Originally published at thefielder.net on September 30th, 2013.
The issue regarding the exit of a member country from the euro currency is a recurring theme in the political debate of recent years. In Italy it meets the consensus of those who would restore the country’s competitiveness through a competitive devaluation, thus avoiding to actualize those structural reforms which, often, bear social implications. This thesis has been largely acknowledged by Italian academics — supported by professors such as Alberto Bagnai and Claudio Borghi — and today it finds consensus in a good part of the electorate, not only with the left.
Those recognizing themselves in the free market, have found themselves forced to defend the euro, contrasting the key positions of the Keynesians and of the advocates of the Modern Monetary Theory. The contrary arguments vary in range, starting from the fact that the competitive devaluation would have inflationary effects on a country importer of raw materials, such as Italy, and the exit from the euro would give the keys of the currency coffers to Italian politics, which would issue currency in order to pay the current expenses of the State, instead of reinforcing balances and introducing cuts in those areas where the public sector registers losses.
It is, however, the position of a rearguard defense which puts aside the criticism that free-market economists, such as Milton Friedman and Friedrich Hayek, had previously moved to the project of the single European currency, which they considered an entirely constructivist-political project with a weak economic foundation. Moreover, on the weaknesses (from the free-market point of view) of the euro, and the European Union more generally, I have already argued in another article.
The focal point, widely disregarded by those involved in conceptualizing, is that reality with its complexity — that the economic analysis seeks, with its human imperfections, to understand — in the end, will prevail over the will of Politics. If the euro is built on clay foundations — and according to the authors it is — it’s only a matter of time before economic fundamentals can create instability in markets and negative feedback in the political arena that will lead towards the disintegration of the European structure and of the euro, as its main instrument. A rearguard defense — as the majority of the liberal world is doing — is, in a similar scenario, the worst of all possible strategies. The outcome is to be sucked in the spiral of a sinking entity, something that the best Libertarian minds had already completely condemned before it was implemented. The policy of competitive devaluations with a «neoliretta» will then become a self-fulfilling prophecy.
It is, therefore, necessary to define an exit strategy from this political and monetary configuration, as far as markets are concerned, so that the mess represented by the euro can be cleaned once and for all. On a political level, this discussion has received «customs clearance» in several countries by pro-market forces no longer confined to «residual» roles. The consensus towards parties which recognize the failure of the European project is rapidly growing throughout Europe — not only towards pro-market parties but towards other carriers of nationalist content as well. However, those who identify such raise in popularity as the possible cause of the end of the EU, are confusing cause and effect: the EU is dying of its own hand, and the euro-skeptical parties will simply be the «liquidators». Therefore, it is through this approach that we write this article: to pay off a political and monetary order which has factually failed, aiming to offer — in respect to monetary policy — a vision and a perspective to the forces that will govern the transition to a different equilibrium.
In the chance of the centrifugal forces prevailing in Europe, as a result of the negative feedback on the political dysfunction of the euro area, the best solution is for them to have an already settled approach for an orderly dismantlement of the EU, preserving what has worked perfectly for decades and which has created benefits for all — that is, the EU single market -, whilst abandoning to its fate all the bureaucratic superstructures manufactured in the last twenty years. The entire legal framework that supports the euro would be questioned if this was the likely scenario.
It is essential to immediately begin a serious discussion on how to manage this transition and what type of monetary framework will be in place once the euro experiment is archived. The starting point on how to do it (on «where we want to go on which prospects» will be considered towards the end of the article) is an article of Ross H. McLeod, Adjunct Associate Professor at the Crawford School of Public Policy at the Australian National University, published on the 4th of July, 2013, in the Wall Street Journal.
McLeod explains how we can achieve the gradual introduction of a fiat national currency with a variable exchange rate with the euro without creating systemic singularity situations, which frighten both policy-makers and markets. All this by using timely mechanisms and the market, thus avoiding a coercive conversion of savings. For individuals, the choice of using the new currency would be entirely consensual. (Reading the article is essential for the continuation of the argument.)
Under these circumstances, the prospect of a system in which the two currencies would be running simultaneously becomes real — with the State that, from a certain point onwards, uses the newborn currency for any use that concerns it (new supplier contracts, new debt issuing, salaries, pensions), preserving euro payments for former debt and for all contracts signed prior to the new currency issuing. The taxes would be paid in euro for the portion of income in euro and in the new currency for the portion related to it. All deposits in euro would be strictly preserved; all the previously existing real wealth, of both private and public sector employees, would be preserved. There would be no overnight fraudulent conversion of an individual's money deposited in bank accounts. There would be no coercive conversion of the state bonds, deposited as a property of citizens and banks, no masked default of the Italian State. No effect, therefore, on the TARGET2 ECB system.
To have a better view of this situation, quite atypical until today, we have to imagine that in the same physical space there are two economic areas governed by different currencies. When the new system is fully operational, it would be perceived as an «international» trade between different segments of the same society; thus, nothing that hasn’t already been theoretically analyzed. How will the exchange rate of two currencies behave? It will depend on the balance of trade between the economies which govern their currencies and on the capital flows between the two «areas». The trade balance depends on the exchange of utilities between the economic agents acting in the individual «countries». The exchange, therefore, would find a balance amongst the utility provided by the public sector to the private sector and vice versa, with the marginal note, however, that the public sector has the benefit that its services are largely coercively imposed: no one can opt-out from taxation giving up national health service, nor can they opt-out from Social Security contributions and invest only on a private pension fund. In summary, the public system would be anyway — as it is now — in a better situation than Saudi Arabia regarding oil, thanks to the legal monopoly on the supply of its services.
The exchange that one can expect, therefore, depends on which economic theory will be used to try and predict it.
If the reader is an enthusiast of the MMT or of certain neo-Keynesian fringes, according to which only the public sector produces value (or at the very least most of the value is produced by it), then they must expect that the new currency will undergo a significant reevaluation, increasing the purchasing power of civil servants, of pensions, but also of Politics on a larger scale. In this case, to avoid the risk of a high reevaluation, the State may issue new currency and proceed to further expand public spending, boosting economy according to the dictates of the classic state interventionism.
Personally, I believe the Austrian theory to be more valid; according to it the State does not produce a value, but rather consumes it, and from here the argument is as follows: the «neoliretta» according to this approach, will depreciate in relevant terms, too. However, there is a rigidity to the depreciation, exactly because of the coercive nature of services’ offer and, therefore, of taxation, which creates a constant demand for the new currency.
The decline in real wages of civil servants would make possible negotiating salary increases according to the changes that occur in the organization and introducing a logic which rewards whoever is skilled and performs best. The State, for the first time, would have a real incentive to produce utility for the individuals: by accidentally transforming the tax-consumer into the best guardian of monetary stability. In fact, it would cut the real costs of politics, of politicians and the salaries of the overpaid bureaucrats of the state. It would allow, in short, to move part of public spending from parasitism towards dynamic incentives, whilst still leaving room for a budget surplus, with which to bring the debt to levels compatible with economic growth, reducing the crowding-out effect of the public debt.
This happens because reducing «real» public spending on the euro, there would be an extra tax return in the new currency from the private sector, since the percentage of taxes on earned euro would, before being collected by the state, be converted into the net of the new currency required to pay the interests on the existing debt in euro.
In a nutshell, a monetary policy would be used to circumvent rulings and legalities that nowadays prevent a re-organization of the state, and to cut excessive executive salaries in the public administration, the cut the cost of Politics, leaving them to devalue, whilst there would be room to support the salaries of the few areas of public administration which, in recent years, have moved the wagon for all the others. This powerful stimulus for change would come from those who, today, are encouraged to immobility.
What are the effects on the private sector induced by the introduction of this new regime? The fact that for companies the use of currency is entirely consensual means that any exchange rate risk in the transition to said currency will be taken freely. Will they move to the new currency? As McLeod explained in his article, it’s simply a matter of which exchange rate the demand and supply will determine and of which market situation the company is currently undergoing, depending on whether it is importing, exporting or tied to the national market.
Therefore, there would be a single market with N freely usable currencies, including the euro, creating a further degree of freedom for the currency users. The euro, initially, would act as an imitation of the gold standard and, in fact, this characteristic would discourage in competitiveness and variable exchange rate the inflationary trends of the newborn national currencies. This occurs because in the variable exchange rate regime Gresham’s Law works in reverse, pushing currency users to find the one with the best features. Simultaneously, the new currencies will grant interest rates as performed by the fundamentals of a given sub-area of each new currency, solving the problem of the stiffness created by economies whose fundamentals diverge in an accelerated manner.
Not only that: the scheme can immediately be expanded to a pan-European level, making it steadier. At a time when there are N currencies issued by public issuers, it is unclear why individuals with adequate capitals cannot be involved in this scheme, or, for that matter, decentralized systems such as Bitcoin or Ripple. Talk about monetary sovereignty is heard quite often, but the real «sovereignty» must be that of consumers to freely choose the monetary solution with which they feel more comfortable and assess as more convenient. Let’s call it, then, monetary freedom. What Europe and Europeans need is more freedom — and the monetary freedom must be amongst them. Free to use the new currency of the Italian State, or the old euro, or a currency in a social ethics bank, or Bitcoin, or any supplier that will guarantee its issuing with gold — each handled in the manner that the issuer decides and on which the very same issuer must gain the confidence of the users of said currency. Or any combination of these in the portfolio. It all revolves around the manufacturing of a dynamic monetary «ecosystem», where it is the free choice of currency consumers to determine who will offer the best currency. A free banking system.
Written by Andrea Benetton and Tommaso Cabrini.