North and South Euros

I had an interesting conversation with Miles Kimball at his blog concerning his idea of splitting the Euro into a North Euro zone and a South Euro zone. This seems like a far more realistic solution than reintroducing drachmas, punts, pesos, and lira. Nevertheless, there are some thorny issues here which Miles says he will address in future blog posts.

In short, a South Euro will quickly depreciate. Because wages are sticky, exports from the southern Euro zone will be relatively cheaper than exports elsewhere, providing a short to medium term boost to Greece, Italy, Spain, and Portugal.

One concern here is that the continued circulation of North Euros in South Euroland, as well as the North Euro's continued use as a unit of account in South Euroland, would make those living in South Euroland highly cognizant of nominal changes and therefore less likely to fall prey to the degree of money illusion that is necessary to drive an export-led recovery.

Of course, as Miles points out, his is a fourth best solution, so one should only nitpick so much, never mind the fact that it takes a solution to beat a solution, and I don't have one.

Drachmas or not?

John Cochrane has had a few interesting comments on Greece leaving the Euro, here, here, and here.

Cochrane doesn't believe in the consensus view that a Greek default means a Greek euro-exit. He thinks Greece can default and stay in the Euro. He also makes the good point that Eurobonds already exist... in the form of Target2 transfers. His last post illustrates how difficult it would be to create a new drachma. I am sympathetic to many of his views.

I had an interesting debate in the comments section of his last post on the difficulties of creating a new drachma.

Greece is no Argentina

Paul Krugman compares Greece to Argentina. Devaluation in Argentina surely helped, and so would it in Greece. But there's a problem. See my comment:

The comparison to Argentina is a poor one. Argentina's central bank was a fully-operational currency issuer when it lifted its peg, and the peso already circulated along with dollars.

Greece's central bank is currently in-operational as a currency issuer; drachmas simply don't exist.

Should the Bank of Greece try to relaunch itself, will its drachma liabilities be voluntarily accepted as mediums of exchange? Probably not, for the same reason its bonds are worthless. Like the Greek government, the BoG simply has no credit. Compounding this is the fact that already-existing euros circulate in paper form, and the fact that so many Greeks have accounts in German banks they can use for payments. Given this broad array of payments choices, the free drachma will be stillborn.

Nor can drachmas be forced into circulation. A country that can't enforce tax laws can't enforce legal tender laws. No, the drachma won't be reappearing any time soon.

Krugman assumes that the euro is like a glove. You can put it on and take it off easily. In actuality the Euro is more like a Chinese finger-trap. It's easy to put on, but once you're in, getting out is well night impossible. As attractive as devaluation is, that's not the core issue. There simply is no way to get from here to there.

Greece will either stay in the Eurosystem, or will try to leave and end up with euro anyways. The latter is informal euroization.

On the problem of ensuring the acceptability of a new fiat money, see George Selgin.

If Iceland were to adopt the Canadian dollar

Nick Rowe brings up the topic.

There are plenty of interesting comments there on how this would work. In particular, how would the Icelandic banks secure liquidity if they were to move to a Canadian  dollar standard? It seems to me that local Canadian banks could act as lenders of last resort to the Icelandic banking system.

Alternately, if Icelandic banks were willing to submit to Canadian regulation, then perhaps things could proceed one step further and get admittance to the Canadian Payments Association, Canada's central clearing system. As members they would get Bank of Canada lender of last resort assurance.

The Euro isn't a glove, it's a Chinese finger trap

Tyler Cowen posts on Is there an easy way out of the eurozone? He notes it would be harder than Robert Barro thinks.

I agree. My comment:

Barro’s is the Euro-as-glove argument. You can slip it on, and slip it off just as easily.

I like the Euro-as-Chinese-finger-trap argument. Once you’re in, you aren’t going to get out of it.*

*Germany can’t leave it easily, because it is owed some E500b by the ECB via the Target2 settlement system. Leave it and lose it. The PIIGS can’t leave, because as Tyler points out, a bank run will immediately result. And if they dodge the run, they surely won’t be able to dodge euroization: citizens will spontaneously disengorge any newly-created liras/drachmas/etc in favour of the already-circulating and vastly superior Euro.