October 27, 2015    11 minute read

Eurozone Credit Market benefits through enhancing Taxpayers’ Autonomy

   October 27, 2015    11 minute read

Eurozone Credit Market benefits through enhancing Taxpayers’ Autonomy

Taxation laws and mechanisms as well as Legal Tender make it difficult for entities to transact in a variety of monies. In many economies, although people are technically allowed to trade with any money they’d like to, the vast majority of domestic trade is conducted in the sole, national money. This can be partially attributed to the fact that that is the sole legal tender (which “means that a debtor cannot successfully be sued for non-payment if he pays into court in legal tender”) since the legal privileging of national money compared to other monies artificially elevates its value. More importantly, the taxation laws’ and bureaucracy’s adaptation to and favour of that one money means that there are significant costs in trying to do business in other monies; for example, the transaction costs that would be incurred by exchanging monies for tax purposes help often make the co-existence of multiple monies economically infeasible. Finally, enabling public sector (including public corporations’) employees to have the proportions of their incomes paid in the various desired denominations would help initiate the necessary impetus via network effects for this reform to help save Greece and, more widely, the Eurozone.

Take the example of Greece: suppose Greece had multiple legal tenders (Euro, British pound, Swedish krona, Swiss Franc, Danish krone, Czech koruna etc. – or even just a small selection of these, though all of them would be better) and had a taxation system and bureaucracy that facilitated payment in multiple monies. So, if an entity earned 30% of its income in Euros, 45% in British pounds and 25% in Swiss Franc and that there was a fixed tax rate of 30%, the composition of their total tax contribution would be according to the proportion of each money held – 30% of the Euros, 30% of the pounds and 30% of the Francs would be paid. Furthermore, a public sector employee may be guaranteed an income with a purchasing power parity of $30,000 but may choose to have 25% of this in Swiss Francs, 40% in Euros, 20% in British pounds and 15% in Czech koruna.

Trading preferences, money demand and creditworthiness

The distribution of exporters (who can use relatively cheap monies and, thereby, sell more), importers (who may choose to employ relatively strong monies so that they do not import inflation), consumers, producers, savers, borrowers, creditors, debtors and so on who can act more optimally according to their various preferences means that there will be increases in (expected) investment, (expected) profits, (expected) output, (expected) employment etc.; this not only means that both disposable incomes and tax revenues will increase but also that there will be a proportionate decrease in agents’ credit risk due to increases in the aforementioned variables. Furthermore, Greece’s sizeable trade deficit (as does France’s, Spain’s, Portugal’s and Ireland’s) implies that there are many importers who might prefer relatively stronger money (such as the British pound) for importing.

The increased money demand (for money such as pounds) would incentivise foreign banks (e.g British, Danish and Swedish ones) to either set up in Greece (thereby bringing jobs and increasing investment opportunities) or, alternatively, lend money and support the operations to local Greek banks (such as the National Bank of Greece, Bank of Greece, Alpha Bank and Pitraeus Bank) so that they can be the intermediaries that help meet the local money demand. Similarly, wherever the ‘exporting’ monies come from (they could be Polish zloty, Czech koruna, Romanian leu or others), the banks from those countries would have an incentive to expand operations in Greece. Furthermore, the Greek government would receive an increased proportion of its taxes in relatively strong monies (since Greece is a net importer) which would enable more effective servicing of Sovereign Debt denominated in Euros (thereby improving Greece’s creditworthiness); after all, if governments borrow in relatively cheaper monies (such as the Euro), then tax revenue received in relatively strong monies (especially in countries that have trade deficits) will allow, all other things equal, greater reduction of debt.

Increased demand for Eurozone Sovereign Debt, reduced yields and increased confidence

The reduced demand for Euros would also naturally work to reduce its exchange rate, thereby making Eurozone Sovereign Bonds relatively cheaper (contributing to increased demand for them and reduced yields). However, it may be argued that the decline of the Euro in recent years has failed to sufficiently lower sovereign debt yields; though this is true, the difference is that that decline was due to lack of confidence, potential defaults, possible exits etc. whereas, this time, improved expectations, creditworthiness, channels for lending etc. would help increase investment inflow and potentially contribute to Euro appreciation whilst the increased confidence would decrease yields by increasing demand for debt (thereby offsetting the possible demand-reducing effect of euro appreciation on sovereign bonds). Whichever effect dominates, whether it be the improvement in confidence in the Eurozone, Euros and Eurozone governments or the devaluation of the Euro, the net impact would be an increase in demand for European Sovereign Debt, an increase in Sovereign Bonds’ prices and, therefore, a reduction in yields. Thus, both creditor and debtor entities would benefit from such an arrangement. All of these benefits would help restore Eurozone Sovereign Bonds’ efficacy as collateral and, thereby, ease up on other credit market channels.

A wider range of available interest rates, decreased liquidity risk and decreased credit risk

Since banks would pay varying rates of interest on different deposits (being denominated in different monies), this range of interest rates will appeal to savers, borrowers, importers, exporters, consumers, producers etc. and the variety of interest rates means that, on a macro view, funds will be distributed across the interest rates according to agents’ savings, borrowing and investment preferences and each agent will also distribute their own funds accordingly. This will also help contribute to an increase in savings and loanable funds for investment (having increased rates available for savers will also help mitigate possible future pensions crises). Since there would be a greater amount of savings than is currently the case, due to the range of interest rates, commercial banks’ liquidity risk would decrease.

Agents with a high credit risk would not have as much access to cheaper credit as they would when compared to a regime with persistently and wholly low interest rates (like they have historically tended to when Central Banks depress interest rates). Similarly, since people would rather save at higher interest rates (and, therefore, in certain relatively strong monies), this means that a higher proportion of loanable funds will be available to borrow at higher interest rates and vice-versa. This ensures that credit bubbles will be restricted in future since people who compete for lower interest rate loans will have to exhibit lower credit risk to avoid higher interest rate loans. However, this does not mean that borrowing would only be done at lower interest rates because, due to money being an instrument of expectations-management, not all agents will value the expected (relatively) low interest rate as highly as others. Hence, some (such as importers, investors or people who are borrowing with the expectation that their loan will provide a stream of future income that offsets the loan payments), may pick a higher interest rate loan if it meant, for example, that a (relatively) high exchange-rate money would enable them to profitably invest more since the stabilised expectation of a higher exchange rate is more highly valued than that of a lower interest rate. Furthermore, some may be willing to pay a higher interest rate on loans if they believed that that money’s exchange rate was less volatile or if they believed that Central Bank issuing that money had a more credible monetary rule.

Restricting asset-price bubbles, automatic trade balance management and reducing expected future volatility of credit risk

Given fluctuations in interest rates and exchange rates, enhancing taxpayers’ autonomy enables agents’ switching from one money to another according to their needs – thereby restricting asset-price bubbles and mitigating trade imbalances. If one particular currency gets too devalued, agents will switch to another (relatively and appropriately) stronger money. Since they could pay their taxes in this money, the government could also finance its debt more effectively with the increased proportion of taxes paid in that money. Hence, there would be a reduction in the expected future volatility of governments’ credit risk. Keynes once wrote that

“It is, I think, arguable that a more advantageous average state of expectation might result from a banking policy which always nipped in the bud an incipient boom”

and, though it is obviously extremely difficult (as has been observed) for Central Banks to know when to nip an incipient boom in the bud (or, indeed, to know when there is an incipient boom) enhancing Taxpayers’ Autonomy might act as the automatic stabiliser that could help accomplish the objective of financial crises prevention that was intended through his speculative proposal for monetary policy.

Two brief case studies: Åland and Büsingen

Åland is a tax autonomous region of Finland within the EU where both Euros and Swedish Krona are used widely in trade; Åland’s unemployment rate was 3.9% in January 2014 and it’s economy is heavily reliant on shipping, trade and tourism. Åland’s trade is exempt from the EU’s VAT and Customs rules, which means that trade in Euros and Krona are on equal tax grounds in this respect – so although we cannot currently abolish taxes everywhere, we can make taxation a level playing field with respect to different monies in order to enable the coexistence of multiple monies. However, although both Krona and Euros coexist, the Euros are unfairly privileged by the fact that the Finnish government provides a cash lump sum every year in Euros (0.45% of total Finnish government tax revenue); hence, reform would have a substantially greater impact if public sector workers could choose the proportions of currencies their income was denominated in. This would encourage foreign banks to start lending directly to the government for this purpose again and to incentivise greater circulation of multiple currencies through network effects.

Büsingen is a German town where the euro is legal tender but since the majority of its inhabitants earn in Swiss Francs, that is the most widely used currency and even an amendment that forced them to accept Euros did not shift them from using Swiss Francs. This suggests that it is neither solely legal tender nor taxation but also what people earn in and, since the public sector and public corporations are significant in most countries (including Greece), providing employees the opportunity to choose the monies that their income is denominated in will enable diversified circulation through self-reinforcing network effects; they would also choose to diversify the denominations since banks would pay different interest rates on different money deposits.

Potentially lucrative involvement of the USA, China and India

Also, the potential benefits could be exponentially amplified if this Tax and Legal reform were expanded to include the US Dollar (since US banks would get involved), the Chinese renminbi (an obvious choice for an exporting money, Chinese banks could also invest and this would simultaneously help China reorient its economy toward services-export) and the Indian rupee. After all, there is clearly demand amongst some Greeks for a weaker currency and, from some (albeit for a smaller proportion) for a stronger currency; the degrees of strength and weakness means that there are parts of the market that will appeal to various different banks that hold deposits in different monies.

Less need for debt restructuring and austerity measures

Ultimately, this means that there would be less need for debt restructuring (as Syriza proposes to negotiate and creditors are reluctant to do) since Greece would gain more tax revenue, more people would be employed, yields would decrease and austerity would be far less painful (possibly even wholly unnecessary if the increase in tax revenue is large enough from all the increased investment, and trade). Furthermore, the competition between foreign banks (American, British, Danish, Chinese, Indian, Swedish, Swiss etc.) will help ensure that Greeks get good, competitive deals (and that means all Greeks – not just certain ones with particular interests).

Thanks goes to Professor Herakles Polemarchakis for helping me consider the impact on credit markets, to Professor Peter Hammond for providing the case study of the Aland Islands, to Sam Bowman for speaking of network effects and to all of them for giving constructive feedback on the original proposal. These proposed reforms could be part of the long-term structural changes required for Eurozone governments that supplement the recent announcement of QE (which Ben Southwood has argued is welcome in the Eurozone but which should be supplemented by structural reforms to the labour market, for example).

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