The Tragedy of the Euro

By Bagus, Philipp | Independent Review, Spring 2011 | Go to article overview

The Tragedy of the Euro


Bagus, Philipp, Independent Review


The Eurosystem, the monetary system in the European Monetary Union (EMU), has brought the euro to the verge of collapse. We can understand how this situation arose in terms of the theory of negative external effects and the tragedy of the commons. Poorly defined property fights in money can cause negative external effects to be neglected. In practice, the EMU has evolved into a tragedy of the commons because several independent national governments have made use of the European Central Bank (ECB) to finance their deficits indirectly.

The theory of the tragedy of the commons states that a publicly owned good will tend to be overexploited and disappear. The euro and its purchasing power are following this course. The euro is threatened by independent states' trying to finance their deficits via the ECB and to externalize part of their deficit costs in the form of higher prices in the EMU. This mechanism of a tragedy of the commons has contributed to the current sovereign-debt crisis in Europe. In this article, I explain how a tragedy of the commons exists in the EMU because of public property in money and how it is caused by the possibility of financing deficits through a single central bank.

External Costs and the Tragedy of the Commons

A tragedy of the commons, a term coined by Garrett Hardin (1968), is a special case of the external-costs problem. External costs generally occur when property rights are not well defined or defended and a single privileged actor can externalize costs on others (Mises 1998, 651). (1) If the actors are not fully responsible for the effects of their actions, they will not take into account all the consequences of these actions. This situation is exemplified by a factory owner who is allowed to dump waste in a lake.

External costs also occur when fiat money is issued. Fiat money is a medium of exchange that the issuer (the state) puts into circulation backed by no collateral except the paper on which the notes are printed. Residents are then forced to accept this kind of money as a means of payment (legal tender). Fiat money thus represents an encroachment on the principle of freedom of contract. People cannot do with their property what they want but are forced to accept fiat money in exchanges and to use it for tax payments. If no one had to accept public paper money, no external costs would be incurred. People could simply decide not to accept fiat money.

Given the absent private-property rights in money production and a monopolist producer of fiat money, the benefits of the production of money accrue to its producer, and external costs take the form of rising prices and, in most cases, a lower quality of money. (2) These external costs are imposed on all users of fiat money. The additional monetary units allow their holders to bid up prices.

The main beneficiary of the central bank's increase in money supply is the government, for two reasons. (3) First, increases in the money supply lead to profits called "seigniorage." Central-bank profits are remitted to the government at the end of the year. Second, central banks can finance government directly by buying government bonds or indirectly by accepting government bonds as collateral for loans to the banking system.

In a tragedy of the commons, a specific characteristic is added to the external-cost problem, and several actors exploiting one property can externalize costs onto others. Not only can one factory owner dump waste into the private lake, but two or more can do so also. Not only can one central bank produce base money, but several can.

The traditional example of a tragedy of the commons is common property such as public beaches or schools of fish in the ocean. They are exploited without regard to the disadvantages that can be partially externalized. The users obtain benefits, but the costs are externalized. By fishing the school, a fisher obtains the benefits; however, all fishers bear the cost of a reduced school size. …

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