Greece’s two cur­ren­cies

Financial Mirror (Cyprus) - - FRONT PAGE -

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 Au­gust 18, 2015, a few weeks af­ter pulling the plug from Greece’s banks (thus mak­ing cap­i­tal con­trols in­evitable), the Euro­pean Cen­tral Bank and its Greek branch, the Bank of Greece, ac­tu­ally for­malised a dual-cur­rency cur­rency regime. A govern­ment de­cree stated that “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 eu­ro­zone 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” (es­sen­tially tax hikes, pen­sion re­duc­tions, and other con­trac­tionary mea­sures) im­posed on the coun­try by the eu­ro­zone 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% of next year’s cor­po­rate tax (as es­ti­mated by the tax au­thor­i­ties).

The se­cond group com­prises listed com­pa­nies whose de­pressed turnover jeop­ar­dises their al­ready di­min­ished share value and their stand­ing with banks, sup­pli­ers, and po­ten­tial cus­tomers (all of which are re­luc­tant to sign longterm con­tracts with an un­der­per­form­ing com­pany).

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. One wide­spread prac­tice in­volves two such firms, say, Mi­cro (a small fam­ily firm fac­ing a large ad­vance tax pay­ment) and Macro (a pub­licly traded lim­ited li­a­bil­ity com­pany that needs to demon­strate higher turnover than it has).

Macro agrees to is­sue in­voices for (non-ex­is­tent) goods or ser­vices ren­dered to Mi­cro, up to, say, EUR 20,000 ($22,000). Mi­cro agrees to pay EUR 24,600 into Macro’s bank ac­count (the price plus 23% value-added tax) on the un­der­stand­ing that Macro will re­im­burse the EUR 20,000 to Mi­cro. This way, at a cost of 4,600 euros, Mi­cro re­duces its tax­able rev­enue by EUR 24,600, while Macro boosts its turnover fig­ure by EUR 20,000.

Alas, due to cap­i­tal con­trols, Macro can­not re­im­burse Mi­cro in FE, nor can it wire EUR 20,000 to Mi­cro’s BE bank ac­count (lest they be found out by the au­thor­i­ties). So, to seal the deal, Mi­cro and Macro ap­proach a cash-rich ven­dor. This is usu­ally a gas-sta­tion owner who is flush with cash at the end of each day and who, for se­cu­rity rea­sons and in or­der to pay for his fuel sup­plies, is obliged to de­posit his cash daily at his bank, turn­ing valu­able FEs into less valu­able BEs. The mu­tu­ally ben­e­fi­cial deal is com­pleted when Macro wires EUR 20,000 in BE to the gas-sta­tion owner, who then hands over a smaller sum of FE (cash) to Mi­cro’s owner, pock­et­ing the dif­fer­ence.

The fact that this in­for­mal deal ben­e­fits all sides ex­poses the ter­ri­ble in­ef­fi­ciency of cur­rent fis­cal pol­icy (namely, puni­tive busi­ness taxes) and how cap­i­tal con­trols mag­nify it. The state col­lects ad­di­tional VAT from Mi­cro (at a loss of cor­po­rate taxes that Mi­cro can­not pay any­way); Macro en­joys the ben­e­fits of seem­ingly higher turnover; and the gassta­tion owner re­duces his losses from con­vert­ing FE into BE. The down­side is that eco­nomic ac­tiv­ity is over­stated and, more i mpor­tant, that re­form be­comes even harder as en­trepreneurs in­ter­nalise the ne­ces­sity to find new, cre­ative ways of bend­ing the rules.

The sole pur­pose of the cap­i­tal con­trols im­posed on Greece last sum­mer was to force the coun­try’s re­bel­lious govern­ment to ca­pit­u­late to the eu­ro­zone’s failed poli­cies. But an un­in­tended con­se­quence was the for­mal­i­sa­tion of two par­al­lel (euro-de­nom­i­nated) cur­ren­cies. Com­bined with the puni­tive tax­a­tion caused by Europe’s re­fusal to recog­nise 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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