Wednesday, April 15, 2015

Gdefault needs not Grexit

The little grumpy cartoon usually represents me pounding my coffee down in agreement as the WSJ exposes some idiocy. Last week, alas, I spilled my grumpy coffee in disagreement with a little part of its otherwise excellent  "The case for letting Greece go."
Thursday marks another deadline in Greece’s struggle to avoid default, as a €450 million payment to the International Monetary Fund comes due. Athens says it will meet this obligation, but sooner or later Prime Minister Alexis Tsipras and his government will miss a payment to someone if it doesn’t agree with creditors on a new bailout. An exit from the euro would then be a real possibility.
Please can we stop passing along this canard -- that Greece defaulting on some of its bonds means that Greece must must change currencies. Greece no more needs to leave the euro zone than it needs to leave the meter zone and recalibrate all its rulers, or than it needs to leave the UTC+2 zone and reset all its clocks to Athens time. When large companies default, they do not need to leave the dollar zone. When cities and even US states default they do not need to leave the dollar zone. A common currency means that sovereigns default just like large financial companies. (Yes, a bit of humor in the last one.)

Sure we can have an argument about whether it would be a good idea. The first 147 devaluations and currency confiscations didn't produce Singapore on the Mediterranean, but maybe the 148th will do the trick. The canard is the logical necessity of Grexit.

This is a particularly dangerous canard too. Greece is undergoing a slow motion bank run. Greeks are wisely taking their euros out of Greek banks and either holding cash or taking it abroad. So, how to Greek banks give them euros without selling all their assets -- loans and Greek government bonds? Answer, they get the money from the Greek central bank, which gets the euros from the ECB. The ECB is getting antsy about funding not just Greek government debt, but the whole Greek banking system.

Sooner or later Greeks will translate all this central banker speak about "capital controls" "liquidity management" and so forth to "there is a good chance that tomorrow morning your bank account will be frozen or converted to Drachmas." Then the run of all time starts and the whole thing unravels.

How do you stop that from happening? By shouting from the rooftops that the currency remains the euro, no matter if the government defaults on its loans to the IMF. At least we can shout from the rooftops that changing currencies is a separate decision, and that stiffing the IMF does not imply the logical necessity of grabbing Greek bank accounts.

To be sure the article gets much right. It's main thesis: Letting Greece default might be the right thing to do
But if Athens won’t implement reforms that would return Greece to growth and sustainable finances, allowing the country to leave would be the least bad outcome.
And if the WSJ understood that "allowing the country to default" is not the same thing as "allowing the country to leave" the case is even stronger. (Though who does this "allowing" is a bit muddy. One more subject-less sentence infects the forlorn English language of policy-speak)
No one should cheer a Greek exit, which would be a disaster for the Greeks.
Yes. Yet another reason to separate sovereign default from a change of monetary units.
Greece’s main contagion threat now would be if it is bailed out again without reform. 
This is the article's central point, and a good one. In financial as in foreign policy, people take important lessons from discovering that threats are empty.
The strongest argument against allowing Greece to leave the euro is that it would dent the bloc’s appearance of permanence, making the euro more like a currency peg that members could leave at will.
Exactly. And if we would all go back to the original Instruction Manual For the Euro, that says sovereign default can happen, just like corporate default, and does not require a change of currency, that permanence would be all the more assured.


  1. For rooftop shouting purposes, allow me to recommend Ed Van Halen's "Panama" -- an attention-grabbing sound that reminds us of a nation which defaulted in the 1980s and still uses the U.S. dollar.

  2. Of course GDefault doesn't imply Grexit, but GSwap (assets for debts) is a better option. From a previous post: >>>> John H. CochraneApril 11, 2015 at 1:32 PM

    you can add real assets as either the flow of surpluses they generate, or add their value. B/P - b (real assets) = E sum ... <<<<<

    That "b" may be the fiscal theory's equivalent to Einstein's cosmological constant. Brilliant.

  3. John,

    "When large companies default, they do not need to leave the dollar zone. When cities and even US states default they do not need to leave the dollar zone. A common currency means that sovereigns default just like large financial companies. (Yes, a bit of humor in the last one.)"

    Despite the humor, there is a significant difference between a state and a sovereign defaulting on it's loans. When a state defaults, creditors can appeal to a higher level court (federal court). When a sovereign defaults, there is no higher court in the land to resolve the interests of both borrower and creditor.

    This is why the 14th Amendment was written and upheld by the Perry Court.

    I am not sure what the legal aspects are regarding Greece, but I would imagine that if Greece defaulted on it's loans it wouldn't voluntarily leave the Eurozone, but they would likely be thrown out. In Greece's case, the higher court is likely the other members of the Eurozone (particularly Germany and France).

  4. Greece is currently in UTC+03 (due to daylight saving) or EEST timezone.

  5. There's actually a far better reason not to leave the euro. There is no guarantee that Greek armed forces or law enforcement agencies will accept payment in drachmae. Wholesale mutiny is a very real possibility.

    The real fear from Athens to Brussels is that any Greek government that attempts to leave the euro will be quickly and violently removed, and replaced by something with no interest in democracy or liberty, and possibly with far more interest in membership of the Eurasian Economic Union than remaining in the EU.

    The euro is as much a political as an economic institution. It always has been.

  6. When Greece defaults, all of the Greek banks will default as well, since they are already under capitalized, and they will loose a big chunk of their asset capital. Only if the European taxpayers pay for their losses due to their Greek bonds, they will survive. Why should they do that?

  7. Yes, but the (ex) Troika will NOT let Greece default on something 200 billion plus of debt owed mostly to her and will not make much of a difference if they do not relax the deficit rule and let the Greeks ave some 2 or 3% deficit instead of 3% surplus.
    The rational solution is the prof JC hinted a month ago in "Beware Greeks.." printing some parallel local currency with zero coupon "fiscal" bonds.
    This is more or less tha same solution that in Germany in 2012 suggested a bunch of economists from the German industry association, Deutsche Bank (Thomas Mayer), AfD leader prof. Bernd Lucke a the “Konferenz zur Parallelw√§hrung”, dec 2012 which was set up by the Bundesverbands mittelst√§ndische Wirtschaft (BVMW) (all the discussions in German though....)
    At the time there was feat in the air in the erurozone and all those German economists came to this conference and came up with 3 or 4 schemes for a parallel currency for Greece, Spain, Portugal, Italy... similar in concept to the idea outlined by JC: "stay in the Euro, but prints some local money to breath..."
    (and I migh add they we are pushing something similar for Italy....where it could work without any default if you use only to cut taxes and not increase spending)

  8. Cyprus banks with their bail-in provide a euro precedent. Greek bank net "assets" are mostly "deferred tax assets", loans in arrears for over 90 days, and Greek government paper, but the existing bailout terms provide for EU 10.2 billion to recapitalize the banks, money that was prudently removed from joint control with the Greeks to where they can't get to it after Syriza got elected.

    Back to the "b" in the fiscal equation, (aka the implicit Ricardian tax), showing it separately also illustrates the price level situation in Europe - properties at the Place Vendome or Potsdamer Platz going through the roof even though CPI goes down.

  9. After defaulting, Greece is free to do what it wants: now they have a primary surplus and defaulting they don't have to pay interests anymore.
    What would be the "lesson", the "punishment" Germany and the WSJ want in order to avoid "political contagion"?

  10. a disaster for Greece? Now is a disaster for Greece. We are talking about a country with 25 percent unemployment and a GDP down 25 percent.
    Yes Greece should exit the euro and have its own central bank. It should renege on its debts. It should balance its budget.

    It should probably print drachmas to the moon for a few years.

    1. I presume you don't have money in a Greek bank, or a business in Greece that wants to buy or sell anything internationally.

    2. You have no idea what happens in greece don't you?
      a)Most greeks don't have money in greek banks because either have zero savings
      or they have moved them elsewhere(under the bed,foreign banks etc.)
      b)Drachma was always accepted internationally for buying and selling things.Always.This is the pure fear mongering.

    3. Most Greeks don't have money in Greek banks? I've never heard this one before- do you have a source for this?

  11. There's a misconception that leaving the euro would allow Greece to devalue. That's wrong, because changing the medium of exchange from euros to drachmas doesn't retroactively change the unit of account from euros to drachmas.

    1. Jose Romeu RobazziApril 16, 2015 at 9:20 AM

      Good point, the drachma probably would have zero credibility, therefore probably people would be doing a "euro accounting" and settling in drachmas.

    2. I think it depends on whether creditors of Greek's Euro denominated debts would accept Drachmas.

  12. How could Greece credibly shout from the rooftops that the currency remains the euro?
    Surely the only person who could say that would be Draghi, and in event of a Greek sovereign default isn't it likely he will be further tightening collateral requirements on Greek banks' access to high powered money?


  13. I don't see what the difference is from your distinction.
    Debt is a contract, and Eurozone membership is a charter. Both are arbitrary and can be designed, enforced and changed in any manner that is mutually agreed upon by the respective parties or in any manner that can be enforced by one or some subset of the respective parties.
    That's the a feature of contracts and charters.

    The WSJ may have used sloppy or imprecise language, but their point holds which is that a unilateral response by Greece to default on obligations to, among others the ECB, will be met by a unilateral response to exclude Greece from access to membership rights at the ECB.

    1. Dan,

      I agree that if Greece decides to default on it's Euro denominated debts, it will likely be removed from the ECB by the other members.

      I think John's point is that Greece could conceivably remove itself from the ECB and yet still stay current on it's previously incurred debts. If Greece reintroduced the Drachma or some other form of local currency, it could operate under a two currency system until those debts are repaid.

      It is also possible (though not likely) that holders of Greece's debts would accept Drachmas in payment.

  14. How often to currency unions last without political union? Are there any historical precedents?

    1. If you count metallic monetary standards as a "currency union", then various countries over the last couple of centuries has left and then rejoined and then left again a metallic monetary standard.

      What makes the Euro different is that even under a gold standard, countries were free to establish their own central bank. If Greek left, they would be leaving both the Euro currency and the European central bank.

  15. Ha!

    WSJ reports today (2-months after this post by Prof. Cochrane - "Europe Asks if Greece Could Default Without Exiting Euro".


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