Monthly Archives: August 2012

A Parallel Currency?

30 Thursday Aug 2012

Posted by in Monetary Policy

≈ 1 Comment

Tags

, ,

It is now commonplace to regard the problems of the Greek economy as a debt crisis stemming from systemic current-account imbalances. The problems are only amplified as Greece is bound to a “fixed-exchange” rate regime and cannot devalue its currency thereby lacking a key measure to stimulate the economy. The plight of debtor in such a currency union is to internally devalue by gradually decreasing factor costs, first and foremost wages.  The implications of ensuing austerity and social unrest and its implications are still not fully understood and so it’s satisfying to see that there are more conceivable options than the binary exit/no-exit option which is discussed in the press.

One out-of-the box solution would be for Greece to issue a parallel currency which was proposed by Deutsche Bank chief economist Thomas Mayer:

“…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….”

The financing of the primary government would work as below:

“..assuming that the Greek government is unable to quickly balance its primary budget, 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)…..”

This innovative and radical solution is also interesting because it offers a lot of insights especially on the topic of what constitutes a modern currency.
Some of the key take-aways are:

1.      A currency is nothing but an IOU backed by the full credit of the government

2.      The government first needs to spend money into existence for money to circulate in the economy.

The government financing its primary deficits with IOUs is the proposal brought forward by Mr. Mayer. It is noteworthy that without a government deficit a currency cannot come into existence. It cannot tax its citizens or issue bonds because the currency does not exist yet. As a consequence a government deficit is imperative for a currency to exist.

3.      Government bond issuance is a tool to regulate the monetary transmission channel

As Mr. Mayer suggests, Greece could fully return to the Euro by buying back Geuros using Euros. While he does not mention a concrete framework of doing so a similar option would be to issue treasuries and redeem the holders in Euros. In any case, an attempt by the government to buy-back the currency, tax citizens, or issue bonds is not a way of financing itself, as this is something it can do by issuing IOUs (the Geuro) but a way to control the value of its currency.

While the proposal of the Geuro is insightful and offers a new look at the debt situation in Greece I also think that the implications of such a thought-experiment reveal the true nature of the role of the government in controlling its deficits to maintain the value of the currency.

Illusion of Certainty

15 Wednesday Aug 2012

Posted by in Uncategorized

≈ Leave a Comment

Albert Einstein defined insanity as “doing the same thing over and over again and expecting different results.”

I would expect letting the same people design rules and regulation on how complex systems ought to behave after failing over and over again would fall into a similar category. When regulators tell us things are risk-free we are being fooled by an illusion of knowledge, one that leads us to stop thinking about the inherent risks. It should be clear that the world isn’t risk free but rather filled with an abundance of risks.

Creating and defining frameworks that aim to regulate things at the micro level can have unseen repercussions on the macro level. Regulation, even though almost always well-intentioned rewarded investors for buying subprime mortgages and European sovereign debt. Banks are/were required to use more capital when making a loan to corporation that they have enjoyed a long-lasting relationship with than when buying Greek government debt.

At the same time, the largely quantitative risk models of the institutions were flawed, based on the accepted notion supported by economists that the markets naturally tend towards an equilibrium. This belief stems from the almost drastically distorted premises such as perfect competition and rational agents and did not allow for much qualitative analysis about the actual behavior of people.

This lack of common sense was already described in the early 18th century by Isaac Newton, who after losing a significant amount of money in the South Sea Bubble acknowledged: “I can calculate the motion of heavenly bodies but not the madness of people.”  

Asset bubbles have been a continuous and frequent reoccurrence from the Tulip Mania in Holland in the early 17th century, to the current financial crisis and rather than trending towards a stable equilibirium markets tend towards unsustainable bubbles.

300 years after Newton’s statement we are still not able to calculate the madness of people yet we are being lulled into a false sense of knowledge that makes us believe we can. Rather than accepting “uncertainty”, as Erich Fromm puts it, “the very condition to impel man to unfold his powers” we are on “The quest for certainty which blocks the search for meaning”.

Representative of this, was the answer of Ben Bernanke, Chairman of the Federal Reserve when asked how confident he was that he could combat inflation once it exceeded an acceptable level. Bernanke answered that he was 100% confident that the Fed could.

100%? Really? That seems very confident. However it makes me think of another political figure (Jean Claude Juncker) who claimed when dealing with rumors about European debt markets: “When it becomes serious, you have to lie.”

I am not sure what is more dangerous, politicians who publically acknowledge that lying is a necessitiy of self-preservation or those who are 100% certain of their own capabilities to influence complex systems. I guess the distinction between them is very blurred today.