21st May 2012
A parallel currency for Greece?
The last few days have seen an increase in suggestions that a route forward for Greece would be to have two currencies. So it would go forwards with the Euro and another currency which would in effect be an I.O.U. John Dizard of the Financial Times expressed it thus over the weekend:
"The Greek government can make payments in its internal debts, including civil service pay, pensions, suppliers, and so on, partly with the euros it collects in taxes, and partly with IOUs"
Okay if we suspend our critical facilities for a moment let us take a look at the next part of this plan:
"After months, or even a year, of self-imposed austerity and morally satisfying defiance of multilateral imperialism, the Greek government strikes a new deal. The IOUs are formally devalued in euros, or, alternatively, at that time, turned into drachma. The official creditors recognise their losses. Greece gets some transfers/loans/ growth aid."
What has been achieved here?
If we look at the economics of the situation we see that Greece will probably drift along for another year without reform under this scenario. This to my mind is one of the worst case scenario’s for Greece as she needs economic reform and she needs it right now in my view. Now I am not making an outright criticism of Mr.Dizard as he is dealing with what he feels is the politics of the situation which as ever I prefer to ignore. If the politicians of Greece feel this is a good strategy let me explain why it will cause more pain and suffering in Greece.
What happens to the banks?
So far what has happened to Greece has been a bail out of her and other countries banks with very little filtering down to the Greeks themselves. If we consider this fact then we should already be troubled by the fact that many bankers (Deutsche Bank for example) support this move. Plus ca change cest le meme chose?
This bit troubles me deeply:
"This still requires keeping the insolvent banking system liquid and capable of doing the day-to-day business of the payments system. That can be handled with a pre-election recapitalisation"
Another bank recapitalisation? How many will it have? I look in vain for any sign at all of any reform for Greece’s banks such as bankers being sacked for incompetence. After all if Greek bankers have not been incompetent over a period where her banks have collapsed then the word incompetent needs to go into my financial lexicon.
Also we need to review this bit: :The official creditors recognise their losses"
So far the European Central Bank has done exactly the reverse! Will it model itself on Adam Posen and do a u-turn? So far it has shown no signs of doing so at all and Euro zone taxpayers need to be aware that it has put them on the hook now as its bond holdings were transferred at par to the European Financial Stability Facility. Has anything ever been more mis-named? Either way taxpayers in the Euro area will end up owning bonds which are valued at 100 when in fact the falls in the new Greek era bonds mean that the true value is more like 14.
If you say this then you provoke yet more questions: "The newly issued Greek PSI (private sector involvement) bonds are probably cheap at today’s prices."
The obvious one is how many do you hold? This of course can be levelled at the banks supporting this plan and I note the use of “probably cheap”. But in my opinion we see why the bonds are cheap when we see this:
"The PSI bonds pay a 2 per cent coupon, increasing to 3 per cent after 2016, 3.65 per cent in 2021, and 4.3 per cent after that. There is no principal due until 2023, which means the burden on Greece is pretty minimal for more than 10 years. At today’s prices you would get back all your money in seven years from interest payments alone."
In my view even a “minimal” burden is too much for Greece right now and an economy which shrank by over 6% in annual terms in the first quarter of this year is unlikely to be able to afford the coupon interest increase in 2016. if you think that then the picture looks very different. my argument here is not that the bonds may not rally but rather how does this help Greece? if you but at 13 or 14 and sell at 16 or 17 you may be happy but Greece has not improved one jot.
In my view this is not a "morally satisfying defiance of multilateral imperialism".
It is a capitulation to it.
If we look further into this we see an issue with the concept of people accepting IOUs which they know are going to be devalued! There is always a weakness in any plan which relies on people being consistently stupid. A big danger would be a refusal to accept the currency which would lead to it having two levels as it depreciated. In some ways if we think of real values there are echoes of Weimar Germany here.
This was expressed many years ago more formally by Thomas Gresham in what became called Gresham’s Law.
When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.
We see this proposal being supported by the banks which recent history informs us is likely to see their debts and liabilities valued more favourably than what the general poulation receives.
My purpose is not to make a direct criticism of John Dizard who is reflecting political imperatives and what he thinks will happen. I am reflecting what should happen and am looking to avoid yet more pain being inflicted on Greece.
To my mind she should exit the Euro and default on some of her debts as soon as possible.
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