Random thoughts on Euro 2.0

I find myself trying to solve the puzzle of the Euro – trying to balance the needs of the independent states against each other, and against the reasonable assumptions of corruption, change, boom and bust, etc

So, the problems:

  1. The countries in the Euro area want a common currency to reduce commercial friction
  2. The countries in the Euro area want to be able to borrow money to finance their debts
  3. The countries may wish to inflate their currency to reduce prices so they can sell their goods more cheaply than others
  1. But you can’t inflate “part” of the euro, at the expense of the other “parts”
  • Countries should have disincentives to taking on “too much debt”.
    1. But exit from the Euro shouldn’t be the only option when they have taken on too much debt

    My Concept:

    1. There is only one currency for the region, as today.
    2. The governments of the 17 countries can issue debt, as today. In the beginning, all Euro-country interest rates are the same.
    3. But there is only one buyer – the ECB. No one else can buy government debt in the Euro region.
    4. The ECB can resell this debt in the public market. But this debt is special – “Greek” Euro debt is auctioned independently from “German” euro debt, etc. And the interest rates set by the market will be used as the terms the next time the ECB buys debt from “Greece” or “Germany”
    5. This debt is also special in another way – if Greece elects to “default” on its debt (i.e. stop making payments in Euros to the ECB as debt bonds mature), two things happen:
    a) The people who bought this “Greek” debt from the ECB are refunded their initial purchase price. So the buyers don’t lose any money, but they don’t earn any money either. It’s a loss, all things considered, but not a catastrophic one. The buyers go in knowing this, so they have no illusions about the “riskless” nature of the debt they’re buying. Which will make the interest rates higher for Greece than Germany.
    b) Greece has to surrender a mutually agreeable, contiguous 1% of their current border lands to the ECB. This land is then auctioned off – any other country in the Eurozone can bid on buying it. (Ideally, each country would present itself divided into 100 chunks when it joins the Euro, prioritizing the chunks from 1 to 100 in terms of surrender). The results of this auction are kept by the ECB.

    Results

    Most likely, what will happen in such a scenario is that no-one but Greece will bid, and Greece will bid 1 euro, win the auction, and so there will be no changes in nationality. Greece resets its debt to zero – if it has a current account surplus, it should actually be in good shape at this point.

    If Greece doesn’t have a current account surplus, they can go back to the ECB and issue new debt, (which has bee reset back to the “default” ECB interest rate). This gives them a chunk of relatively free money that they can use to build infrastructure/whatever to help them grow out of debt.

    But, there is always the credible threat that someone else will buy that land. Which is potentially disruptive for everyone involved. But at some point, less disruptive than letting Greece default over and over again. The threat is meaningful enough that Greece has strong incentives to be fiscally responsible. But it is also moderate enough that a single “mistake” doesn’t destroy the country, and gives them a reasonable alternative to exiting the Euro.

    Anticipated Objections
    They won’t allow their land to be seized.
    Then they keep their land, and the ECB will no longer buy any debt they issue, and none of the debt they do issue independently will have the guarantee of the ECB behind it. I.e. no-one will buy it. Essentially, they’ll have to exit the Euro.

    They’ll sell debt independently.
    See above – the ECB will only “protect” debt that they issue – if Greece issues debt independently, there’s no guarantee from the ECB.

    If the land is sold, people’s lives will be disrupted
    Yes. This gives them an incentive to keep an eye on their representatives (especially the people in Zones 100 and 99) And in any case, it’s far less disruptive than war…

    The land parcels will be gerrymandered
    Probably. But given the rules:

    • Must partially be in contact with the border
    • Must be contiguous
    • Can’t cut a country in half

    They can only play games with their land for so long before it really hurts.

    The land they offer will be worthless
    Probably the first couple of zones will be… but you can’t do that forever.

    The Germans will eventually own all of Europe!
    Only if everyone else is incredibly foolish and profligate. Which I don’t think they are.

    Hyperinflation!
    There is a path through which multiple countries, defaulting cooperatively, could end up forcing the ECB to print tremendous amounts of money to pay for the defaults. But hyperinflation is generally a problem associated with war or social revolution, which makes such cooperative defaulting exceptionally difficult.

    This doesn’t help Greece today
    Why not offer Greece the opportunity to accept this plan, and present a 100-zone solution. In exchange, the ECB prints Euros to pay off all the outstanding Greek debt. Greek gets a reset, and now has a credible alternative to leaving the Euro.

    This doesn’t help Spain today
    Okay, now you’re just nitpicking – Spain is a lot larger, but the ECB has the printing presses, and the Eurozone is large enough to handle a fairly significant growth in the money supply without going into a hyperinflationary spiral. And another thought – existing spanish debt could be “folded in” to the new ECB model – so Spain would still owe money, but it would be backstopped by the ECB and the 100-zone contingency.

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