The currency that replaces the euro

The currency that replaces the euro

Back in 1719 and 1720, a Scotsman named John Law was in charge of France’s Treasury. He faced a very particular set of problems.

Too much government debt, not enough control over monetary policy and a sputtering economy.

In other words, the very same problems that Italy faces today.

Law’s solution to all three challenges also happens to be exactly the same solution that Italy’s government has in mind.

According to a recent Bloomberg article, titled ‘Italy’s Scary Parallel Currency Threat’, the idea is already gaining political traction:

‘…The document invited the government to consider issuing small denomination bonds to help speed up its settling of debts. All parties, including the opposition Democratic Party and Forza Italia, voted in favor – the Democrats later disavowed the decision.

Small denomination bonds? What exactly is going on?        

Attempting alchemy, by decree

Italy’s government is so broke it hasn’t been paying its bills, leaving suppliers and contractors in the private sector reeling — to the tune of more than 50 billion euros…

And the politicians are wondering why their economy is doing so badly! The government doesn’t pay its bills!

But that could soon change, with bills paid in something other than euros.

Here’s how the scheme works, just as it did in John Law’s day…

Instead of paying people in money now, the government promises to pay them money in the future. These promises to pay are called mini-bots, named after normal Italian government bonds.

This is where the remarkable thing happens. The alchemy that made John Law famous…before he became infamous.

The mini-bot promises to pay and circulate just like money in the economy, even though they’re really just loans to the government — promises by the government to pay the bearer euros in the future.

How can a loan be confused for real money?

That’s the secret.

Because the government is unlikely to ever default on a promise to pay, that promise should be as good as money anyway. A guaranteed future payment is almost the same as a payment.

This is especially true because the mini-bots can be used to pay taxes in the meantime. So instead of sending the government your euros to pay your tax, you just send the government its own IOUs. The two cancel out and your taxes are deemed paid. It’s a bit like a transferable tax credit.

Usually, a loan to someone must be paid back to the lender who lent it. But because mini-bot loans are payable to the bearer, they can be exchanged between anyone. And thereby used to pay everyday bills between anyone.

You could pay your accountant and newsletter subscription fees with them, for example. Then the accountant uses them to pay his taxes.

The government has effectively performed alchemy. It has turned a loan to the government into money circulating in the economy. Promises to pay euros are converted into pseudo euros.

Is it money? Is it debt?

Impressive, right?

But what’s the net effect of these mini-bots?

They effectively increase the money supply in the economy. It’s a form of QE. A licence to print pseudo euros. In a way the Italian government can control, and the EU and ECB can’t.

This theoretically stimulates the economy because the government’s suppliers finally get paid. And more money is sloshing around in the economy.

It also allows the government to borrow more money and pay its bills. But will the debt be counted as such if it looks and acts like money? Depends who you ask.

ECB President Mario Draghi said mini-bots ‘are either money — and then they’re illegal — or they’re debt, and then that stock [of debt] goes up.

To the Italians, mini-bots sound like a solution to the three problems the government faces. Too much debt, control over monetary policy and economic stimulus. Mini-bots allow the government to borrow more in an indirect way, issue more money and stimulate the economy.

And that’s just what happened back in John Law’s day. An epic boom in the economy and financial markets began. He became absurdly rich in the process.

But there’s a reason we don’t allow governments to run monetary policy. The way I see it, politicians can’t be trusted with that much power. They always abuse it. And things go sour.

In the end, this is what happened in John Law’s day, leading to the breakdown of the financial system and a crisis in the economy.

How to replace the euro, one step at a time

Europeans today are worried the Italian government will do the same, with the same result.

But there’s a bigger risk that is dominating the financial headlines here in Europe.

I believe that if the mini-bot system comes into being, it will create a second monetary system that operates alongside the euro.

A monetary system that would allow Italy to leave the euro with minimal disruption to its economy. Because the secondary system it reverts to is up and running already.

But what about all those euro-denominated debts the Italian government has? If Italy leaves the euro, would it pay up? Unlikely. Defaulting on the debt is one of the benefits of leaving the euro at all. So Italy will default. It would be the biggest default in history.

But that won’t happen until Italy’s alternative mini-bot monetary system is up and running.

It’s a bit like Britain securing trade agreements with other countries before leaving the EU.

You need something in place to transition to if you want the transition to be smooth.

This means you still have time to prepare for Italy’s crisis. But it’s drawing near.

Until next time,

Nick Hubble Signature

Nick Hubble,
For The Daily Reckoning Australia