As Greece’s cash crunch continues and its negotiations are moving slowing and tending towards an impasse, it becomes more and more likely that the beleaguered borrower will issue some sort of scrip in order to fund operations while remaining in the Eurozone. How and how well might that work?
By Jérémie Cohen-Setton, a PhD candidate in Economics at U.C. Berkeley and a summer associate intern at Goldman Sachs Global Economic Research. Originally published at Bruegel.
What’s at stake: As Greece faces a severe shortage of euros, the idea of introducing a parallel currency used for some domestic transactions – while keeping the euro in place for existing bank deposits and for foreign transactions – has made a comeback. Although historical examples of parallel currencies exist, the analysis of the idea remains in its infancy. It remains unclear whether and how one could find the right mechanics.
Biagio Bossone and Marco Cattaneo write that according to several recent media reports, both the Greek government and the ECB are taking into consideration the possibility (for Greece) to issue a parallel domestic currency to pay for government expenditures, including civil servant salaries, pensions, etc. This could happen in the coming weeks as Greece faces a severe shortage of euros. A new domestic currency would help make payments to public employees and pensioners while freeing up the euros needed to pay out creditors.
Ludwig Schuster writes that at the present time, we are talking about around thirty recent proposals calling for a parallel currency in the eurozone, and these have been coming from very different backgrounds. While specific proposals have been mentioned now and again in the media, the response has been barely discernible.
Ludwig Schuster writes that the idea of parallel currencies was discussed before the creation of the euro. It was, for example, proposed to first introduce the euro complementary to the national currencies, to soften the transition to complete integration. As we now know, the political decision-makers went down a different path. Similarly, following reunification, the German Federal Government decided to take the Ostmark out of circulation after introducing the Deutschmark instead of keeping it as a secondary currency during a transition phase (the then Minister of Finance, Oskar Lafontaine, was unable to gain support for this idea).
John Cochrane writes that in modern financial markets, a country doesn’t even need the right to print money in order to, well, print money! Bonds are money these days. Greece can print up small-denomination zero-coupon bearer bonds, essentially IOUs. Gavyn Davies writes these IOUs would not formally be given the status of legal tender, since this is explicitly against the terms of the treaties. Yanis Varousfakis writes that the great advantage of such schemes is that it creates a source of liquidity for the governments that is outside the bond markets, does not involve the banks and lies outside any of the restrictions imposed by European institutions.
Biagio Bossone and Marco Cattaneo write that the introduction of a Greek parallel currency could take place in at least two ways. The first avenue would be for Greece to issue IOUs, i.e., promises to pay to the bearer euros upon a future time expiration. Basically, these IOUs would be euro denominated debt obligations issued and used to replace euros to pay salaries, pensions, etc. The second avenue would be to issue Tax Credit Certificates (TCC) and assign them to workers and enterprises at no charge. TCC would entitle the bearer to a tax reduction of an equivalent amount maturing in, say, two years after issuance. Such entitlements could be liquidated in exchange for euros and used for spending purposes. Liquidation of TCC would take place against purchases of TCC by those who would provide euros in exchange for the right to the future tax cuts.
Robert Parenteau writes that when issuing tax anticipation notes the government is essentially securitizing the future tax liabilities of its citizens, and creating what amounts to a tax credit. This tax credit will not be counted as a liability on the government’s balance sheet (British consols are a historical example of this), and will not require a stream of future interest payments. Thomas Mayer writes that demand for special government debt can be created by requiring employers to pay any increase in the minimum wage in this denomination. To protect banks’ balance sheets, the domestic authorities could tax withdrawal of deposits and money transfers abroad at the rate of the discount of the new means of payment to the euro in the market.
Thomas Mayer writes that as labor costs would accrue in part in euro and in another part in the parallel currency, labor costs composed of both euro and parallel currency would decline against labor costs in euro only. This would raise competitiveness and especially help labor-intensive exports (e.g. tourism).
Thomas Mayer writes that there are historical examples of a parallel currency introduced during periods of financial stress, only to disappear later. For instance, California in 2009 paid debt in IOUs that circulated temporarily as a parallel currency to the US dollar. The state repurchased these instruments against dollars after the financial tensions had eased. Also, during the US Civil War, the Union states in the north introduced United States Notes to fund war costs. These notes, dubbed ‘Green Backs’, circulated as currency in parallel to the Gold dollar and were later repurchased by the US government. Against this experience, Argentinian provinces issued IOUs during the debt crisis of 2001. But this was only a prelude to the abandoning of the peso-dollar exchange rate link and the introduction of a floating exchange rate regime for the Argentinian currency.
Biagio Bossone and Marco Cattaneo write that none of those attempts have been carried out on large enough of a scale to successfully address the competitiveness problem, and certainly not in the framework of a monetary union managing a parallel currency in an agreed process with the other member states. J.P. Koning writes that Alberta in 1936 and Greece in 2015 are in similar situations. Both are non-currency issuers within a larger monetary zone. Both have awful credit. Neither is part of a larger fiscal union. In early August 1936, when the program debuted, an unemployed Albertan was paid, say, a $1 certificate for each $1 worth of road maintenance work rendered. This certificate was to be redeemed by the Alberta government two years hence, or in August 1938, for $1 in Canadian dollars.
A Hard Thing to do in Practice
J.P. Koning writes that the issuance of parallel currencies seems like a hard battle to win as anyone planning a Greek parallel currency faces a conundrum. In order to pay its bills the government can do little more than introduce a volatile asset that trades at varying discount to euros. This asset’s volatility and relative illiquidity won’t make it very popular with its recipients. An attempt to render that asset more acceptable in trade by setting a one-to-one conversion rate to the euro will result in a short-circuiting of the scheme as everyone races to redeem IOUs.
J.P. Koning writes that if the IOUs trade at a variable discount to euros, then their ability to serve as a competing medium of exchange will suffer. This lack of liquidity militates against one of the key selling points of a Greek parallel unit, which is to finance the government by displacing some of the existing circulating medium of exchange, euros, from citizens’ wallets. Preferably, unwanted euros would trickle back to the European Central Bank to be cancelled, reducing the ECB’s seigniorage but augmenting the seigniorage of the Greek state as Greek IOUs rush in to fill the void. However, if the new Greek parallel unit cannot compete with the euro’s liquidity, then there will be very little ‘space’ for Greek IOUs to occupy in Greek portfolios, and little relief for beleaguered government finances.
J.P. Koning writes that if the Greek government tries to promote the liquidity of its parallel currency by having the units trade at a fixed one-to-one rate with euros, then a garbled version of Gresham’s Law would overwhelm Greece. The Syriza government’s willingness to buy bad money from the public with good money will promote mass conversion into euros and thereby drive all the bad money from circulation. Greek parallel units will cease to exist.
Robert Parenteau writes that the discount would reflect risks that Greece either change its mind about accepting its own debt for tax payments, or that it would suspend the roll over, essentially defaulting on this new class of debt. Tyler Cowen writes that the problem is that of credibility. Even seeing a new currency, no matter what the plan, could cause people to think their bank accounts will be redenominated, leading to bank runs.