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Julian D. A. Wiseman
Abstract: A private-sector company could take Germany out of EMU, even against the wishes of the German government.
Contents: Introduction, How would this work?, Coins, Profits, The counter-attack, Costs Sceptics, Morality, Conclusion
Publication history: only here. Usual disclaimer and copyright terms apply.
A previous essay, The end of EMU: legal ramifications, discussed the non-recoverability of the eurozone’s members’ former national currencies. It concluded that even if a country (or all countries) left EMU, euro debts and euro assets would remain in euro. This was followed by The end of EMU: How Germany might leave, which discussed the how the German government could introduce a new German currency without being in breach of the Maastricht Treaty. It will be assumed that readers are familiar with these two essays.
At the time of writing these two essays, this author did not realise that a private-sector company could take Germany out of EMU, even against the wishes of the German government. Further, doing so would be enormously profitable.
For this private-sector company, the object is to issue banknotes, and to have these become the preferred medium of exchange within Germany. For the German people to prefer to use the new currency rather than the euro, it must be seen to be both stable and German. The various steps below are designed with this in mind.
An issuing institution would be needed. The simplest course would be to buy a small German bank, and rename it the Deutsche Zentralbank, or DZB for short.
The new currency would need a name. For the purposes of this exposition, let us call the new money DEX. This name has the advantage of immediately suggesting an ISO 4217 code, the three-letter codes by which currencies are identified (such as ‘USD’, ‘GBP’ or ‘CHF’).
The DZB would print banknotes. These would have the ‘look and feel’ of German money: perhaps each denomination would bear the portrait of a famous German composer. Several billion bank notes would be required.
Banks would be permitted to open DEX-denominated accounts with the DZB. The DZB would pay interest on deposits, and would be willing to lend DEX, at a slightly higher interest rate, against suitable collateral. These two interest rates would be set by an Interest Rate Committee, initially composed of the directors of the DZB, though later appointed by the German Länder. (Also see The Bank of England and the Sterling Money Markets: A Critique for commentary on the detail of the implementation of monetary policy.)
DEX would be redeemable for euro, at an exchange rate of 1 for 1. A holder of DEX, in electronic or paper form, would always be able to exchange them for euro at parity. This gives the DEX a minimum value.
Initially, DEX would be made for sale at a price of 1 euro each. Later, after the euro has fallen in value, the sale price of DEX would be increased, so as to prevent a fall in the dollar value of a DEX.
This provides the basic infrastructure for a new currency; but people would have to be given a reason to accept it, and also to prefer it. Hence the new currency will need promotion, in several senses of the word. Promotion will be made easier by the fact that success would be self-fulfilling. This is because, if DEX are used, the foreign exchange markets will fear a de facto demonetisation of the euro in Germany and elsewhere. This fear would be reflected in a lower price of the euro, encouraging more people to use the DEX as a store of value and medium of exchange, which would further weaken the euro.
But how can this virtuous circle be started? This author envisages an intense campaign, conducted initially in only one town. A press campaign would explain the redeemability of the new German currency. In addition, a team of shoppers would be hired. After training, they would be given DEX, and their job would be to spend it, explaining its redeemability as they go. The redeemability should be further emphasised by providing security vans: a shop can summons a van up to twice a week to collect DEX, with euro then being credited to the shop’s account. The success of the whole project would greatly depend on the intensity of this very localised initial campaign.
Coins are expensive to mint, but the ECB has helpfully provided an alternative. Euro coins of any one denomination all have the same design on the front. But this is not true of the reverse: coins have national backs. So there is ‘German’ 50¢ coin, the back of which has a different design to the ‘French’ 50¢ coin, which is different again to the Italian or Greek 50¢ coins. These coins have the same notional value: fifty euro cents. The ECB intends that coins will circulate throughout the eurozone, without regard for the ‘detail’ of the design on the back.
But the DZB could undertake that it would always issue a DEX in return for 100¢ in German euro coins. Such an undertaking would have three benefits.
First, it would obviate the need for the DZB to mint coins. Economic agents would accept German coins as if they were worth the appropriate fraction of a DEX.
Second, it would emphasise the German-ness of the DEX.
Third is a point in crowd psychology. Once it was known that German coin can be redeemed for DEX, some people would hoard German coins, preferentially giving change in non-German coin. And when you, the reader, notice that your newspaper seller doesn’t give change in German coin, it becomes very tempting for you to pay for the newspaper in non-German coin. Hoarding would spread, and as hoarding implies doubt about the euro, that doubt would spread.
The DZB will have three main sources of profits: issue, trading and seigniorage.
Issue. Initially, DEX will be issued at a price of EUR 1. As the euro falls, this price will be increased to prevent a fall in the dollar price of a DEX. But the formal redemption value of a DEX will remain at parity. So if a DEX is sold at a price of 1.5 euros, 1 euro must be invested in euro-denominated assets (in case that DEX is redeemed), but the other 0.5 euro is profit, and should be sold for hard currency.
Trading. The DZB will be in an extraordinarily powerful position in financial markets. During the transition from EUR to DEX, the DZB’s knowledge about its own balance sheet would enable it to make large trading profits. The euro will collapse, as will the price of euro-denominated bonds, and implied volatility will head skywards. Later, non-euro interest-rate futures will rally, and non-euro government bonds will outperform their swap markets. Measured in euro, the Frankfurt stock market will exceed its previous high. All these price moves are predictable, and given their likely size, it should be possible to convert a few hundred million dollars into a few tens of billions.
Seigniorage. Cash pays no interest. Banknotes issued therefore constitute an interest-free borrowing by the central bank, and the money so borrowed can be invested in interest-paying assets. Seigniorage is extremely profitable, and indeed the profitability of seigniorage is the reason why the issuance of money has traditionally been a state monopoly. If a country has issued 100 billion of monetary units, and interest rates are about 5%, this is worth 5 billion units per year to the country — far in excess of the cost of printing. Indeed, it is worth 5 billion units per year, every year, a stream of payments worth 100 billion. If the DZB were to become the primary issuer of money of money in Germany, then it would be worth several hundred billion dollars.
In describing this scheme with other bankers, two objections have been put forward. One former colleague put it concisely: “it should not be forgotten that the state controls both the laws and the guns”.
What is to stop German law declaring DEX to be, for example, a form of gambling and hence illegal without an (unobtainable) licence? Of course, a state has a sovereign ability to make laws, and the only way to counter it is with another state’s sovereign ability. So DEX will have to be money. Imagine that a poor far-away country is persuaded, with a small number of millions of dollars, to make the DEX legal tender. For these purposes it would suffice for DEX to be legal tender even on only one square foot of soil. The international law of money then comes to the rescue:
The underlying assumption [of Lex Monetae] is that money as a legal construction is subject to the power of the State. It is held that each State exercises its sovereign power over its own currency, and that no State can legislate to affect another country’s currency.
So, Lex Monetae would export the monetary status of DEX to Germany. The agreement with the non-German country must allow the DZB to plead sovereign immunity: great care would be needed in drafting.
Further, some steps will also be necessary to protect the DZB from being nationalised. This can be done, but for brevity’s sake the details are not given here.
The state also controls ‘the guns’, but these would not be that useful. By the time that the DZB exists, the plan would have moved from being personal to being corporate, and therefore known to too many people. For a eurozone state to kill that many in Germany and elsewhere, aside from the diplomatic consequences, would not help persuade the financial markets of the euro’s long-term viability.
How much would it cost to perform a hostile takeover of the note-issuing function of the ECB?
The world’s largest private-sector printer of banknotes would charge of the order of $200 million to print the required number of notes, and would take about two years to do it. A small German bank must be bought: perhaps another $200 to $400 million. Some trading money would be required, and a reserve. So, at a guess, this takeover shouldn’t be attempted with less than $1 billion in risk capital, and twice that would be recommended.
If a reader has a billion or so dollars that wants to be converted into a hundred or so billion dollars, please do contact the author.
There will be sceptics. An editorial in a major newspaper will suggest that the DEX is a Ponzi (pyramid) scheme, that is, that late-comers are being used to pay off earlier purchasers. The correct response would be to invite the press to scrutinise the accounts. Hence an audit trail providing absolute clarity of accounts will prove very important.
Other central banks produce a simplified set of accounts each week (in the Bank of England’s case, since 1833); the DZB should do so daily, and publish these on the web. The assets and hence the accounts should be split into two.
The redemption portfolio should consist of ultra-safe assets. The value of this portfolio, measured in euro, must always exceed the number of DEX outstanding. So, if all the outstanding DEX were redeemed for euro, then this portfolio could be sold and the owners of the DEX paid. Most probably, the assets in this portfolio would consist only of triple-A euro-denominated short-term bonds.
The trading portfolio may consist of any assets or derivatives, subject only to one constraint: the value of this portfolio must not fall below zero. Further, it must be apparent to an accountant that it cannot fall below zero. For auditing purposes, it might be easiest to apply this constraint at the level of each counterparty. If the value of the exposure to a counterparty cannot fall below zero, then that counterparty should be willing to state that in writing, thus providing the required reassurance. In practice, this means that the DZB’s exposure to derivatives will always take the form of being long of options.
So, the note-issuing function of the ECB is amenable to hostile takeover. Would such a takeover be moral?
Undoubtedly, collapsing the euro would take bond prices down with it, and hence there would be a large transfer of wealth from savers to borrowers. In particular, much pension saving would disappear. However, this isn’t as bad as it seems, because the borrowers are companies, which are listed on the stock market and hence owned by the same savers that owned the bonds. There would be some losers, but since the governments have had the real value of their debt reduced to zero, they could make up at least some of the difference.
In contrast, one could argue the politics. Germany’s politicians foisted the euro on the German public, very much against their wishes. Later it became apparent that at least one senior German politician was being financially supported by the French. Even if this financial support never amounted to a bribe, it does appear that the French spent a small number of millions of Deutschmarks on buying all the Deutschmarks. Good value perhaps, but the stuff of which future revolutions are made. And so, if there is going to be a reaction, let it be sooner and commercial rather than later and violent. However, it should be said that it isn’t quite so clear cut. The later ‘violent’ revolution is far from certain: what increment in probability would be needed to justify action now?
An alternative view argues that, though the German decision to enter EMU was tainted, it was a legal decision taken by a democratic government, and therefore not to be usurped by a private-sector bank. But one could counter that the DZB is not usurping any power, it is merely giving the German people a choice. If they accept it, well and good; if they don’t, bad for the DZB’s shareholders, though perhaps pleasing to the other eurozone governments.
It isn’t clear: neither side has a monopoly on truth.
Although the former national currencies are irrecoverable, that does not mean that the euro will last forever. A government can introduce a new currency, and if the people want a new currency but the government does not provide, then the private sector can and perhaps will.
Julian D. A. Wiseman, March 2001
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