Spain may of course hope for external help from Brussels and the ECB, but there are chances that such help will amount to too little, too late. Spain needs to do something, although the range of actions it can take seems rather limited.
One thing it could do, as an earlier post advocated, is take liberties with the euro. This post gets back to the subject and examines a concrete example of how it could proceed.
Spain would emit promissory notes (IOUs) in order to relieve its economy in two ways:
- Inject liquidity in an economy paralyzed by a credit-crunch.
- Help finance a budget deficit that amounted to 8.9% in 2011, and that Spain would be supposed to reduce to 5.9% in 2012. If it tries to do so, additional austerity measures will aggravate the recession (and possibly trigger the collapse), if it does not, it will face prohibitive rates and won't be able to get the money from the markets.
There are certainly many ways in which a promissory note scheme may be designed. Let's see what it could look like:
- The Spanish government discloses in advance all details of its scheme (because promissory notes, just like money, require confidence, and thus transparency).
- Notes (IOUs) entitle the holder to receive a payment in euros on June 1st, 2015.
- Each month, the government emits notes for a maximum nominal amount of 4 billion euros, for a limited period of two years. That's roughly half the deficit, and 10% of the budget.
- IOUs are issued in notes of 1, 10, 100 or more euros and printed on paper. They are directly used to pay for the domestic expenses of the state, according to a given ratio (a civil-servant making 1,600 euros a month would receive 1,400 euros and 200 "notes" to be withdrawn at a post-office).
- The notes bear no interest. Technically, this means that the beneficiary of the note offers a discount to the Spanish government. With 3-year market rates at 5%, notes are worth about 86% of their face value at the moment of emission.
- Banks are allowed to open current accounts for notes. They can offer short-term loans in notes, and exchange euros for notes, or conversely, at market rate.
- In addition to the scheme, the government implements reforms for improving competitiveness (and having a more flexible labor market).
|One the face of it, not much different from money|
Several questions must be positively answered for the system to work:
- Would civil servants accept to be partially paid in notes ? This is highly likely. In the example above, the civil-servant would abandon 1.75% of its salary, a decrease that would remain mostly virtual if the the civil servant is able to buy things with the notes.
- Would merchants then accept the notes ? This is again quite likely. In the depressed state of the Spanish economy, they would rather be glad to sell anything at all. In which proportion they accept notes, or whether they accept them at face value, may in fact soon become key selling points.
- How would react the international financial markets ? This is a more debatable question, but it not unreasonable to think that markets would welcome the scheme, and that the rates on Spanish Government Bonds would return to affordable levels. What we've seen in the crisis so far is that the markets are wary of Brussels inaction, but react favorably to anything that looks like a solution, even a partial or temporary one (markets have been quite keynesian so far, in showing some distrust of austerity - dig Krugman's blog for evidence).
More liquidity, less fiscal pressure. Would that be enough to restore growth? Maybe, maybe not, but at least it would help. And apart from growth, it should also have a positive side effect on banks.
People won't exchange their notes for euros. They will as much as possible do the opposite, spend notes and save euros (Gresham's law: bad money chases out good), lowering the pressure on the balance sheet of banks.
The scheme displays additional tactical advantages:
- It puts pressure on Brussels and the ECB. As they might not like the scheme, they will have more incentives in coming with their own solution.
- It provides Banca de España with the possibility of becoming lender of last resort for commercial banks (in notes). Although such a possibility should be clearly announced at the start of the scheme.
- Should the events turn nasty elsewhere in Europe (and that can happen any day), Spain could make its scheme more aggressive.
Suppose now that after a couple of years growth returns (thanks to the scheme or for whatever reason). Spain would balance its budget, and rates would reflect the confidence of the markets. Spain would be in position of repaying its notes as intended and ending the scheme.
Or it could renew it and use it as a monetary tool to place in the hands of Banca de España rather than those of the ECB. Since such a tool would work both ways, it would help prevent the next housing bubble.
And if growth does not return, Spain could more easily decide to exit the euro and switch to the peseta, since the transition would have been facilitated by the existence of the notes. By the way, that's a reason why notes should not be called pesetas in the first place (although they are technically not much different). If the initial intent is not an euro-exit, people should not be made to believe it.
It must be noted that such a scheme is more promising if the debt level is low, the government credible, and the economy structurally healthy. Spain displays all three conditions, Greece none of them. It is however quite likely, and most unfortunate, that Greece will have to experiment IOUs first.
Such a dual currency system is neither odd, nor creative one. It is old-fashioned. We now increasingly hear that the euro replicates the gold standard. But the euro rather replicates gold itself. Under the gold standard, national economies had national currencies pegged to gold. In the eurozone, national economies use a common currency, in the same way as they did with gold before the 20th century. When those economies progressively issued bank notes (with a promise to repay in gold) in the 18th and 19th centuries, they created their own currencies. Gold (and other metals) remained in use until the gold standard was abandoned in the 30's. The difference between the euro and gold is that the ECB can increase the supply of euros at will, while no one ever had the power to create gold out of nothing. But if the ECB does not make enough use of its power, that difference is of little use for troubled European economies.