Imagine a depositor in the US state of Arizona being permitted to withdraw only small amounts of cash weekly and facing restrictions on how much money he or she could wire to a bank account in California. Such capital controls, if they ever came about, would spell the end of the dollar as a single currency, because such constraints are utterly incompatible with a monetary union.
Greece today (and Cyprus before it) offers a case study of how capital controls bifurcate a currency and distort business incentives. The process is straightforward. Once euro deposits are imprisoned within a national banking system, the currency essentially splits in two: Bank euros (BE) and paper, or free, euros (FE). Suddenly, an informal exchange rate between the two currencies emerges.
Consider a Greek depositor keen to convert a large sum of BE into FE (say, to pay for medical expenses abroad, or to repay a company debt to a non-Greek entity). Assuming such depositors find FE holders willing to purchase their BE, a substantial BE-FE exchange rate emerges, varying with the size of the transaction, BE holders’ relative impatience, and the expected duration of capital controls.
On Aug. 18, 2015, a few weeks after pulling the plug from Greece’s banks, the European Central Bank and its Greek branch, the Bank of Greece, actually formalized a dual-currency currency regime. A government decree stated “Transfer of the early, partial, or total prepayment of a loan in a credit institution is prohibited, excluding repayment by cash or remittance from abroad.”
The euro zone authorities thus permitted Greek banks to deny their customers the right to repay loans or mortgages in BE, thereby boosting the effective BE-FE exchange rate. And, by continuing to allow payments of tax arrears to be made in BE, while prescribing FE as a separate, harder currency uniquely able to extinguish commercial bank debt, Europe’s authorities acknowledged that Greece now has two euros.
The real effects of the dual-currency regime on Greece’s economy and society can be gleaned only from the pernicious interaction between the capital controls and the “reforms” imposed on the country by the euro zone authorities. Consider the following beguiling example. Greece’s companies fall roughly into two categories. In one category are a large number of small firms asphyxiating under the tax office’s demand that they pay in advance, and immediately, 100 percent of next year’s corporate tax. The second group comprises listed companies whose depressed turnover jeopardizes their already diminished share value and their standing with banks, suppliers, and potential customers.
The coexistence, in the same depressed economy, of these two types of businesses gives rise to unexpected opportunities for shadowy trades without which countless businesses might close their doors permanently.
The sole purpose of the capital controls imposed on Greece last summer was to force the country’s rebellious government to capitulate to the euro zone’s failed policies. But an unintended consequence was the formalization of two parallel (euro-denominated) currencies. Combined with the punitive taxation caused by Europe’s refusal to recognize the unsustainability of Greek public debt, the dual-currency regime produces unforeseen incentives for informal transactions in a country that desperately needs to defeat informality. The reality of Greece’s two currencies is the most vivid demonstration yet of the fragmentation of Europe’s monetary “union.” In comparison, Arizona has never looked so good.
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The writer is a former finance minister of Greece. ©Project Syndicate
