Nick Rowe writes:
Eurozone governments and banks that cannot pay their obligations in Euros may end up paying their obligations in a scrip that is not pegged to the Euro. A scrip issued by each national government that is worth whatever people think it is worth. And if people start using that scrip as a medium of exchange, and medium of account, it becomes a new money. Sure, Greek supermarkets might prefer payment in Euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves. And the supermarkets’ suppliers might prefer payment in Euros, but it’s either accept New Drachmas or let the vegetables rot in the fields. And the workers picking the vegetables might prefer payment in Euros, but it’s either accept New Drachmas or nothing….
But how exactly does a government scrap the old money? It’s not as obvious as it sounds. How can it stop people measuring prices in “old” dollars, and using old dollars for their shopping? (It’s easier in the case of hyperinflation, when the old money is already heading for extinction anyway).
First, the government starts doing its own shopping in New Dollars. The government is a big shopper. Just as we tend to use the same language as those around us are using, so we tend to use the same money as those around us are using.
Second, the government stops enforcing new contracts requiring payment in old dollars, and lets old contracts be paid in New Dollars.
Third, the government stops making change in old dollars. The reason a $20 bill is worth two $10 bills is that the central bank is willing to convert one into the other. And that mutual convertibility makes $20 bills and $10 bills fungible and easy to use as money.
Fourth, as a final resort, stop enforcing laws against counterfeiting old dollars.
I haven’t seen a better idea, but does this address my two main concerns? The first is that, as the transition occurs, there is no credible promise not to confiscate euro-based bank accounts. So the banking system collapses due to runs.
The second is that is takes a few months to produce the scrip and in the meantime the banks are collapsed, and even if nationalized the government can’t make good on all the deposits. Now the government stands up and tries to push its new, crummier currency. Eh (Girton and Roper 1981). Alternatively, the government could confiscate the euro deposits when it nationalizes the banks, and turn them into drachmas, in which case the “scrip” is already there in the banks. But in the short run there is no new currency, the banks are iffy, and even Argentina has never tried something that extreme.
Imagine having a severe shortfall of both banks and currency for a few months. How much would gdp fall? At least thirty percent? How much could foreign banks and abstract loan credits step in to fill the gap? How quickly would such an economy bounce back? I don’t know. It seems to me that all transition paths lead to that outcome, one way or another. Maybe it’s worth it in the longer haul, but you can see why many people believe there is no path out of the eurozone.
If it happens, it will be through markets forcing this solution upon periphery governments, through silent bank runs, rather than the governments deliberately opting to leave the eurozone. Can you imagine a Prime Minister voluntarily accepting a gdp drop of thirty percent over the next six months?
Addendum: Here is a good update on the silent bank runs.