As the ink dries on a new deal to provide Greece with a Euro130 billion loan, TH is struck by how many people misunderstand the euro crisis and the solutions available. He is also struck by how quickly most people jump to the conclusion that euro exit means sovereign and banking default default. What people forget is that Europe is facing two crises not one, and that two tools are needed to resolve the situation in an orderly way. TH reckons a depreciating parallel currency is one of those tools (financing – i.e. official lending — is the other).
To most people, the euro area is suffering a fiscal crisis and that is more or less it. As such, they frame the policy debate in terms of whether any proposed solution solves the fiscal crisis. This is in most part what the haggling in Brussels has been all about. When you think about it from that perspective, talk of euro exit almost certainly implies that a country would redenominate and monetise its government debt. No wonder they think that TH is a bit of a delusional crackpot (well not quite) when he talks about introducing parallel depreciating currencies as a solution for the euro periphery. TH reckons that had they thought about the euro area crisis as a primarily current account crisis, they would think differently.
One reason for forgetting that the euro periphery is experiencing a current account crisis is because Greece et al. don’t have their own currencies. But, as FT columnist, Martin Wolf, recently explained at length, a country can have a current account crisis even if it has no currency to call its own.
Indeed, international macroeconomists understand that most international crises, like that affecting the periphery, are twin crises (see Kaminsky and Reinhart, for example). That is, when these crises happen they not only represent a shortage of export receipts to pay for imports (a current account crisis), but also a shortage of financing to pay for the imports (typically due to a fiscal or banking crisis).
As the great Dutch economist Jan Tinbergen pointed out, an economic policy maker with twin crises to resolve will need two tools. For peripheral Europe, as with most twin crises, those two tools are financing and adjustment judiciously balanced: financing to solve the fiscal crisis and adjustment to solve the current account problem.
So far, Brussels has worried about the financing side of the equation (i.e. the fiscal or banking problems). For two years policy makers and bankers have haggled over how to provide Greece (and other euro periphery economies) with the money it needs to finance the fiscal deficits that countries in deep prolonged recessions with unemployment over 20% generally need to prevent complete collapse. But few have seriously discussed how the adjustment to overcome the current account problem will occur. Instead policy makers think that the natural adjustment process, known as the specie flow adjustment process (after which this blog is named) will work as elegantly as David Hume proposed over two centuries ago. That is, as money flows out of current account deficit countries such as Greece, Portugal and Spain, the corresponding fall in aggregate demand will cause wages and prices to fall and return the periphery to a competitive position vis-à-vis their euro area counterparts. Oh, it’s so simple … not.
There is no doubt in TH’s mind that the advocates of the classical adjustment process would work, … eventually. But only after severe economic and political turmoil like that which we are witnessing in Europe today. Surely the objective is to do better.
In Torrens Hume’s mind, doing better means coming to terms with the fact that Greece, Portugal and Spain need a better adjustment mechanism (in addition to financing like that just negotiated with Greece) and that mechanism is a parallel depreciating currency.
Here is a restatement of the plan to deal with competitiveness:
1) introduce a new currency (the worgl) in parallel with the euro and let the central bank supply whatever is demanded (which may not be much);
2) require that wages be paid in the new currency;
3) set a pace of devaluation for the new currency over the course of 1 to 2 years.
This would do two things. First, with wages paid in the depreciating currency, competitiveness would be regained, unemployment would fall and the economy will stop contracting. Second, on the demand side, the depreciating currency will stimulate demand as people seek to spend it rather than hoard it. It would effectively be a Gessellian currency.
It’s also worth noting that while those with loans in euro that receive payment in the worgl will find it more costly to service their debts, those with euro deposits will enjoy an increase in their wealth in terms of worgl.
Some people would argue that introducing a new currency would cause a banking crisis due to currency mis-match, but surely the internal devaluation would do the same thing. In the best case scenario, if wages and prices adjusted quickly down by say 30%, would not a firm’s ability to service its nominally fixed debts be just as impaired as they would have if the adjustment was due to a currency devaluation? And if they didn’t adjust, I am sure that firms suffering from 4 years of negative growth operating in an economy with 20% unemployment, are almost equally likely to default on their loans as firms facing a currency mis-match.
There may be alternative ways to restore competitiveness — some argue that it is structural reforms, which would some how make Greeks and Euro periphery countries change their labour leisure preferences, and suddenly become more prodcutive by working more. But, at the end of the day, these do nothing to help get the periphery out of a currnecy union to which they should never have belonged.
And, something for the video junkies:
Note: this post was updated on February 25th .