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How a Flaw in The Human Brain Is What's Preventing a Solution in Europe

Gen Nishino | Riser | Getty Images

People don't understand money. That's why the Eurozone crisis isn't getting solved.

Let's back up for a second: This morning we wrote about a radical note from Jefferies, which argued that if the ECB wasn't going to buy Italian debt, then at least the BoE should do it.

The argument: Well, if Italy goes down, then it will buffett the UK economy pretty hard (including its banks) so might as well get pre-emptive and go ahead and do it.

We can safely say this will never happen, but not because it's not a good idea. The idea is fine from an accounting economic standpoint, but everyone in the UK would go ballistic.

Same with the Fed if it tried to monetize Italian debt... Everyone would turn on Bernanke.

And the reason everyone would go ballistic, is because people don't understand money. Their minds still inhabit a gold-standard world, where central banks can somehow "run out" of money, and bailouts automatically "cost the taxpayer" billions.

This was a point that Paul Krugman recently made in a post about banking and fractional reserve lending... Let me add that the fractional reserve thing exhibits a characteristic common to a lot of what I see in the Paulist camp: they have an oddly antiquated notion of what money and finance are about, one that misses the “virtualness” of the modern world. They still think of money as being pieces of green paper, rather than what it mostly is now, zeroes and ones in some server somewhere. They still think of banks as being those big marble buildings, in a world in which most banking is a lot more abstract than that.

The only problem here is that Paul Krugman aims too narrowly. It's not just the Ron Paulists who have such a hard view of money.

Alan Greenspan, who ran the Fed, said in testimony...

But as I've testified here before to a similar question, central bankers began to realize in the late 1970s how deleterious a factor the inflation was. And, indeed, since the late '70s, central bankers generally have behaved as though we were on the gold standard. And, indeed, the extent of liquidity contraction that has occurred as a consequence of the various different efforts on the part of monetary authorities is a clear indication that we recognize that excessive creation of liquidity creates inflation which, in turn, undermines economic growth.

The fact of the matter is that we're not on a gold standard. Period. A system of fiat money, where the only limits are on resources (labor, commodities, etc.) is nothing like a gold standard, where there is actually a hard limit on the amount of money there is.

The problem is, it's hard to conceptualize the non gold standard world, since for most of us money is actually finite, and it's this bias the prevents solutions in Europe.

This story originally appeared on Business Insider

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