Friday, February 6, 2015

Beware of Greeks Bearing Bonds

Once again, the news is full of opinions that Greece might be forced to leave the Euro. Once again, it makes little sense to me. U.S. corporations, municipalities, and even states default, and do not have to leave the dollar zone as a result.

Most recently, the story goes, if Greek banks can't use their Greek government bonds as collateral with the ECB, the Greek government will have to leave the euro so it can print Drachmas to bail out the banks. There are of course many ways in which this makes little sense -- if the bank has promised Euros, then a Drachma bailout does not stop a default. The government would have to pass a law "converting" euro deposits to Drachmas. But consider the story anyway.

Another common story right now: If Greece were to default, it would have a hard time borrowing to fund primary deficits. By leaving, it can print up Drachmas to pay bills.

OK, here's the obvious solution: Greece can print up small-denomination zero-coupon bearer bonds, essentially IOUs. They say "The Greek government will pay the bearer 1 euro on Jan 1 2016." Greece can roll them over annually, like other debt. Mostly, they would exist as electronic book entries in bank accounts, but Greece can print up physical notes too.


Who will buy? Most of Greece's spending is transfer payments, to pensioners, health care, government workers, and so on. Greece can pay all of these with IOUS. It can "recapitalize" or lend to banks with these.

Sure, they'll trade at a discount. Probably a hefty discount.  If Greece accepted the IOUs at face value for tax payments, however, the discount might not be that large.  Mostly, the discount would reflect risks that Greece either change its mind about accepting its own debt for tax payments, or that it would suspend the roll over, essentially defaulting on this new class of debt.

Yes, this proposal amounts to creating a separate or dual currency, while staying on the euro. That is exactly the point. Not only does a country in default not need to change currencies, in modern financial markets, a country doesn't even need the right to print money in order to, well, print money! Bonds are money these days. There's the Drachma conversion, devaluation and inflation so many commenters desire, can happen (the latter when promises are inevitably broken) all  without leaving the Euro.

I gather California did something similar recently, paying bills with transferable IOUS and thus avoiding the prohibition on states printing money. Commenters let me know if you remember the details.

To be clear, I don't recommend this path! This is a theoretical-possibility blog post, not an advice-to-Greece blog post. (Advice remains, stop fooling around, massive structural reform tomorrow morning, grow like crazy, pay off debt.) And yes, it would be a horrible fate for government workers and pensioners. However, maybe better than the alternative: "leaving the euro" means having bank accounts (what's left after the run) transformed to inconvertible drachmas, and being paid in drachmas, with the whole point is to inflate away the value of the same government claims. So promises for euros might be better. Who knows, maybe eventually the Germans and the IMF might pay these off too.

This works nicely as a matter of economics. If readers know what would stop Greece from doing it legally, I would be curious to know. Of course, "the Germans aren't that dumb" is one good answer, and such debt would count against the debt and deficit limits. But that doesn't really get at the question. The question is, do the legal restrictions against Greece printing money and spending it in the euro would stop Greece from printing up "debt" and paying bills directly with such debt rather than raising euros on capital markets?  Opinions?

Update

There are lots of different ways to market the same thing, and skirt pesky laws and international agreements. Another: sell "tax indulgences." For 95c today, you can buy a transferable coupon that is acceptable for 1 euro of tax payments next year. This is nicer actually as there is no need to default or roll over. The "roll over" happens automatically. Taxpayers cash in this year's indulgences, the government sells next year's.

66 comments:

  1. Greece should default, restructure, and start over - just like any U.S. household that is underwater without reasonable hope of achieving solvency.

    Lenders should bear the cost of making bad loans.

    Debt is part of a capital structure, not a moral contract.

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    1. Jose Romeu RobazziFebruary 6, 2015 at 8:20 PM

      Argentina tried that, it didn't work.

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    2. Between 2003 and 2007, the Argentine economy grew by an annual average of roughly 8 percent, while unemployment dropped from around 20 percent to about 8 percent.

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  2. There's no need for Germans to be dumb. The IOU's discount rate will be, more or less, equal to the fiscal cut the EU is demanding to the Greek Government (the pensions and public salaries cut Syriza has promised not to cut). Argentina and argentine provinces have a lot of experience to share!. Adrián S.

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    1. The difference is that the IOU's can be used to allow the local economy to grow, by starting a jobs program for the unemployed, and increasing purchasing power. I am surprised that supposed economists don't know about Keynes.

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  3. Leaving the economics aside for a second, is there any evidence that leaving the euro would even be politically viable for the Greek leadership? Whether it's rational or not, people have a strong aversion to inflation. I don't know anything about Greek politics but I would imagine there would be a major backlash to a return to the drachma if it was just viewed as an attempt to erode purchasing power.

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    1. 80% of greeks are against leaving the euro. So, no, not really viable politically.

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    2. Actually, that percentage has dropped dramatically in the last few days in my country. The 80% was before the elections and the turmoil of the past two weeks.... The ECB decision made a huge difference too... I know many ppl that were absolutely terrified about leaving the euro and now simply say "we' ll survive"

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    3. Thanks for the response, Amy. It just surprises me how little this seems to be discussed sometimes when I hear supposed experts talk about whether or not Greece will leave the euro. I think it's just as much a political issue as an economic one.

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    4. Greece is in a Financial Coup d'état! (MAT) police is Reorganized and Gov is in Tight Control. All Folks are Afraid to talk! (Punishment is Severe). Greece is Russia's New CUBA. Punishment for EUROPE and for President Obama! But Vlad will be very nice to Dr Merkel

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    5. Greece needs to join the middle east sect and get out of the euro. the ethos of greeks is closer to middle eastern values than european.

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  4. Prof Cochrane,

    My first impression is: that's the brightest idea I've seen so far on Greece. After mulling over it for a few days I might spot some horrendous flaw in it. But I like the look of it .

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    1. Here is a related approach I proposed at a Levy Institute conference in Athens in late 2013, Ralph. If you see ways to improve upon it, please let me know. It is a messy solution, no doubt, but perhaps preferable to the turmoil a Greek exit from the euro would introduce.

      http://neweconomicperspectives.org/2013/12/exit-austerity-without-exiting-euro.html

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    2. Rob,

      A lot to like there. A couple of things:

      "Of course, to make this alternative financing mechanism, enforcement of tax collection will need to be improved in some nations. A more equally distribution of the tax burden across citizens would also help in the issuance of these notes."

      Agreed.

      "A second criticism of this alternative financing mechanism is that it would offer a quick route to accelerating inflation, if not hyperinflation, as some of the constraints on government budgets would be reduced or removed."

      With a fixed money supply (no new borrowing from central bank), a government has a difficult time generating broad inflation across an entire economy (unless of course it is out bull dozing productive enterprise). If a government sells securities for Euros and then spends those Euros, the general price level is unchanged but the relative prices of goods demanded by the government versus the goods forgone by private enterprise may change.

      I think those concerns are overblown. It is bad fiscal policy with an obliging central bank that creates hyperinflation. I am presuming that the ECB would not be a buyer.

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    3. greeks around the world have immense personal wealth. why dont the wealthy greeks support thier mother country instead of demanding a free hand from the rest of the EU ? wealthy greeks aquired wealth often via corruption and it is no secret that greeks have very corrupt minds, dont pay taxes and cut every corner wherever they form communities. in australia for example greeks are the 4th largest community in prison . this in a country that has afforded them every conceivable advantage as greeks run the real estate industry here. and yet many still find themselves involved in crime. it is no different in greece where governments were prone to corruption for decades and this is the result. it has caught up with them now. i think it is time greeks pull their own socks up and work hard and fair like many others especially in germany have done. lets not forget germany was virtually destroyed after ww2 whereas greece was lavished with total freedom after ww2.. and its take greece 70 years to destroy itself with corrptioin while germany toiled and worked hard producing the worlds best products in engineering to automotive.. greece is still exporting olive oil.. PULL YOUR SOCKS UP GREECE !!

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  5. Go back to the days of Colonial Script? I love it.

    This is the easy part for Tsipras et al. The hard part will be dealing with entrenched oligarchs and bureaucrats in Greece and convincing people to pay their taxes. That's a complete socioeconomic do-over. Usually something of that magnitude entails lots of guns and near-total rending of the social fabric.

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  6. There seems to have been a lot of talk going around among mainstream economists (especially of the MIT variety) which says " debt (I assume that is government or private) is OK if you borrow in your own currency". Well, of course, it depends on the currency. If your the US or Switzerland sure. Most countries, however, unless they are large and economically and politically powerful (like the US) or small ones that have a hard currency that has been earned over very many decades (like Switzerland), usually have to convert their own currency into currencies with liquidity and keep a stock of foreign exchange reserve of such currency. The latter are also the currencies in which trade is denominated - overwhelmingly, of course, US dollars. Despite everything, there is not a great wish by Greeks to return to the Drachma.

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    1. Objection to the "MIT variety" allegation. Both Robert Mundell and Mario Draghi hold doctorates from MIT.

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  7. This sounds similar to the neo-chartalist proposal - http://www.levyinstitute.org/publications/tax-backed-bondsa-national-solution-to-the-european-debt-crisis. Do you see any fundamental differences?

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  8. Dear John, the IOUs would be illegal under the Maastricht Treaty. They would be akin to a parallel currency issued by a national government, which is explicitly forbidden. Not to mention the fact that if a government pays employees and suppliers in IOUs this constitutes ipso facto a default with all the legal and practical consequences.

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    1. Germany and France set the precedent for enforcing the Maastricht Treaty: Ignore it when you want to.

      If you're going to break bad, break big, and use the ELA to print euros even if the ECB prohibits it. That would drive the eurocrats crazy. What are they going to do - throw Greece out of the euro? That would entail breaking the Treaty too.

      This is an amazing situation to watch. An irresistible lender vs an immovable debtor. The main problem for the irresistible lender is that the immovable debtor has arithmetic on its side, no matter how much pain the lender inflicts.

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    2. Fabio:
      Hi and thanks for writing. I don't think it's that clear. Though economically akin to a parallel currency, they're not -- they are debt. They are promises to pay euros, in a country that firmly remains part of the euro system. They're promises to pay euros in the future, and will trade at a discount. And using IOUS to pay bills is not a default. If they tried to pay interest payments on government debt with IOUS, that would be default. But if they pay pensions, government workers, etc. with IOUs, that's not a legal default on anything. We know Greece is allowed to issue one year zero coupon debt. The question is what in Maastricht (the parts anyone pays any attention to!) stops Greece from issuing that in small denominations, easily transferable, acceptable for tax payments?
      John

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    3. Zero bonds are allowed by troika but up to a certain limit, I think 15b €. Even this issuance is under conditional agreement of troika and up to a limit.

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    4. John,

      "If they tried to pay interest payments on government debt with IOUS, that would be default."

      That would be an attempt at Ponzi finance, though it would not necessarily be a default.

      Suppose you bought a ten year U. S. zero coupon bond and ten years later you rolled over the interest and principle by buying another ten year U. S. zero coupon bond. That is not a default because you (as bond holder) were willing to accept payment on a bond in the form of another bond.

      What it comes down to is choice - does the owner of the debt have the option of payment in full / rollover, or is rollover forced down their throat?

      For instance, can Greece take their one year zero coupon debt and forcibly roll it over to two years, five years, ten years, etc?

      AFAIK, there is nothing in the Maastricht treaty that precludes a government from accepting something other than Euros to fulfill tax liabilities. As long as the government sells those other assets for Euros, Greece can extinguish it's Euro denominated debts.

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    5. There may be an issue with Article 128 of the Lisbon Treaty, hence the importance of structuring these instruments as debt issues. And in any case, some lawyer could be found to interpret the language in Greece's favor, tying up the legal challenge for long enough for Syriza to get the Greek economy growing again, which would make it politically difficult to reverse, especially given the anti-austerity mandate Syriza was elected upon.

      .http://www.lisbon-treaty.org/wcm/the-lisbon-treaty/treaty-on-the-functioning-of-the-european-union-and-comments/part-3-union-policies-and-internal-actions/title-viii-economic-and-monetary-policy/chapter-2-monetary-policy/396-article-128.html

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    6. Rob,

      There is no mention of debt in article 128.

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    7. Mightn't the IOUs be both a debt and a currency? Am a bit lost here--don't see why these would be strictly one or the other. Fascinating idea.

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    8. JZ,

      Currency always trades at par with currency. Bonds / debt issues vary in yield to maturity and duration.

      When government debt is sold, even identical issues sold at the same time can have a slightly different interest rate.

      Or even consider a two year government bond that has aged one year and a new one year government bond. Both are issued by the same government, but can have significantly different interest rates / market values.

      What I am getting at here is that if Greece tries to use debt as a currency, they would wind up with a potentially infinite number of currencies all trading against each other.

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    9. Frank you are bringing up an important issue about the need for currency to trade at par. I think that people generally link exit from the Euro with the need to issue Drachma notes and coins. I'd much rather they keep using Euros for cash in Greece. The problem apparently addressed by this blog post is how Greece should borrow Euros without cooperation of the rest of the Euro system.

      I'm not as learned as the other commenters here, but I don't see what is wrong with a Greek central bank simply issuing Euros to the local banks - and anyone else who wants them - even if these central bank deposits don't count for anything with the monetary union. It's like issuing shares in an MMF run by the government. Instead of interest rates determined by markets, they can simply pay GDP growth. If Greece is forced out of the monetary union, then there would be an exchange rate to move money in or out of Greece. But that is still technically simpler than some of the alternatives being discussed here.

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    10. 1. Currency does not always trade at par with currency - see the central bank rouble balances before the final collapse of the old Sovs.

      2. The Greeks have in fact been using such government IOUs for years, promissory notes issued to suppliers of their insolvent "free health care" system and other socialist accounting miracles where 2+2 equals anything the voters decide.

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    11. It's true that par is a policy, not an economic law. Some people want to break par in order to tax cash. Miles Kimball explains how this would help break the zero lower-bound and allow for negative interest rates.

      My own suggestion is that maintaining par by law (i.e. legal tender rules) can help the Greeks out of their current mess. It might take up to a year to introduce Drachma notes and coins. I would have them postpone this step, and let the Greek public use Euro notes and coins for awhile. Let's see how they set prices knowing that people might pay using either cash or bank deposits. And during this time, the monetary union authorities will need to decide whether or not Greece has done anything that justifies removal from the union.

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  9. This post of John Cochrane's has inspired me to do a post on my own blog in the subject of local currencies and Greece. Basically, if local currencies make sense (e.g. for Ithaca, New York State in the US) why not for Greece? See:

    http://ralphanomics.blogspot.co.uk/2015/02/cities-issue-local-currencies-why-not_7.html

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    1. Ralph:
      Your post is very interesting. But I think a local currency is prohibited by EU. And your description of a privately issued local currency could solve a shortage of cash problem -- an increase in money demand not matched by money supply. But it doesn't solve a government debt problem. So, what I am imagining is different in two crucial ways. It is debt, a promise to pay euros in the future, though it circulates like currency. And it is issued by the government to pay their bills. I'm not persuaded Greece is suffering from "lack of demand" caused by too much money demand and not enough money supply from the ECB -- something like Kansas in the 1930s by the popular story.

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    2. Prof. Cochrane - this is the first idiotic thing I've seen you post, and I'm a longtime student and admirer of your work especially on fiscal theory. But you had one right idea, California, where the SEC informed the legislature that issuing IOUs is issuing securities, and that it's illegal to distribute unregistered securities - see CUSIP number. The Greeks have voted to suspend the laws of arithmetic at home, and to suspend laws of proof of reparation claims abroad - see claims of gold reserves allegedly stolen by Germany - but one hopes these twin afflictions aren't contagious.

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  10. This whole thinking that when Greece leaves the Euro there will be hyper-inflation is strange, to put it mildly. Today, Greece is in deflation and monetary policy is extremely tight. When Greece leaves the Euro, monetary policy will be loosened, and in fact return to something normal. There will be some imported inflation for a few months, and normal, benign inflation afterwards.

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  11. California did indeed try issuing IOUs ("scrip") rather than paying with cash. Result: what they were really doing was forcing their creditors to issue interest-free loans to the state, which were not particularly liquid. (State employees had a hard time paying their rent or buying groceries with the state-issued scrip.)

    The big problem Greece faces is their acceptance of widespread tax evasion - in essence, a big tax cut for the rich. It didn't create any jobs, and was destructive to the economy. Perhaps aggressively going after the tax evaders, seizing their property, and selling it to generate funds is a wiser course than selling public assets to the vultures. But then, allowing a Russian-style looting of the public assets and destroying the social safety net was always the point of the vulture-mandated austerity policy.. wasn't it?

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  12. Argentine provinces issued IOUs during and before the 2002 crisis. "Patacones" in Buenos Aires Province, http://en.wikipedia.org/wiki/Patac%C3%B3n_%28bond%29

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  13. This solution resembles the one we proposed for Italy in a book published in 2014 (with Biagio Bossone from the FMI and Warren Mosler writing the introduction) to introduce deferred tax credits and use them to cut taxes on business and and payroll in order to get out of the current depression. I had run it also with Nick Rowe for instance getting a positive answer ("...If people do use them as a medium of exchange, then it is as if the individual EU countries can print their own money, at a floating exchange rate. Then they might work....(http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/07/when-is-helicopter-money-optimal.html) )", so I would take a little space to ask an opinion here.. We also agree that the best thing would be to cut wasteful public expenditure, eliminate corruption, cut regulations, reform the justice system etc...but unfortunately we are all people over fifty and we want to suggest something doable in our lifetime.
    Also, suffocating Italian small and medium companies with taxes and lack of credit as the Troika sponsored Austerity ended up doing does not promote any of the above reforms, it just kills the only thing that works in Italy, small and medium private companies.
    So, we are starting to go around with this plan: Italy could issue (free-of-charge, electronic) Deferred Tax Credits to enterprises and workers which as bills of exchange would not require future reimbursement from the State, so they might not be regardes a debt (?). Rather, two years after issuance, the Italian State would accept them for the payment of all taxes to itself. Since they di not have use per se before two years they would not impact the Italian government budget before, say, 2017, yet their recipients could immediately convert them in euro (by selling them in the financial market at a discount comparable to that on a two-year, zero coupon government bond) and then after 2 years use them for reducing their tax burden. We propose at least 100 billions out of 800 billions of total taxes paid, all tax cuts, the biggest tax cut in the history of Europe...
    The two-year deferral provision would allow output to respond to increased demand and generate revenues which somehow offset the shortfall causing tax receipts to increase (I know, I know you are sceptical on this, but Italian industrial production is down 28% from 2007 and it would be a 100 billions tax cut directed mostly to business...).
    In theory these issuance could not end up violating the the Maastricht treaty 3% budget deficit as required by the fiscal compact if this huge tax cut would improve both supply and demand. Of course they might trade at a significant discount to Euros depending on expectations on the EU reaction and a possibile dissolution of the euro...
    People like Bill Mitchell write ok, but why not go all the way and exit the euro because it leads there... I think in the end it might end up this way, but the point is that our government can issue a parallel currency and cut taxes right now and then you see where you go from there.
    I also asked the ECB staff if there was any law or regulations within the EU that forbids a national country to issue them and got this answer for what is worth
    Directorate General Communications EUROPEAN CENTRAL BANK
    Dear Sir, Thank you for your email.
    Unfortunately, you refer to issues for which it is not up to the ECB to deal with and therefore not in a position to answer questions. ...

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    1. gz,

      "People like Bill Mitchell write ok, but why not go all the way and exit the euro because it leads there..."

      Not necessarily. Think of it like the Bretton Woods system. During Bretton Woods, the U. S. was required to make interest payments on outstanding external debt in gold. Internally, the U. S. could make interest payments using available tax revenue denominated in federal reserve notes.

      Instead of allowing the U. S. dollar to float against gold or reinvoking the war time interest rate limitations on government debt, the Nixon administration instead decided to pull the plug entirely, closing the gold window. That was an administrative choice rather than a single viable solution.

      Italy can make the alternate administrative choice, pay it's external debt in Euros (similar to what the U. S. was doing with gold under Bretton Woods), but rely on alternative financing going forward through the sale of deferred tax credits.

      I think it is instructional to look at who was on the U. S. committee that recommended the abandonment of Bretton Woods:

      Paul Volcker (later Fed Chairman)
      Arthur Burns (current Fed Chairman)
      John Connally (current Treasury Secretary)

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    2. Interesting the ECB did not see your proposal as being in its jurisdiction. Did you follow up and ask which EC entity is relevant for considering such proposals?

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  14. I don't see why they should use bearer bonds that need to be rolled over every year. I think the ideal local currency would be Euros deposited at the Greek central bank that pay GDP growth every year. I'm not sure if this violates the EU treaties, but the Greeks already seem comfortable proposing GDP-linked debt. Why not use it as currency as well?

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  15. To explain a bit further: these deposits at the Greek central bank would be "Euros" in the sense that they would be legal tender within Greece, even if Greece was no longer an EU member.

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  17. My understanding is that the Greek economy has been undergoing "structural reforms" for 5 years under the supervision of the Troika and the experience has been worse than the U.S.'s under the Great Depression. So they want to try something different.

    Hopefully they can come to some arrangement with the troika that both can live with. The numbers are small where the Troika is concerned. It's all political and about sending a message and pushing through "structural reforms." If the Troika won't make allowances, then they'll be in effect kicking Greece out of the Euro, for the Greek government was elected on a campaign promise to change from the current path.

    If the Greeks and the Troika can't come to an agreement, then the ECB won't provide liquidity for the Greek banks.

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  18. The idea of "tax backing" always seemed a little weak to me (Warren Mosler proposed it many years ago), because presumably most Greek taxpayers own property in Greece - they can't escape the reach of the Greek government. To really work there have to be large Greek taxpayers that the Greek government can't touch without the active assistance of other governments.

    But if it did work, then the bonds would effectively be senior to the existing bonds. That's because the "tax backing" of the new bonds would deprive the government of tax money to pay the old bonds, in the event of default. So this would count as a default on the old bonds.

    ---

    Question: how much is Greece's 6% (or whatever it is) ownership of the ECB worth? It's not a marketable asset, I know, but it's valuable. This makes the ECB kind of a secured creditor.

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    1. ...which is exactly the problem: There are huge tax payers who are using the eurosystem for tax evasion. Just consider Germany's Hoctief, who runs the new Airport of Athens: they miraculously managed to not pay their VAT dabt of 500M Euro. And they are still allowed to run the Airport thanks to "corruption"

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  19. @ nick edmonds. The Mosler paper you refer was addressing the eurozone debt panic of 2012, but is still relevant because tax-backed-bonds would free EZ countries from having to rely on the ECB backstop conditional on austerity programs, like JC proposal here (at least if you do not wait until a quarter of you bank deposits are gone and you are at the mercy of the ECB pulling the ELA...)
    To issue "tax backed bonds" or JC small-denomination zero-coupon bearer bonds does not address directly the need to increase money in the EZ economies now in depression, either through more expenditure or tax cuts, but would allow Greece, Spain or Italy to do so.
    In the case of Greece though, Syriza seems to want something like 5% of GDP in additional public expenditure, which will not make Greece more competitive and so it will not work within the Euro, I am afraid. At the same tima Greece has little negotiating power because its banks lost deposits and have to post their own bonds to get ELA liquidity etc...
    Italy would have better chances to implement this proposal, because its banks have been getting even too much deposits recently, it did not ask any ECB backstop like Ireland and Spain and and it can use this idea to create a dual currency while staying on the euro to just cut taxes. This can really work, because in our country the tax burden has been increased by about 9% of GDP since the Euro has been launched (around 1996) and we have been running an average primary surplus of 2,4% of GDP for almost 20 years now. So Italy could be in a decent negotiating position, if it understands that can use Cochrane's and Mosler's idea of issuing a dual currency (floating against the Euro) and simply cut a bunch of taxes. Italy can issue a dual currency floating against the Euro, use it to cut 100 billions in taxes and get both a demand and supply positive impact. We would add that, in order to have better negotiaing power, it can use Deferred Tax Credits because this way it can make the argument that is not even debt and after the 2 years delay it might not break the 3% limit (as mentioned in my previous post).

    Anyway, the Mosler 2012 tax-backed-bond article mentioned by Edmonds is where we started to come up with the above described plan to issue Deferred Tax Credits for Italy, see for instance this short summary in English http://www.economonitor.com/blog/2014/07/which-options-for-mr-renzi-to-revive-italy-and-save-the-euro/. I am personally thrilled to see some encouragement in this direction from the JC piece above, but better also try to check with the author)

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  20. I gather California did something similar recently, paying bills with transferable IOUS and thus avoiding the prohibition on states printing money. Commenters let me know if you remember the details....
    ---
    here is Bill Mitchell on California IOUs: "California IOUs are not currency … but they could be!" http://bilbo.economicoutlook.net/blog/?p=3145
    and also compared with our tax credits for Italy: "Yet another solution for the Eurozone"
    http://bilbo.economicoutlook.net/blog/?p=29092&cpage=1#comment-35853

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  21. You seem to take it for granted that Greece should pay 100% of its debts which are now mostly owed to foreigners. Is this a moral or an economic stance? Surely countries default all the time. A notable example from admiitedly a while ago is the Southern States who defaulted on their Civil War debts (also owed to foreigners). They don't seem to have suffered any penalty. If Greece did default it would find it harder to borrow in the future and would have to pay a higher interest rate. But Greek government debt should surely form part of any well-diversified portfolio (including maybe the University of Chicago's endowment fund?). .

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    1. Nick,

      The Greek government is beholden to it's voters, not to a well-diversified portfolio. And so if the Greek voters decide it's government should retire 100% of it's debts, we can't counter.

      "Is this a moral or an economic stance?"
      It is a who does government work for stance.

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  22. John,

    "OK, here's the obvious solution: Greece can print up small-denomination zero-coupon bearer bonds, essentially IOUs. They say The Greek government will pay the bearer 1 euro on Jan 1 2016. Greece can roll them over annually, like other debt. Mostly, they would exist as electronic book entries in bank accounts, but Greece can print up physical notes too."

    "If Greece accepted the IOUs at face value for tax payments, however, the discount might not be that large. Mostly, the discount would reflect risks that Greece either change its mind about accepting its own debt for tax payments, or that it would suspend the roll over, essentially defaulting on this new class of debt."

    Better,

    Greece can print up small-denomination zero-coupon fixed duration equity. They say "The Greek government will accept this equity as satisfactory payment for the discharge of 1 Euro worth of tax liability in January of 2016". This would mean that they would only have intrinsic value domestically, not internationally.

    I am not sure if Greece has a rollover system set up to buy government obligations. In the U. S. it is called the primary dealer arrangement for Treasury debt. However, if a person holding equity issued by Greece did not have a tax liability equal to or greater than the value of the equity he / she holds, that person would be able to roll over the fixed duration equity to a future date, perhaps at a discount.

    "If Greece accepted the IOUs at face value for tax payments, however, the discount might not be that large." The discount would reflect the relative supply / demand for the two assets. That relative demand would be a function of Greece's trade balance. Someone from Germany would have no reason to buy the equity because he / she would not have a tax liability in Greece. Someone from Germany may have a reason to buy Greek bonds as part of a diversified portfolio of sovereign debt.

    "To be clear, I don't recommend this path!"

    Why not?

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  23. Greece leaving the EZ makes even less sense considering that they would have to tear up the Maastricht treaty, thus exiting the European Union too. There is no EZ exit mechanism in the Maastricht treaty exactly because the signatories wished to clearly signal the Euro will be around forever. International treaties operate on the principle of all or nothing, so that one or more of the signatories can't renege on some irksome compromise at the cost of everybody else. Sometimes governments can brazenly breach treaty provisions but that's not possible for the Greeks because there is a clear arbiter: The European Court of Justice. Expecting a lawyer to come up with a loophole that the court will accept is a huge gamble, because it has a miniscule chance of succeeding. The only sure way Greece could leave the EZ without leaving the EU is by negotiating an exit addendum to the treaty, That means they can't avoid dealing with Merkel & Co anyhow, who will try and extract all kinds of guarantees for the debt (for example no converting euro debt to drachma), so from Syriza's point of view the idea of an exit is a stillborn idea.

    If Syriza is backed into a corner where EU exit starts to look uncomfortably close they could default on all of the debt to the EU members, leaving Greece with 40% of the debt that they have now. That remainder is in the hands of the IMF, ECB and private investors. That still leaves the Greeks with a budget deficit but they can always try their luck with a return to the private markets.

    As for issuing IOUs Ireland tried something like that and the ECB moved against it, stopping them from issuing more. But perhaps Draghi would be more reasonable than Trichet was? Otherwise the only other way would be to strike lots and lots of commemorative coins (the only way member states can mint money). The downside would be that they are only legal tender within Greece. IIRC it would also require the cooperation of the Greek central bank. I don't hear about this possibility in the press so I guess there are some provisions I'm unfamiliar with that hinders minting on a vast scale.

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  24. The problem with Greece is that Greece has cut spending by some 25% (primary spending) since 2010. Yet, instead of GDP increase, as austerity proponents predicted, Greece has lost some 20% of their GDP. Greece is currently running 4.5% primary surplus. Troika wants further reforms, but if 25% cut in spending and 4.5% surplus actually lowers GDP by 20%, you have to ask if further cuts would cut GDP more.
    Greece wants to keep primary surplus at around 1.5% and see if that increases GDP. Merkel wants to simply punish Greece.
    Nobody talks about punishing politicians from other countries, including Germany, who let Greece into Euro based on clearly falsified data for political reasons. Shouldn't their countries also bear costs of that mistake?

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  25. What I have in mind is France in Louis XIV and the subsequent era, when the government issued a great amount of "Billet d' Estat" or "Billet de Monnoye" to finance the war. In practice, "billets" could be used in transactions, while they would only be traded with great discount on their nominal value.

    Although the bubble bust in that era took care a part of debt issue, the eventual solution for France to solve that problem is to strengthen their public finance system. "Billets" only could buy some time for the deeply-indebted economy.

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    Replies
    1. This is an excellent analogy. Also the Assignats, issued against future sale of church property. They also bought some time, and ultimately blew up. Economists who have not done so yet, take the morning off and read Tom Sargent and Francois Velde "The Macroeconomics of the French Revolution" in the JPE.

      I should make very clear in response to this and other comments, I don't think any of this is a good idea, and will very likely lead to ruin just as it did for France.

      However, it is interesting to map out the possibilities. The standard story that default must mean changing currencies just makes no sense. There is a whole range of possibilities in between sobering up and fixing the economy, and default, currency swap and quick devalation and inflation.

      Delete
    2. Thanks for the reply and sharing that reference. Interesting article!

      Delete
    3. Before the assignats in France John Law managed to pay off the entire French national debt by swapping its bonds for shares in the Mississipi company. Nobody else ever has managed a state debt for equity swap so completely before or since though Hjalmar Schacht and his Rentenmark came close.

      Delete
  26. I too have been arguing all along that a Greek exit is unlikely. It's become such a cliche in the media that few people outside Greece seem to know that there is no support in Greece for quitting the euro and Syriza has been very clear that they will not leave the euro.

    Your idea of paying government bills with debt instruments is actually a kind of soft Grexit. It would chase the good money out of Greece (euros would leave to the rest of Europe) leaving Greece with its own pseudo-euros accepted at face value only by the Greek government. Accepting them for tax payments would not prop up their value, it would only accelerate the departure of euros from Greece as no one would use euros to pay taxes anymore.

    That does mean though that Greek banks will soon run out of cash. The collapse of the Samaras government started a run on the banks, and what the ECB did last week was move to limit the EU's potential losses from a default by capping the amount of euros Greek banks can draw from the Eurosystem. This is worse than the Cyprus scenario: Greek banks will run out of cash with no prospect for any quick European rescue. They will probably have to freeze deposits for a considerable time while Syriza either makes a deal with the EU, decides to try to quit the euro, or loses power as people realize how suicidal it was to elect them.

    http://globalizedblog.com/2015/02/europe-girds-for-greek-default.html

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  27. Germany's Mefo Bills under Schacht worked better but they are not studied much.
    Schacht established the Metallurgische Forschungsgesellschaft (Mefo) a shell company, which had no employees, equipment, organization or operations, but could stipulate public procurement contracts and could pay contractors by issuing state-guaranteed bills of exchange at variable maturities. These so Mefo bills could be discounted at the banks into Reichsmark on demand, although the Raichsbank could temporarily suspend convertibility on monetary policy considerations. At the time Germany has just defaulted on its foreign debt by the way. Large emissions of Mefo bills paid for actual deliveries of goods and the bills circulated as money and succeeded in revitalizing the economy. Between 1933-1938, notes h Niall Ferguson, Germany’s gross domestic product grew, on average, by eleven percent a year, with no significant increase in inflation
    ---
    Mahe has a chart of GDP and inflation in Germany that is quite striking

    Mahe E (2012) “Macro-economic policy and votes in the thirties: Germany (and The Netherlands) during the Great Depression”, Real-World Economics Review Blog, June 12

    Schacht (1967) The Magic of Money, Oldbourne

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  28. IIRC Canada was paying interest on overpayments of tax installments. They had to either eliminate the practice or at least cut the interest rate significantly because they started receiving large over payments as market interest rates fell. Companies were using their tax installment accounts the way they might have used a money market account. Greece could do the same.

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    Replies
    1. Absalon,

      No reason that Canada (or Greece) would need to limit maturity to a year or two.

      Delete
  29. Greece is currently running primary surpluses. They have strictly no interest in issuing such bonds after a default, since by definition they would no longer have any financing need.

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  30. John,

    "Another: sell tax indulgences. For 95c today, you can buy a transferable coupon that is acceptable for 1 euro of tax payments next year. This is nicer actually as there is no need to default or roll over. The roll over happens automatically. Taxpayers cash in this year's indulgences, the government sells next year's."

    Have you given any thought to what becomes of tax indulgences that cannot be cashed in the current year because an investor has bought more indulgence than he / she can take advantage of? Are they extinguished / become worthless or are they rolled over to a future year?

    If extinguished, you are better off with a range of maturities (1 year to 30 year) so that one bad year does not wipe out your investment.

    And really the 30 year limitation on government securities is structured around the housing market. A house constructed today is anticipated to have a 30 year useful life if left unimproved - hence few mortgages are written for terms longer than 30 years.

    With tax indulgences, a government could reasonably offer maturities of up to 50 years figuring that is the maximum time a person will be working for a paycheck and paying taxes (Age 18 to Age 68).

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  31. Mr Variufakis Stated that "he wI'll do everything but if it meant to depart the Euro they Will! Just a matter of Time! And They will hide all relationship of Euro to Drachma because it Will show how bad the Economy is. Out of Euro Out of Europe Out of NATO. They can't do anything! Turkey is NATO and next Door! The Turks as Always will be loyal
    To US interests! In Exchange with Vlad, Dr Merkel will win UKRAINE, near Germany, Solid Work Ethic. RUSSIA will come Via Bulgaria to warm Water Thesaloniki! Leave Poor Athens to the Tourists! EUROPE will thrive!

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  32. Interesting to read your proposal! More and more economists seem to have started paving the theoretical road towards a parallel currency approach for Greece and the Euro Zone. I recommend to look into this list of proposals http://www.veblen-institute.org/Parallel-Currencies-for-the?lang=en and invite everybody who is able to read german or use google translate, to take a glance at this comprehensive reader published by BVMW (the biggest German Association of SMEs): bvmw.de/uploads/media/die_parallelwaehrung.pdf
    It contains a collection of parallel currency proposals presented at a hetrogeneous workshop at BVMW in July 2012. Best, Ludwig

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  33. Reposting, since I'm not sure whether my initial comment got lost or not:

    The Target 2 balances seems to add a new risk factor to the equation that can't be solved with IOUs, and really put the EMU in jeopardy. Thoughts?
    More: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/11421500/ECB-risks-crippling-political-damage-if-Greece-forced-to-default.html

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