Montenegro money supply

Factual Questions
1

I recently visited Montenegro. Their currency is the Euro, although they are not part of the EU.I don’t mean they have their own currency pegged to the Euro. I don’t mean just that they will accept Euros. I mean it’s their official currency.

How does this happen on Day 1? How do they get an infusion of Euro banknotes to get to a steady state?

Once they do the startup, how do they control the M0 money supply? They can’t print more money.

The only other case like this I can think of is Turks and Caicos, where the official currency is the USD.

2

For a while, Argentina tried to use the US dollar.

I presume they then work like any other entity that has no central bank to print money - same as, say, a US state or city works. Presumably there’s a level of cooperation with the European central bank for accessing physical cash.

So basically, it needs to keep its deficit and trade balance of payments under control, and M0 takes care of itself. It’s central bank would operate like any regular bank in the EU? If they start to run low on funds, either sell bonds or raise taxes. Like any large conglomerate, the ability to borrow depends on the confidence of lenders.

After all, money is basically that which others will accept from you as money.

3

They keep an eye on income and expenditures. They manage their Euro reserves pretty much the same way countries used to manage gold and silver reserves, back in the days when currencies were backed by precious metals.

In a crisis, they will have less flexibility than countries that print their own money. Whether or not that is a problem, depends on whether or not you trust the European Central Bank.

4

There’s several countries that use the US$ as their currency: East Timor, El Salvador, Ecuador, Marshall Islands, Micronesia, and Palau. Some of them mint their own coinage, though. There’s other countries that have the dollar as legal tender in addition to their own currency.

There’s also some other countries not in the EU that use the Euro as their currency.

5

The likely answer to this is, they had a lot of Deutsche Marks on hand, and they just traded those for Euros when the Euro came out.

Montenegro hasn’t had independent control of its own money supply since 1922, so it’s not like they didn’t already know how to handle this situation. In fact, they’ve switched official currencies several times in the last century, so it’s almost a normal thing to them.

6

Some currencies are pegged to the US dollar by their central bank, which basically means that their central bank maintains a policy of “1 unit of our currency should be worth X USD”. In order to maintain that peg, the central bank needs to maintain a reserve of USD and be willing to trade it at the pegged rate for the local currency. Similar to how the US Fed uses open market operations to hit its interest rate target.

If the pegged rate is unrealistic, people will “challenge the peg” and insist on buying/selling the local currency at the peg rate until the central bank runs out of reserves at which point the central bank won’t be able to defend the peg.

But if a country has had a reasonably-maintained pegged currency for some time, switching to an explicit “the reserve currency is our currency now” regime is pretty straightforward. You already have the reserves, but now they’re backing your banking system instead of your currency.

7

Not only is the Panamanian balboa pegged to the U.S. dollar, but Panamanian coins for fractions of a balboa are in the same denominations (1 centesimo, 5 centesimo, 1/10 balboa, 1/4 balboa, 1/2 balboa). The coins are the same size and weight as their U.S. counterparts, and vending machines accept them interchangeably.

8

Like I said, it’s no different than any other entity that cannot print its own money - like a US state. They raise taxes, they issue bonds and try to sell them.

At a certain point, if they can’t keep a positive balance in their central bank, they hit the wall - creditors refuse to buy bonds that may not be paid, other banks refuse to accept their transactions, can’t even get pallets of bills and coins, so their employees and creditors go the the ATM and can’t get cash out, someone selling to Montenegro or its citizens will demand payment via something other than the Montenegro banking system, etc. They then have to reconcile their balance with the world, pay outstanding transactions - again, either taxes, or issuing bonds, or… selling state assets. Cut back on expenses- lay off civil servants, cut salaries, issue proclamation to reduce pensions, worst case seize private assets. (As a sovereign country, they can make these unilateral decisions, and usually get away with it). Sometimes the IMF or such will step in and arrange matters, and tends to require the same austerity. Greece is a good example - does it really matter if a country is in the Euro zone or not, if they use the currency? They just have no input into monetary policy as a non-participant.

However, if the country wants to remain a democracy, it has to watch the central bank balance so it does not come to extreme measures. Greece I suppose was lucky - they borrowed from European banks, many German, and so the bail-out was as much to save the banks as to save Greece. But the crisis was pretty much textbook - they kept borrowing, banks kept lending, until they could no longer afford to pay the bonds due and pay all the internal obligations like subsidies, pensions and wages. (and tax collection was also lax).

The main difference, as they say, is that a country cannot exactly go bankrupt. Instead, it has the arbitrary power to rearrange its internal affairs such that costs should balance and begin to pay off accumulated debt. (After all, you can’t auction off a country at a bankruptcy sale… we hope)

9

Many countries prefer to control their own exchange rate. This is (in theory at least) a self-balancing mechanism.

When Greece had its own currency, if it ran into problems, the exchange rate fell, meaning that their goods and services became cheaper for other countries. Holidays in Greece would be cheaper and more tourists would come, adding income. Exports would be cheaper, boosting production etc.

Of course, it also means that Greeks would pay a lot more for their holidays abroad, so they would stay at home. The downside. and there’s always a downside, would be that the price of imported goods rises.

10

Isn’t that how the Louisiana Purchase happened?
Though I don’t think Montenegro has any colonies it could sell…

Brian

11

As I understood, Napoleon had other fish to fry so simply unloaded the Louisiana Purchase so he wouldn’t have to be bothered with it. Otherwise, I assume sooner or later the British would see an easy opportunity to walk in and tie up even more French army. (Hmmm… all that area as part of Canada? No thanks.)

Further to the OP - is there even a M0 to worry about? The only relevance would be if there was a problem with free trade, so the amount of money inside Montenegro was relatively fixed. But I assume it’s pretty much free trade with Europe, so the amount of money in circulation in the country is relative to the balance of payments for import/export, etc. (I.e. nobody will buy Ruritania’s only export, carved garden gnomes, so every time someone buys something from abroad the amount of Euros in Ruritania drops and money is scarcer, deflation kicks in…)

12

I think you’re referring to a “currency board” system such as in place in Hong Kong.

There are two levers. The central bank can raise the borrowing cost of the local currency (ex Hong Kong Dollar) to step short selling. HK did this ~1996 when overnight interest rates went to 900%.

Second, if the central bank runs out of reserves, then they “simply” switch to USD. (Eg, the Hong Kong dollar disappears).

There is always speculation that the currency board exchange rate will have a “one time adjustment”. This is complete and utter bullshit. Pegs work because there is NEVER an adjustment. For Hong Kong, I had dinner with the “father” of the peg in Shanghai around 2002. The main issue they had was proving to the Bank of England, that the BOE would never have to spend a pound to support the system. Also, the official exchange rate peg range of $7.75–7.85 was just a bullshit number to appear scientific. And avoid the 1:1 peg issue.

IIRC the Euro and USD exchange rate was set at USD1 = E117. Stupid rate. Too obvious for speculators to target USD1: Euro1.

Having a peg or using a foreign currency also requires:

  1. accept the interest rate
  2. risk of “importing inflation”. Maybe your economy deserves low rates, but you have to accept the higher USD rate
  3. lose ability to devalue your currency (of course, to most currency holders this is a plus)
  4. More that I don’t remember off the top of my head. I left hong kong in 1998.
13

There are about twenty different European international-cooperation ventures, all independent, and each with a slightly different list of member countries. The Eurozone is not the EU is not the Schengen zone is not the list of sponsors for the ESA or CERN, etc.

14

Nope, we had our own currency, the Peso, but it was pegged to the dollar, in the end, as you said, it proved unsustainable, with disastrous consequences.
But it wasn’t impossible to revert because we still had the Peso, just had to stop trying to peg it to the dollar.

15

I’m not totally familiar with how the terms are applied, but my understanding is that a currency board is the most “firm” type of peg (and HK in particular maintains basically 100% reserves of the backing currency, so the peg can’t fail), but there are other, looser schemes (e.g. a crawling peg) where the central bank provides an exchange rate target that it can succeed or fail at maintaining.

Of course, if you’re going to commit to never having an adjustment, why have a separate currency at all?

16

Easier to maintain the local supply of bills and coins. In most countries, old bills are taken out of circulation by local banks who exchange them for fresh bills from the central bank. But in countries that use some other country’s currency, the local banks do not perform this function. Bills in circulation just keep getting used over and over again until they fall apart.

Coins are never returned for fresh ones, but new coins are constantly being added to circulation as banks make requests for coins from the central bank or the mint. But neither of these things happen where there’s no local coinage/currency.

17

This is the catch. a pegged currency (at a fixed rate) must be able to match any requests for exchange. Some countries, typically dictatoorships and the old Iron Curtain countries, had an “official” rate but the average citizen could not simply exchange their local money for foreign currency. Hence the black market, usually with a much more realistic exchange rate. Usually currency restrictions went along with restrictions on imports to avoid an obvious balance of payments problem.

AFAIK it’s not illegal for banks in the USA (or most other countries) to sell pallets of fresh bills and coins to foreign buyers. The reverse - collecting and returning dead" bills - could also be accomplished by a central bank. This, however, usually requires some official intervention. In countries where foreign currency is preferred over the local version, but is not the official currency, obviously authorities are discouraging its use not facilitating it.

Which would segue into a discussion of Euro dollars - the estimate is that between 20% and 50% of all US cash is held outside the USA (says the Canadian with a couple of hundred dollars US in my drawer). The other estimate is that a significant amount of this is counterfeit, since some foreigners are likely less sophisticated at spotting this. The narcotics trade does not help with this.

18

Good point, I am not conversant with this. On review, to be more accurate, Montenegro is not part of the Eurozone, which is the Euro currency union:

Austria, Belgium, Croatia, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Montenegro has adopted the Euro unilaterally, with no agreement with the EMU. They cannot print/mint euro coins or currency, and depend on the influx of euros already in circulation, which is what prompted my question.

19

Kosovo has done the same. Four of the micro-European countries (Andorra, Monaco, San Marino, and Vatican) have adopted the Euro with an agreement.

20

And that’s not even considering the costs of collecting old bills, shipping them to another country, and shipping the new ones back. Don’t forget to count the cost of security for this transport. Who’s going to absorb these costs? Probably no one, which is why it usually doesn’t happen.