John Dizard wrote in the FT last week about a new and so far little noticed monetary phenomenon, the Italian mini-BoT. As he noted, the new Italian coalition partners have agreed to fund their tax cuts and spending plans by issuing these new financial instruments. As he noted:
These would be small (euro) denomination, non-interest-bearing Treasury bills in the form of bearer securities that would be secured by tax revenues. “BoT” is the abbreviation for an Italian treasury bill, and the small denomination makes them mini.
He added:
Conventional BoTs are electronic book-entry securities but the mini-BoTs would be printed, reportedly using the state lottery's ticket presses, and the designs have been selected.
The essential question is, then, whether these are an alternative form of currency, or not. As Dizard noted, no one would be obliged to accept them in payment, and as a matter of fact they would almost certainly trade at a discount to their par value, precisely because they do not carry interest. But, the whole point of these Treasury bills is that they are, in effect, a discounted upfront settlement of tax liabilities owing, and for precisely that reason the Italian government will accept them in payment of tax when it becomes due. They do, then, share all the characteristics of money even though the new coalition government says that it is not creating a parallel currency to the euro.
They instead say that the BoTs simply represent upfront payments of tax. As such they claim they do not represent an increase in the Italian national debt, although since I would argue that any government-issued promissory note that is only cancelled upon payment of tax is, by definition, a government debt, I think that stretches credibility the the limit. Candidly, they are also, and for precisely the same reason, money in all but name.
But, worryingly, many of the constraints on the use of cash in the Italian economy will not apply to these notes. In particular, whilst it is illegal to make settlement of any debt of more than €3,000 in cash in Italy, this rule will not apply to these bonds. And precisely because they are printed they might be bonds, but they will for all practical purposes behave like printed money, and that means that they are bearer bonds in all but name. Everyone involved in tackling illicit financial flows knows the risk that these bonds create. The shadow economy should have a field day with these.
But, perhaps their most important feature is macroeconomic. It is well known that the Italian banking system has been quite unable to deal with the demand for growth in the Italian economy precisely because it still has so many 'zombie' non-performing loans that restrict meaningful new lending. Under the rules of the Eurozone there is nothing Italy can do about this. But with its own 'shadow' currency Italy may be in a different position, even if a very dangerous one with regard to the creation of illicit activity. The prospect of new investment may be created. That could change Italian financial fortunes. If it does that is dangerous to those who oppose populism. But it is also deeply dangerous to those who believe in the importance of European financial stability which is, for better or worse, and for richer or poorer, based on the euro present. If BoTs become commonplace that primacy will cease to exist and Europe will have a multicurrency system that would be fundamentally dangerous to tax revenues, financial stability and ultimately to political coherence.
I have always been opposed to the euro: I thought it a disaster in the making before it was introduced, and nothing about it has ever made me change my mind. However, dual currencies are even more dangerous. If the ECB has any sense at all (and I leave that for others to debate) then it should not just be slapping down on these BoTs, but it should instead be actively considering how it can replicate the freedom that they provide to governments who wish to undertake fiscal policy at a time when that this is essential for the growth of their economies when monetary policy has ceased to have any relevance at all. This is the real economic crisis in Europe: if BoTs bring it to a head that may be no bad thing. But I worry for Italian stability in the meantime.
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Innovation will always, sooner or later undermine any system, however carefully constructed (usually by lawyers and bankers) to ensure it doesn’t happen. Throughout the 18th century the monopoly of the Bank of England was guaranteed by Act of Parliament, and constructed in ‘boiler-plate’ legal terms by the best minds the Law and the Bank possessed. It collapsed not through Parliamentary reform, or new thinking in Parliament; but accidentally, through innovation that nobody in power understood; until it was too late.
Around 1865 Henry Dunning MacLeod with insight and acuity described what happened in his ‘The Theory and Practice of Banking’. It was near the end of the Napoleonic wars that:
“ …the London bankers introduced a change in the method of doing their business. Instead of giving their customers notes or deposit receipts for the sums left with them, the gave them ‘cheque’ books, with a number of bank drafts upon themselves. The customer kept these books at his own house, and, whenever he he had occasion to make a payment, he filled up one of these blank drafts in the payee’s favor, and the banker undertook to such a draft on demand, provided he had funds of his customer’s ”in his hands to pay them, just as he was in the habit of paying his own notes on demand. This method of doing had so many advantages over bank notes, that it universally superseded them in London. From that period London bankers ceased entirely to issue notes, though they never were forbidden to do so until the Act of 1844. This change, simple as it may appear, is of great historical interest, for we shall see hereafter that it was this circumstance that destroyed the monopoly of the Bank of England. Bank notes, we have seen, are nothing but promissory notes, payable on demand. By a fortunate accident, the opportunity that method afforded of circumventing the monopoly of the Bank, was not discovered till many years afterwards. If it had been, there cannot be a doubt that Parliament would have put it down very quickly; when it was discovered, the age of such monopolies had passed away, and the demand of the Bank to have it provided against was refused.” (MacLeod, Vol.1, 2nd edition, 1866)
Are these Italian Bradburys?
It rather looks like it
Followed by 3.5% War Loan, which failed badly, but “succeeded” triumphantly.
Don’t see how the ECB could slap down these bonds without providing an alternative – and that is the bonds’ skill.
This is ‘Italians first’ writ large and when Matteo Salvini, the leader of the far-right League, says “I didn’t ask for votes . . . to continue on a path of poverty” who would contradict that?
No wonder, also according to FT https://www.ft.com/content/722376cc-5c3b-11e8-9334-2218e7146b04?segmentid=acee4131-99c2-09d3-a635-873e61754ec6
60 per cent of voters had a “favourable” or “very favourable” opinion of a Five Star-League tie up, more than the combined 50 per cent that voted for the parties in the general election.
The ECB may yet have their comeuppance – true, potentially at the price of instability, but they don’t have to let it get to that stage if they don’t want to. Any crisis is one the ECB will own….
As Bepe Grillo one of the of the five star movement founders spoke about money way back in 1998 http://www.progressivepulse.org/brexit/is-italy-the-white-hope-for-european-reform may be they should have seen it coming?
I think this may be a much bigger moment than many realise
Great post RM. Sounds like a little Italian hernia in the straightjacket of the single currency. Hopefully it could tear the whole Eurozone structure down as everyone else does the same. I agree it is ‘money’ – the state is defining the unit of account and accepting the money/bond back as a tax liability. As to who does what with it inbetween:
You further point suggesting the bond attacting drug dealers and their bankers the world over is interesting. If these nice chaps are to fund Italy’s scheme, why settle for 0% interest on the instrument? We all know how they got their money, chuck a demurrage charge on the bond. Guv becomes biggest fence on the block, and hopefully the Italian people get a cut. Job done!
Come back Hjalmar Schacht all is forgiven!
http://www.nakedcapitalism.com/2013/12/philip-pilkington-hjalmar-schacht-mefo-bills-restoration-german-economy-1933-1939.html
[…] Cross-posted from Tax Research UK […]
To me this looks like a diifferent manifestation of the anti-austerity sentiment which to some degree fueled Brexit.
Germany is not listening: Die schwarze Null continues to haunt Europe / http://bilbo.economicoutlook.net/blog/?p=39403#more-39403
Brussels does not get it: Italy Went Boom A Long Time Ago (and that’s the point) / http://www.alhambrapartners.com/2018/05/21/italy-went-boom-a-long-time-ago-and-thats-the-point/
I seem to recall a time when the Italian retail trade used sweets as a currency, giving them instead of small change to consumers.
Brian, You are right about that, and they also had 150 lire bank notes when the lira was worth 2,000 to the pound. The story was that the aluminium in a 100 lire coin was worth more than 100 lire and they used to be melted down by the Swiss and turned into watch cases. Purely apocryphal of course. I’ve still got some of those notes.
I’ve seen this story about the mini-bots in an online financial magazine but as far as I could tell the Italian newspaper La Stampa had not reported it, and there were about 3 column inches in the Telegraph business suppliment. There was a short mention in the Italian online magazine, The Local Italy, plus a mention in Il Quotadino. Well done to Richard for finding it.
However, the government still has to be formed and agreed by the President who has the right to refuse candidates for the “cabinet”, and the story I read said that the bots were unlikely to be issued inside two years – if at all.
The trick would be to make them digital and I suspect this is the aim of the proposed Bank of England digital currency. I am going to a talk by a BoE employee tomorrow on this subject.
If the problem that these bonds ‘solve’ is a liquidity shortage due to bad loans paralysing local banks, then the economic effect will be all the bad effects of writing off the bad loans *without* the correcting the mismanagement or outright corruption that caused the problem.
The good effect – reflation – is equally directed to the BoT holders and to the benefit of the delinquent borrowers, failed businesses, ‘zombies’, or outright fraudsters; these entities probably offer little or no value to the economy.
The worst-case scenario is that the very ‘zombies’ who have soaked up all of the liquidity that the banks ought to be creating, may well turn out to be significant purchasers of BoTs. In other words: money being created by ‘demand’ for non-performing loans.
Add into the mix large-scale tax-evasion and a potential default on the bonds, and it starts to look a bit Wiemar.
You’re saying they’re deliberately crashing their economy? To what end?
I’m not saying the Italians are deliberately crashing their economy if that’s what you mean. I am saying the construction of the euro has caused the economic doldrums that the eurozone finds itself in. This is the result of the loss of monetary sovereignty in the member countries. There is a knock-on effect over the rest of the EU. I do give Osborne his due, he reigned back on austerity when he realised the economy was bombing and that’s why the UK did much better than the rest of the EU in the aftermath of the recession.
And it’s not me saying it; I am passing on the wisdom of a large number of economists who promote Modern Monetary Theory. Try reading “Reclaiming the State” by William Mitchell and Thomas Fazi published by Pluto Press.
The Italian problem is not in a lack of liquidity in local banks or mismanagement of the Italian economy (although those do have some bearing), but the flawed architecture of the euro. Unless surplus nations are prepared to make large transfers to deficit ones it can’t work, and even then you’d need a central fiscal authority – a EU Treasury – like we have in the UK for the whole of the Union. The Bundesbank would never allow that.
I fear you are right that the bots will finish up in the wrong hands. I wouldn’t mind betting they will trade at a premium, not a discount, as people grab them, as you suggest, to launder underperforming loans etc. Sadly they won’t help ordinary people rather in the same way that QE didn’t. There are, however, proposals for a Basic Income payable to those without any other form of support, and a flat-rate tax system which might help. A Job Guarantee would be better.
Don’t raise the old turkey of Weimar that is always trotted out as soon as anyone talks about reflation or inflation. That was a completely different matter that was caused by the allied powers sequestering the German industries of the Rhineland leaving the country with no means of production. That said the problems of the EU are in large part the legacy of years of austerity and underinvestment which, similarly, has decimated production.
I could give a lengthy answer, but we seem to be as much in agreement as we seem to differ.
Try “OK then, Wiemar-Lite”.
We have ‘lite’ or diluted ingredients for the Wiemar recipe here; and, like Pepsi Lite, a collapse in popularity isn’t a disaster because the real thing is still available to the economy, in the form of real Euros.
I do not doubt that these notes will be worthless in five years, and turning up in economics textbooks twenty years from now.
Nevertheless, it’s reasonable to ask how much damage they can do, on their journey from the printing press to landfill sites. Italians won’t be forced to use them – as I say, real money is still available – so we won’t see ‘Wiemar Classic’ wheelbarrows trundling banknotes to the shops for a loaf of bread.
I tend not to use the ‘Wiemar’ Bogeyman for reflation – that’s a genuine attempt to reinvigorate a moribund economy with real investment, rather than creating money with no underlying creation of value, however indirect; but BoT’s really do deserve the pejorative epithet of ‘printing money’.
Arguably, they are worse than indiscriminate printing, or supporting banks (but not the real economy) by quantitative easing: the benefit goes to zombies and to corruption, rather than indiscriminate inflation – not so much reflating, as refloating bodies in a swamp.
Further, they are being printed into an economy without demand, and without stimulus, with an ineffective government…
…Which has just been replaced, as in Wiemar, by right-wing ‘populists’ who could be called more ominous names.
I can only hope that my ‘lite’ canard applies to them, too.
Not quite sure where I picked it out from, amongst various reports on the new Italian coalition, but a quote from Lorenzo Fontana, a top Lega Nord official, seems highly relevant to this and many other threads:
“We think that people come ahead of economic obligations and that it’s not possible to impoverish citizens in order to respect constraints decided by others. The people come before the economy. For too long these priorities have been backwards.”