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Currency complications for the euro

Italy’s proposal to launch a parallel currency is stoking the ire of the EU and the ECB. Where can this all lead?

Italy’s proposal to launch a parallel currency is stoking the ire of the EU and the ECB. Where can this all lead?

John Redwood

in Features



The euro is unlike other major currencies. It is not backed by a single state with all its taxpayers. The European Central Bank (ECB) is not owned by one country with one government calling the shots over the size of the Bank, its duties and who runs it. As a result there is more political risk in the euro. We saw this in the periodic euro crises earlier this decade. Some depositors of euros in Cypriot banks discovered their euros were worth less than others and could not be withdrawn at will during the crisis. The people of Greece discovered that the ECB did not stand behind their banks and allow payments of money out of their bank accounts when the Greek state was in dispute with the EU over its debts.

Ever since Mario Draghi, the President of the ECB, said they would do whatever it takes to assist the Euro things have been better for the single currency. Interest rates have stayed at zero. The ECB has stood behind the main banks in the system, and sufficient credit has been advanced to avoid a recession in most parts of the Eurozone. In Italy there was another recession in the second half of last year, and this year is also slow going. Two populist parties swept to power in the last general election, and formed a government pledged to reflate the economy with spending increases and tax cuts that would violate the rules of the euro scheme.

Last year the two sides reached an eventual accommodation over the 2019 budget. The EU allowed Italy to borrow a bit more than they wanted in return for Italy scaling back its ambitions to tax less and spend more. The Italian Parliament with a majority of Lega and 5 Star governing party MPs recently passed a motion approving a scheme to issue more treasury bills in small denominations to make financing state activities easier. The Italian Treasury is not bound to follow this nor does it have immediate plans for such an issue. However, the fact that this idea is still being canvassed without a clear government slapdown means we do need to consider its impact.

Treasury bills are usually short term loans to the government by larger investors. They are recorded and traded electronically. These proposed small denomination treasury bills would have no repayment date and no interest rate. They look much like a banknote in their printed form and would be issued in the same values as euro banknotes, with a 5,10,20,50,100,500 euro treasury bill. The ECB was asked about them last week in their press conference. Mr Draghi stated that if they were an alternative currency they would be illegal. The euro has the sole right to be considered legal tender in the Eurozone. If they are, in reality, small value treasury bills, he said they are extra debts for the Italian state which would have to be within the existing debt ceiling set by the EU.

It is curious the ECB offered two explanations of what these instruments might be. They do look much like a parallel currency in their prototype form. The idea is to get people to take them up and use them by offering them to people for services they provide or tax rebates they are due from the state, and to accept them in payment for petrol at state owned filling stations and the like to get them into use.

These treasury bills are a provocation to the EU and the ECB. They are part of the friction caused by austerity policies in Italy and the poor growth rate. The Lega party which stands behind this idea is sceptical about the euro scheme and its economic disciplines, and wants to find a way around the rules. Lega must also know, however, that many Italian voters do not want to see a banking crisis and a forced exit of Italy from the euro on bad terms through government confrontation with the EU and the euro scheme. Our base case assumes both sides will avoid any such extreme event. It would, in the meantime, be wise to recognise the extra political risk in the Eurozone in general and Italy in particular posed by the obvious unhappiness of the current Italian government over the budget policies and the lack of growth.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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