The Greek Crisis: Time to Rethink the Concept of "Money"

As the economies of Europe stagger, and Greece in particular staggers under the weight of a depression exceeding in scale the devastation of the 1930s,  it appears difficult to see a way out of this agonizing cycle of repeated financial meltdowns. In fact, there are  creative ways to solve not only our recurring fiscal crises but our ongoing social debacles as well. Solutions are already in place where terrible problems once existed.  But these solutions challenge many existing economic paradigms, no less than the concept of “money” itself.

Commenting on the recent negotiations between Greece and its EU “partners”, economist and market analyst  Rob Parenteau suggests that tax anticipation notes, or “TANs”,  would way be a for Greece to give itself more fiscal spending wriggle room without violating Eurozone rules.  Bear in mind that modern money (what we call “fiat currency” because it is created by government fiat) has no intrinsic value in the absence of state sanction.   Since the demise of Bretton Woods, any tenuous link to the gold standard has been extinguished. 

So what does impart value to a fiat currency? In the words of economist Abba Lerner: 

“The modern state can make anything it chooses generally acceptable as money…It is true that a simple declaration that such and such is money will not do, even if backed by the most convincing constitutional evidence of the state’s absolute sovereignty. But if the state is willing to accept the proposed money in payment of taxes and other obligations to itself the trick is done.”

The modern state, then, imposes and enforces a tax liability on its citizens and chooses that which is necessary to pay taxes. The unit of account has no real value if not ultimately sanctioned by use from the State.  By extension, the state is never revenue constrained because it alone determines what is money.  The tax is what gives the currency its value insofar as it functions to create the  notional demand for federal expenditures of fiat money, not to raise revenue per se. Value has been given to the money by requiring it to be used to fulfill a tax obligation, but the money is already in existence, not “created” by the revenue.

It is in this context that one has to look at Parenteau’s TAN proposal.  It is important to note that the tax advisory note would not replace the euro, but operate in parallel to extinguish national tax liabilities.  The note would be guaranteed at a 1 to 1 rate by the Greek government. More significantly, by imparting a value to these TANs (i.e. letting them be used to extinguish national tax) this will ensure a natural source of demand for them. Each individual vendor, contractor, or even government employee will accept the  new notes up to the individual’s expected tax liability. 

Skeptical? Well, there are other historic examples of local currencies operating in parallel with national ones. As economist L. Randall Wray has noted, in Argentina as the financial crisis deepened after 2000, local governments began to issue “Patacones” (bonds with interest) as local currencies, paying workers and suppliers, and accepting them in tax payment. Utility companies began to accept them—knowing they could pay part of their taxes with them–and acceptance spread even to international corporations such as McDonald’s.

There are other historic examples closer to home (“home” in this case being the heart of Europe).  Germany has had a history of creating notgeld, or emergency money, in the wake of the problems introduced by WWI reparations.  None other than that Old Wizard Hjalmar Horace Greely Schacht, head of Germany’s Reichbank in the 1930s, himself introduced the Mefo bill, which were company issued IOUs, well beyond the corporation’s capital base.  They were discounted by Schacht’s Reichbank.  Indeed, it was the collapse of globalization that allowed Schacht a degree of freedom for unilateral action from the Reichsbank office that would have been unthinkable before 1929. This freedom would first be applied to Germany’s international liabilities and then its internal economic structure.   The Nuremburg trial transcripts described the plan in the following manner:

Transactions in “mefo” bills worked as follows: “mefo” bills were drawn by armament contractors and accepted by a limited liability company called the Metallurgische Forschungsgesellschaft, m.b.H. (MEFO). This company was merely a dummy organization; it had a nominal capital of only one million Reichsmarks. “Mefo” bills ran for six months, but provision was made for extensions running consecutively for three months each. The drawer could present his “mefo” bills to any German bank for discount at any time, and these banks, in turn, could rediscount the bills at the Reichsbank at any time within the last three months of their earliest maturity.

The bills were used as fiscal boost for the intertwined priorities of rearmament and work-creation. Through Mefo bills, monetary expansion could be concealed to appease traditionalists at home and go unnoticed abroad. The formal justification from the central bank perspective was that the government would eventually compensate the Reichsbank for the Mefo advances, effectively paying for the spending at a later part of the business cycle. The upshot is that the resulting spending engendered the German economic boom that took place under Hitler

For less extreme examples than Nazi Germany, it is worth noting that the US had at least 5 forms of paper currency going at the same time in the 1920s.  These were used interchangeably and included:

1. Gold Certificates (redeemable in gold coin until FDR’s prohibition on private citizens holding gold)
2. Silver Certificates (redeemable for coin or bullion)
3. National Bank Notes (issued by US government chartered banks with equivalent face value of bonds deposited by bank at Treasury)
4. United States Notes (issued directly by Treasury and also called Legal Tender Notes, but with no “backing”)
5. Federal Reserve Notes (redeemable in gold on demand at Treasury or in gold or “lawful money” at any Federal Reserve Bank, until FDR’s prohibition, when it was just declared legal tender redeemable in lawful money at Fed or Treas).

Clearinghouse certificates were created and spread during the Great Depression (http://mises.org/library/economics-depression-scrip), as during the prior financial panics in the US as well, as a form of complementary currency creation. They supposedly traded at par in many cases.  Indeed, many of these certificates existed through most of Bretton Woods until the late 1960s. 

Those who are not of a “neo-chartalist” persuasion might be skeptical of the claims that a 1 TAN for 1 euro exchange rate could be sustained.  Their argument centers on the fact that even if one imparted value to the tax anticipation notes by allowing them to be used to extinguish tax liabilities, a quasi-parallel currency would still plummet in value relative to the euro and wouldn’t do much in terms of boosting aggregate demand as the value plummeted.

 Let’s consider that argument for a moment:  Say TANs plummet and start “trading” in private exchanges in Greece at 4 TANs to 1 euro or some such horrible disaster. So you are a Greek citizen. You have tax arrears. They are equal to say one years’ worth of your salary. You will take your euros, buy TANs and deliver them to the Treasury, who are obliged by law to accept tax payments in TANs at the prescribed 1 TAN=1 euro, scoring you a huge effective tax deduction in the process – but one you had to earn by selling euros and buying TANs – thereby bidding up the price of TANs relative to euros.  If this is done over and over again by many citizens with tax arrears (yes, they are huge in Greece), ultimately the “depreciation” of TANs to euros will be essentially arbitraged out of the market.

As any Wall Street arbitrager would realize, the only reason why one would do not do that trade, all day, and every day, for oneself and all relatives, would be if one believed that the “market maker”, the Treasury, would ever run out of its capacity or willingness to accept TANs as a means of settling tax payments, at 1TAN=1 euro. And recall that the market maker, in this case the Greek Treasury, has virtually unlimited authority to impose new taxes and raise existing tax rates, which directly influences the demand for TANs, or if that doesn’t do the trick, to varying the proportion of government spending through TAN issuance, directly influencing the flow supply of TANs.

In other words, by design, there is a self-correcting mechanism through arbitrage that should keep the 1 TAN to 1 euro “exchange rate in a pretty tight band, as long as it is clear that tax liabilities can and will be settled with the Treasury at a 1 TAN =  1euro exchange rate. Maybe people who do not trade in markets do not understand this so readily, but anybody who works in Wall Street or the City would understand it.  After all, “arbs” on Wall Street scalp minuscule basis point discrepancies at the speed of light these days in automated arbitrage programs or high frequency trading. TANs have a built in self-correcting mechanism that work precisely that fashion.

As for the supposed “heterodox” quality of Parenteau’s proposal it is worth noting the following irony:  isn’t it peculiar how we marvel at (and handsomely reward) financial engineers on Wall Street when they create all kinds of debt instruments that get counted as “money equivalents” (as an example, consider that perpetual bonds are ruled Tier 1 capital for banks under the Basel Accord rules), and all kinds of equity that look like debt? Or even better still, how we applaud the ingenuity of financial engineers when they stitch together such Frankenstein monsters as total return swaps, exchanging one set of returns on one asset for another set of returns, while never nominally changing the ownership of an asset (these types of instruments played a critical role in the 1997-8 Asian Crisis, as well as the more recent 2008 Financial Crisis).  Yet for some odd, unspeakable reason, we simultaneously refuse to entertain even the possibility of a similar level of creativity and hybridization to the realm of government finance.  Or we hand wave it away, declaring it dead on arrival, simply impossible, fraught with all sorts of inconceivably difficult complications, and bound to eventually lead to general irresponsibility, outright misallocation of resources, and ultimately, the dreaded hyperinflation. This appears to be the case even with things we should know nations have done successfully before (like 5 currency types running side by side in the US in the ‘20s), but no one seems to remember, or at least no one bothers to mention this “verboten” subject.  It’s time for the Greeks to give the rest of the world a reminder of what is possible.