Wednesday, May 30, 2018

Parallel Currency - Revisiting Justified?

Ever since it became public that Yanis Varoufakis had worked on a Plan X for a parallel currency, the term 'parallel currency' has assumed a bad odor. When it became public that Star-Lega of Italy were also eyeing the alternative of a parallel currency, markets went into shock. But why?

Before the introduction of the Euro, every country had a parallel currency. It was called 'local currency'. Business was conducted in other currencies as well and they were called 'foreign currency' (I remember when, years ago as a tourist, Greeks seemed to prefer getting paid in Deutsche Marks rather than Drachma). The difference between the two currencies is that the local currency was the only legal tender in each country and it could be printed by each country whereas the foreign currency had neither advantage.

With the Euro, the members of the Eurozone gave up their local currency and opted for a foreign currency as their only legal tender, a foreign currency which they could not/cannot print. What's badly missing now is a local currency which a country can print, even though it may not be legal tender. In short, a parallel currency.

Greece, actually, already has one parallel currency - postdated checks. If B accepts a check from A, dated for payment 3 months later, in lieu of cash payment, then the postdated check has assumed the character of a currency. B will only accept the postdated check in lieu of cash payment from A if he knows that he can pay his creditors' bills with that check. I do not know how common this practice is today but I remember that, only a few years ago, I was told that postdated checks were a rather common form of payment among small businesses.

Assume that Greece starts with a parallel currency called 'Drachma' with an exchange rate of initially 1:1 to the Euro. Assume further that the Bank of Greece commits that the new Drachma is fully backed by the gold reserves of the Bank of Greece, i. e. each holder of a Drachma can redeem his notes in gold at the current gold price. I doubt that Greeks would have a problem accepting this new Drachma at the same value as the Euro. The only problem is that the Bank of Greece will not have enough gold to back all the new Drachma issued.

As a result, the new Drachma would be backed by the full faith and credit of the Greek state, no more. And since the Greek state would generously print the new Drachma (that would be the idea of the whole thing), it is near certain that this new Drachma would lose value against the Euro very quickly.

The great advantage of a parallel currency over a Grexit would be that Greece remains a fully-fledged member of the Eurozone and those who have Euros can happily continue to do business in Euros without incurring any additional fees. The advantage for the Greek economy is that the state could provide financial breathing space by issuing the new Drachma. Greeks may discover that it is better to receive payment in a parallel currency of lesser value than no payment at all in a Euro of full value.

The great challenge of a parallel currency lies in its implementation. Since it is not legal tender (only the Euro is allowed as legal tender within the Eurozone), no one can be forced to accept it. And people will only voluntarily accept payment in a parallel currency if they know that they can pay others in the parallel currency and how much they can buy with it.

Perhaps the time has come to revisit Yanis Varoufakis' Plan X.


  1. Markets go into shock if a parallel currency is proposed?

    I do not know why they should, as ultimately the ability of a country to repay its outstanding bonds will be enhanced after a parallel currency is introduced. (The point of parallel currency is to introduce economic growth and reduce unemployment) Italy and Greece should therefore introduce them as it will ultimately help to repay bonds denominated in Euro.

    I do not think that a New Drachma would necessarily be worth less than the Euro, as long as the New Drachma could be used to repay Greek taxes.

    If the government will accept 100 New Drachma to pay outstanding Greek taxes of 100 Euro the Euro/New Drachma exchange rate will be 1:1. Always.

    Will Greeks accept the New Drachma? Almost certainly, especially if the Greek government spends 30 New Drachma each month to give to each Greek citizen to spend as they like.

    The implementation should be fairly simple, not more complicated than a payment card or public transport card with a computer chip.

    Once the new parallel currency is accepted, Greece can introduce a job guarantee, for example, where the government would become the employer of last resort, allowing it to reduce unemployment against payment of the New Drachma.

    Economic growth would be bigger, as more Greeks work. This additional economic growth in GDP might be enough to generate so much additional taxes, that there is no Euro huge shortfall in expected tax income.

    I went trough some calculations in 2015 which are probably still valid.

    Ultimately, parallel currency are the way to go for any country which has high unemployment and is part of the Euro. I am seriously surprised that none of the Southern countries with big unemployment has tried something like that.

    It would give more power to each country and less power to the ECB, the EU institutions and the markets.

  2. The alchemists are on the loose again.

  3. Matt, there seemed to be many more local or alternative parallel currency or voucher projects when I looked into it. Especially in the southern sphere. If i ignore exchanges without money exchanged along the lines you do something for me, I do something else for you, other then the later, at least it feels, bitcoin.

    Strictly I find it interesting, superficial look only. How you weave the origin of taxes into your larger narrative. Taxes were historically only used to benefit empire? And thus war? And the latest empires are not necessarily out for war only but other but more economically oriented. Like in the present case the new German purely financial empire?

    The most startling statement by Yanis, I for whatever reason keep on my mind. From an original German interview, if I recall correctly, that circulated on the web only in a abbreviated English translation version: There was this statement by him more in passing.

    In his grand new European world, based on his and his supporters ideas, the ECB could give 1.000 € directly to the not so well of Germans. Like the ones that try to survive on minimum wage. Not sure if it existed then already. Maybe it didn't.

    No, it didn't:


  4. Why would any person buy currency underwritten by the poorest and most untrustworthy government in EZ, with currency underwritten jointly by all the other EZ members?
    Unless you assume that the government would make it legal and mandatory that civil servants and pensions were remunerated with new Drachmas, that'll be the day. I assume that they would also be permitted to pay their taxes in Drachma. In that case most government procurement could not be paid as there is an element of imports in them and government would have very little income in EUR. The EUR element would have to be covered by those who"happily continue to do business in EUR", who presumably would pay their taxes in EUR.
    It would eventually recreate the old east block system with official exchange rates and black market (free market) rates. With Greek propensity and talent for fraud, smuggling and black marketeering it would be a jungle.
    Greece would not remain a member of the EZ, it interferes with free movement of capital and, by extension, goods.

    1. I agree that the key question is how to get a parallel currency going when it is not legal tender, i. e. when using it is voluntary. The state could not pay salaries/pension in the PC because the recipient could sue the state for payment in Euros.

      Perhaps the better approach would be to make the PC a second legal tender (next to the Euro) but that would require a revision of treaties. Why would the EU not agree to such a revision when it's good for both, the Eurozone AND the country?

      Greece would definitely stay in the EZ despite the parallel currency. That's the whole purpose of the exercise. Schäuble suggested a temporary Grexit to achieve breathing space and new adjustment. I think a parallel currency would accomplish the same thing with much less turmoil.

      Trade and capital flows would be unaffected by this because they would continue to take place in Euro and within the Euro-system but for a Greek importer who does not have Euro revenues and/or Euro savings, imports would become more expensive because he would have to buy the Euros with the PC.

  5. From John Mauldin's newsletter:

    "Italy’s situation could blow up the fragile trust that keeps Europe together, and the leading parties may even be planning for it. The discussions between Lega Nord and Five Star included an idea called the “mini-BOT” that would effectively serve as a parallel currency.

    The BOT is Italy’s Treasury bill, and as in the US, it serves as a kind of cash equivalent in electronic trading. The mini-BOT would be a government debt instrument, in paper form, that pays zero interest and never matures. The government would use it to pay social benefits and accept it for tax payments. Private businesses would not be required to accept it, but they could.

    Private businesses and individuals would also, in theory, buy the mini-BOT as a way to pay their taxes. But they would buy them at a discount. So, traders would immediately set up an arbitrage where the person getting the social benefits payment could sell them for euros for, call it, a 5% or 10% haircut. Former Prime Minister Silvio Berlusconi, who is still a force in Italy, insists this would be legal. The Northern League sees a way to ease the transition out of the euro and the Five-Star Movement sees a way to increase spending without having to take on euro debt. And since the new coalition government wants to increase the deficit an additional $180 billion euros or so through a combination of tax cuts and increased spending, this is being seriously proposed.

    The mini-BOT probably could be a practical alternative to the euro for many transactions. From what I’ve read, the other eurozone countries would have difficulty stopping it because the euro would still be the only formal “currency.” And other Mediterranean countries would watch this experiment and begin moving in the same direction themselves.

    You see where this goes. Italy might be able to use mini-BOTs (or let’s be honest and call them the new lira) to finance deficit spending without breaking eurozone rules. This could ultimately debase the euro and blow apart the eurozone. Germany would have to leave. From there, you can draw your own map.

    Is this what the Italian populists want? Some of them, yes, but I suspect their leaders know not to go too far. More likely, they see it as a bargaining chip—a plausible threat they can use to extract concessions from the ECB and other eurozone leaders. The Greeks threatened something similar in 2015 and it didn’t work. I think Italy has a stronger hand.

    But it gets scarier when you think about how this could happen. If Italy’s new government decides to launch a parallel currency, they will probably do it with no warning at all. Tipping their hand would spark capital flight and reduce the benefits. We could literally wake up one morning to learn the lira (or something like it) is back and Germany is leaving the Eurozone. Imagine how markets would react.

    I think this scenario is unlikely, but it points to something else. As the coming debt crisis matures, national leaders and central bankers will find their choices narrowing. I’m constantly amazed at their creativity, but it has limits. They can’t kick the can down the road forever. At some point, the road ends and then they have to choose. When your only choices are “impossible” and “terrible,” then you pick the latter. We are going to see previously unthinkable ideas be seriously considered, and sometimes chosen, because all other options are even worse.

  6. I kicked your idea around with a few friends at our Sunday lunch. Postdated checks are as expected still widely used, by small and big businesses. It cannot be compared with your Drachma scheme, it is voluntary IOU's. It is done between business acquaintances who know each other and who can, to a certain extent, judge each others's economic situation. It causes lots of strain on productive business, as the checks are only accepted within a closed circle, and certainly not cross border. It favors those close to the end users (retailers and middlemen) and hampers those close to the periphery (producers). The producers buy materials and wages on cash basis, and sell products on credit, thereby preventing any investment in production. It's a perfect picture of the closed Greek economy.
    The governments has issued IOU's for years, but they don't call them that, and they are not voluntary. They call them employment contracts, pension obligations and purchase orders, all of them are paid late. Alas, it has given the government some breathing space, not that thy have used if for any sensible purpose. You suggest creating more breathing space by a parallel currency or IOU's. A banker in our circle said that if forced, it would cause an immediate run on the banks. If it was offered on a voluntary basis it would have no takers, but in the shaky environment it could still cause a trot on the banks and financial investments. ?????
    Closing and nationalizing the banks was an integral part of Plan X, so was conversion of EUR deposits into new Drachmas. Plan X was not a plan for a PC, it was a full-fledged plan for a new currency, and the IOU's were only a transition until the New Drachmas could be printed. With Varoufakis duplicity it was sometimes presented as a parallel currency within the EZ, and sometimes as a new currency, no need to scare the voters.

    1. Yes, a PC is a form of IOU, but it's a negotiable IOU (employment contracts, pension payments, etc. are not negotiable). I am torn between a voluntary and forced PC. One thing is certain: a forced PC is not allowed under current treaties because only the Euro is allowed to have legal tender.

      There has got to be a way to make a voluntary PC work, I just lack creativity for it. The trick would be to create a demand for a PC. What if the government accepted payment in PC instead of Euros?

      Regarding Plan X, I have never read it. I just thought it was a proposal for a PC. Didn't know it was a Grexit plan.

  7. Yes Greece tried it in 2015 and failed, but Schauble had to spell out the Dirty Harry question. I do not think it will go that far in Italy, they look for compromises. They will ask themselves the question and answer it with a resounding NO.

    1. Greece didn't try anything. It chickened and backed out.

  8. If you can find a way of selling a Greek government backed PC to Greeks, then one wonders why the government cannot find a way to sell their bonds to Greeks, after all they carry a substantial interest.
    Joking aside, it is an interesting discussion but, no amount of financial engineering will create value. Financial engineering can shuffle around with values, and can, in certain circumstances, be a catalyst for value creation. Greece does not need a catalyst, she needs a plan for how she will become more productive, and actions to implement that plan, which does not seem to be forthcoming.

  9. These are just half-measures. Let's go all the way, recognize that the euro doesn't work in it's current state and either reform it or abolish it. Imo trade and capital restrictions are going to be a great help in the event of a euro breakup, so it's encouraging to see that we are slowly entering a new international era of controlled trade. I suppose that Germany is going to find it difficult dumping it's production abroad in such a scenario, but they made their bed and now they must lie in it.