Gerald Holtham says countries within the single currency could devalue if we introduced a National Unit of Account
Europe is committed to a single currency but the Euro is not working. Europe therefore needs a single currency that does work. What would such an arrangement look like? It all depends why people want the Euro. If it is as a stepping stone to a United States of Europe, the current crisis serves the function of stampeding people to that outcome, whether they want it or not, with the claim that the Euro will fail unless underpinned by a common fiscal policy and more powerful common institutions. The claim that a single currency requires a single fiscal policy is in fact unwarranted but serves a political purpose. There is nothing further to be said if that purpose is accepted.
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There is a certain amount of evidence, however, that the purpose is not accepted by many European citizens. Close co-operation that links economic interests and makes war unthinkable is fine. Political decisions taken far from the citizens they affect and ironing out local idiosyncracies is less popular. Indeed, enthusiasm for the European Union has visibly waned in a number of countries. It is important, so it seems to me, to accommodate local patriotic feelings without allowing the European ideal to fall into utter disrepute with a collapse into discordant nationalisms.
So it is probably best to accept that the will to political unity is inadequate and we need a Euro that can survive in a loose confederation of states with different social and fiscal policies. If we accept that the point of the Euro is to facilitate the operation of the single market and reduce transactions costs, without ulterior political motive, then the United States of Europe solution, is a steam-hammer to crack a nut. If the political will for such a development is lacking then another solution is required. Contrary to the assertions of both those who desire political union for its own sake and those who hate the Euro and wish it to fail, such a solution may well exist.
Note, however, that the solution makes possible a single currency in the current Europe of nations. It does not in itself solve the current crisis of debt and recession. I’ll come back to that. First let’s deal with the architecture of the Euro. Everyone seems to agree. The trouble with the Euro is that deficit countries cannot devalue and are condemned to competitive deflation that exacerbates, rather than relieving, their debt burdens. The Financial Times has published two articles addressing this problem. Professor Julian Le Grand has suggested leaving the Euro, devaluing and re-entering immediately. Martin Jacomb has suggested giving up and reverting to national currencies. Neither amounts to a systematic solution.
The solution is to distinguish two functions of money: legal tender and unit of account. Europe at present can support having a single way to settle bills but it cannot currently sustain having a single unit of account. Each country can keep the Euro as its sole legal tender but should introduce a national unit of account (Nua). It should legislate that all contracts between residents, all domestic price lists and all wage slips should be expressed in both Euros and Nuas. It would be as well to make the Nua a simple quotient of the Euro, say one tenth (1 Euro = 10 Nua). Communications with non-national, non-residents would not be affected, nor would bank deposits.
The government should take the power to fix the relationship between the Euro and the Nua by decree and to specify that in all dual price arrangements, the Nua price is preserved when the exchange rate changes. It can thereby announce a devaluation without having a separate circulating currency. Of course, that can be strictly enforced only for those deals where the government is a participant. In other cases the government would rely on moral suasion, an appeal to people to play the game in the collective, national interest. No doubt, some people would seek compensation for a rise in the Nua cost of living by pegging their receipts or earnings to the Euro. Yet that risk exists with a national currency, where inflation may well follow any depreciation. The risk is lower, the more depressed is the economy.
If people more or less played the game, producers would find their wage costs had fallen and margins on foreign sales, where prices were fixed in Euros, were better than margins on domestic sales, fixed, for the moment at least, in Nuas. Domestic goods would be cheaper than imports. The desired competitivity consequences of devaluation would be achieved.
It is evident that any such arrangement would be likely to work in a high-trust society where people pay their taxes and generally abide by the rules, like, say, Austria. It would be less effective in a low trust society with closed networks of influence and a culture of tax and rule evasion, like, say, Greece. There is no denying that it would be likely to work less well where it was most needed. But if it worked to any degree, it would represent an improvement on the current situation.
Devaluation itself can fail and result only in inflation if there is a determined resistence to any reduction in real wages. In any case, if a deficit country cannot operate a nua arrangement, it is most unlikely to be able to sustain the austerity demands of an unembellished single currency.
The nua would apply to prices for current goods and services. There would be no attempt to alter the value of existing bank deposits. However, all equity and bond prices could be dual-priced. That means yields on securities originating in a country thought to have an excessive price level would be higher owing to the perceived risk of devaluation. That should provide a natural corrective in countries where borrowing is rapid and domestic inflation is higher than the European average. However, the sanctity of bank deposits, is necessary to prevent speculative bank runs and switching of deposits within the Euro-zone.
Given a unified banking system, all banks would pay the same for their reserves but would be forced to discriminate in their lending, which would be double-denominated so would effectively be in nua. This system would be enhanced by common banking regulation and a truly unified banking system but does not require common fiscal policy.
At the same time the claimed advantages of a single currency would be preserved. Prices would be quoted in the same numeraire in all countries, supporting the single market. There would be no need to change currencies to travel abroad, bank deposits, cash and coin would have the same significance everywhere, reducing many transactions costs.
With a system like that, even the UK could join.
Of course, as already conceded, announcement of such a system would not resolve the immediate crisis. That requires some debt forgiveness and for more European banks to be declared insolvent. A unified system of bank deposit insurance would preserve the integrity of the payments system while bank shareholders and bondholders would lose their money. That would be painful but preferable to States pretending that they could make those losses good – at risk to the integrity of their own debts.
In a perfect world, surplus countries would also expand domestic demand with looser fiscal policies allowing heavily indebted deficit countries to grow without themselves having to resort to further debt finance. That will not happen however. Driven by a hatred of collective action of any sort, for decades right-wing economists have been concocting increasingly far-fetched reasons for not believing the simple income-expenditure logic of Keynes’ insight into the variability of aggregate demand.
Unfortunately, Germans and Dutchmen take a rather Calvinistic approach to economic analysis and are predisposed to believe any nonsense as long as it asserts that saving is always good and spending always bad, whether conducted by individuals or governments. Ninety per cent of the time that belief is salutary, but they cannot shake it off on the few occasions when it is destructive – like after a credit boom and bust and during a debt deflation. And they are helped in error by ideologues who dream up logically airtight but utterly unrealistic fantasy worlds where there is ‘Ricardian equivalence’ and people don’t spend income generated by government demand because they anticipate possible higher taxes at some uncertain point in the future.
Even with banking reform and nuas operating alongside the Euro, therefore, the convalescence of the European and world economies will take a long time.