What is a foreign currency? A foreign currency is a currency which a sovereign state cannot print on its own. By giving up their local currencies, 17 European sovereign states gave up their right to print their own currency.
Let me think aloud for a moment. What if Greece, for example, introduced – in addition to the Euro and not in its stead – the Drachme as a new local currency? What would be possible impacts?
The Euro remains in place and everyone who owns or owes Euros does not lose or win anything. Those who have Euros and want to continue to do their business in Euro are free to do so. Essentially, Greece would have 2 legal currencies: the Euro and the new Drachme. However, the government would from now on pay its domestic bills (salaries, pensions and all the other government expenses) in the new Drachme at the original Euro/Drachme exhange rate of 341 Drachme for 1 Euro. The new Drachme is a currency which the government can print on its own. Since printing money has something to do with inflation, the new Drachme will depreciate against the Euro if the government prints more Drachme than it has available in Euros at the exchange rate of 341 to 1.
If the government now has to pay a pension of, say, 1.000 Euro, it doesn’t pay in Euro but with 341.000 new Drachme instead. If the government wants to increase salaries and pensions, it can print new Drachme. When the government is spending more in Drachme than it has in Euro at 341 to 1, it is de facto printing Drachme without any counter-value. The latter, of course, will have something to do with inflation and the new Drachme will become worth less than the equivalent of 1 Euro at the exchange rate of 341 to 1.
The recipients of government expenses (state employees, recipients of pensions, etc.) now only have Drachme to spend (unless they want to use Euros from under their mattresses or from their bank savings). When they now want to pay their bill at the shopkeeper’s, the shopkeeper will want to take his price in Euro, multiply it by 341 and ask for that amount in Drachme. If the government does not print more Drachme than the equivalent of 341 Drachme for 1 Euro, things will continue as though there had never been a new local currency.
In all likelihood, the government will have to print more Drachme than it has Euros available at the exchange rate of 341 to 1, and the Drachme will become worth less against the Euro. While the Drachme amounts which recipients of government expenditures receive may go up in nominal terms, they are likely to buy less and less Euros at the exchange rate of 341 to 1. Government expenditures will become less in terms of Euros; recipients of government expenditures will receive less in terms of Euros; what they now spend is less in terms of Euros than before; and the shopkeeper will receive less in terms of Euros than before. Throughout the economy, wages and prices will decline in terms of Euros.
Imports will become more expensive in terms of the new local currency and exports will become more competitive.
A new Euro/Drachme exchange rate will develop on its own. A foreigner who would never have considered buying an apartment in Greece at the exchange rate of 341 to 1, might now consider to do that when he gets perhaps twice that amount in Drachme. A German importer who ceased buying agricultural products from Greece when they became too expensive in terms of Euro might now want to start importing again if their price in terms of Euro drops significantly.
Cross-border transactions (between Greece and other countries) will continue to take place in Euro. If the government no longer receives its revenues (taxes) in Euros but in the new local currency instead, where will it get the Euros from which it needs to honor its Euro-obligations abroad? Well, it would have to buy these Euro in the new Euro/Drachme foreign exchange market. The more domestic inflation there is, the more nominal Drachme the government will need to buy the Euros in the new foreign exchange market.
The above proposal is purposely headlined with “thinking aloud”. Common sense suggests that there must be a catch somewhere. But these are certainly times where it cannot hurt to think aloud!