How to fix the Euro
I broadly agree with the Angloamerican consensus about the, um, challenges associated with the Euro from an economic perspective. (David Beckworth has a very nice explainer.) We do understand that the Euro was adopted for political more than economic reasons. Unfortunately, with the benefit of hindsight, the hoped-for political benefits of the common currency seem to have materialized less than the long-warned economic problems, and the economic problems have now poisoned the politics. But we are where we are. I think it unlikely that the Euro will be dismantled except in the context of a crisis that would put the whole European project at risk, even more than recent crises already have. So the challenge, I think, is to come up with institutions that would help mitigate the economic flaws of the common currency, and that might be acceptable in a political union whose electorates, for the moment, feel no great solidarity with one another. Ideally, Europe might pursue a US-style union, where transfers made upon universal criteria to households and business blunt regional wealth and income asymmetries, without provoking the indignation that direct intergovernmental transfers provoke (and would provoke in the US as well). But, after the trauma of recent events, I doubt that a Pan-European safety net will be politically achievable anytime soon.
If “ever closer union” is on pause for now, perhaps Ashoka Mody has it right when he advises, “To stay close, Europe’s nations may need to loosen the ties that bind them so tightly.” Mody’s specific suggestion is that Germany and other Northern European countries depart the Euro, replacing one very suboptimal currency area with two more reasonable blocs. He makes a good economic case, but the political symbolism of a Dollar/Peso Europe would be pretty terrible. I think there is a better way.
In the heat of the recent Greek crisis, many commentators (Coppola, Koning, Mason) noted that “membership” in a currency zone is not a discrete, all-or-nothing thing, but rather a continuum. Many people advised Greece to loosen its bonds to the currency zone just a bit by issuing its own scrip, not denominated in a new Drachma, but in the Euro itself. This is not a new or radical idea. Even in the United States’ famously functional currency union, the State of California has periodically resorted to issuing dollar-denominated “registered warrants” in order to sustain necessary spending through cash crunches. For related proposals, see Bossone & Cattaneo (1, 2), James Hamilton, Rob Parenteau, and of course Yanis Varoufakis.
Issuing Euro-denominated scrip would not mean leaving the currency zone, any more than California’s registered warrants took California out of the dollar zone. However, in the context of the current crisis, if Greece had issued such notes, it would have been interpreted as a first step away from full-fledged membership in the common currency. Looking forward, what would be better would be to normalize the practice, throughout the currency zone, of having governments make domestic expenditures (and only domestic expenditures) in scrip. Greece would issue scrip, and so would Germany. The characteristics of the scrip (but not the value) would be standardized across the Eurozone. In particular, each country’s scrip would be a zero-coupon security, to be redeemed in Euros at face value over an uncertain term. (I think fixed-payout, time-varying claims represent an underused design for securities; I’ve suggested them elsewhere.) Each week, each government would issue a new batch of scrip, to cover that week’s domestic payments. The rules for redemption would be simple: first-issued, first-redeemed, at a pace determined at the discretion of the Treasury without precommitment. Governments whose tax receipts easily cover their expenditures could choose to redeem the scrip nearly instantaneously (after some minimal period, perhaps one week). Governments that wish to run a deficit would redeem scrip more slowly.
The scrip would not become a de facto domestic currency. It would be too fragmented; each week’s vintage would have a different market value. Scrip would not be redeemable at face value to pay taxes.
What this all amounts to is a means by which states can finance themselves with forced borrowing from their own citizens who receive government payments. That sounds a bit mean, but it solves two important problems that currently plague the Eurozone:
International fragility — As the Greek crisis highlights, sovereigns ought not rely upon foreign borrowings in a currency the state cannot issue. The future is always uncertain, and when things go wrong debt securities must default or be renegotiated. That is awful even in small-scale private contexts. In an intersovereign context, it can lead to immiseration on a large scale through depression or war. Successful states mobilize the risk-bearing capacity of their own populations in order to finance government activity. Domestic politics can adjucate conflicts between local creditors and the public’s interest in government services in ways that outside institutions cannot. The interests of domestic creditors overlap much more with other domestic constituencies than the interests of foreign creditors do. International creditors have very little reason to support the work of a foreign government (other than taxation and debt service), while domestic creditors balance their interest in getting paid against other interests related to government performance.
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No constituency for taxation — The Euro was conceived as currency of “prudence”, with its Stability and Growth Pact intended as a straitjacket on government borrowing. So it is ironic that the architecture of the Eurosystem destroyed the incentives of domestic constituencies to support efficient tax collection. By design, the Eurosystem preserved the practical ability of Eurosovereigns to borrow from the banking system inexpensively and at will (a privilege which remains intact, supported by the ECB, for all countries except Greece). Beneficiaries of government expenditures had little reason to support taxation, since the funds they wanted spent could be borrowed. More importantly, the Eurosystem absolved domestic constituencies of the usual consequence of undertaxation, that their incomes and saving would lose value from inflation. Ordinarily, creditors in any country are powerful constituencies for balanced budgets and “sound money”, which sometimes means cutting expenditures but also means raising taxes when expenditures cannot be cut. [1] While Eurozone states that borrowed (whether as sovereigns or through banking systems) did experience higher inflation than creditor countries, the difference was modest. Citizens knew that the value of their money was externally anchored, a Euro would always be a Euro. This imported stability hindered the emergence of any domestic constituency in favor of developing (and exercising) the state’s capacity to collect taxes.
If government domestic expenditures, including transfer payments like pensions, are made in the scrip proposed, the market value of those securities would be directly related to the perceived willingness and ability of the state to tax in order to retire the IOUs at a reasonable pace. The villains’ in lazy creditor morality tales — beneficiaries of the welfare state, govenment employees, vendors of goods and services to the state — would become powerful constituencies for building and maintaining an efficient tax system. This would restore the natural tension in domestic politics, a balance that Eurozone institutions uninintentionally destroyed, between domestic constituencies with an interest in taxation, and other domestic interests who would be net payers of tax and so lobby to streamline expenditures.
This proposal would not fragment the Eurozone. The Euro would remain the universal unit of account and medium of settlement. [2] The proposal would loosen the strictures on government expenditure compared to existing arrangements, but importantly, the risk associated with that extra fiscal freedom would be borne entirely by domestic constituencies, not by external creditors. It would restore to Eurozone states some of the tools they lost for managing domestic shocks, without requiring unpopular transfers or destructive borrowing from other states. It would strengthen Eurozone states, as polities.
The lesson of the Asian Financial Crisis and the extraordinary reversal of financial flows that many Asian countries were able to engineer is that the strength of a state is largely a matter of its capacity to mobilize domestic risk-bearing, rather than rely upon external finance. Eurozone institutions unintentionally short-circuited that capacity. It’s time to restore it.
Some institutional details:
Universality — This proposal should be implemented universally within the Eurozone, as an institutional innovation for the common currency. Within states that have no immediate need for new borrowing, the market value of “state expenditure notes” would be par, and no one would have reason to complain. However, if adoption of the notes were made optional and became associated with perceived-as-weak states, states that could really benefit from financial flexibility and incentives to develop an effective tax system would be reluctant to adopt them for fear of stigma. A fig leaf — “Even the Germans do it!” — is the one concession to solidarity that this proposal requires. Otherwise, this proposal segregates risk, rather than blurring borders, which might be a relief to Northern European publics.
Liquid Markets — All states would be required to arrange low-transaction-cost, liquid markets in state expenditure notes. Recipients of government expenditures who need to make immediate payments may choose to convert them to cash Euros at a discount. Others may hold their notes and await redemption at face value. The discount to face at which the securities trade would provide ongoing information about the perceived fiscal strength of the state, and a very visceral incentive for recipients to see to that strength.
Banking considerations — Domestic, and only domestic banks, would maintain custody of the notes on behalf of customers. However, the notes would be held in segregated accounts, not on bank balance sheets. The Eurozone desperately needs to eliminate bank exposure to the sovereign debt of member states. These proposed notes would be an unusually speculative form of sovereign debt, and absolutely inappropriate as bank assets. Banks would merely provide the service of holding notes for customers and liquidating them into customer accounts on demand, as an important convenience and at regulated spreads.
Definition of “domestic expenditures” — A “domestic expenditure” by a member state would be defined as a payment to a domestic bank account. All domestic bank accounts would be paired with custodial accounts for expenditure notes. States could insist that transfer payments be made to domestic accounts, and might prefer to purchase goods and services from firms with domestic accounts as well. Foreign firms wishing to do business with cash-strapped governments and willing to accept the financing terms might open local bank accounts, but in general this restriction would ensure that most of the notes are spent to domestic constituencies. Speculation in the notes by nonresidents would be discouraged, in order to keep incentives (maximize the rate at which notes can be redeemed) and control (vote and participate in domestic politics) well-matched.
Interaction with traditional debt — The rate of redemption of expenditure notes would be entirely at the discretion of the issuing government, while coupon and principal payments on traditional debt must be made on a preagreed schedule. In that sense, one might imagine expenditure notes to be “junior” to Treasury bills and bonds. However, in the event of default, debt restructuring, or sovereign refinancing by ESM / EFSF / ECB / IMF / etc., expenditure notes would be treated as senior to other Treasury securities. (Expenditure notes would be treated analogously to uninsured deposits in bank capital structures, available for “bail-in” only after other unsecured creditors have been wiped out.) This is very important, as it would encourage buyers of traditional securities to price the credit risk of the sovereign’s full capital structure, including the debt embedded in outstanding expenditure notes. Formal seniority also reduces the risk that foreign creditors will be able to use the notes to shift the consequences of their own poor credit allocation decisions onto involuntary domestic creditors.
Of course, short of an outright restructuring or refinancing, governments might choose to slow redemption of expenditure notes in order to retire traditional debt, which is fine. Strong domestic constituencies would limit the pace of such a reprofiling. If, eventually, finance via expenditure notes largely replaces traditional sovereign debt, that would be great. Domestic finance is much better for a polity than foreign finance, and variable maturity notes decay in value gracefully, while overextension of traditional debt causes disruptive oscillations between complacency and crisis.
Update: Perhaps the first proposal to address Eurozone problems via issuance of scrip came from Warren Mosler. When putting together cites for this post, I did not find that proposal where I had linked it previously, and simply omitted it. Fortunately, my commenters are not as lazy as I am, and point me to this 2012 version by Mosler and Philip Pilkington. I am very glad to acknowledge the prescience of Mosler’s work and the very strong influence of his “Modern Monetary Theory” on the thinking that underlies this post. My apologies for the original omission, and thanks to commenters JKH and Roberto for helping to remedy it.
[1] This may seem a little far-fetched in a US context, where creditors prioritize low taxes over any other thing, but that is unusual. The United States’ “reserve currency” status blunts the effect of debt and money issue on currency value, so creditors have less reason to prefer taxation to borrowing. In a small country with a floating currency, the potential hazard of overissuing government paper is more immediate to holders of local currency debt.
[2] Currencies are no longer “media of exchange” except for very small transactions. They are means of settlement. When I make a purchase with my credit card, I do not trade dollars for goods, but issue a bond (guaranteed by my bank) that may be eventually settled in government money if the recipient demands it. Currencies are media of settlement, not exchange.
Update History:
- 24-Jul-2015, 5:20 p.m. EEDT: Bold update highlighting and acknowledging MMT and Mosler’s earlier work.
- 24-Jul-2015, 10:30 p.m. EEDT: Added links to Bossone & Cattaneo proposals.
Good, out-of-the-box, thinking!
This just could work. I think all sides must be looking for a new approach. Who will take the lead?
July 23rd, 2015 at 7:31 pm PDT
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SRW,
Doesn’t work!
It’s just a bond. The value of these scrips will keep falling for some nations.
Why wouldn’t anyone who works for the government demand to be paid higher in these scrips than in Euros?
July 23rd, 2015 at 7:57 pm PDT
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And I’d add that your plan is a clever plan to default on existing debts and then move on by forcing people a bit to buy new bonds.
July 23rd, 2015 at 8:11 pm PDT
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As usual, I’ll have to comment before I’ve fully read the post, because I don’t know when that will be, and the comment is probably still worthwhile. So better now than never, or after the five minute blogging window expires.
That said:
It looks like it’s best to just leave the Euro (or flee in terror). Because a giant very disparate currency zone without fiscal integration, and on top dominated by inflationaphobes and VSPs, is just a horrifying nightmare of constant recessions, depressions, and lost decades.
And I just don’t see getting much fiscal union. The problem is the classic problem of population heterogeneity and social programs. It gets looked at as giving away money to “those lazy people”. It’s a very hard problem to get around, and it can destroy a social safety net.
And on top, who knows when Germany will get over its inflationaphobea and reliance on illusionary morality plays in deciding monetary policy. Not for a long time. The costs of staying outweigh the costs of leaving, especially especially over the long run. And even if we’re dead in the long run, our children aren’t.
The population heterogeneity is just too much to overcome, and you can really destroy the existing social safety nets. It’s sad, but true. The giant free market is great, the working together with an EU government on basic scientific projects and foreign policy, great. But currency union, a horror, without great social advance first to be able to handle population heterogeneity.
July 23rd, 2015 at 9:29 pm PDT
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My first impression:
VERY well thought out – as is your standard
But you have become MMT
With attribution to Mosler absent
Am I wrong?
How many original ideas are there?
July 23rd, 2015 at 11:23 pm PDT
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Why do you propose that one cannot use scrip to pay taxes? Because of the point about constituencies for them (taxes, that is)?
July 23rd, 2015 at 11:39 pm PDT
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JKH — I tried to cite Mosler, but his relevant proposal seems to have disappeared from the internet. I have a bad link to where it once was here. Certainly my views in general are MMT-influenced, but I’m not sure how to cite that. The best I could find was MMT-identified Parenteau (whose tax anticipation notes are similar to what I recall of Mosler’s original piece. It was coauthored, I think, perhaps with Parenteau himself).
July 24th, 2015 at 2:04 am PDT
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Is there any difference between “medium of settlement” and “medium of account”?
July 24th, 2015 at 2:19 am PDT
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Steve,
I think this is the Mosler paper:
http://www.levyinstitute.org/pubs/pn_12_04.pdf
Regards.
July 24th, 2015 at 5:16 am PDT
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Steve,
I was thinking mostly of the generic characteristic of the purest form of their brand – spending some form of medium of exchange into existence – as opposed to borrowing. That gets applied to the Eurozone situation with facilitating consequence for taxation. The generic idea predates and supercedes the crisis application. Likely a number of papers on it as the crisis evolved but I think the connection was made in the earliest stages.
July 24th, 2015 at 5:59 am PDT
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Roberto & JKH — Many thanks for calling attention to the omission, and doing the work I lazy failed to do and finding another cite. I’ve added an update acknowledging Mosler and pointing to the 2012 version Roberto found (which I think is not quite the same as the one I recalled, but certainly very similar).
July 24th, 2015 at 7:31 am PDT
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Great post – from what you know, is there any legal issue in the Treaties about this?
I cant think of any, to be honest – they can be a dealbreaker.. but not a bad solution, and importantly one that keeps everyone “sort of” happy.
July 24th, 2015 at 7:48 am PDT
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I find the seemingly growing popularity of scrips and parallel currencies among economists utterly bizarre.
This is a debt security used for payment of public spending, not parallel money. At least you avoid the problem of dual exchange rates. But it’s still totally batty.
What you’re proposing is that Euro Area governments issue a senior debt security, with a peculiar feature that its redemption date is unknown and at the discretion of the issuer. Rather than selling these debt securities to raise euros from the public, governments would give them as payment to recipients of public spending, delivering them into special bank accounts.
For governments able to sell debt at low interest rates, this would merely be an inefficient way of selling debt to the public. Ordinary people and companies wouldn’t want to hold them, so a system would crop up in which banks automatically converted them at market rates upon their receipt.
For Greece, such scrip would have very little market value. To sustainably elevate Greece’s spending power, the stock of scrip would have to indefinitely continually grow. Only future nominal growth of actual euro income could give Greece resources to ever start paying down the stock of scrip. So Greek scrip would be worth literally pennies on the euro. And this would actually just be a way for the government to stiff certain groups of recipients of public spending. Inevitably the government would have to stiff those with the least power over government. Suppliers couldn’t be repeatedly stiffed, as they would just raise their prices. Pensioners could be stiffed.
A redemption would be like announcing that a group of holders of scrip had won the lottery. That would invoke suspicion of favoritism, and given the difficulty of making the beneficial ownership of scrip completely transparent, the incentive for such corruption would be very strong. All redemptions could only be paid for by increasing the proportion of public spending paid for in scrip, or by fiscally consolidating, or from nominal growth of euro income.
July 24th, 2015 at 9:46 am PDT
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Prof. Waldman;
Have you considered the Tax Credit Certificates as a possible alternative?
See these contributions
http://www.voxeu.org/article/parallel-currency-greece-part-i
http://www.economonitor.com/blog/2015/07/from-grexit-to-exitaly-lets-stop-this-madness/
BTW, Marco Cattaneo and myself have launched this idea in a contribution last year co-authored with Warren Mosler (unfortunately the article is in Italian)
It would be interesting to know what you think about this instrument.
July 24th, 2015 at 9:57 am PDT
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Prof. Waldam,
Have you considered the Tax Credit Certificates as a possible alternative?
See these contributions:
http://www.voxeu.org/article/parallel-currency-greece-part-i
http://www.economonitor.com/blog/2015/07/from-grexit-to-exitaly-lets-stop-this-madness/
BTW, Marco Cattaneo and myself have introduced this idea in a contribution with Warren Mosler (unfortunately, the article is in Italian)
It would be interesting to know what you think about this instrument.
July 24th, 2015 at 10:01 am PDT
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Since apparently nothing will make exit palatable to the peripheral euro members, it is a good idea to devise alternate solutions to the problems that the currency union has caused. So this post is welcome. However, this fix strikes me as a political non-starter for the same reasons that more orthodox proposals have been.
Although California’s registered warrants are cited as an instance of modern scrip issuance, I don’t think many Californians will report anything but disgust for those episodes. The warrants were issued only to cover one specific liability of the state — tax refunds, a minor form of income that most probably view as a “bonus” — so we didn’t have the sort of outrage that might have resulted if state workers and other recipients of routine spending had been paid in warrants. But I think it’s fair to say that most of us who received refunds in the form of warrants found it indicative of the monstrous dysfunction of the state government at that time. For the debtor nations, having suffered through years of austerity, the introduction of scrip would probably be tolerable if not welcome. But in “responsible, prudent” creditor nations, recipients of scrip would scream bloody murder, just as they do at higher inflation and debt write-downs.
July 24th, 2015 at 11:57 am PDT
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SRW:
I’m not sure that the California dollar was strictly Constitutional, but it came and went quickly enough that nobody really challenged it seriously. We still pay our quarterly estimated taxes on an insane front-loaded schedule though…
July 24th, 2015 at 12:11 pm PDT
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@Tom Warner
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“What you’re proposing is that Euro Area governments issue a senior debt security, with a peculiar feature that its redemption date is unknown and at the discretion of the issuer. Rather than selling these debt securities to raise euros from the public, governments would give them as payment to recipients of public spending, delivering them into special bank accounts.
For governments able to sell debt at low interest rates, this would merely be an inefficient way of selling debt to the public. Ordinary people and companies wouldn’t want to hold them, so a system would crop up in which banks automatically converted them at market rates upon their receipt”
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Thats why this isn’t being recommended for govts able to sell debt at low interest rates! This is being recommended for Greece, who because of political conditions (not real economic conditions) cant “spend” or issue debt. This isn’t being recommended as a permanent condition but just a s a way for Greeks to weather this crisis for them selves and eventually go back to Euros.
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“For Greece, such scrip would have very little market value. To sustainably elevate Greece’s spending power, the stock of scrip would have to indefinitely continually grow. Only future nominal growth of actual euro income could give Greece resources to ever start paying down the stock of scrip. So Greek scrip would be worth literally pennies on the euro. And this would actually just be a way for the government to stiff certain groups of recipients of public spending.”
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Not necessarily. I think it all would depend on the number of greeks who were committed to it working. Its not unlike any other “buy local” initiative. The number of suppliers who commit to rebuilding Greece from within will strengthen the scrip. I do think that Greek tax liabilities would need to be extinguishable with the scrip to really make it successful however.
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” Inevitably the government would have to stiff those with the least power over government. Suppliers couldn’t be repeatedly stiffed, as they would just raise their prices. Pensioners could be stiffed.”
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All POSSIBLY true. But again the outcome can be determined by the commitment of the Greek people. They don’t need any German advice or help.
July 24th, 2015 at 12:37 pm PDT
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It seems like a very logical technocratic idea that would have little practical chance of ever being adapted. Have you by chance been reading any Kotlikoff recently?
July 24th, 2015 at 1:19 pm PDT
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@OP It seems like, unless Greece switched to a hard balanced budget (not just primary balance, mind you!) the time delay before which you could expect to be able to redeem your scrip would steadily increase toward infinity. You say people who need cash immediately could sell their scrip on the market at a discount, but after a point this won’t be true. As the time horizon (and default risk) gets high investors will demand big discounts to the point where your pensioner/contract/etc. is not getting an adequate payment; and these are people who actually do need payment to live or stay in business.
So as Tom said above it seems like contractors will demand massive price markups to accept these things, and then turn around and sell them to investors at whatever exchange rate investors are willing to accept. At that point it is just regular domestic bond issuance subject to all the market constraints Greece faces now. On the other hand, pensioners cannot just raise their bids, so this will turn into an effective massive pension cut. As you say this will create a constituency for tax increases but in the meantime, Syriza has promised to protect pensions. Ditto for unemployment benefits and disability benefits; they would have to be continually increased or become worthless (an idea that this is just scrip inflation and not a fatal problem is emerging in my mind but I’m not ready to develop it. You inflating scrip is tied to a non-inflating euro so . . . hmm . . .) Government employees will behave similarly to contractors. Perhaps this is a decent scheme to achieve public sector wage cuts and internal devaluation, but people won’t be fooled; may as well just cut wages by cutting wages.
Then there is the political problem. Germany and the Netherlands will never agree to something like this. They’re supposed to issue a bunch of scrip just to redeem it a week later? From their perspective that will just inconvenience everyone for no reason. And it has that funny money feel to it that is the antithesis of the self-aggrandizing, hard money balanced budget moralizing self-conception Germany has built up. You’d have to sell it as a noble sacrifice the Germans make to help Greece, and we know that won’t fly. I think it would be way easier to talk Germans into reintroducing the Deutschmark than into doing to this.
@winterspeak, California actually has paid its public employees in scrip. The state government does it for a couple months almost every year. The reason is the state operates on annual budgets, but has a bunch of ultra-dumb constitutional amendments that make it really hard to pass a budget and even harder to enact taxes. Plus the California Republicans are dead-set against any taxes and most public spending so they resist every budget. So typically the legislature doesn’t manage to pass a given year’s budget until well after the previous year’s budget has expired. This means that the state agencies have no spending authority and can’t pay their employees or contractors. As a remedy a convention has developed wherein everyone goes without pay during the gap and then the agencies give them the back-pay when the budget is finally passed (the budget covers the whole year, including the part already in the past). This has matured to the point that the state actually has agreements with certain private banks, wherein the banks will pay state employees on time and the state pays the banks back later at interest. However in this system there is no physical “scrip”, no asset that the state pays in lieu of dollars. Instead the state straight up doesn’t pay people and people just keep working on faith that the state will pay them eventually (not sure what federal employment law says about this, maybe it doesn’t apply to states). Or alternatively it gets banks to pay them in genuine dollars.
@Greg: You seriously need to go reread the OP. Steve is proposing this as a permanent measure to be adopted by all eurozone nations.
July 25th, 2015 at 12:52 pm PDT
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July 25th, 2015 at 4:07 pm PDT
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July 25th, 2015 at 9:20 pm PDT
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@Chaz
When you say ” permanent measure to be adopted by all eurozone nations”….. so what! All that means is that he is not suggesting something that only Greeks can do now. It would mean that any Eurozone country would have this type of option….. which is of course THE POINT of suggesting it. It gets around the issue of no fiscal consolidation in the Eurozone and allows at least a modicum of sovereignty. Is it a panacea? Of course not. Is it way better than the policies which hamstring countercyclical spending by governments in the service of “sound finance” religious beliefs? You bet.
Just because someone has a tool at their disposal doesn’t mean they would necessarily use it.
July 26th, 2015 at 3:13 am PDT
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[…] Hathaway to prosper long after he steps down as CEO. (Barron’s) • How to fix the Euro (Interfluidity) • Gold is doomed (WonkBlog) • Housel: Why rules of thumb beat precision (Fool) • A Dozen […]
July 27th, 2015 at 4:39 am PDT
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«By design, the Eurosystem preserved the practical ability of Eurosovereigns to borrow from the banking system inexpensively and at will»
That’s not quite right! Because this ability was given to all EU governments, including those outside the eurozone. My usual quote from this irritated-sounding paper by the Bank for International Settlements:
http://www.bis.org/publ/qtrpdf/r_qt1312v.htm
«In the European Union (EU), authorities have allowed supervisors to permit banks that follow the IRB approach to stay permanently on the Standardised Approach for their sovereign exposures.
In applying the Standardised Approach, in turn, EU authorities have set a zero risk weight not just to sovereign exposures denominated and funded in the currency of the corresponding Member State, but also to such exposures denominated and funded in the currencies of any other Member State.»
“zero risk weight”!!! HAHAHA!!!
«(a privilege which remains intact, supported by the ECB, for all countries except Greece).»
That privilege is intact for Greece too: the greek government continues to have the privilege to borrow cheaply and at will from any *solvent* bank in the eurozone with the full support of the ECB, as long as the solvent bank is *willing* to lend (that is, donate) to the greek government. The ECB will just refuse an unlimited overdraft to *bankrupt* banks, and of course the major greek banks are bankrupt *again*, unless there is a prospect of them being recapitalized by solvent governments. The ECB has modulated their overdraft to the greek banks not in any “political” way, but in direct (if overly generous) proportion to the willingness of solvent governments to take them out of bankruptcy. Because the ECB treaties forbid it from offering overdrafts to insolvent banks, and the ECB have interpreted “insolvent” in amazingly narrow ways, to favour the greek banks and the greek government.
«Beneficiaries of government expenditures had little reason to support taxation, since the funds they wanted spent could be borrowed. More importantly, the Eurosystem absolved domestic constituencies of the usual consequence of undertaxation, that their incomes and saving would lose value from inflation.»
This narrative seems to me quite wrong, because there have been several EU (not just eurozone) countries that, given the ability (thanks to their implementation of the BIS rules) to borrow a lot cheaply while it lasted, have not taken it up in a dramatic way, unlike Greece, and in lesser ways when they did.
M Lewis in his Vanity Fair articles and his “Boomerang” book describes the situation well:
«The tsunami of cheap credit that rolled across the planet between 2002 and 2007 has just now created a new opportunity for travel: financial-disaster tourism. The credit wasn’t just money, it was temptation. It offered entire societies the chance to reveal aspects of their characters they could not normally afford to indulge. Entire countries were told, “The lights are out, you can do whatever you want to do and no one will ever know.” What they wanted to do with money in the dark varied. What they wanted to do with money in the dark varied. Americans wanted to own homes far larger than they could afford, and to allow the strong to exploit the weak. Icelanders wanted to stop fishing and become investment bankers, and to allow their alpha males to reveal a theretofore suppressed megalomania. The Germans wanted to be even more German; the Irish wanted to stop being Irish. All these different societies were touched by the same event, but each responded to it in its own peculiar way. No response was as peculiar as the Greeks’, however: anyone who had spent even a few days talking to people in charge of the place could see that. [ … ] As it turned out, what the Greeks wanted to do, once the lights went out and they were alone in the dark with a pile of borrowed money, was turn their government into a piñata stuffed with fantastic sums and give as many citizens as possible a whack at it.»
It all depends on the culture of the elites and the way and how heavily the voters lean. In banana republics run by viciously upward-redistributive kleptocracies with significant patronage networks the outcome was very different from other countries.
July 27th, 2015 at 12:20 pm PDT
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On the general nature of the proposal of paying in drachma-bonds those who receive their money from the government I wrote a very similar analysis around here about R Parentau’s comical TAN proposal:
http://neweconomicperspectives.org/2015/02/get-tan-yanis-timely-alternative-financing-instrument-greece.html#comment-1230219
The main issue with forcing drachma-bonds onto the populace is that as Y Varoufakis also pointed out the eurozone treaties make only the euro legal tender, and therefore any greek business or citizen paid in drachma-bonds would be able to sue the government for payment in euros, the ECJ would force the greek government to do that, and the EU treaties make the ECJ judgements valid in all EU countries, and the greek government would then have to pay euros or leave the EU.
Now that W Schauble has come out for letting Greece out of the eurozone probably there is a chance to amend the eurozone treaties to allow drachma-bonds. But that would have to be allowed for *all* eurozone countries, and that would make a big confusion.
The other main problem with SR Waldman’s scheme, which is much better than the laughable TANs from R Parentau, is that «The villains’ in lazy creditor morality tales — beneficiaries of the welfare state, govenment employees, vendors of goods and services to the state — would become powerful constituencies for building and maintaining an efficient tax system» is wishful thinking.
Because the greek government is run by a kleptocracy, a large part, and perhaps even a majority of those “villains” are actually poor hard working people, who are essentially powerless, while the large minority of members of the kleptocracy would manage to get paid in euros or just jack up the bribes, embezzlement and other grifting that is by far the largest part of their income.
The reason why the euro is so popular with low income people in Greece, while the middle class and the upper class are quite happy with a return to the drachma, is that the poor for the first time probably for over a hundred years, have been paid in real money, money that doesn’t vanish with time, and they are prepared to suffer a lot to avoid being perpetually crammed-down by their kleptocratic masters.
When a government goes bankrupt someone has to be crammed-down as s Johnson wrote in his excellent article in the Atlantic “The silent coup”. The greek recipe for a long time has been the classic kleptocratic one: the government borrows a lot when the times are good to feed the controlling kleptocracy, when times go bad the government defaults on the debt and devalues the currency to cram-down wage earners in general and government employees, pensioners and suppliers in particular, and then uses the poverty of the victims as misery-porn to beg for “humanitarian” loans; all while the kleptocrats kept their huge wealth abroad in hard currency and in ard assets.
Put another way, before the euro kleptocratic banana republics have always had a dual-currency regime, with the kleptocracy doing business and savings in hard currency via foreign banks, in Greece it used to be the german mark or the swiss franc, and those excluded from it paid in ever- falling drachma-bonds issued with great productivity by the local banks. In countries run by even more rapacious kleptocracies than the greek one nobody, not even the desperate poor, ends up accepting the local whatever-bonds, and the economy becomes dollarized. The dual-currency story is hard perhaps to understand in the USA, but it is the norm in large parts of the world, not just Greece.
The mild form of the kleptocratic dual-currency story has been happening in Greece quite regularly. It has been happening regularly even if the «beneficiaries of the welfare state, govenment employees, vendors of goods and services to the state» have been regularly crammed-down if they were not part of the kleptocracy because they have never been «powerful constituencies» and would not become so just because they be forced to receive the drachma-bonds in this proposal.
Banana republics stop being dual-currency areas, with a hard foreign currency for the powerful kleptocratic elites, and the soft local currency (when it exists) for the powerless low income people, when the middle and upper classes decide to reduce their kleptocratic tendencies to a level compatible with enabling a single currency. Greece is far from that, even if low income people in Greece probably hope that staying in the euro will be the catalyst for a change of mind of their middle and upper class masters.
July 27th, 2015 at 1:10 pm PDT
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Finally a counterproposal of my own, a bit tongue in cheek: let’s invert for Greece the usual dual currency story, of a strong foreign currency and a local weak one, with a very quick, cheap and simple scheme, by amending the eurozone treaties by letting any eurozone country adopt in parallel to the euro the cambodian riel!
Instead of creating a new currency scheme or a new bond scheme to pay government recipients, just adopt an existing weak currency, and the riel is so weak that it is barely circulating even in cambodia.
There is no need to print new drachmas or new notes: just pay a small royalty to the cambodian government, or in early days just airlift to Greece a few containers of riel banknotes (typically sold by weight I guess), and the greek government can be in business in days with an official sovereign currency and no delays to create a new drachma or new notes.
Instead of the usual dollarization of the economy, Greece can try rielization. It is cheaper, faster, simpler than new drachmas, TANs or the new notes described here.
Your read it here first! :-)
Some web searching uncovers some amusing links:
http://www.scirp.org/journal/PaperInformation.aspx?PaperID=23337
«The paper uses a dual-currency search theoretic approach to demonstrate that it is possible to induce the acceptance of a local currency in a dollarized economy. [ … ] if the government can raise a sufficiently high probability of exchange between the two currencies»
https://improveafrica.wordpress.com/2013/09/10/worthless-currencies-an-argument-for-embracing-dollarization/
«The use of weak and fragile currencies has made poverty worse in many African countries. Weak currencies have left countries clutching bundles of useless cash, while real wealth is shipped elsewhere. Fragile currencies have turned political problems into economic crises through depreciation, rampant inflation and extreme poverty. Africa should embrace dollarization to avert the poverty trap.»
July 27th, 2015 at 1:24 pm PDT
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July 28th, 2015 at 10:50 am PDT
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[…] Raising the minimum wage – mainly macro Attracting students to economics – Vox EU How to fix the Euro – interfluidity Proxies for monetary disequilibrium – Nick Rowe After the crash, can biologists fix […]
July 30th, 2015 at 1:46 pm PDT
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«the hoped-for political benefits of the common currency seem to have materialized less than the long-warned economic problems, and the economic problems have now poisoned the politics»
Well, after several years of dealing with various flavors of grifters and scammers claiming to be the greek government, long late meetings with those grifters and scammers, being constantly attacked as evil monsters by the same grifters and scammers and their patronage clients, I think now all 18 eurozone governments feel more together economically and politically than ever, more unified than ever, and so has been public opinion in all those 18 eurozone countries. It is notable that all offers and agreements with the greek government have been taken at unanimity.
This crisis has brought the eurozone together, if only in exasperation! :-)
More seriously, the crisis countries like Ireland, Portugal, the baltics, etc., after receiving for decades large net transfers and huge loans at very low interest rates from the richer EU countries, mainly of course financed by Germany (transfers) and France (loans), and misspending them famously, when they had to choose between between blowing up the financial systems of those richer countries and suffering a fall back to pre-bubble levels because of (mostly) their greedy mistakes, they demonstrated that they are reliable political and economic partners. Those richer countries won’t forget that soon.
Germany in particular won’t forget anytime soon that in none of those countries this kind of awful vileness was as popular as in another:
http://www.thetimes.co.uk/tto/news/world/europe/article4357405.ece
http://www.dailymail.co.uk/news/article-2054406/Furious-Greeks-lampoon-German-overlords-Nazis-picture-Merkel-dressed-SS-guard.html
http://www.dailymail.co.uk/news/article-2101614/Greece-debt-crisis-Greeks-brand-Germans-Nazis-taking-control-economy.html
http://www.bloombergview.com/articles/2015-05-07/greece-saunters-across-the-autobahn
«the new Greek prime minister’s condescending lectures to the German people, in the unquenchable Greek thirst for magazine cartoons of German leaders in Nazi uniforms»
August 6th, 2015 at 1:12 pm PDT
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