Eurozone Crisis and Its Solutions: Some Thoughts about Parallel Currency Regime

Beginning of article

1. Introduction

Current conventional thinking in Europe argues that there are only two solutions to the Eurozone crisis--a debt monetization, or an Eurobond. The first is illegal under the European law, the second is now illegal under the German constitutional law. Moreover, an increased body of thought inquires about the possibility of the Eurozone's restructuring--effectively implying that some countries leave the common currency entirely.

All these "solutions" face seemingly unsurmountable obstacles. A monetization of debts threatens the Northern Eurozone countries with what they would consider an inflationary Armageddon. Eurobond (or any form of the "joint and common" responsibility for the Eurozone's countries debt) is unacceptable to the northern countries taxpayers, well aware about their growing contingent liabilities for their own future pensions and healthcare. And, indeed, it is argued that if a country would leave the Euro entirely, the resulting shock to the integrated Eurozone's financial system would have a significant and protracted negative effect on all European economies.

One possibility, however, is seldom mentioned--that is, the possible introduction of a second currency in the most affected countries, to be used domestically alongside with the existing Euro (hence the term "parallel" or sometimes "dual" currency regime).

An introduction of the "dual" currency would facilitate a restoration of competitiveness (as defined in the euro denominated costs--i.e. the internal devaluation) while simultaneously mitigating the devastating impact of current "austerity" arrangements on employment, standards of living and the political stability. Moreover, it could mitigate fiscal stresses by generating some inflation tax revenue.

Indeed, for this to work a managed bankruptcy (i.e. the debt restructuring) in at least some of the countries introducing the dual currency regime might be necessary, reducing the present value of the Euro denominated liabilities to a serviceable level. That would undoubtedly affect the creditors (Northern financial institution) but to a lesser and more manageable degree (if done properly, in a cooperative manner) compared to the case of the country outright leaving the Euro.

Existing discussions and ideas with respect to parallel and dual currency regimes are reviewed in the Part 2. Parts 3, 4 and 5 then constitutes the analysis of the parallel currency idea as it may apply to current Eurozone circumstances. Part 6 concludes.

2. Parallel Currency in History and the Economic Thought

Parallel currency regime can be defined in general as the situation where two or more currencies (or currency proxies), including monetary metals, circulate simultaneously and fulfill one or more money functions in a single legal jurisdiction (a state or a group of states).

Parallel currency regimes in the form of bimetallism (or multimetallism, as was more often the case) dominated the world markets and economies for the most of human history, effectively till the last third of the 19th century. Several metals (and their combinations) were simultaneously used for coinage and as a medium of exchange, store of value and often the standards of deferred payments (or letters of credit for the long distance trade as the case might be). The gold and silver dominated in this regime, with copper coinage extensively used for local transactions and other needs.

The causes for these "parallel currencies" regimes varied by countries and regions. But in general a (hypothetical) "monometall" regime would fail to provide a desired quantity of payments specie (i.e. the liquidity), both for long distance exchanges (where both the gold and silver were used) and local markets (where the copper coinage dominated). Problems in this system stemmed from the changing relative market values of the underlying monetary metals. But the lack of viable alternatives maintained these regimes till the onset of the modern economy and often beyond. For the more detailed and penetrating discussion the interested reader should consult, for example, Davies (2003), or Redish (2006).

The developments in techniques of government, accounting, banking and credit management, together with a seemingly steady growth in the gold supply and advancements in printing technologies resulted in the basically worldwide adoption of the monometallic, "gold" standard monetary regime in the last third of 19th century. The important, even if often overlooked characteristic of this regime is a widespread and expanding use of paper banknotes and transferable bank balances in lieu of a direct use of the monetary metal (gold) for all monetary functions. However, in a gold standard regime these banknotes are redeemable for the gold in predetermined ratios--which limits their issuance and (supposedly) ensures the monetary stability. Banknotes here are simply more efficient and convenient to use compared to gold coins and bars.

Gold standard, by tying the money supply to the supply of gold proved to be too restrictive in the age of the full employment and the growth oriented economic policies, especially when those policies were coupled with the efforts to engineer the social and income redistribution reforms. Hence, it was eventually abandoned in favor of single fiat currency regimes on the nation state …