Political control of money

2011-MAY-01

All vibrant economies grow upon the same building blocks. Most of these are intuitive and well known, like hard work and savings, which are the twin underpinnings of capitalism. The rule of law is also important in building a strong foundation, for two reasons. It ensures a level playing field so that everyone can compete according to ability and without favouritism. More importantly, consistent application of an equitable law protects property rights, which must be inviolable for any just society to grow and prosper.

The quality of money is another important building block for a sound economy. Not all monies are equal. Who, for example, in selling a good would have chosen to receive in exchange the Ostmark in preference to the Deutschemark? Inferior monies like the Ostmark or Argentine austral, Zimbabwe dollar, Serbian dinar and countless others when terribly debased eventually disappear or are replaced because they no longer meet the needs of what people – in other words, the market – demand.

While inferior money can appear anywhere around the globe, it always has one common characteristic. It is money that exists under political control. It is money for which decisions are influenced by politicians and not made by independent central bankers autonomous to the political process. This point can be made clear, for example, by comparing the Deutschemark to the French franc throughout the 50-years prior to the launch of the euro. Because an independent Bundesbank capably managed it, the Dmark achieved a stable, consistent purchasing power. It was sound money throughout these five decades. In contrast, the franc suffered from periodic bouts of inflation and devaluation because of the recurring political influence placed upon the Banque de France.

It is therefore alarming that the independence of the European Central Bank is eroding, notwithstanding the protestations of its managers and Europe’s political leaders to the contrary. While many had always harboured doubts about whether an untested ECB would achieve the same status as the Bundesbank, the new ECB was nonetheless given the benefit of the doubt by nearly everyone so that it could prove itself worthy to receive the people’s trust. But the sceptics have been vindicated. The clear evidence came from the startling about-face by ECB President Jean-Claude Trichet. After repeatedly pledging not to relax fundamental sound money principles for the sake of any country, his decision in May of last year to start buying Greek government bonds as part of the political solution to the Greek debt crisis was a resounding wake-up call that politicians – and not Mr. Trichet or the ECB Board of Governors – ultimately determine ECB decision making.

Since then the ECB has continued to buy government bonds, thereby bringing many dodgy assets on to its formerly pristine balance sheet. This questionable policy has inevitably yet understandably drawn comparisons to show that in contrast to the Bundesbank, the ECB is not independent from political pressures. It has also rightly raised concerns about the long-term viability of the purchasing power of the euro.

The obvious concern is that these ECB decisions to buy government bonds favour political expediency and are therefore eroding the fundamental principle of any money that aims to be sound. The consequence is that the euro will never achieve the same status that was carefully and conscientiously earned over fifty years by prudent Bundesbank management of the Dmark, a sound currency that is now gone but not forgotten.