Over the last two months, family business has kept me away from blogging. Before that, I was in the throes of finishing a first draft of a book manuscript. The family business is over and I’m now in the far more relaxed process of fixing the manuscript, so this time I think I think we’re really back!
In December of 2010, I made a bet with Doug Muir and Omar Serrano that the eurozone wouldn’t make it to March 25th, 2013. If any of the big eurozone economies leave the single currency, I win. The bet is structured so that I will lose even if Ireland, Portugal, and Greece all abandon the euro; it has to be Spain or Italy. The loser will either fly across the Atlantic to meet the winner, or pay for the winner to fly to meet them, and then buy them a steak dinner, with port and cigars.
The big question, of course, is how a government could leave the eurozone. Now, Nick Rowe has proposed a way. “Eurozone governments and banks that cannot pay their obligations in euros may end up paying their obligations in a scrip that is not pegged to the euro. A scrip issued by each national government that is worth whatever people think it is worth. And if people start using that scrip as a medium of exchange, and medium of account, it becomes a new money. Sure, Greek supermarkets might prefer payment in euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves. And the supermarkets’ suppliers might prefer payment in euros, but it’s either accept New Drachmas or let the vegetables rot in the fields. And the workers picking the vegetables might prefer payment in euros, but it’s either accept New Drachmas or nothing.”
Sounds almost painless! Matt Yglesias implied so. But it wouldn’t be! It would be a mess and cause the economy to cycle the drain until the government defaulted on its debts anyway. Moreover, it would not cause the scrip to drive euros out of circulation.
Consider, for a moment, what Spanish obligations consist of. In part, they are debt payments. Spain’s debts, however, are denominated in euros and will remain denominated in euros no matter how many nuevas pesetas are printed unless the Spanish government withdraws altogether from the European Union. Rather, the obligations which the Spanish government can insist on paying in nuevas pesetas are the obligations that it owes to its own citizenry: salaries, pensions, unemployment benefits, etcetera. The nueva peseta would trade at a discount against the euro, of course, but that is the idea.
Except ... the incomes of Spaniards would drop in terms of euros. They would be increasingly earning in discounted nuevas pesetas. The problem, of course, is that they would then be paying less taxes in terms of euros. But the Spanish government owes debts denominated in euros! The debt burden would rise. The more the debt burden rises, the more the government needs euros to pay it. The government would, of course, trade nuevas pesetas for those euros. That would increase the discount on nuevas pesetas, further driving up the size of the debt burden, further increasing the discount on nuevas pesetas. (While this is going on, the interest rate on Spain’s euro debt would skyrocket, of course, unless it is by then owed to the European Union rather than private investors. In that case, however, it is very unlikely that Spain would be going around issuing scrip to pay salaries.) At the end of the story Spain’s income in euros falls enough to force the government to default on its euro debts, but only after setting off an inflationary spiral.
There’s a second problem. Rowe wrote, “Greek supermarkets might prefer payment in euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves.” That, however, isn’t correct. Government employees might be paid in new drachma, or nuevas pesetas, but they can exchange those pesetas for euros. The supermarket cannot be required to accept those pesetas unless Spain leaves the eurozone. If the owner insists on being paid in euros, then the customers will swap their pesetas for euros in the market and he or she will be paid in euros. This is a process that has occurred in many high-inflation countries, where people abandoned the local currency for the dollar ... and in most of those countries, the dollar was not legal tender! In short, the logic breaks down at that point: it is not clear why the pesetas would replace the euro as a medium of exchange ... except, of course, to make tax payments.
Of course, it isn’t clear that Spanish government employees (or pensioners, or students, or the unemployed) would want to receive devalued nuevas pesetas in lieu of euros. They would, quite rationally, perceive it as a pay cut. Anyone who owed money would be doubly hit: their debts would still denominated in euros.
Finally, such an action would be perceived (correctly) as a prelude to formally leaving the eurozone, precipitating the mother of all capital flight. Without leaving the eurozone (in fact the country would have to leave the European Union altogether) the government would have no way of combating that flight.
In short, introducing scrip would be a terrible way to exit the eurozone. It would run a high risk of triggering a depression, and it would certainly worsen the country’s debt burden. Professor Rowe is, I think, incorrect. History bears this out: the issuance of patacones (or créditos) in Argentina around 2000 did not result in the creation of a new Argentine currency or stave off default. Rather, they contributed to the depression, and quickly inflated away.
There are many ways in which the eurozone could fail. The issuance of a parallel currency for any length of time strikes me as one of the worse ones. Is there a hole in my logic?