In response to the on-going financial crisis in the euro zone, LFMI, a leading economic policy think-tank in Lithuania, has worked out and submitted to responsible institutions a plan which would help countries exiting the euro zone to build stable and sound money. LFMI‘s proposal can be also used by the euro zone when attempting to strengthen the euro and to restore people‘s confidence in the single currency.
The persisting crisis of euro zone state debt is increasing the probability that some euro zone countries will be forced or will choose to leave the euro zone. In the LFMI’s opinion, this would be a significant challenge both for the exiting country and the euro zone itself, but at the same time it would serve as a unique opportunity to re-establish sound currency and people‘s confidence in money.
“The major vice of the existing money is that it is not limited, that central banks, including the European Central Bank, may print any amount of money at will. As a result, money loses value, its purchasing power diminishes and all citizens pay the invisible “inflation tax,” – LFMI’s Senior Fellow Rūta Vainienė explains the defects of the current monetary systems.
LFMI points out that stable money is a necessary condition for prices to go down, for people’s income and savings to retain their value and for people to be able to plan their financial future. Devaluation of a currency hits the most at low-income people since they do not have financial abilities to invest.
In its stable money plan, LFMI proposes specific steps that should be taken by a country intending to ensure a stable and strong currency for its citizens. The essence of the plan is that such a country should restrict its money emission, tying its currency with precious metals, that is, gold. LFMI proposes to implement the transition from the euro to a new independent currency in two stages. During the first stage, the exiting country would introduce its new national currency which would be pegged to the euro at the exchange rate 1:1. During the second stage, LFMI proposes to replace the current euro reserves with a precious metal and tie the introduced monetary unit with a chosen quantity of metal.
“Lithuania still remembers the strong national currency, litas, in the inter-war years whose strength rested on gold. It was gold and silver that the market has chosen as a monetary unit out of a variety of commodities. Linking the worlds’ major currencies with gold has been completely abandoned historically quite recently, only in 1971,“ – speaks LFMI’s Senior Policy Analyst R. Vainienė.
R.Vainienė highlights that as global currencies keep confronting crises and central banks fail to cope with monetary problems, increasingly more economists in the world recommend returning to the gold standard. “However, some economists criticise the pegging of currencies to gold, fearing a potential gold price bubble, deflation or hikes in supply. Our study gives thorough answers to these arguments, weighing the real risks and refuting the apparent ones,” – says R. Vainienė.
The sound money plan proposed by LFMI has been developed, for the most part, for countries who may decide to exit the euro zone, but its cornerstone proposal – the pegging of currencies to gold – might well be used by the euro zone itself, if it decided to shift from a discretionary policy pursued by the European Central Bank to the gold standard.
LFMI submitted the stable money plan to the European Central Bank, the European Commission and a number of other institutions and central banks in other countries. The LFMI plan can be downloaded at the link bellow.
LFMI has been actively working in the field of monetary policy since 1992. When Lithuania braved the fall of the rouble 19 years ago and introduced its national currency, LFMI presented a plan of creating sound money and took an active part in its implementation. Following LFMI’s advice to adopt the currency board principles in Lithuania, the Law on Litas Credibility was passed that pegged the litas to the US dollar and later to the euro. The currency board in Lithuania has helped the country to trammel hyperinflation, restored Lithuanians’ confidence in litas and build strong foundations for economic reforms and growth.
LFMI is a private non-profit non-partisan think-tank established in 1990 to promote the ideas of individual freedom and responsibility, free market, and limited government.
SOUND MONEY INTRODUCTION PLAN
Lithuanian Free Market Institute
Summary
Let us start by stating common principles, essential for choosing a solution from various alternatives: money is a universal equivalent of economic resources, while economic resources are known to be scarce. Recent monetary history represents human attempt to overcome the scarcity of resources by making money abundantly available. This makes this crisis a product of human nature rather than mismanagement or miscalculation.
Ordinary people want more money more quickly to satisfy their needs.
Companies desire more and “quicker” money as well, their need is limited by profit and loss mechanism.
Governments yearn for “more and quicker money”. Their needs grow as their functions expand. Citizens are raised in the spirit of “rights”. “Rights” require financing.
The current crisis therefore reminds us that a successful transition to new independent currencies (NIC) should not be limited to technical details; it should revive all the basic functions of money.
It is often said that there is no exit from the eurozone, because the exit mechanism was not included in to the membership agreement. Historically, however, none of the monetary unions had an exit plan developed in advance; yet they went through disintegration process. There is always an exit, and the eurozone is no exception.
This plan does not aim at specific interest groups; it provides a solution which will benefit every citizen but not at the expense of others.
By the proposed plan we seek:
1) to lay the grounds for the viability of the NIC;
2) to protect the rights of creditors;
3) and to maintain stable commercial ties between counterparties.
Reformers should not assume that there are easy and costless exits. One should choose the exit that is the least damaging, and provides a solid basis for future competitiveness and economic growth.
Today the euro has been weakened by the attempts to cover public deficits via monetary means. Currently, monetization is being conducted indirectly. Disciplined countries take the burden of undisciplined ones. This redistribution takes many forms but in addition to its economic outcomes, it causes moral hazard and public dissatisfaction.
The single currency allowed international cross-subsidizing. That created an illusion that economic prosperity can be achieved by cheaper financing alone. Essential reforms of welfare systems and the improvement of the business climate were not addressed.
The ECB has increased the money supply (M1) 2.6 times since 1999. The money multiplier in the eurozone is 3.7 for M1 and 7.7 for M3. The constantly deteriorating purchasing power of money depreciates savings and income and thereby encourages society to indulge in “fast consumption”.
The constantly increasing supply of euros redistributes wealth among member sates and generations, destroys prices and savings, and causes malinvestment leading to the consumption of capital and, in the long run, – the general impoverishment of the people in the eurozone.
The introduction of a new monetary unit may be needed if:
– a country decides to create better currency and protect itself fro overspending countries (“German” type exit);
– EMU members decide to exclude overspending countries (“Greek” type forced exit) and to protect euro;
– a country seeks to monetize the debt or to create bigger inflation (“Greek” type voluntary exit).
The exit mechanism is not limited by a country’s size or economic potential, but the outcomes will vary.
After evaluating the different scenarios and historical evidence, namely, parallel circulation of currencies, adoption of another state’s currency, introduction of the national currency as fiat money, and currency board arrangements we came up with the exit proposal that leads to the soundest foundation for future growth.
The main principle of the sound money is to apply the currency board elements:
a) a fixed exchange rate 1:1 between the euro and the NIC during the exit period;
b) euro reserves to back 100% of NIC in circulation (Money base);
c) 2 -4 weeks of dual circulation of NIC and the euro;
d) No sole legal tender for new contracts.
The scheme of the transition
In the proposed plan the exchange of cash is voluntary. The propensity to exchange euros into NIC will mainly depend on the market’s expectations regarding the qualities of the new currency.
The denomination must be implemented for all euro – deposits, banking loans (mortgages) in to NIC on the eXit day X at the fixed rate 1:1. Private sector contracts have to be denominated. However, there is some space for the decisions of the counterparties involved. There is no general rule for the denomination of public debt. The option not to denominate the debt is more preferable, because this will not create legal problems and encourage non-inflationary monetary policy. All public sector obligations to citizens, i.e. transfers must be denominated, as well as the public procurement contracts. Pension and investment funds should be granted the right to decide whether and to which extent they switch to a new currency.
The preparation stage must include establishing the legitimacy of the exit; formation of a special task force; drafting legislation, supplying banks with the new money, developing IT solutions; raising public awareness, setting aside a transition fund.
If the central bank ends the changeover at this stage that means that a country merely imports the European monetary policy. Thus, the full exit is still incomplete. The country must follow a monetary scenario of their choice and provide NIC with the desired qualities.
After the analysis, we propose to choose gold as a reserve commodity with the full understanding of its benefits and shortcomings. The study addresses major criticism of using gold, such as the dangers of deflation and the deleveraging process.
The proposed plan returns the real meaning of the promise that symbolically is indicated on the British pound “I promise to pay the bearer on demand the sum of … pounds” and this will be a fundamental feature of the NIC.
