It is that easy to cook up new money?

Por Nicolas Cachanosky. Publicado el 16 de noviembre de  2011 en

The financial, and fiscal, crisis in Europe has brought doubt to the future of the Euro. Can it persist, or are we witnessing the end of the Euro? But, if the Euro is to be abandoned, how will the transition play out? In this respect, a latest post in the The Economist’s blog Free Exchange says the following:

“Creating a new currency is not that difficult. A determined country could simply pass a law saying that all financial dealings should henceforth be conducted in the new lira (or drachma, or escudo, or whatever). Colleagues who have covered Argentina tell of how, in August 2001, the province of Buenos Aires issued $90m of IOUs to employees as part of their pay packets. These bills, known as patacones, were soon widely accepted in exchange for goods and services. McDonalds even offered a special ‘Patacombo’ menu in exchange for a $5 denomination IOU. Argentina broke its “irrevocable” currency peg to the US dollar a few months later.”

This paragraph calls for two comments. First, to create a new currency is nothing easy; it is, on the contrary, very difficult. It is so difficult that, historically, money in itself is a spontaneous market outcome. Undoubtedly, what the author of the post is arguing is that it is not difficult to abandon the Euro and issue a ‘new’ currency (lira, drachma, etc.). In this sense it is a ‘new’ currency. But, if the Euro is abandoned in favor of other currencies, it will be because European governments are unable to honor their debts, as Argentina was in 2001. The likely outcome, as in Argentina, is a devaluation; for this is why a new currency issued by the country is needed.

Second, the case of Argentinian issued Patacones was not as straightforward as seems to be implied by the article. Different states, due to absence of monetary resources, decided to issue bonds and enforce legal tender laws on those IOUs. The states had to accept their own IOUs as valid for tax purposes, but only to a certain percentage of the total tax payment. Buenos Aires did not issue $90m of new currency, but $90m of debt. If something is clear about the situation in Europe it is that the European countries are not in a position to be able to issue further debt. What Argentina did was to unilaterally declare default on its international debt and then enforce domestic debt by paying government payroll with IOU.

Something that did happen in Argentina, was the appearance of barter clubs where people met to barter different goods and services. As these clubs grew, they developed their own private currencies. This mini-economy grew so much that security measures against fake currencies were needed. Eventually, these barter clubs started to form a network between them. If the issuance of IOUs by the states was so easy and efficient, not only should barter clubs not have appeared, there should have been no need of new, private, currencies.

The potential abandonment of the Euro faces serious challenges. The issuance of new currencies is not the only one. If the breakup of the Euro implies devaluation and a new constellation of exchange rates, then the outflows and inflows of European firms may face a sudden shift in value, bringing severe economic consequences. If, for instance, Italy decides to leave the Euro, use the Lira, and depreciate its currency, how then will the private sector pay their liabilities in Euros?

Nicolás Cachanosky es Lic. en Economía, (UCA), Master en Economía y Ciencias Políticas, (ESEADE), y Doctorando en Economía, (Suffolk University). Es profesor universitario.

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