will try to make good use of this lecture, something that Rothbard would be proud of.

2:29I owe him a lot. It was through his Ethics of Liberty that I discovered all the implications of my libertarian genes. His clear economic and political prose was very inspiring for me and I owe him another one that I talked about earlier. I first wanted to call my book The Case Against the Euro in honor of Rothbard's grades, The Case Against the Fed. So I feel a bit sorry that I eventually did not do so, but I will try to make up for it. Finally I decided to call the book The Tragedy of the Euro. and not only for the reason that the Euro has proved to be a tragedy for liberty in Europe and will be so in the future, but also because the main argument or maybe the main argument of the book is that it is a tragedy of the commons.

3:24And this concept, the tragedy of the commons, made me think on the subject of monetary externalities. And there's not much written on monetary externalities in the Austrian School. We have Walter de Soto who claims that fractional reserve banking is a tragedy of the commons, which implies negative externalities from money. But there's not much else. There's not even much on externalities as such in the Austrian School. Rothbard, for example, he dedicates only roughly half There is half a page in Man Economy and State on externalities, even though he uses a slightly different terminology.

4:09He calls negative externalities external diseconomies or external costs, a term which he doesn't define explicitly. He just states, quote, but cases of external diseconomy all turn out to be instances of failure of government, Enforcing Agency Adequately to Enforce Individual Property Rights And then he gives us the typical example of air pollution. For further information, he refers to Mises's quote on external diseconomies. The only good discussion by an economist is the excellent one in Mises's Human Action, page 650 to 53. So even Mises has only three pages on externalities.

4:55So I would like to go into more detail today. I will first try to reconstruct externality analysis and then apply it to money, analyze different layers of it in money, and then propose several reforms to eliminate some or all of these externalities. I hope you're now ready for my 30 years of accumulated wisdoms to come to you now. Well, the mainstream definition. Orthodox textbooks often define the externalities as uncompensated effects of actions on third parties, on bystanders not participating in a particular action or exchange.

5:41Triple examples are someone smoking next to you in a restaurant as a negative externality or a neighbour planting flowers in his garden that look nice as a positive externality. And then the literature goes on to distinguish between psychic, pecuniary and technological or real externalities. Pecuniary externalities are internal feelings that a particular action invokes on third-parties. Such a feeling would be the nice view that the beautiful neighbor's garden provokes. Pecuniary externalities result when actions affect third-parties indirectly through the price system.

6:28So when a new restaurant opens in a neighborhood, it tends to have a negative pecuniary effect on competing restaurants. Finally, real or technological externalities are defined as the direct effects that actions of some firms have on the physical output of other firms affecting its production function. The typical case is a factory that pollutes a farmer's field, so the physical crop production of the Farmer is Humped, so we can see a physical destruction of the property of a third person. Unfortunately this mainstream taxonomy of externalities is very problematic and not very useful to analyze problems of the real world. First the definition of externalities seems to be too broad.

7:24Any action may have psychic, pecuniary, or technological externalities. So psychic externalities. The planting of the flowers by the neighbor may have negative or positive externalities on all bypasses. Negative, because people might be allergic against flowers, would be a negative. If the neighbor puts a photo of his beautiful garden In other words, any action that is known to third parties may affect their well-being. Regarding pecuniary externalities in a society with a high division of labour, a consumer buying chewing gum in China may have a pecuniary externality on all other producers worldwide because the money that is spent on chewing gum cannot be spent on other goods.

8:21And regarding technological externalities, implementing scarce resources in an investment project affects the production function of all other firms directly, may affect it directly. If I convince a famous singer to sing at my charity event for free, of course the same As such, the definition of externalities, the mainstream definition, seems to be too broad to be useful as an analytical tool. Second, the distinction between technological, pecuniary and psychic externalities seems to suggest that they are both objective and subjective externalities.

9:07Yet 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. So there is no clear-cut distinction between real pecuniary and psychic externalities. Also, technological and pecuniary externalities affect the subjective well-being of third parties. Let's take the typical example of technological externality, the pollution of a farmer's field. When a farmer produces fewer crops due to the pollution, his well-being is affected subjectively. If he wanted to produce fewer crops to increase prices, he might actually welcome the pollution.

9:56Also, pecuniary externalities are relevant to actors only if they affect their subjective well-being. It's not the higher or lower monetary income as such that is important to actors but their subjective valuation of these changes. This leads us then to the question, why distinguish between technological, pecuniary and psychic externalities if all affect the subjective being in the end? Why not only refer to psychic externalities? This leads us to the third critique. All externalities are psychic or subjective and individually experienced by actors. Therefore, the mainstream classification is flawed and, most importantly, puts aside and does not mention and thereby hides the true and only meaningful distinctive characteristic of externalities, which is the poor definition and defence of property rights.

10:58The poor definition and defence of private property rights is objectively discernible from the outside. In fact, if other effects resulting from actions that respect private property rights are relatively uninteresting, because all actions may have effects on third parties in the sense that they may affect their subjective well-being, But actions that do violate private property rights and inflict damages on the property or health of third parties pose important theoretical questions. Those actions may be called irresponsible as they do not account for the effects resulting from the ill-defended property rights. Consequently, I, in line with the Austrian analysis, will define externalities as effects of actions that affect third parties and that do not respect private property rights.

11:53It's in line with Mises. For him, positive and negative externalities, or what he calls them external benefits and costs, occur when a proprietor does not assume the full advantages or disadvantages of employing and Property because of ill-defined or defended property rights. So here we have, and they often generate perverse incentives harming third parties, which we will see later. Here is a table where we have positive and negative effects on third parties in the first The first row are where property rights are respected and the second row are where they are not.

12:38So where property rights are respected and they have positive effects, the example would be savings and investment. There is capital accumulation, productivity, rises of labour also and wages tend to increase. So there is a positive effect on a third party, which is the worker, whose real wage tends to increase. 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. 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.

13:29In fact, no violation of property rights. Then negative effects. Here, where property rights are respected, a boycott, for example, I could convince someone not to go to McDonald's, negative effect for McDonald's, but no property right violation. On the other hand, we see that anything may be, in any case, the divorce may have a negative effect Another example would be gold production in a 100% gold standard that prices increase, but there's no violation of property rights. There's no go to the ill-defended or ill-defined property rights.

14:21A positive effect. A tyrannicide. Someone kills a tyrant, so for many subjects that will have positive effects. Another example would be someone kills your competitor in any market. It may have a positive effect on you. Property Rights Violated. Another example that shows that one action can have positive or negative externalities would be air pollution. I have a house with white walls. Then there's air pollution. They get dark. I contract painters to paint it white again. Positive effects on the painters caused by ill-defined property rights.

15:09And we see that this is also an example for negative externalities because I have to pay the painters, for me it's a negative externality. Another example would be of a negative externality violated property rights, a wealth tax, reduces capital accumulation, tends to reduce productivity, wages tend to be lower than otherwise, a negative effect on third parties or public roads that suddenly Emigration Without Invitation is possible. So what is there in the circle? This is what I define as negative externality, because there's a negative effect on third parties and property rights are violated.

15:54I might add that ironically, the mainstream analysis has used positive effects that do not violate private property to justify property rights violations, which may then exert negative externalities. The lighthouse example, it has positive effects on third parties, they call them free riders that did not pay for the lighthouse. So they say it's justified to tax these people who use violence, violate private property rights and build a lighthouse with public money. which could then have true negative externalities. So now let's see if we can apply this concept to money.

16:44Of course, government manipulation of money affects its purchasing power. However, most manipulation of government does not affect the physical integrity of a fired paper note. paper note. So from the mainstream point of view there is no technological or real externality. Maybe even Rothbard would not consider it as a negative externality. He points out in his discussion of external cost that in a free society no one owns the value of a property. So no one owns the value of one's cash balance. Nevertheless, a criminal action may reduce the value of your property. So there can be violations in property rights in the monetary sphere that affect the value of cash balances and therefore constitute negative externalities.

17:44Here one must not forget that it is the services of a good that makes it valuable for an actor. And when property rights to money are not defended, the services it provides are affected negatively. Pioneers of this approach are Hoppe, 94, or Hoppe-Hülsmann & Bloch, 98, and Walter Soto, 98, that refer to negative externalities resulting from property rights violations in money. And my suspicion is that the distinction between the value of the property and the physical Property explains why these externalities resulting from meddling with property rights and money are sometimes neglected. I might add that even Rothbard might agree that there can be negative externalities from meddling with money because he himself points repeatedly to the service a good provides in contrast to the physical content.

18:40As a matter of fact, tangible goods are valued not so much for their physical content as As for their services to the user, whether he is a consumer or producer, the actor values the bread for its services in providing nourishment, the house for its services in providing shelter, the machine for its service producing a lower-order good. In the last analysis tangible commodities are also valued for their services and thus on the same plane as intangible personal services. Economics therefore is not a science that deals particularly with material good or material Welfare. It deals in general with the action of men to satisfy their desires." The same is true for money. What are the services of money? Well, money is valued mainly for its services as a medium of exchange and the store of value. People demand to hold money in their cash balances because they thereby reduce the uncertainty of the future. As Rothbard 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.

19:52Also 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. 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. The higher the demand for money, the higher the services it provides tends to be as its purchasing power is built up. The higher the supply, the lower the services a given unit provides tend to be. The lower the quality of money the lower the services a given unit provides tend to be. What is also special of money is that its services may be affected even though the physical integrity of it is not affected, even though the physical integrity of the existing dollar Another note in your wallet is not affected, it's the services it provides may be affected.

20:57So let's look for the negative externalities in our present monetary system. In a gold standard, the production of base money or money proper respects private property rights. The gold money producers assume the full costs of money production. Even though prices tend to increase due to the money production, there is no violation of property rights or ill-defined property rights. No one has to accept the newly minted coins. People are free to use alternative currencies. Consequently, there are no negative externalities. In our modern monetary system, however, base money production implies negative externalities, is added as it is not free and competitive. There's a money monopoly which implies a privilege violating property rights as no one is allowed to use his own property to produce base money.

21:49And this privilege is normally combined with legal tender laws which present a violation of the freedom of contract and thereby also property rights. People cannot use their property in the way they want but must accept the legal tender in exchanges. As the property rights are violated, negative externalities may evolve consisting in what? When the monopolist produces more base money, prices are bitten up and the price increase harms third parties. Damage is inflicted on the purchasing power of money through a violation of property rights. Money head rents fewer services than it otherwise would have yielded, and it is these reduced services that present the negative externalities, in the same way as it is in the case of pollution of a farmer's field.

22:47The pollution yield leads to less services in the form of a lower crop and providing Less Nourishment, and the money producer, the Centre Bank, does not assume therefore all costs of his action and will try to maximise his income out of the money production at the same time attempting to avoid a breakdown of the monetary system, leading to a redistribution in his favour. This was about the production of the negative externalities due to the production of base money. Let's go to the negative externalities due to the production of fiduciary media in the fractional reserve banking system.

23:32Another area where property rights today are ill-defined and defended is in banking. In a deposit contract, the depositor entrusts to the depository a good to guard, protect and return on demand. So the fundamental purpose of a deposit contract is to maintain the full availability of the deposited good, which implies the obligation of custody and safekeeping of the good deposited. The bank's duty is to hold 100% reserves on these deposits. Consequently, it's both a privilege and a violation of private property rights if banks are allowed to expand credit and and hold fractional reserves. Governments have granted the privilege to banks to hold fractional reserves.

24:20In other words, they have not defended the property rights of depositors. Banks can exploit the purchasing power of deposits entrusted to them, and the results are negative externalities. The creation of fiduciary media leads to upward pressure on prices. The services from money held are reduced. Existing depositors lose purchasing power as the privileged banks have created new money. Another externality of fractional reserve banking and production of fiduciary media is that the quality of money is reduced. The quality of money is its capacity to fulfil its functions as a medium of exchange, store of value and unit of account.

25:08By credit expansion, the reserve ratio of deposits is reduced. Banks expand credits to grant loans for long-term investment projects. As a result, the average quality of assets that might be used to redeem deposits falls because banks acquire illiquid assets with the newly created money. Therefore, the money becomes a worse store of value. The quality of money is reduced. Another negative externality is that credit expansion also distorts relative One may make the argument that in the case of our present fractional reserve banking system we are not faced with ill-defended property rights, but rather with ill-defined property rights. In fact, it may not be clear for many parties involved if they deal with with a deposit contract.

26:10Probably many depositors want a complete availability of their money, which is characteristic of a deposit contract. However, banks tend to regard the deposited money as loans granted to them. So it's not clear who really owns the deposited money. And bankers fail to make clear whether they have been authorized or not by the depositor to use the money. states what Soto states, quote, to fail to clarify or fully specify these details indicates a remarkable ambiguity on the part of bankers and in the event that adverse legal consequences result, their weight should fall on the banker's shoulders and not on those of the contracting party, who with good faith enter into the contract believing its essential purpose or are of course to be the simple custody or self-keeping of the money deposited, end quote.

27:07So it's not clear in our present fractional reserve banking system what kind of contract is entered into, whether it is a loan or deposit. Without clear and unambiguous contracts property rights are ill-defined, resulting in negative externalities. Thus, we may interpret modern fractional reserve banking in basically two ways. First, we may We may regard deposits as ill-defended, because banks have the privilege to use genuine deposits. Second, we may regard the property rights of demand deposits as ill-defined, because it's not clear what kind of contract is actually being signed. With both interpretations, modern fractional reserve banking system leads to negative externalities. And here we are faced with a special case of negative externalities, namely a tragedy A Tragedy of the Commons, a term coined by Gerrit Harden.

28:02A Tragedy of the Commons is defined by two aspects. There's a rivalrous use of the resource and there's non-excludability in the access of the resource. That is, many people can exploit it. A Tragedy of the Commons occurs in the case of unowned or common property resources. Mises calls this as an extreme instance of negative externalities Because not only one actor, but several actors can exploit a resource due to ill-defined or ill-defended property rights. A typical example is the harvesting of fish in the ocean. As property rights on fish stocks are not defined, anyone can harvest the fish, reducing the stock. All fishermen bear the cost, the burden of the reduced stock of fish, while the advantage of fishing is fully absorbed by the individual fishermen.

28:52Thus there is an incentive to fish as many fish as possible, because otherwise other fishermen may deplete the stock. A tragedy of the commons thereby leads to a tendency towards a destruction of the common property resource. And we can apply the concept of the tragedy of the commons to banking, state-wide risotto. Fractional reserve banks can exploit the common property resource, that is the deposits of their depositors. Any bank that expands credit reaps the full benefit of the money creation, yet it does not assume the full costs, which are borne by all money users and also by other fractional reserve banks, because banks see the possibility to benefit from credit expansion reduced as the purchasing power of money falls.

29:42Thus, there is an incentive to exploit the commons as fast as possible, because otherwise and of course other banks will exploit it via credit expansion. Nevertheless, competition and the interbank clearing mechanism is a check on the exploitation of the deposits. Fractional reserve banking therefore is no pure tragedy of the commons. A pure tragedy of commons has virtually no limits on the exploitation of the common resource. It works like this. A bank that expands credit faster than other banks will lose reserves to the more conservative banks and it might fall into severe liquidity and ultimately solvency problems. Only when all banks expand in the same rhythm, there are no reserve losses due to the clearing mechanism.

30:30Thus, there is an incentive for banks to collude and coordinate credit expansion. And banks have traditionally pushed for the institutionalization of the coordination of credit expansion through the interaction of central banks. Because the central bank can coordinate the credit expansion of the banking system, can prevent reserve losses and ensure a controlled exploitation of the commons. The central bank, by regulating the exploitation of the deposits of the commons, may prevent the total destruction of the resource and the purchasing power of money. The treasury of the commons thus is alleviated and converted into what people call a managed commons. The regulation of the banking industry prevents the immediate 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.

31:29Well, we have another layer in the euro system of externalities. It's a tragedy in the monetization of government debts. This tragedy is unique for the Eurozone because several independent governments can use one banking system to finance the debts by increasing the money supply. How do governments monetize their debts? Traditionally, there have been two instruments by which central Central Banks monetize government debt. One is that central banks buy government bonds from the banking system. The other is that they accept government bonds as collateral for new loans to the banking system. Let's assume here's an example. The government spends more than it receives in taxes. For the difference, it prints some nice-looking government bonds which are bought by the banking Banking System. The banking system in the Euro system may use these bonds as collateral to get new loans from the ECB. So the banking system gets new reserves and can expand credits on top of these reserves. This is, of course, a deficit that does not hurt very much because

32:52what happens at the end of the year is that the government pays the interest on the bonds to the banking system, which they are the owner of the bonds, and of course the banking system has to pay interest on the loans it receives from the ECB. The ECB at the end of the year, what does it do? It returns the profits to government. So here to see a little bit quantitatively how much it is, how many government bonds are owned by the banking system in Europe? Well, 25, recently almost 30 percent.

33:28The second way is the way that does the Fed. We have the same here, a deficit, bonds are issued, bought with money from the banking system, and here the Fed buys the bonds outright and gives new reserves to the banks that can expand credits on top of it. Base money increases. 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. 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.

34:21In 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. In both cases central banks effectively monetise government debt. They increase base money to hold the government bonds outright or as collateral, thus indirectly financing the government's deficit. In addition to this outright monetization of government bonds, there is an indirect monetization occurring within the financial system. Market participants know that central banks buy government bonds and accept them as preferred collateral. Banks buy the bonds, ensuring a liquid market and pushing down yields.

35:09Knowing that there is a liquid market in government bonds and a high demand by banks, investment funds, pension funds, insurers and private investors buy government bonds. Government bonds become very liquid and almost as good as base money. They stand as a reserve to be converted into base money if necessary. As a consequence, new money created through credit expansion often ends up buying liquid government bonds, indirectly monetizing the debt. So, let's imagine the following example. The government has a deficit again. The banking system buys the bonds. It pledges them as collateral for new reserves to the banking system. But we have seen the banking system only holds 30% of the government bonds. Where's the rest of the government bonds when it's not in the banking system?

35:57Well, China has some, but there's also another one. We have seen that the reserves have now increased. Banks hold new reserves. They have received new reserves. That means they can expand credit. They may give a loan, grant a loan to the constructor that starts constructing a project and pays his workers. The new money flows to the workers, what do the workers, what part of the money they may save and invest in investment fund and the investment fund buys government bonds because they are very liquid. So here we see that indirectly the new money creation, a big part of the money creation may end up buying government bonds because of the preferential treatment by the central bank, because of the direct monetisation that is going on.

36:52Well, now, in the euro system, the European Monetary Union, several governments may use that describe direct and indirect mechanisms to finance expenditures and please voters. Any government in the Euro system may do the following. It may issue bonds to pay for its deficit. The fractional reserve banks buy these bonds and use them as collateral to receive loans from the ECB. The new resource may then be used to expand credit on top. And the tragedy of the commons develops because any government may use the banks and the ECB There exists actually an incentive to have higher deficits and print relatively more government bonds than other governments because printing bonds becomes almost analogous to printing money. The governments that print bonds faster than other governments profit as they receive relatively more new money. So there's a redistribution from the slower printing governments with lower deficits to the faster printing governments with higher deficits. So the redistribution The European Union system of the national governments, part of the advantages and disadvantages are transferred to the general population in the respective countries.

38:09Take 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. The Greek government maintains high deficits to pay unemployed public workers, high pensions and other social expenditures. Thereby, the wages of many Greeks are raised above the free market level. Greeks use then the income to import goods and services from abroad, whereas they are cheaper. A trade deficit is thereby maintained by the government deficit. In order to pay for these deficits, the Greek government prints bonds that are then purchased by the banking system in order to use them to obtain funds from the ECB or the Euro system.

38:58New money is created and tends to bid up prices. While the purchasing power of the Euro affects all users of the currency, the costs are shared by all users of the currency, the printing of the Greek government bonds benefits primarily the Greek government and special interest groups that receive income from it. Is it a negative externality? Yes, because the Euro If the Euro is a legal tender fiat money, it represents an infringement on property rights. 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. Imagine the following case to visualize the redistribution. 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.

39:50The 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. 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. Other people faced with the rising prices of German cars are the losers in this redistribution. Of course, not only the Greek government may use this mechanism for its own advantage and that of the Greek population, but the other governments of the Eurozone may do so as well. And the government is on the winning side of the redistribution scheme if it prints government bonds faster than other governments.

40:38Take the example that Germany prints its government bonds at a pace of 3% of GDP, but the rest of the governments print these bonds at a pace of 10% of GDP. So let's assume that the purchasing power of the euro falls 8% per year. Then prices rise faster than the German government prints its bonds. Even though the German government deficit spending is at 3% of GDP, real government spending may actually fall. So the incentives resemble a tragedy of the commons. The incentive is to print faster than your peers. In fact the system resembles a system where several actors have access to a commonly owned printing press. While the analogy is close, there are some There are some differences. It's not a pure tragedy of the commons. There are some limits.

41:35Otherwise, obviously the euro would have disappeared already in hyperinflation. So what are the limitations of it? Well, governments cannot print euros directly. They can only print bonds. And banks may not buy these bonds. And the ECB may not accept these bonds as collateral. And resulting from this, there are some differences. And there's the Stability and Growth Pact, which I will talk about later. So, why might it not happen that the banks buy the bonds and the ECB would not accept it as collateral? Why would the monetisation not work? Well, first, collateralised lending with government bonds may be unattractive for banks. If the interest rate offered for the government bonds is lower than the interest rate banks must pay for loans from the ECB, Banking will be unattractive.

42:29Second, governments may default on their bonds and the default risk may deter banks from purchasing the bonds. In the Eurozone, however, the default risk was and still is reduced by implicit bailout guarantees. The Euro is a political project. That is all what my book is all about. Thus we see the importance of the combination of politics and the monetary setup. The euro is conceived as a further step towards the unavoidable political integration of the European Union. Politicians imply that there can only be progress via more political integration. Any regress would imply a defeat of European politicians and put into doubt the whole project of the EU, and the whole project of the socialist vision for the EU.

43:25Consequently, a default of a member state that might force a country to exit the Eurozone would not only be regarded as a failure of the Euro, but also of the greater project of the European Union, the European super-state, and thus market participants for a long time regarded a default as politically next to impossible. The expectation was that in the worst case, the fiscally stronger member states would support the weaker ones. Countries such as Germany or the Netherlands would guarantee the bonds of the Mediterranean nations and prevent a default. Now we know market expectations were accurate. The implicit guarantees have become explicit. Greece and Ireland were bailed out in 2011 by the rest of the Eurozone.

44:15Third, banks are faced with a liquidity risk in the scheme where they use CCB to refinance themselves and pledge government bonds as collateral. Why? Because the term of government bonds in most cases is longer than the term of the loans granted by the ECB. I am a bank and I have a Greek government bond that is 10 years long. 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. 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.

45:02The 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. The political willingness to save the euro project supports the ratings. The liquidity risk is also expressed by the risk of a change in the interest rates or in the value of the government bonds. First, the ECB might refuse to accept certain government bonds as collateral, and of course the ECB requires a minimum rating by rating agencies for bonds to be acceptable as collateral. Before the financial crisis, the minimum rating was A minus. In order to support the banking system during a period of falling ratings, the ECB reduced It's minimum rating to BBB-minus, but it always said it will only be for one year.

46:03This implies if government bonds would fall below the minimum rating, they would cease to be acceptable as collateral. However, we have seen the danger of this to happen is not really high either because the ECB tends to be accommodative, and it has been in respect to its collateral rules for government bonds. As I said, it wanted to cease the reduction of the minimum rating after one year, but when it saw that the rating of the Greek government would not achieve an A minus, it extended the rule for another year. And the ECB also stated that it would not apply special rules to a single country. But then the Greek government, it appeared that it would not even achieve a BVB minus, So the ECB then announced it would accept Greek debt no matter what, even if rated junk, which has already occurred.

46:59So a precedent was set and governments from now on can expect that collateral rules will be changed to support the deficits and the ECB to be accommodative. The ECB is just an instrument, has become an instrument of politics. 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. 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. So the banks may offer more government bonds as collateral than the ECB makes available. 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.

47:57So, despite these frictions that I discussed, the possibility to indirectly finance government deficits through the ECB constitutes a traditional tragedy of the commons, 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. Thus, to restrict these perverse incentives, Germany and other relatively hard currency countries enacted the Stability and Growth Pact. The Stability and Growth Pact intended to limit the debts and deficits of member states. According to the Stability and Growth Pact, government debts shall be below 60% of GDP and deficits below 3% of GDP.

48:48Thus, 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. Of course the incentive is to exploit the quota to the maximum, that is to have a 3% of GDP deficit. This is the incentive if the quota is really enforced. However, the Stability and Growth Pact was never enforced. It utterly failed because governments themselves decided on the very sanctions that they would have to enforce upon themselves. 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.

49:44Yet the cartel is not enforceable, and the incentive for members is to exceed the quota to benefit on cost of members fulfilling the quota. In fact, in 2010, all Eurozone governments had a deficit higher than 3% of GDP. So, you have seen there are three layers in the Eurozone of negative externalities. One is the production of base money, property rights not defended. Then production of fiduciary media, property rights not defended either. either and then there's a tragedy of the commons also in the monetisation of government debt. And of course, how do we eliminate these negative externalities? Well, simply by defending and defining well private property rights. Of course, the more of the externalities that we do eliminate, the higher will the resistance of the privileged class of the current system with the political class and banks and big business.

50:51So let's look at the different options that there are. This is a table where we have the negative externalities on the top. On the right is the external negative externalities due to the base money production. Then we have the tragedy of the commons due to the production of fiduciary media by the The Frictionary Reserve Banking System and then the Euro area specific tragedy in the monetization of government deficits. And then they have the monetary setups. In the current Euro system, the externalities are high, negative externalities are high for all three. A reform would be to enforce a stability and growth pact, for example with automatic sanctions.

51:40Any government that exceeds the 3% government deficit gets an automatic sanction. So this would limit the tragedy of the commerce in the monetisation of government deficits. However, Germany and the EU Commission proposed automatic sanctions, but even this modest reform seems not to be possible because there is resistance from other governments against this limit, putting limits to the possibility to monetize the debt. Another reform similar is the monetary growth rule by Milton Friedman. There we would limit the negative externalities from base money production.

52:28For example, if you say the central bank can only increase base money 5% per year, A system of national currencies that is returning to the Deutschmarks, the Lira, the Francfonds, this would of course eliminate the tragedy of the commons and the monetisation of government depth through the Euro system, because the Euro system would cease to exist. So there's none. The tragedy of the government's intervention of the Fiducia media would remain and also for each government could still use its own central bank to produce basement and monetize its debt.

53:21The next system would be fractional reserve free banking to abolish central bank, abolish legal tender laws, of course there would be no tragedy of the commons into monetization anymore and no external effects of monopolistic based money production because anyone could produce, would produce currencies that would end through the clearing mechanism, the tragedy of the commons of the fractional reserve banking system would eliminate, eliminate it. And lastly Eliminating all negative externalities would be clearly to restore property rights, to defend property rights 100%, define well property rights in money. That is to return or to go to a 100% commodity standard. There would be no tragedy of the commons in monetisation, nor by fiduciary media nor by base money.

54:24So, to conclude, we are faced with several layers of negative externalities in money due to ill-defined and ill-defended property rights. We have a tragedy of the Commons and fractional reserve banking and the production of fiduciary media and of the monetisation in government debt in Europe. And we can group monetary reforms and systems according to the extent that they eliminate They eliminate these negative externalities and perversion samples. Only a 100% commodity standard would restore property rights fully and eliminate all negative externalities. Let's hope that we can go to the system without or before a total collapse of our current monetary system.

55:14For this to happen, we have to win the battle of ideas. Good luck to all.