July 2019 newsletter: Letter from Germany — The Euro, Italy and Mini-Bots
16 Jul 2019
In his latest Letter, Michael Burda looks at German responses to the suggestion that the Italian government should issue small-denomination, short-term debt, as a means of making payments.
After returning from the annual ECB Forum in Sintra, where Olivier Blanchard and other grandees pled for more fiscal space, I see that Germany’s newspapers and websites are abuzz about Mini-Bots. Not a new form of artificial intelligence, Mini-Bots are a proposal of some members of the current Italian government (Lega cum Movimento5Stelle, M5S for short) to issue small-denomination, short-term debt to meet payments, mainly for reducing arrears with small contractors (currently estimated at €50b or 3 per cent of GDP). BOT stands for ‘Buono Ordinario del Tesoro’ and would be little more than an IOU, probably bearing zero interest, and negotiable under certain conditions. As any historian of economics will attest, scrip issuance is a natural and understandable economic reaction to a liquidity shortfall. The Wikipedia page for ‘scrip’ gives scores of examples from US colonial times to the Great Depression when governmental authorities issued IOUs, sometimes limited to certain transactions, most often at a discount when exchanged for real money or goods. In the Weimar hyperinflation, many reputable German entities paid their workers in scrip, denominated with many, many zeros.
ECB President Mario Draghi was clear: Either Mini-Bots are debt — and they are counted in Brussels against Italy’s efforts to meet the EU Commission’s conditions for fiscal discipline; or they are money — in which case they are simply illegal. Yet maybe he wasn’t clear enough, because the Italian government continues to push the fiscal envelope, promising to pass this autumn a flat income tax as well as a guaranteed minimum income. This would raise the budget deficit, which is already creeping upwards again. Could Mini-Bots give the Italians wriggle room at a time when ‘fiscal space’ is at a premium? In the light of a stalled proposal to raise VAT (since 2017) — there are few alternatives. Now facing a government debt/GDP ratio of more than 130 per cent, Italy is reaching the point of no return, and any rise in interest rates would put the budget under enormous strain. With cumulative growth of only 9 per cent since the Euro was introduced in 1999 — less than ½ of one percent per annum — the economy’s real GDP remains 5.1 per cent below its peak of 2008 (see figure). Certainly the ‘China shock’, lack of dynamism, and a general loss of competitiveness are the root of Italy’s long-run malaise, but additional fiscal austerity right now would only make a dismal situation worse.
At first sight, the Mini-Bot proposal looks like a trial balloon — a lot of hot air and posturing according to some Italian friends — so it is not immediately clear why Germany is up in arms about it. Yet the Italian government has steadily increased the heat and volume of pronouncements on this form of debt over the past few weeks. In effect, Mini-Bots could achieve exactly what cash-strapped governments and businesses often do to make ends meet: squeeze suppliers via forced loans and price flexibility. The Italian proposal is so interesting because the government, which purchases goods and services amounting to 16 per cent and touches more than 48 per cent of GDP, would peg the Mini-Bot’s value for payment of tax liabilities of private firms and households in Euros at 1:1. Every tax payment with Mini-Bot would extinguish debt — and Gresham’s Law virtually guarantees that firms will use them. I am guessing this would keep the instrument from trading at a discount. This fixed exchange rate requires no central bank, just the promise of the state to accept them at parity. Seen from this perspective, the proposal might have positive macroeconomic effects. Most new-Keynesian models with sticky prices would predict positive effects of tax cuts and transfer increases on growth if any of the coming Italian triple dip recession is due to sagging aggregate demand. That is, as long as the Italian government does not succumb to the temptation to increase the volume of Mini-Bots without end. This, of course, might be the most heroic assumption of all. Most German commentators see the Mini-Bot proposal as the Einstieg in den Ausstieg (entry to the exit). If the Italians want to leave the Euro, they reason, this would be the way to acclimate the population to a new means of payment that some future government could convert into Nuova Lira. The Lega claims to have ‘learned’ from the Greek episode. Yet most surveys suggest the Italians want to keep the Euro. And everyone knows that any suspicion of conversion would lead to massive Euro withdrawals and the collapse of the Italian banking system. So keeping the Mini-Bot out of the financial system would appear to be a sine qua non for the plan to work. How that should happen is anyone’s guess. The blockchain?
The ECB Forum I attended two weeks ago was supposed to celebrate 20 years of the Euro. While there is much to admire about its technocratic execution, European monetary union was poorly planned in deep and disturbing ways, and critical reflection of this fact was missing in Sintra. First and foremost: Regardless of how compelling political reasons for a single currency may have been, excluding banks and banking union at the outset was irresponsible, and remains the Euro’s Achilles heel to this day. Second, a monetary union that preserves the national central banks is a central problem, as I have pointed out elsewhere (https://voxeu.org/article/redesigning-ecb). The ECB is owned by member countries’ central banks and, by extension, by the national governments, so the monetary union was ultimately a national, rather than a European undertaking. The abolition of national central banks was never on the table, even though it should have been, if only to de-politicize the ECB’s refinancing policies and supervision activities, and to encourage cross-border bank mergers. Finally, getting back to the Mini-Bot, while it is laudable that the ECB is independent of national governments on paper, effectively it is just as susceptible to fiscal dominance as other central banks are. Italy is about to prove it. The Italians may have found a fatal chink in the armor of the ECB. What can prevent the Italian government from issuing scrip? A wrist-slapping from the Commission will hardly work, and anything tougher will encourage the populisti. Why wasn’t this contingency covered in the Maastricht Treaty?
I was reminded of my very first trip to Italy as a student, frequently finding myself at the receiving end of gettoni (photos above) — tokens of the state telephone system — created as a response to high inflation rates of the 1970s. My colleague Battista Severgnini from Copenhagen Business School has pointed out to me that private banks issued ‘minicheques’ (miniassegni) in the late 1970s as a stop-gap reaction to the general shortage of coin. While the miniassegni had to be 100 per cent backed by reserves at the Banca d’Italia, the Mini-Bot clearly does not! So innovative, these Italians…
Best regards from Berlin!