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.