Matthew Melchiorre

Although gold traditionally has been the alternative asset for those wary of fiat currency debasement, there is an emerging newcomer: virtual currency. Bitcoin, created in 2009 by Japanese developer Satoshi Nakamoto, is a self-regulated and anonymous online payment system with a fixed supply of currency.

The selling point of Bitcoins (BTCs) is their value cannot be artificially debased. Although the supply of BTCs will increase predictably in number though 2017 (the currency is still developing and needs to circulate enough BTCs to support its later ambitions), the limit is fixed at 21 million BTCs. After 2017, the increases are small half-steps towards the 21 million BTC target.

There is no central bank, operating under the influence of government, to manipulate the currency for political ends.

That said, Bitcoin still has a long way to go before becoming a real alternative to the fiat currency we use everyday. There are only a handful of merchants that accept BTCs directly, hackers present a real danger to your “virtual wallet” — and since the Bitcoin is peer-to-peer and completely anonymous (each transaction has a randomly generated, thereby untraceable, key code) — finding the perpetrators is essentially impossible. Also, volatile trading volumes while the currency is still in its infancy can pose serious exchange rate risk to users.

The Finns don’t seem to mind the risks though — they are the highest per capita users of BTCs. Americans and Germans are the largest volume users.

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American financial regulators could take a lesson from their European counterparts. The recent EU bail-in/bailout of Cyprus, despite its dangers, shows that reducing moral hazard in the banking industry without provoking bank runs is possible.

As I write in Forbes, Cyprus is one of the most insolvent Euro member states.

Non-performing loans [in Cyprus] (NPLs) are 15.5 percent of gross loans, which is comparable to Italy (13 percent), Ireland (19 percent), and even Greece (21 percent). But the real problem is Cyprus’s staggering inability to absorb losses. NPLs account for an enormous 264 percent of tier 1 capital—a level so high that not even basket case Greece, at 217 percent, can compare.

Cyprus got this way because of the risky actions of its banks, which were heavily invested in Greek debt. Once Greece hit the wall, so did the Cypriot banking system.

Unlike larger countries like France, Italy, and Spain, the little Mediterranean island’s fate does not have great effects upon the Euro in purely economic terms. But its precedent matters because markets extrapolate future EU actions (for example, what the EU will do when larger economies come under financial scrutiny) from present ones. Accordingly, Cyprus represented a low-stakes means through which to change expectations for the future. In February, before the drama and media hype surrounding Cyprus began, I wrote about this opportunity in the Global Post.

Europe should think twice before simply handing out a bailout package equal to the entire Cypriot economy.

As Ireland’s current plight shows, burdening the taxpayers to save the banks and bondholders imposes unnecessary and long-lasting pain. Once the European Union provides the stabilization funding needed to prevent Cypriot contagion to the rest of the euro zone, the EU ought to set a new precedent going forward: that inefficiency has the freedom to fail.

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Monetary policy is inherently redistributive. And as I explained in a January article in Forbes, monetary expansion helps Wall Street at the expense of Main Street.

But let’s put the theory to a brief test. Using U.S. data from 1959-2012, I investigated the relationship between changes in the monetary base and changes in employment levels for finance and manufacturing — representing the health of the finance industry and the real economy, respectively.

A simple regression (controlling for other monetary variables such as the federal funds rate and the prime bank rate) showed that each 1 percent increase in the monetary base was associated with a 0.4 percent increase in financial sector employment and a 0.03 percent decrease in manufacturing employment. For the statisticians out there, these results were statistically significant at the 1 percent level.

Of course, this rather simple least squares regression is by no means conclusive. But it sheds some empirical light on an important topic not often discussed in modern debate on monetary policy: the redistributive nature of the printing press.

In a January National Review article, I explained how Baltic countries such as Estonia that had undertaken short-lived but severe cuts to government spending and revenues — what I termed “real austerity” — had been outperforming West European countries that had been increasing both spending and taxes then speciously claimed “savage” cuts had taken place — what I termed “phony austerity” — for the past three years.

But a relevant question for the economically troubled European countries and U.S. remained: Were such painful-but-temporary measures in the Baltics worth their economic cost? The answer is an emphatic “Yes!”

By 2012, Estonia’s cumulative increase in GDP since 2008 (even after implementing austerity in 2009-2010) was greater than that of the Euro area average and of the frequent punching bag of the anti-austerity crowd: the U.K. By 2014, estimates indicate Estonia will have overtaken Germany in terms of GDP gained since 2008.

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Post image for Europe’s Latest Wake-Up Call: Italian Elections

Europe, which has been enjoying a recent respite from financial chaos, is about to get a rude awakening: Italian elections. Voters will go to the polls this Sunday through Monday, and the winner will soon upset the Eurocrat and financial calm that has surrounded Italy since Mario Monti’s caretaker government took office in November 2011. In the months following this weekend’s election results, financial markets will increasingly expect progress on reform of Europe’s third-largest economy. But Rome will be unwilling to deliver.

That’s because the almost certain winner, a centre-left coalition led by the Democratic Party is resistant to the kinds of reform that Italy badly needs. There is some hope for change, however.

Although Italy’s centre-left coalition is likely to win a majority in the House of Deputies (Italy’s lower parliamentary chamber), a clean victory in the Senate (the upper chamber) is much less probable. As a result, the centre-left group will probably coalesce with the centrist group backing former technocrat Prime Minister Monti. Despite his technocrat government’s lackluster record, Monti has at least attempted liberalizing reforms and budget consolidation. And he has set forth a new agenda pushing for more. In contrast, the Democratic Party wants to go in the opposite direction: adding more regulations to an already broken labor market and easing the drive for austerity begun under the Monti government. But a centre-left coalition that includes pro-Monti centrist parties will have to make concessions for liberal reforms and budget consolidation, or risk governmental collapse.

There’s also the specter of the populist Five Star Movement threatening to compound parliamentary logjam. Although it seems highly unlikely that it will be part of any governing coalition, current polls place the movement at receiving roughly 15 percent of the general election vote. That translates into a smaller percentage of parliamentary seats because of a special “majority bonus” going to the proportional winner in this weekend’s elections, but the movement is loud and has an enthusiastic following. Unfortunately, its economic illiteracy is rampant—with radical propositions like banning stock options.

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This week’s State of the Union address was full of plans for government action and spending to combat U.S. economic malaise. At the same time, the President claimed that there were drastic cuts to the federal budget on the way (referring to sequestration, under which spending actually continues to grow but at a slower rate). This doublespeak mirrors that of European politicians and hides reality: more government isn’t making the economy any better.

Illustrating this point is the dichotomy in economic performance between Western European countries — whose politicians claim to have made cuts but in reality have increased budgets each year since the Eurocrisis began in 2009 — and their Baltic counterparts — which underwent actual cuts in the size of government.

Eurostat just released fourth quarter 2012 data on economic growth this week, and it follows the three-year trend of Baltic over-performance relative to the rest of Europe. The Euro Zone as a whole registered dismal Q4 2012 growth of -0.6 percent while Latvia and Estonia grew by 5.7 and 3.4 percent, respectively.

As I wrote in National Review last month, there is a world of difference between austerity that leaves out the public sector while businesses suffer from recession, and austerity that forces government to tighten its belt along with the private sector. The first strategy, which I like to call “phony-austerity,” doesn’t work. The second one, which I like to call “real austerity,” does.

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Inflator-In-Chief Ben Bernanke defended today his third round of quantitative easing and additional $45 billion monthly purchases of U.S. Treasuries (totaling $85 billion per month in Fed balance sheet expansion) as efforts to combat “transitory factors” dragging down the economy. Yet there has been nothing “transitory” about the almost five-year recession lasting since 2008.

As I explain in Forbes, Bernanke is no more than a magician attempting to paper over the real problems within the U.S. economy with the sleight of hand of the printing press. Ultimately, he and his central banker cohorts cannot defy a fundamental law of economics known as Say’s Law: People supply what they demand.

By focusing solely on demand-boosting measures, inflationary economists do not address the root cause of the current malaise.

Economists who advocate raining down dollar, euro, and yen bills from their high-flying helicopters say this needs to be done to gin up flagging demand, but this puts the cart before the horse. One cannot demand anything without first having something to supply. The crisis today is not that economies aren’t demanding enough value, but that they aren’t creating enough value.

Printing money isn’t just ineffective. It’s redistributive and distortionary.

In recent years, redistributive monetary policy has benefited finance at the expense of other productive industries. Consider the U.S. bubble economy of the mid-1990s. Cheap money from the U.S. Federal Reserve redistributed value from the rest of the economy to primary dealers within the financial industry. Even after the 2008 crisis exposed the industry’s inefficiencies and bloated size, the Fed continued to support the employment of its financier friends through zero-interest rate policy.

According to my calculations on data from the Bureau of Labor Statistics and the Federal Reserve, employment in business management and finance during the past 20 years correlated negatively at a moderate magnitude with changes in the interbank interest rate. Simply, financial employment increased when interest rates decreased. Moreover, production suffered while finance boomed. Industrial employment had a strong positive correlation with the interbank rate over the same period.

Another pernicious effect from the printing presses running overtime is inflation. The signs are already out there. Major stock indices have recovered to their pre-crisis highs, despite the global economy still being stuck in a rut. The International Monetary Fund’s commodity price index has increased by over 100 percent in just over two years. And a trip to the grocery store these days requires bracing for a case of sticker shock for fresh produce like apples. Once primary dealers start lending their new money, generalized inflation will be a real danger, threatening price stability.

Read the whole article here.

Third-quarter unemployment data from Eurostat, Europe’s statistical agency, provides still more proof actual cuts in teh size of government — what I call “real austerity” — contributes to real economic growth. Baltic countries continued a three-yeear trend of decreasing unemployment. Those, primarily in Western Europe, who engaged in phone austerity –  when government claims to have tightened its belt but actually increased overall spending and taxation — saw unemployment continue to increase.

Unlike their peers, Latvia and Estonia both made fast and deep reductions in government spending and in tax revenue during their 2009-2010 austerity programs. Unemployment spiked in 2009 as these economies took the painful-but-necessary steps to restructure themselves to become competitive and productive. Since then, their unemployment rates plummeted faster than any other European country throughout 2010 (the year following austerity’s initial implementation) and consistently have continued to decrease at faster rates than the Eurozone and European Union averages.

The rate of unemployment within Latvia is still relatively high (14.1 percent vs. the EU average of 10.1 percent), but it continues to fall at an increasing rate. Estonia now boasts a relatively low rate (9.9 percent vs. the Eurozone average of 11.5 percent). But this is not relevant when assessing the effectiveness of austerity. What matters is by how much the unemployment rate is declining post-austerity relative to economies that have not engaged in austerity. This compares the speed of recovery. And by this measure, Latvia and Estonia — the paragons of fiscal austerity — win hands-down.

Of course, unemployment doesn’t tell the whole story. For a more in-depth analysis of austerity’s success, check out my article in National Review. I compare the effectiveness of real austerity in the Baltics with the ineffectiveness of phony austerity in the U.K.

A report released yesterday by the European Court of Auditors exposed the European Union’s €5 billion boondoggle into increasing “energy efficiency” in public buildings.

Within the three countries that received most of the funds — Italy, Lithuania, and the Czech Republic—the audit estimated that the time it would take for energy savings to compensate for project cost (the “payback period”) averaged a whopping 51 years. In reality, such benefits will never accrue because the renovations made will certainly be in dire need of repair and further renovation before then.

How is such inefficiency possible? Because governments receiving the funds spent them without concern for cost. The report states:

None of the audited countries had approved cost-optimal minimum energy performance requirements for buildings and building components, nor did they systematically collect data of the energy consumption profiles of existing buildings.

Although reading through some of the more outrageous payback periods (288-444 years in one case) is entertaining, such waste is not surprising. The public sector just doesn’t minimize costs as effectively as the private. And since national governments received the funds from the European Union (who collected them from the member states) instead of directly from their own citizens, there is an even greater accountability gap than normal between the public sector’s actions and the critical eye of the citizens.

As the New Year approaches, many challenges loom for Europe. Here’s a quick list of the toughest hurdles for 2013:

1. Implementing the Single Supervisory Mechanism (SSM): Earlier this month, European leaders agreed to establish a supranational banking regulator for the member states of the European Union (EU). The European Central Bank (ECB) will directly supervise banks with assets greater than €30 billion or 20 percent of national GDP. National regulators, operating within the confines of the European regulatory framework, will oversee smaller banks within their respective countries. Although the SSM is scheduled to begin operation in March 2014, the actual regulations to be enforced are still unwritten. As political leaders hash out the specifics next year and attempt to harmonize national regulatory structures of EU member states into one single framework, tensions will run high. Calls for a common European deposit insurer or reinsurance scheme will likely be one of the political speed bumps, as Brussels insists and Germany resists. The drama this fall between EU leaders and the U.K., Sweden, and the Czech Republic (all opting out of the common regulator) was a taste of the future tension that implementing the European banking regulator will inevitably entail.

2. Bailouts:The European Stability Mechanism (ESM), Europe’s permanent bailout fund, began operation this fall. Essentially, the fund is a more fluid way for Europe to bailout its struggling members, as raising and disbursing bailout funding now relies on bureaucratic procedure instead of intergovernmental political wrangling. The ESM’s Board of Governors, made up of the member states contributing to the fund, decides whether to approve requests for rescue funding. Voting weights reflect the capital contribution of the members, so Germany, France, and Italy have the most influence. Additionally, the ECB buttresses the power of the ESM through its “unlimited” sovereign bond-buying Outright Monetary Transactions (OMT) program, as any member state that formally requests ESM funding and agrees to ESM conditions can also apply for OMT assistance. Neither ESM nor OMT assistance has yet been requested by the member states. The ESM is also incomplete. It cannot recapitalize banks directly until the SSM is in place — thereby raising the stakes for negotiations next year concerning the SSM’s implementation.

Although Spain received a bank recapitalizationof €37 billion earlier this month from the ESM (first going to Spain’s “bad bank,” because direct recapitalization is prohibited without the SSM), that funding was part of €100 billion credit line approved by Europe in June — the ESM was simply the vehicle used to deliver the pre-authorized cash. Madrid will almost certainly come back for more, as the bailed-out banks make private bondholder haircuts and trim back credit to repair their balance sheets – a painful but necessary measure that will temporarily increase the volume of non-performing loans and trigger a restructuring of more banks. Another European bailout risk is the recurring Greek debacle, as next year’s strong round of budget cuts threatens to inflame political tensions. Europe was on the edge of its seat this spring when it seemed that Greece’s far-left Syiza party would come to power and repudiate current and future reforms. Fortunately, this did not occur. June elections gave the conservative New Democracy party the most votes and a political mandate to pursue austerity and keep Greece within Europe. But this is a fragile equilibrium, as Syriza came in a close second and populist anger in Greece could resurface and destabilize New Democracy’s power when new budget cuts to pensions and public wages take place next year.

But a European bailout crisis in 2013 will not come from Spain or Greece. That hinges on whether larger economies and larger ESM contributors like France and Italy will be in need of rescue funding, as the cost of such potential bailouts would break the bank.

3. Estrangement of Non-Eurozone Members: As the currency bloc pursues greater integration, non-Euro members like the U.K. and the Czech Republic drift further away from Europe. They don’t want to cede more sovereignty to Brussels, and the U.K. is even pushing to repatriate some. The momentum in the U.K. for a referendum on EU membership has been gaining steam over the past several months, and although it will likely not occur until the 2015 general elections, its recurrence in European dialogue and in domestic politics is driving a wedge between Brussels and London.

4. Italy’s General Election: Now that technocrat Mario Monti’s government came to an end last week, Italy risks a return to the same political class whose failure to countenance reform made Monti’s appointment a necessity. Italy will hold a general election in February. The result will have major implications for Europe, as Italy is the third largest contributor to the ESM and the Eurozone’s third largest economy. In the EU Observer, I discuss the broken nature of Italian politics and why it is incapable of solving Italy’s economic dilemmas in its current state. Although Monti only made modest reforms in 2012, he at least had the courage to confront Italy’s stagnant politics, in which politicians are all rhetoric and no action. Now, it seems Monti will endorse a coalition of centrist parties that, if given a majority in parliament, will return him to government. But this is a tall proposition, as polls indicate that the center-left party is poised to reap the most votes in February and history shows that centrist parties have always been a marginal force in modern Italian politics. A return of the anti-politician Monti signals a continued commitment to reform and friendly Italian-European relations while a return of Italy’s political class means Italy’s backsliding on Monti’s hard-fought changes and a more adversarial attitude towards Europe and the liberal reforms it is pushing Italy to make.

5. U.S.-Europe Free Trade Deal: A White House-EU committee will release its report in the coming weeks on the feasibility of a U.S.-EU free trade deal. A Transatlantic Free Trade Area (TAFTA) could boost trade between America and Europe by $200 billion annually, according to a study carried out by Sweden’s National Board of Trade. A deal, my colleague Iain Murray writes in the Huffington Post, could also have great potential to increase labor mobility and business productivity between the U.S. and Europe if it liberalizes bilateral immigration to allow a freer movement of workers seeking opportunity but not necessarily citizenship. However, age-old trade stumbling blocs may obstruct agreement, not coming least from Europe’s unrelenting commitment to protect its agriculture through tariffs, regulations, and the biggest single item and subsidy on the EU budget: the Common Agricultural Policy.

Europe, having already chosen more integration at the fork in the road, has a long year ahead of it in 2013. Time will tell whether that will be a path to prosperity or a superhighway to perdition. But one thing is certain. The further that Euro-skeptic member states go down the path to less integration while their pro-integration counterparts continue down the path to more, the harder it will be to bridge the gap between them down the road.