The Euro – remedies or replacement?

Date: 21 Apr 2015 Comments: 0

The crumbling euroThe latest Greek difficulty is the headline, but the underlying problem is with the Euro itself. The incompatibility of the German economic position and that of the Mediterranean countries requires settlement, not just by dismissing the Greek membership, but by correcting the valuation method for Germany.

It is hard to see any “Plan B” for the Euro, as famously noted as not existing, but a continuation of the joint currency can only be achieved if any one of several unlikely events occur:

  • There is a political agreement to centralize government of (at least) the Euro countries, including tax collection and control of the budget process. We have no sign of this being accepted in any country.
  • There is an agreement to centralize all current national debt into one long term, united liability. Whether this was solely for debts up to now, or was for an ongoing basis, it would be seen as rewarding the spendthrift governments to the detriment of the hard-working tax paying northern citizens – and, as such, most unlikely.
  • There is a method of price adjustment agreed whereby differing exchange rates are agreed to reflect the underlying economic positions of, in particular, Germany versus the rest. The upcharge for such exports by Germany would generate a tax revenue for the weaker EU countries, based on their imports and on need. There is no current likelihood that Germany would accept such a burden, particularly on non-EU sales, meaning it is a non-starter; but even if such a scheme were created, it would take a lot of control to avoid cheating in many respects.

One other alternative is for there to be an agreement that the Euro is an unfair and basically unsound financial structure and should be broken up as soon as possible. Leaving aside the level of political embarrassment that would be caused (which would be profound in many quarters), the actual method of dismantling the Euro is hard to envisage.

The splitting up of the Euro would seem to require at least three factors to be agreed:

  1. How to value existing Euro holdings and debts within a new currency alignment. For instance, if at the extremes of the spread the new DM is worth 1.50 old euros, while the new drachma is worth 0.5 old euros, then holders would have to choose how many of their current 1,000 euros they want in DM (up to a total of DM 650) or in drachma (up to a total of GD2,000).
  2. The terms of choice may restrict bank account holders – including borrowers – from converting to any currency other than their national version. This would assist in limiting too much concentration of demand in any one new currency, but could create a high level of cheating ahead of the split. There could be too many ways in which the only people going to suffer are the poor, who have less flexibility to open foreign bank accounts and/ or travel abroad with stacks of high value notes.
  3. The amount of time it would take to get new currency notes printed for each country would cause far too big a delay in implementation, during which time the markets would be in chaos. The only way to manage such an eventuality is to withdraw all, or virtually all, notes from circulation – with new currencies only issued electronically. This may cause concern for many, who would see the danger of state oversight and technical glitches being too great to risk such a solution.

Regarding this third factor, I would like to comment on the position of electronic currencies, or what is a planned newer concept of digital currencies, to see if there is scope to answer the critics and to create a workable solution which would be acceptable to the majority of citizens. And, importantly, how to manage the introduction of change, ideally without rewarding those who have extracted funds from the weaker countries into the strong.

The blockchain technology has some strong arguments in its favor, not least its ability to lower costs of transactions dramatically. It is also suitable for managing the unbanked members of the community, being simple to accommodate non-bank payment options via mobile phones or debit cards. The current resistance to Bitcoins is mainly based on the origins of this product, i.e. the belief that it was invented to enable criminals and money launderers to evade regulatory control by passing value in secret manner. That belief happens to be completely untrue as to the secrecy, but there is still a level of truth in the background of the first users.

The creation of digital currencies in Europe could be used to bring about an alternative to cash, assuming this was to be encouraged at government level. One particular benefit for honest citizens would be in enabling a movement to real time VAT collection, something we have been pushing for ten years now. (See separate notes on RTvat on this.)  And this raises the broad aspect of why such a move should be urgently encouraged at this time; the potential saving of fraud and underpayment is still in the order of $200 billion per annum, apart from a similar amount in administrative savings from such a change. And now there is one more important element to such a move; if VAT is settled to the buyer’s country’s tax agency (rather than the seller’s) we can finally see a correction in the imbalance between the Euro member states.

I will briefly highlight this position:

  1. VAT can be charged on a sale of any goods or service within the settlement of transaction, rather than based on invoice submission. When it is an intra-EU transaction, the price should be converted into the buyer’s currency, inclusive of VAT, while the settlement to the seller is for the net amount in its currency. The VAT is settled immediately to the buyer’s tax authority, based on the VAT rate fixed by that country.
  2. If the buyer is a VAT-registered company, and the product purchased is applicable, it will be entitled to an immediate refund of the amount. There is no need for any delay in settlement, given the usage of real time data management by the tax authorities and payment facilitators. There is an advantage for those businesses that buy in raw materials or trading stock for resale; they would be entitled to the relevant VAT to be recovered immediately on payment, rather than having to wait for the end of the tax cycle.
  3. Conversely, the seller of the goods will not receive the VAT – and therefore is unable to misuse or steal this amount. The losses of the tax authorities are too large to continue, as are the costs for merchants in administrating the VAT service.
  4. The problem with any tax collection system is primarily involved in cash transactions. And, of course, if there are to be changes in the manner of operating the Euro (or its conversion back into domestic currencies), the Euro notes are an issue as well. The solution is to limit the usage of cash as an option. While it may be too drastic for many people to remove cash entirely, a withdrawal of all notes above €10 would make for a far simpler and more compliant solution.
  5. Such a move may seem radical, but the enormous improvement in fraud control goes a long way to justifying such a change. It would also simplify the separation of liability of each central bank; whether the current Greek crisis is temporarily resolved or not, there will be another problem sooner or later. The imbalance between the economies within the Euro are too great to carry on unchecked for long.

The potential saving in fraud losses opens up a source of financing for the indebted Member States within the EU. While the logical approach would be to reduce the fraud by country – and reward each country directly – our suggestion is that the anomaly of the Euro impact of favoring the large exporting countries, to the detriment of the poorer importing countries, should be offset by any form that can be used. While nobody would suggest there will be a complete eradication of the VAT fraud losses, there can be a major reduction. Creating a fairer distribution should be an appealing way to resolve a massive problem.

Finally, there is one other possible corrective measure involved in the real time pricing adjustment, that being to create surcharges on imports from particular countries by the poorer Member States. This could, at least in theory, encourage manufacturers to move some of their plants to less developed countries, which may help on the employment side. There would be a problem in watching how companies may attempt to cheat, but there can be sufficient penalties to discourage much of this.

In summation, I am afraid the likelihood is that the Euro will be kicked down the road again; but we will run out of road sometime soon. The long term answer is clear; either a return to individual currencies or a premium charge structure will be necessary. In the short term, expect more assistance for the rich countries and definitely more poverty for the poor, caused by the incorrect value of the euro compared to the different GDP levels. But at least let’s control the fraud better – and make some amends with the funds.

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