Paper Promises: The Eternal Debt Cycle

By Philip Coggan

A populist movement has emerged from the heartland of America that is campaigning for a fundamental change in economic policy. European nations are locked into a fixed exchange rate system and struggling to repay their debts. As Mark Twain once remarked, “It is not worthwhile to try to keep history from repeating itself.”

The current debt crisis is merely the latest in an age-old battle between creditors and debtors. Creditors have a penchant for devising systems to fix the value of money, so as to protect their interests. But every so often, the system breaks down as the borrowers become overwhelmed by the burden of their debts.

While creditors want to fix the supply of money, debtors usually want to expand it. That was the cause of the great populist campaign of the late 19th century, led by William Jennings Bryan. In some ways, Bryan was the Barack Obama of his time–a Midwestern Democratic senator who was a powerful orator. But the movement Byran led was more akin to the Tea Party, drawing its strength from the farmers in the heartland states. Those farmers were being squeezed by a combination of falling crop prices and the fixed value of their debts. So Bryan campaigned for silver to be added to the money supply—the 19th century equivalent of quantitative easing—famously declaring, “mankind shall not be crucified upon a cross of gold.”

Bryan’s campaign was part of a long political tradition that regarded “eastern money power” with suspicion, a tradition exemplified by Andrew Jackson’s abolition of the Second Bank of the United States—a forerunner of the Federal Reserve. The “sound money” men of the east all duly lined up behind the Republican William McKinley, who won the 1896 election.

Flash forward 116 years, and the rivalry between the creditors and debtors remains. There is still resentment in the old farming states against the east coast elite, but their respective stance on the balance of power in economic policy have completely reversed. The Tea Party is all for sound money—in favor of balancing the budget and deeply suspicious of the Federal Reserve and Ben Bernanke’s policy of quantitative easing (QE), or money creation. On Wall Street, by contrast, orthodox opinion is all in favour of QE as a means of supporting the economy and (crucially for the finance sector) the bond and equity markets.

What is so remarkable, then, is that the Tea Party seems to be a populist movement in favor of austerity. It is very hard to imagine this happening anywhere else. There is no sign of similar discourse in Europe. The Greeks are not rioting in support of an austerity program, quite the reverse. If the European Central Bank is unpopular, it is because it is perceived as being too tight with money, not too loose.

The Greek crisis also has echoes of another historical era–the demise of the gold standard in the 1930s. After the monetary chaos that ensued in the First World War, countries tried to reconstruct the gold standard in the 1920s. For instance, Winston Churchill put Britain back on to gold at the pre-war rate in 1925. This was not the great man’s “finest hour,” earning him a lengthy rebuke from John Maynard Keynes in his book, The Economic Consequences of Mr Churchill.

There were several reasons why the standard did not work so well after 1918, but perhaps the main one was the advent of democracy. Before 1914, Europe had been ruled by the creditor classes, who had an interest in seeing the purchasing power of money maintained. But keeping up with the standard required some short, sharp shocks to the economy that involved lower wages and higher unemployment, which was hard to push through in a mass democracy. The British Labour government in 1931 for example, fell rather than approve a 20 percent cut in unemployment benefits. Given the threat of Soviet communism, even right-wing politicians were reluctant to push workers too far.

With the adoption of the Euro, European countries have fixed the value of their money—not to gold but to a currency dominated by Germany (the gold standard is a way of internally fixing the value of money; a fixed exchange rate is a way of externally fixing it). The traditional European way of getting out of a crisis would have been to devalue their currencies, but that option is no longer available. So having fixed the value of money everything else must now adjust. In other words, wages and prices must fall. The resulting austerity programs are hard to push through in a democracy, which is why both Greece and Italy have technocratic-led governments.

The irony is that it is now even harder to get out of the euro than it was to leave the gold standard. In the 1930s, the earlier a country left gold, the quicker its economy recovered. The disruption was minimal. When a British Labor politician saw the subsequent Conservative-led government abandon the link to gold, he said, “Nobody told us we could do that.” This was in part because leaving gold was the equivalent of writing down your debts—creditors were being paid back in debased money. But if Greece leaves the euro and adopts the drachma, it will still owe money in euros; the same applies to its banks and corporations. The debts will be even harder to pay back because the revenues of Greek banks and corporations will be in devalued drachmas.

So the wheel of history turns again. While some talk of a return to the gold standard, those European countries that have fixed their money value are becoming irritated under the constraints it entails. Like a political washing machine, economic policy is set on a cycle of wash, rinse, and repeat.




Philip Coggan is the Buttonwood columnist for The Economist and his latest book is Paper Promises: Debt. Money and the New World Order

(Photo Courtesy of spike55151)


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