Italy: A parallel currency would be as stable as a house of cards

The designated government in Rome is promising Italy nothing less than (economic) political change – which could also include daring experiments such as the creation of a parallel currency to the euro. The country is weighed down by an enormous mountain of debt of 130% of GDP, which does not even include unpaid invoices and supplier credits amounting to as much as EUR 100bn and which could bring quite a number of small entrepreneurs to the brink of financial ruin. Given that austerity is not a matter for the 5-Star Movement and Lega, and debt is likely to rise in view of the proposed tax reform, they are openly considering settling the liabilities with the government’s borrowers’ notes (so-called mini BOTs) rather than in euro. These borrowers’ notes will not be legal tender, as this would otherwise quite clearly infringe EU treaties. However, the government would in turn have to accept these as payments for taxes to boost acceptance of this parallel currency.

If Rome really puts the idea into practice, the European institutions are unlikely to wait long before bringing an action against this process. Regardless of the legal concerns, how promising could such mini-BOTs be? The key to a currency’s success is the trust it commands. It is usually up to the central banks to ensure this trust is in place in the same way the ECB is assigned with maintaining confidence in the euro. In the case of the mini-BOTs, this task would fall to the Italian government in its capacity as issuer. As long as the citizens and companies are confident the government will accept these mini-BOTs and swap them into euros indirectly (through repayment of tax liabilities denominated in euro), the experiment could allegedly succeed initially and incite envy in other countries such as Greece to follow suit. In a best-case scenario, these borrowers’ notes would also be accepted as a means of payment in the general economic cycle.

However, this confidence assumes there is faith in Italy’s solvency. If the Italians repay their tax liabilities in future with mini-BOTs, the government loses tax revenues in euro, whereby the payment obligations to other countries and bondholders continue to be denominated in euros. Given that mini-BOTS are non-convertible (in other words, cannot be traded on the currency markets), the government cannot use them to repay its debt. In the long run, this would result in an ever greater gap between income and expenditure in euro, which would ultimately have to be refinanced on the capital market. If confidence in sovereign solvency falls as a result, companies are unlikely to accept mini-BOTs any longer, as they would have to repay their liabilities to international entities and banks in euro. The mini-BOT project is not only under threat of collapsing like a house of cards. The risk of Italy becoming insolvent could also increase suddenly if the government issues so to speak uncovered cheques. It is therefore hardly surprising that the discussion about mini-BOTs alone is hitting Italian bonds hard and diminishing confidence already in the country’s fiscal sustainability.

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