By Peter Tase
Prof. Steve H. Hanke, a professor of applied economics and co-director of the Institute for Applied Economics, Global Health and the Study of Business Enterprise at the Johns Hopkins University in Baltimore, published on February 12th, 2020, together with Prof. Todor Tanev (Sofia University) an extensive – well argued – analysis on the currency board of Bulgaria. Their academic analysis was published at the prestigious Central Banking Journal, an information resource based in London, where Prof. Steve Hanke is a Contributory Editor and writes regularly for the Viewpoint Column, which brings together timely analysis from experts across the globe. Prof. Hanke specializes in exchange rate regimes and crisis management. Prof. Todor A. Tanev is a Fulbright Senior Research Fellow at the Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise. He is a professor of public management, public policy and strategic governance at Sofia University, Bulgaria.
The following is an excerpt of their (Hanke and Tanev) article published at Central Banking Journal, focused on Bulgaria’s Currency Board and its geostrategic implications.
“The year 1997 was both the worst and best of years for Bulgaria. The year started badly. In February, Bulgaria’s hyperinflation peaked at the fantastic rate of 242% per month. Then, things dramatically changed for the better. On July 1, a currency board law was adopted, and the Bulgarian National Bank (BNB) – specifically, its issue department – began to operate under currency board rules. These rules required the lev to be fully backed by Deutschmark reserves (now euro reserves) and to freely trade at a fixed exchange rate with the Deutschmark. With that, the lev became a clone of the Deutschmark, and good news followed:
- The currency board results were immediate and dramatic. The annual inflation rate collapsed to 13% by mid-1998. Interest rates collapsed, too, with the BNB basic rate falling from above 200% in early 1997 to 5.3% in October 1998. And that is now all. Demand soared for the lev that the new currency board had issued. And, as night follows day, the foreign reserves at the BNB soared, too. After all, the only way lev could be obtained was by exchanging Deutschmarks for lev at the stated fixed rate of exchange. The BNB’s foreign reserves rocketed from US$864.26 million at the end of 1996 to US$2.49 billion at the end of 1997.
In addition to these immediate, positive results, Bulgaria’s currency board allowed Bulgaria to weather all post-1997 external financial crises – including the collapse of the Russian ruble in 1998, the Greek financial crisis of 2009 and the great recession of 2009.
- The currency board also allowed Bulgaria to weather the 2014 banking collapse of Corporate Commercial Bank. The Corpbank catastrophe was not caused by the currency board system (the BNB’s issue department), but by the failure of the banking and supervision departments of the BNB to properly regulate and monitor Corpbank. Unlike most cases in which banking and currency crises are joined at the hip, the Corpbank crisis did not disturb Bulgaria’s currency. Thanks to the currency board system, Bulgaria did not witness a typical banking currency crisis. Indeed, the crisis was restricted to the banking sector. So, Bulgaria’s currency board mitigated the damage that accompanied the collapse of the Corpbank.
- Importantly, the currency board imposes fiscal discipline on Bulgaria’s politicians and fiscal authorities because the government cannot borrow from the currency board. In consequence, since the installation of the currency board in 1997, fiscal deficits have been tightly controlled, and the level of Bulgaria’s debt relative to its GDP has plunged. Bulgaria’s fiscal discipline and debt reduction have made Bulgaria a star fiscal performer in the 28 – country European Union. Indeed, Standard and Poor’s recently upgraded Bulgaria’s credit rating to BBB, with positive outlook. This places Bulgaria at the top of the ratings for all Balkan countries.
- The geopolitical aspects of Bulgaria’s currency board should not be allowed to pass without mention. As former president Petar Stoyanov confided to one of us (Hanke), Bulgaria would have had much more difficulty entering the North Atlantic Treaty Organization in 2004 and the European Union in 2007 if it were not for the confidence and stability created by Bulgaria’s currency board.
- It is not surprising that Bulgaria’s currency board is highly respected and supported by the populace. Bulgarians are rightly proud of their lev and what is the most important post-communist Bulgarian institution: the currency board system.
With this record in the currency sphere, it is rather shocking that Bulgaria finds itself adrift, like a barge lazily floating down the Danube, occasionally putting out a boat hook to avoid collisions, but a barge adrift nevertheless. In consequence, instead of Bulgaria running its own currency show, Brussels appears to be running the show. At present, Bulgaria, under directions from Brussels, is actually contemplating abandoning its own currency, the lev, and its currency board (BNB’s issue department). These would be replaced by the euro and the European Central Bank (ECB). Such a dramatic move raises a number of troubling questions:
- Why would Bulgaria want to try to fix something that is not broken? Polling data indicates that Bulgarians are not too keen about the idea of abandoning their beloved lev and replacing it with the euro. This sentiment among the public should give Bulgarian politicians cause for concern about the potential adoption of the euro.
- Why in these times, when nationalist sentiments are running high, would Bulgaria contemplate giving up its monetary sovereignty? Indeed, the Bulgarian populace knows that by formally joining the eurozone, Bulgaria would give up its national sovereignty over its monetary system. This sovereignty is valuable, particularly if the euro encounters troubles. If that happens, Bulgaria could immediately switch its currency board’s anchor from the euro to a superior anchor currency. Furthermore, Bulgaria could make this switch without asking for any other country’s or organization’s permission because, with its currency board, Bulgaria retains full sovereignty over its monetary system.
- Why would Bulgaria want to join and be locked into a club whose very future is uncertain? Formal entry into the eurozone would be like checking into the Hotel California. As the Eagles’ song lyrics put it: “You can check out any time you like/But you can never leave.” At this time, the only country that could check into and then check out of the eurozone is Denmark. It has obtained a valuable opt-out option, something Bulgaria does not have, and looks never set to obtain.
- Why would Bulgaria want to incur the costs required to formally enter the eurozone? For example, when Lithuania abandoned its currency board and currency, the litas, to join the eurozone in 2015, it transferred €43.05 million ($46.99 million) as part of its contribution to the ECB’s capital. In addition, it transferred €338.66 million to the ECB’s foreign assets and €162.45 million into the ECB reserves and provisions. These transfers constitute a cost because these funds – once transferred to the ECB – while still Bulgarian assets, are tangled up in a web of ECB/EU rules and politics. So, a loss in freedom and flexibility accompanies the transfer of funds required for formal eurozone entry.
- Why would Bulgaria want to give up known rules of the road and fiscal discipline for a moral hazard that encourages bad fiscal behaviour? Entry into the eurozone brings with it a moral hazard, one that is not associated with a currency board. Just look at Greece. Interestingly, maybe that is exactly what some Bulgarian politicians who advocate formal membership in the eurozone are dreaming about. Maybe they are tired of the tight straitjacket that the currency board makes them wear. Of course, the Bulgarian populace likes the straitjacket feature of the currency board. Indeed, that is probably why the public justifiably harbours concerns about the adoption of the euro and the discarding of the currency board’s straitjacket.
- Why would Bulgaria be pursuing formal entry into the eurozone when it is already securing many of the benefits from its peg to the euro? By virtue of the fact that the lev is a clone of the euro, Bulgaria is in the eurozone, and it is ‘in’ without having to carry the burden of any of the costs associated with formal entry.
Does it makes sense for Bulgaria to be contemplating entry into a club that is employing different standards for entry for Bulgaria than those that have been used for other members. Great care is required when dealing with organizations that apply double standards. Both Estonia and Lithuania employed currency board systems. These systems were similar to Bulgaria’s, and – not surprisingly – produced similar results. One of us (Hanke) knows this first hand, as he was deeply involved in the design and implementation of all three currency board systems. But, when Estonia (in 2011) and Lithuania (in 2015) adopted the euro, it was clear sailing, as it should have been. After all, they were already both part of a unified currency area – the eurozone – as is Bulgaria. But, for mysterious reasons, the standards for formal entry into the eurozone that are being applied to Bulgaria are different to those applied to Estonia and Lithuania. Indeed, it has not been clear sailing for Bulgaria. In May 2019, Bulgaria was denied the right to enter ERM-2 by the European Commission. This suggests that, even if Bulgaria was to formally enter the eurozone, the nation would risk not being treated on the same footing as other members.”
To read the full research article please click here.