It was sometime in the 1960's. My uncle was teaching in Bulgaria. He wanted to buy stuff in Britain, but wasn't allowed to take much money out of Bulgaria. My father was farming in Britain. He wanted to buy stuff in Bulgaria, but wasn't allowed to take much money out of Britain.
My uncle and father thought up a Cunning Plan. My father went to Bulgaria, where my uncle gave him money, and my father bought stuff. My uncle went to Britain, where my father gave him money, and my uncle bought stuff.
The Cunning Plan was possibly illegal? But it was Pareto Improving. My uncle preferred buying British stuff to buying Bulgarian stuff. My father preferred buying Bulgarian stuff to buying British stuff. The Bulgarian government wouldn't care whether it was my uncle or my father buying Bulgarian stuff. The British government wouldn't care whether it was my father or my uncle buying British stuff. (Even if they had hoarded money, instead of buying stuff, I can't see why either government would care whether it was my uncle or my father hoarding the money.)
The Cunning Plan was economically equivalent to barter. It was exactly as if my uncle had bought Bulgarian stuff, my father had bought British stuff, and then the two had swapped the stuff.
The Cunning Plan worked because my uncle and father knew each other, and trusted each other. What was needed was some sort of internet dating site, so that people like my uncle and my father could find each other, with the host checking that both sides could be trusted. But the dating site would need to be open to threesomes too, for cases where someone in Albania wants to buy stuff in Britain, someone in Britain wants to buy stuff in Chad Cyprus, and someone in Chad Cyprus wants to buy stuff in Albania. Or foursomes. Or orgies with all sorts of people from all sorts of countries taking part to greater or lesser extents.
What would happen if there were more farmers in Britain wanting to meet teachers in Bulgaria than vice versa? You would need some sort of price to adjust, so British farmers would get a worse deal, which would discourage some, and Bulgarian teachers would get a better deal, which would encourage some more.
If the British or Bulgarian governments tried to fix the price in that dating market, that would cause problems. There could be an excess demand or excess supply. Which would create all sorts of problems, and lead to rationing, because some British farmers or Bulgarian teachers wouldn't be able to find a partner. So the governments might need to decide who gets priority in finding a partner. And then people would start to think up even more Cunning Plans to get round those government decisions.
Or, we could forget all about exchange controls and Cunning Plans, and just have flexible exchange rates.
Worthwhile Canadian Initiative 
This reminds me of hawala – a system that worked particularly well until 9/11 (I believe it still hobbles along now but governments across the world have clamped down on the system to make flows of money more ‘track-able’). Hawala like systems not only circumvent capital controls but they also help people avoid steep foreign exchange transaction costs and bid ask spreads.
I have done the same thing informally on a couple of occasions. I sometimes remit money back to my parents in India. My parents’ friends sometimes send money over to their children studying in US colleges. On a couple of occasions it worked out to be more efficient for my parents’ friends to send money to my parents in exchange for me sending an equivalent amount of money to my parents’ friends’ children.
http://en.wikipedia.org/wiki/Hawala
primed: yep. I think it’s exactly the same. There’s nothing new under the sun. If something needs to be invented or reinvented, it will be.
A couple of people – including Delong – have made the remark “money is a substitute for trust” in exactly this meaning…
david: yep. But there are two things that money resolves: trust is the first; getting 3 (or more) people to all meet at once to do a 3-way exchange is the second (the coincidence of wants gets resolved either by money or by all 3 people doing a simultaneous 3-way deal). I wanted to get both of those ideas in.
That BBC Cunning Plan link doesn’t seem to like Canadian IP address – this link worked.
Could the Cyriot government allow claims on deposits to be transferred to others? For example a firm in Cyprus has 500K euros in a bank account that is frozen. They’re a good customer of my Canadian firm but unfortunately can’t withdraw any cash at the moment and can’t be sure how big of a haircut their deposit will have. I am willing to sell them 100K of merchandise for say a 200k of of their account. The legally transfer me that share of their deposit. The bank is notified and puts a hold on 40% of the account. Effectively this would mean a currency devaluation in which financial assets denominated to Cypriot Euros were marked to their expect future value.
Yep, too. Hence Delong:
Thanks Frances. Link changed.
Vladimir: I don’t know. If the Cyprus bank doesn’t allow you to withdraw money at all (as at present, except for small amounts of cash) then it won’t work. But if they allow you to withdraw cash, or write cheques to other Cypriots, but don’t allow you to transfer funds abroad, then I think it would work. Effectively it means the Cyprus Euro is different from a Euro anywhere else, and trades at an exchange rate determined by negotiation between fathers and uncles.
david: Yep!
“but wasn’t allowed to take much money out of Britain.”
That reminds me of a story about Ludwig von Mises in Guido Hulsmann’s biography. Mises had fled to the US in 1940, and his funds were in London. Wartime exchange controls prevented Mises from getting his hands on his money, and he had no job. Desperate, he got Hayek – then at LSE – to buy up rare books with his funds, including an original “Wealth of Nations”, and then send these by boat to the US.
I guess buying rare economics books made sense… if there’s any product an economist can appraise best, and avoid getting gypped, its economics books.
“Or, we could forget all about exchange controls and Cunning Plans, and just have flexible exchange rates.”
Or we could have a Euro system whereby exchange rates are fixed and there are no exchange controls. All inflows and outflows are netted out on the books of Target2, and net imbalances need never be settled.
JP. But under Target2, Germany might be worried about permanently exchanging BMWs for electrons that might default, and Club Med countries might be worried about unemployment due to insufficient AD and want to keep the money at home, since they can’t print it. So either might impose exchange controls.
Such Cunning Plans are often discussed in International Business under the name of “Counter Trade” (e.g. http://en.wikipedia.org/wiki/Counter_trade)
Counter trade ( or barter, as we say in french “Qu’en termes élégants ces choses sont dites entre gens de bien)” In so beautifuls words are such things said between people of breeding”) : in the early 70’s, Bombardier got its start in the water-bomber business in Europe by seling to the two then-poor countries of Spain,Portugal and Yugoslavia. Short of foreign exchange, they gave wine to the QC gov’t who passed it to the SAQ (state-owned alcool business) . The proceeds were transfered to Bombardier.
My generation was thus introduced to wine through abundant exposure to Faisca, Mateus, Union de Taragonna and Mostar-Zilavka. It was a patriotic duty to drink foreign wine ( those who remember candian wine of the era, the humanity, the humanity…) Mostar -Zilavka was from the Mostar area in Bisnia and due to the late unpleasantness is no longer availble. Faisca and Mateus caught on and are still on the shelves.
But as long as we are talking about the usefulness of money, it would be good to tell the other side of the story. As soon as trust is gone and money is part of the economic system:
1. speculative attacks on currencies, which can be devasting
2. People devoting more and more real resources to the acquisition of money for its own sake, rather than using money purely as a tool.
A good example here is bitcoin. Look at the USD/bitcoin, which went from less than a dollar to $35 to $2 and is now at $70 per bitcoin in the space of about 3 years.
And people are devoting tens of thousands of dollars to bitcoin “mining”, basically buying expensive hardware to solve calculational problems. Those resources could have been used for something productive, but are spent on the acquisition of more bitcoins.
Not to mention the whole host of parasites and intermediaries in the financial system that do nothing but buy and sell money for money, yet account for 30% of economy-wide corporate profits. I.e. there is also a reason that history does not have a kind view of money changers and why some nations prefer to impose capital controls. It is not all just an innocent veil over barter.
“Russian President Vladimir Putin signaled acceptance”
http://www.bloomberg.com/news/2013-03-25/cyprus-continues-to-plunder-the-loot-in-bailout-medvedev-says.html
one day faster than I expected
apparently convinced of our cunning plans: http://www.youtube.com/watch?v=H4wQn8F-YDw : – )
looking at
Somebody committed a crime! This proves laws are ineffective! Which hurt the poor of (insert country from Mexico to Latvia here) worse – currency crises or exchange controls? Money is not neutral – it’s a form of power. And the amount of money does not correspond to the amount of actual goods and services – you can create (or destroy) various sorts of money so as to manipulate power relations. Happens every day. Floating exchange rates can work – if regulation controls large flows of money and other relations of power (internally and externally) are not too unequal. Note that many of these conditions are missing over much of the world.
One could also note that human cunning is much over-rated, especially by those who think they are most cunning. Baldricks are more common than Blackadders.
genauer,
do you realize that the new restructuring plan does not tax deposits held at the government-owned Russian Commercial Bank?
makes sense to me.
In the last week, the international money transactions of Cyprus were about twice as high as normal, but were not allowed into certain directions.
One Russian bank survives untouched.
Putin is extremely quick to nod his approval, ….., to signal that some Russian banking stays in Cyprus, or how else should I see this?
That means that Euro and Putin had an agreement before.
I begin to doubt that Dijsselbloem’s “template” was a gaffe.
I think nobody has anybody with some small scale barter.
The government needs money, and in wide lands it is sometimes difficult to collect.
Much easier at a port, as tariffs.
Buchanan pointed out, that the US fed government, for the longest time, lived basicaslly of tariffs, income tax came up 1913.
genauer,
Let’s see. The new plan:
– protects about 2 billion euros worth of deposits at one of Putin’s pocket banks,
– effectively destroys its two biggest competitors in the Cyprus offshore banking sector,
– completely screws thousands of Russian SMBs that were trying to hide money from Putin’s tax inspection.
So, if this whole mess has a single winner it’s certainly Putin. (A few well connected Russians may have lost some money – I have no idea whether it is true or not – but some degree of collateral damage is unavoidable.)
D_w
The Cyprus banks were open in Greece and in London too. I am pretty sure that it did hit just the intended.
But I ‘ve got a much more cunning plan!
When I wondered, why they try to demonize Germany and Angela so much, with an Adolf moustache, please, she can not even run a good beer tent tongue lashing,
It suddenly dawned on me:
The Hellenic, and probably most the Balkans, they want, they need a leader they can fear, with a mustache, believable to eat their first born for breakfast, somebody absolutely WITHOUT a PhD, in Germany now even the communist leaders have one : – )
Now, who could this be?
Our milk raised Vietnamese orphan Philip Rösler? Look at him, and tell me if you could fear him putting you in a bamboo cage, floating in the Mekong.
Bob Smith’s Marine Le pen, or Hungarian Victor Orban, a Calvinist? Please, nobody gets scared by those.
Putin, not so bad, but for some saber rattling, this could irritate the Americans. And showing his muscles around was not really that fearsome, he is a desk warrior, like Merkel.
The choice is obvious:
Recep_Tayyip_Erdoğan
– Male, the right age, a moustache (needs some blackening, maybe a little trimming : – )
– He lives in the neighborhood, has borders with Greece and Cyprus
– He doesn’t fit the old stereotypes Nazi vs communist, but brings a new element to the game, Neo-Ottomanism, without raising the fear of radical Islam
– They already got a lot more German tanks, submarines, gun-factories, because they paid their bills, unlike the Greek : – )
– They know how to rule unruly Balkanese, and he put away half his generals, on pretty thin conspiracy charges
Sometimes I see continental Europe, from the North Sea, to the Atlantic, to the Med, to the eastern marches, under the thumb of a political-economic system that is destroying people’s lives, forcing workers to migrate to the German heartland or else escape outside, denying countries the autonomy to make their own decisions for good or bad, forcing them to supplicate themselves to the German Chancellor, whose whims can make or break them. Except AM is the smug schoolmarm, telling them it’s all their own fault, and that she is only doing what’s best for them, and that if they would all only behave like good Germans, everything would be fine, rather than the angry aggrieved AH. And I just pray that Britain can retain its independence, despite being outnumbered and outgunned, and survive and lead the resistance.
Yes, the analogy is not exact, but I can understand why others might see it that way. And I have much more sympathy for Germany, both in the past and in the present, than many. I know the Germans suffered much more than the Brits, and that terrible things were done to them.
I have been re-reading Leon Degrelle, a Belgian Rexist who joined the Waffen SS with other Belgians and fought on the Eastern Front. It was a pan-European army. There was even a very small British contingent. And many who fought in it did so out of conviction that they were creating and defending European civilisation.
How are you any better than the people exhibiting Nazi-Merckel pictures genauer? You have just written a ridiculously insensitive, offensive, racist (‘unruly Balkanese’) and quasi-fascist in its adulation for ‘strong leadership’ thesis, collectively stereotyping other people because they became unruly in the face of their county’s GDP being reduced by 25% in three years. Who would have guessed?
The biggest difference, of course, is that this time the Germans really didn’t start it all. And the Germans are no more at fault than any other country that joined the Euro.
Nick: “The biggest difference, of course, is that this time the Germans really didn’t start it all…”
And then you take a look at German NGDP growth and you see that monetary policy seems quite a good fit for it. Or you read this inteview with ECB president: http://www.ecb.int/press/key/date/2012/html/sp120323.en.html and you see sentences like this “The Prussian element is a good symbol of the ECB’s key task: to maintain price stability and to protect European savers.” So maybe it was French-Italian conspiracy of ECB presidents that started all this?
But in spite of all this, I am already beyond blame-assigning phase (even if I am afraid that most people in Eurozone did not even start started this phase yet). With mess of this scale only one thing is certain – there is enough of blame around that anyone can get as much as he wants.
JV: agreed.
But this comment thread has now been derailed into a discussion about Germany (which perhaps I too should not have joined in).
So: no more comments about Germany per se. This post is about monetary theory, exchange controls, and fixed vs flexible exchange rates.
BTW, did I leave it too implicit? My “Cunning Plan” was nothing more than the reinvention of flexible exchange rates with national currencies. Or was that sufficiently obvious?
Nick,
I think it all depends on the strength of the substitution effect. In a large diversified economy the substitution effect is usually strong, so it makes sense to have a national currency. But for small specialized countries like Greece or Cyprus, the adjustment will happen mostly via the income effect, which you can reproduce with austerity policies.
Since a small country would also find it more difficult to conduct independent monetary policy, I don’t see any obvious benefits from a local currency, but a very obvious cost in the form of periodic current account crises.
To clarify a little bit.
Inside a common currency area a country has a problem when it hits a debt ceiling (e.g. Greece) – or maybe when the debt ceiling suddenly collapses due to a decline in collateral prices(e.g. Spain) – because it has to adjust its level of net borrowing with strong negative consequences for aggregate demand.
If a country has a national currency, this changes the situation in two important ways.
1) The country can change the debt ceiling by adjusting interest rates.
2) It can change net external borrowing by adjusting the exchange rate (at constant domestic income).
In a big diversified economy both mechanisms are very effective and the adjustment is much easier compared to a common currency area:
– in the short term, a devaluation will increase net external borrowing because of the J-curve effect, but monetary policy will soften the impact on aggregate demand by temporarily increasing the debt ceiling,
– in the long term, net external borrowing will decrease and the level of debt will stabilize.
However, in a small specialized economy:
– a devaluation may increase net external borrowing not only in the short term, but also in the long term, since the substitution effect is small;
– monetary policy may not be very effective at moving the debt ceiling if the domestic financial markets are underdeveloped.
As a result, a small country would be worse off compared to the common currency case, because a devaluation will force an even more dramatic change in net borrowing and aggregate demand.
very well said by D_w, why there is some significant advantage for a small country, to be within a currency, even if it is by far not an OCA. This was one of the arguments for the Euro, which is still somewhat valid, the transaction costs while traveling or buying some thing abroad, that is pretty negligible today.
I buy at amazon UK and US with the same ease as DE, with the same credit card, of course shipping from the US costs something.
It might be worth how to look at the Carribean Islands and central American states, how they deal with that. Internal Devaluations ? Is their a curse of the mid size, like Haiti?
Nick.
See http://www.ripplepay.com
One more clarification:
“- a devaluation may increase net external borrowing not only in the short term, but also in the long term, since the substitution effect is small;”
this can happen if exports are inelastic
To discuss market size and access with that,
maybe business size and diversity,
I could imagine, that we could do this with the example cell phone market,
Canadian RIM for smartphones and Finnish Nokia for the mass market leaders for some time, but now struggling again, and somehow loosing out to Apple, Google, Samsung,
very predictable from my point of view.
Just a proposal, maybe it inspires some of you.
Before we now forget about me developing my really sinister, much more than cunning, plan for world domination by my franconian tribe : – )
and make up time tables, who will leave, and not join, what kind of union, when,
I dont want to forget about a link, I enjoyed a lot:
Some day I’m going to get you to put together a book called Rowe’s Fables which is going to consist of parables like this one, but with a sentence at the end to explain the moral of the story, something like “Flexible exchange rates are better than fixed ones.” Love these posts, but never am quite sure whether or not I’ve got the point!
genauer: “Is there a curse of the mid-size?”
Yes. Macchiavelli recommended to the Prince not to meddle in the affairs of the Greats.
And today, seeing the Middle East, we should tell the Prince not to meddle in the affairs of the Smalls.
In French we say “Vivons heureux, vivons cachés.” “Let’s live happy,let’s live hidden.”
I’m not sure it’s a serious proposal, but a Turkish Minister says Turkey would support Cyprus converting to the Turkish Lira:
http://www.hurriyetdailynews.com/turkey-favorable-if-greek-cyprus-wishes-to-switch-to-turkish-lira-eu-minister.aspx?pageID=238&nID=43503&NewsCatID=344
Doesn’t help Greece, Spain, or Italy, though.
thinking for quite a while about Nick’s last 2 posts, especially the wording and references, I think we should actually continue that , manana.
I believe, in the end, we could come to very similar conclusions, where certain things should end, and then one can also find common ways to get there.
Exchange controls a.k.a. Reinhart/Rogoff “financial supression”
the basics of barter: reliability, enforcability, fairness, “Trust”
In the meanwhile, I have 2 links, coming up today, which I think can inspire your thinking
1. Some 42% of the world apparently very unhappy how certain things are organized at present
http://www.bloomberg.com/news/2013-03-25/brics-nations-plan-new-bank-to-bypass-world-bank-imf.html
“We need to change the way business is conducted in the international financial institutions,”
“The U.S. has failed to ratify a 2010 agreement to give more sway to emerging markets at the IMF, while it secured Jim Yong Kim, an American, as head of the World Bank last year over candidates from Nigeria and Colombia.”
These guys are so mad about it, that they organize their own monetary fund now
2. “Aut viam inveniam aut faciam”
I believe, that many of the participants here have so far very little exposure to the rough and tumble of the “real world” out there.
http://www.bloomberg.com/news/2013-03-26/hannibal-inspires-gm-s-girsky-to-slash-at-opel-s-culuture.html
An american “UAW consultant” gives the Hannibal in a 20 000 worker Auto Company
It shows again,
a) that even the US and DE auto cultures have long simmering difficulties with each other, after the Daimler-Chrysler Disaster.
b) In certain situation, you can’t mince words any more
“Every time you opened the door, more dead bodies fell out”
c) it is nearly always the tiny hard-left who tries to play the nationalist card.
d) Chopping heads starts at the top: “Since January 2012, only four of Opel’s top 18 leaders remain”.
Summarized in the translation:
“I shall either find a way or make one.”
and for this I have another Superbowl youtube (I am getting used to those citations : – )
please note the fundamental two team structure to it.
Jacques, I meant it differently, with respect to currencies.
But responding to your quote, we have here similar “Gehe nicht zu deinem Fürst, wenn du nicht gerufen wirst”. “Nicht auffallen, dann kann man nicht reinfallen”.
Paul Krugman says Cyprus should quit the Euro now. I feel like he hacked into my brain, and said what I was going to say. I read that about 25% of Cypriot workers are employed in banking or closely related professions(!!). But, despite the “(!!)” the size of that sector will surely decline a lot. What will replace it? With its own currency and flexible exchange rates, there would now be a big devaluation, which would make Cyprus a much more attractive exporter of (e.g.) services to tourists.
Cyprus’ banking troubles are largely caused by their banks holding a lot of Greek bonds. When Greek bonds went down, Cyprus and its banks went down. And with Cyprus’ GDP going down, will Cyprus bonds go down too? It is like dominoes. But I am very surprised how slowly it takes for one domino to hit the next.
Ironically, every time the Eurozone really screws up, like over Cyprus, the Euro drops against other currencies. Which helps the Eurozone economies recover a bit of aggregate demand. The fixed exchange rate system of the Eurozone is on life support provided by its flexible exchange rate with the rest of the world.
Nick,
1) I think the local value added in a typical Cyprus package tour is about one-third of the final price – the rest is plane tickets and distribution costs, so the retail price is not very sensitive to the exchange rate and after devaluation export revenues (in euros) may actually decline.
2) As a direct result of the banking crisis about 3 thousand bank employees will lose jobs – that’s slightly below 1% of the total workforce. Important but not huge.
3) Cyprus imports virtually everything. If Cyprus leaves the euro it will find it very difficult to borrow in euros and its economy and standard of living will collapse.
4) Krugman’s comments on the eurozone are as usual uniformed, biased and totally irresponsible, given that he’s one of the leading experts on international economics.
“some British farmers or Bulgarian teachers wouldn’t be able to find a partner.”
Flexible exchange rates? I thought you were making a pitch for E-Harmony and Bitcoin. 😉
“Krugman’s comments on the eurozone are as usual uniformed… ”
I meant un-informed, not uniformed. Though, come to think of it, they are also pretty uniform.
Once again, a eurozone country could benefit from introducing its own currency if:
– there is considerable potential for import substitution;
– the exports are highly elastic;
– there is strong potential demand for financial assets denominated in local currency.
As far as I can tell, Cyprus satisfies non of these conditions, so leaving the eurozone could lead only to a full-scale economic collapse.
Doctor__why,
I agree with your arguments.
On the other hand, just 5 years ago, Cyprus got by without the Euro.
How did this happen? Euro de facto standard, or ….
I do not think, you exchanged Gold bullion : – )
Could you tell a little bit, how the currency thing worked the last 50 years in Cyprus?
genauer,
They had to rely on some indirect trade barriers and currency controls, for the most part. However, I moved here right after Cyprus joined the euro, so I have no firsthand experience of living with the pound.
Nick Rowe: “But I am very surprised how slowly it takes for one domino to hit the next.”
Time to doubt ratex models, or at least the ones which imply meaningful efficiency?
Dr Why: For sure Krugman is one of the leading experts on international economics, as you say. But I’m not clear why this means he should conform to your opinions. Just look at what you wrote:
Once again, a eurozone country could benefit from introducing its own currency if:
– there is considerable potential for import substitution;
– the exports are highly elastic;
– there is strong potential demand for financial assets denominated in local currency.
Would you really have the balls to say that in a seminar with Krugman watching you? What would you say if he simply replied, as he very well might: “Model, please?”
Kevin,
“Would you really have the balls to say that in a seminar with Krugman watching you?”.
Absolutely. And I would be able to show a model.
If you’ve got an argument which the author of Currencies and Crises might find compelling, publish it and please post a link here. Any fool can say Krugman is “uninformed, biased and totally irresponsible”. On some blogs the mere mention of his name is enough to start people flinging poo like that. If you can do better then you should.
Kevin, I understand your position. However,
1) I’m not that interested in economics. If I were I would have chosen an academic career.
2) Nobody has to pay any attention to what I say, but I’m always happy to reply to concrete arguments.
3) If somebody here in Cyprus decides to follow his advice, this may lead to food shortages and social unrest and even – in some scenarios – Turkish military intervention. So I take Krugman’s words very personally.
The Turkish stalking-horse is the rarely-spoken point here.
I think what happened in pre-Euro-Cyprus is kind of crucial here.
The population of the southern part of Cyprus is 838K. This ain’t China, but this is not such a small labour force. A million is not a small number of people.