An emergency currency regime for Greece
With the agreement of the Eurogroup to accept the Greek reform proposals the latest crisis in the euro area seems averted – for the moment. Apparently, Greece had no other option than to give in and prolong its current bailout program as requested or leave the monetary union. The latter would have been a complete surrender to the challenges of a common currency – not of Greece but of its European “partners”. All can-kicking in recent years, all refusals to face the needs of a functioning monetary system, all costly bank bailouts to prevent a destabilization of national financial markets and policy structures, and all sacrifices made by individual countries under harsh austerity constraints in order to “save the euro” might have been fruitless as a Grexit inevitably would have triggered a chain reaction among other member countries and possibly the union’s breakup.
The danger is not banned yet: Gabriele Steinhauser (Wall Street Journal) wrote immediately after the official consent that the IMF and others still have concerns over the seriousness of the reform measures. Alkman Granitsas (Wall Street Journal) listed five things to know about Greece’s proposed reforms which its creditors might not expect or approve. And in order for the funds to be released the program must be implemented successfully and all its conditions met.
How real is the risk of a Grexit under these circumstances? In principle, no one could force Greece to leave the eurozone. As Phoebus Athanassiou wrote in an ECB Legal Working Paper: “[W]hile perhaps feasible through indirect means, a Member State’s expulsion from the EU or EMU, would be legally next to impossible.” And voluntarily they would not go. Polls show that up to 80 percent of Greeks want to keep the euro. This is the dilemma Greek Prime Minister Alexis Tsipras is facing, as the NZZ noted the other day. On the one hand most Greeks were supporting his unbending attitude in negotiations with the Eurogroup. On the other hand, they want to keep the euro which, as almost everybody is telling them, would have been impossible if he had succeeded. The question is, however, whether in this special case the Greeks eventually could not both have their cake and eat it.
Let us take stock. Greece is a small country in a monetary union which is both politically and economically largely dominated by Germany and a couple of other members. The adoption of an artificial common currency and centralized monetary policy is a unique experiment which prevents the Greek government from adjusting the exchange rate to domestic needs. Despite this restraint – and in contrast to the many myths prevailing in public debates – Greece managed to achieve an extraordinary economic performance in international comparison in recent years. Its fiscal consolidation is the fastest among European countries. Its change in overall responsiveness to Going for Growth recommendations has been the highest among OECD countries. It is leading the OECD reform ranking. Its government revenue in percent of GDP is rising. Its competitiveness as measured in Unit Labour Costs is higher than the euro average. (See Brian Lucey‘s collection of charts for these and other figures.)
As Greece’s Finance Minister Yanis Varoufakis told the Eurogroup (quoted by Tim Worstall, Forbes):
“We are committed to sound public finances. Greece has made a vast adjustment over the past five years at immense social cost. Its deficit is now below 3% in nominal terms, down from 15% in 2010. Its primary surplus has reached 1.5% at the end of last year, its structural balance, as measured by the IMF, has reached a surplus of 1.6%, the best performance in the EU.“
Solvency and liquidity
Above all, Greece is facing two major problems:
2. A widespread fear of Grexit and currency conversion, which brings Greeks to withdraw cash from their banks and drives private capital out of the country, strongly limits the scope for policy action.
A bank run is the greatest immediate danger. In what the Wall Street Journal called The Greek Re-Vote in February an estimated €2 billion (others talked of €5 billion) was leaving the country each week already. Maybe the prospect of an ever larger number of bank customers withdrawing their deposits and the resulting threat of bank illiquidity was the main reason for the U-turn of the Greek government accepting the Eurogroup deal in contrast to earlier statements.
Observers wondered about the role of the ECB in this situation. Guntram B. Wolff (Bruegel) pointed to the fact that “[i]n a normal bank-run, a central bank needs to provide unlimited liquidity to allow all depositors to withdraw their cash if they wish to. For the Greek banking system, the theoretical limit would be the size of all deposits. … The Greek banking system has a pretty large deposit base of 243.8 billion (December 2014).”
Although recently the ECB increased its amount of Emergency Liquidity Assistance (ELA) from 60 billion to 65 billion the question arose whether it would be prepared to go beyond this and act as a lender of last resort to the whole system. Guntram B. Wolff wrote:
“[M]y answer would clearly be “it depends”. If there is certainty that Greece stays in the euro, its banks remain solvent and a political compromise is reached, then the answer is an unambiguous “yes”. More problematically, if there is a clear political consensus that no agreement between euro area partners can be found, then the ECB cannot provide unlimited funding. The reason is simply that the ECB would know that in the case of a certain exit, the Greek banks would be insolvent as the economy is collapsing and therefore the value of the assets of the banks would be inferior to the liquidity provided. And even if Grexit wasn’t certain but government default was, parts of the banking system would be insolvent requiring limits on ELA.”
What would happen if Greece would run out of funds? Nikolaos Chrysoloras, Marcus Bensasson and Christos Ziotis (Bloomberg) described How a Liquidity Squeeze Could Push Greece Out of the Euro. In this case Greece would not only be unable to further service its international debt obligations. State and banks would no longer be able to adequately provide the economy with cash. Government would be forced to cut expenditures and also to establish a new currency to secure payments. Many would regard this as a first step to a de-facto exit from the euro area and a return to the drachma.
But maybe there is still another option: New currency could be introduced in parallel to the euro explicitly for a limited time and a well-defined limited purpose with the intent to return to the status quo ante as soon as political and economic prospects do no longer cause panic and anxieties, confidence in the ECB’s lender-of-last-resort function is restored and capital flows are reversed.
In the past, there have been several proposals to introduce a parallel currency as a solution to the Greek dilemma. Sven Böll (Der Spiegel) reported on a blatant sort of cleansing approach which aimed at ejecting Southern European crisis countries from the monetary union “in a civilized way”. Accordingly, not only the drachma but also peseta, lira and escudo would be brought back alongside the euro. Their countries’ national central banks would tie these currencies to the euro at fixed rates which would allow them “to remain connected to the euro and devalue their currencies and still have a calculable form of payment at their disposal.” … “Withdrawal from the euro would take place “in an orderly and certainly cautious manner,” and could possibly be reversed after a few years through a complete return to the monetary union.”
Another concept to separate the wheat from the chaff via parallel currencies was proposed by Thomas Mayer, former Chief Economist of Deutsche Bank Group and Head of DB Research, and now a senior fellow at the Center for Financial Studies at Goethe University Frankfurt and external adviser to Deutsche Bank. Considering the likelihood of a euro breakup he mused about the alternative of a “mutation” of the existing monetary arrangement to a three-tier monetary union. He explained:
“The first step in this process would be for northern European countries to index all financial and real-economy contracts, as well as payments to and receipts from governments, to national inflation rates. This protects these countries’ residents from the effects of the ECB’s looser policy. Should inflation really kick up, however, the contracts could be redenominated in a new currency whose supply would be managed by a subsidiary of the stronger countries’ national central banks.
The parallel currency would exist only virtually, as a means to store wealth in countries with secure government finances and strong trade links with Germany. The euro would continue to be used as the basis for cash transactions. …
“Softening” the euro still might not be enough for countries like Greece, however. When external funding for these governments’ budget deficits eventually dries up, they could be made to issue IOUs to their domestic creditors. When these IOUs start to be traded, they could assume the role of a second parallel currency. But this currency would exist only as a means of transaction; the euro would remain as a store of value in the background.
Thus a three-tier euro zone would emerge. Countries like France, Italy and Spain would become the “core” countries, where the euro would be used both as a medium for transactions and a store of value. Germany, the Netherlands, Finland and its peers would constitute the “upper tier,” where the euro is a means of transaction but not a store of value. Countries such as Greece, Cyprus and Portugal would compose the “lower tier,” where the euro is a store of value but not a means of transaction.”
Matthew Boesler (Business Insider) elaborated further on Thomas Mayer’s idea of a parallel currency for Greece. Summarizing his approach he wrote that the Troika could decide on “a partial stop in financial assistance, with continuing support for debt service needs and the Greek banking sector but no further support for the financing of the government’s primary expenses.”
Where would the cash come from to cover the latter expenses? Boesler, citing Mayer:
“[A] plausible response of the government to the shortage of euro cash as a result of the end of financial transfers would be to issue debtor notes (IoUs) to its creditors, promising payment as soon as fresh euro cash would become available. As creditors lacking euro cash would have to use the IoUs to settle their own bills, these instruments would assume the role of a parallel currency (let’s call it Geuro).
The Geuro would probably quickly be used in most domestic transactions. For the purchase of essential imports, Geuros would have to be exchanged against euros, most likely at a hefty discount of 50% or more. Since an increasing number of domestic goods, services and wages would be paid in devalued Geuros, the export sector could reduce its prices in euro and regain competitiveness against foreign suppliers. …
Greece could formally remain in EMU, execute the exchange rate devaluation necessary to regain international competitiveness, and in the future decide for itself through issuance of Geuros, whether and over what time span it would want to return to a hard currency that is stable against the euro. It could eventually even return completely to the euro by repurchasing Geuros against euros.”
David Marsh, too, reflected about a parallel currency for Greece. In the event that talks with creditors break down, in his concept Greece would also remain part of the eurozone but with different arrangements for domestic and international transactions. He wrote:
“Greece would have to print its own currency, the new drachma (ND), which would be heavily depreciated. All domestic wages and prices would be fixed in ND, with the euro still in force for international payments. The government could initially peg the ND wherever it wished, maybe 10% below par with euro, but could then leave it to float lower. Very likely the new currency would settle 20 to 30% below the current imputed value of the Greek currency against the euro.”
The fixing of contracts and payments in a new currency with rapidly declining value is exactly what many Greeks fear. The mere announcement of such a policy would result in more cash withdrawals and capital flight driving the country ever faster into ruin.
But what if the state makes it quite clear from the beginning that
– no existing contracts would be touched;
– in reaction to a liquidity shortfall new currency could be issued by the government, but also by any other economic agent with public acceptance deciding whether it gets established or not;
– new currency which would be established beside the euro would be solely intended to transitorily fill the gap which the ECB left in retreating from its lender-of-last-resort function;
– its use, and that of the euro, would not be restricted to a special purpose such as government transactions, domestic sales or international trade;
– the exchange rate between the euro and any new currency would be negotiated freely in transactions;
– denomination could be chosen freely by the issuer – be it in euro or another currency or a precious metal;
– the circulation of new currency would be limited explicitly to the time of the shortfall in euro liquidity. Once economic prospects improve and the role of the ECB becomes less ambiguous it would cease;
– any kind of new currency beside the euro would be held and dealt in entirely voluntarily.
This is the concept of Notgeld (necessity money or emergency money) as it is known from history.
There is a long tradition of emergency money in times of crisis. However, as noted by Iliazd in the introduction to a remarkable Flickr Notgeld album of over 5,000 mostly German notes “Notgeld was not the norm but the exception in the history of currencies” making it a sought-after collector’s item.
Here are some extracts from the introduction to illustrate the nature of the instrument:
“Notgeld (emergency currency) was issued by cities, boroughs, even private companies while there was a shortage of official coins and bills. Nobody would pay in coins while their nominal value was less than the value of the metal. And when inflation went on, the state was just unable to print bills fast enough. Some companies couldn’t pay their workers because the Reichsbank just couldn’t provide enough bills. So they started to print their own money – they even asked the Reichsbank beforehand. As long as the Notgeld was accepted, no real harm was done and it just was a certificate of debt. Often it was even a more stable currency than real money, as sometimes the denomination was a certain amount of gold, dollars, corn, meat, etc.
It was not legal tender, so the only people who dealt in it were those that wanted to. It was very stable and debt free. To keep it flowing, sometimes it was set up to lose 2 or 3% of its value every month, which kept people from hoarding it.
There were several advantages to issuing Notgeld. First, it stabilized local government and local markets, so people could sell and buy what they needed and government services kept functioning. Second, it was a stabilizing influence on the real currency, which was still used. And third, it helped to concentrate the real currency at the government level, so they could import things not found locally.
It was a controlled complementary currency, so prices were set by whoever issued it. In effect, this created wide scale and orderly rationing.”
Reading this I was wondering what role a digital currency such as Bitcoin could play in such a case these days …
The introduction of emergency currency beside the euro would allow the Greek government to flexibly react to a liquidity shortage, mitigate its effects and resume negotiations with its creditors under less pressure. In contrast to concepts of a parallel currency emergency currency would be created where it is needed. The spreading to many issuers would reduce the risk of default. Different conditions and denominations would secure the attractiveness in different circumstances.
In analogy to an argument used by Martin Sandbu (Financial Times) Greece cannot make Notgeld legal tender beyond the payment it is used for. But an emergency currency would enable the government to economise on euros, leaving them for cases where Notgeld would not be accepted. These would include
– cases where emergency money is not accepted in domestic transactions;
– most international transactions;
– international debt payments.
Since living and making economic policy in a state of emergency is not desirable and promoting economic growth has highest priority to end it as soon as possible, default on existing debt and negotiation of debt restructuring is a real option. As Michael Pettis stressed, trade and investment flow to countries with good future prospects, and not to countries with good track records. Once growth prospects improve, with among other things a manageable debt burden, “foreign businesses and investors will fall over each other” to regain the market regardless of a country’s debt repayment history. He emphasized: “This is one of those things about which the historical track record is quite unambiguous.”
In another article Pettis further elaborated on the point:
„Debt can be thought of as a moral obligation when a loan is extended from one individual to another, especially if there is no interest on the loan. But loans to businesses or to sovereign entities are business transactions, and they should be managed as such. The only moral obligation in restructuring sovereign debt, it seems to me, is for policymakers to fulfill their political responsibilities to do what is in the best interests of their citizens and to participate in a responsible way in the global community. The debt restructuring process is, in other words, morally neutral.”
There must be innumerable disadvantages of this proposal to allow for emergency currency and I am looking forward to your comments on it. Surely, at first glance, the idea seems crazy. With several currencies in circulation economic processes risk to become more cumbersome, less efficient and less transparent. But, as Michael Pettis asked in a different context: Compared to what? The Greek economy is already in disastrous shape, its debt burden is choking any long-term economic recovery, it can never grow its way out of its debt no matter how radical and forceful the reforms, and a liquidity shortfall may put an abrupt end to any remaining illusion of the benefits of EMU membership.
Examples of parallel currencies in and outside the euro area have shown that they can function remarkably well on a local level, promoting entrepreneurial initiative and stimulating economic activity. For Greece, fending off the immediate dangers, regaining control over its economic – and to some extent within existing restraints – monetary situation as prerequisite for long-term recovery should take precedence over all other political considerations. Maybe a crazy idea is what is needed now.