Monday, June 29, 2015

Kashyap on Greece

Anil Kashyap has an excellent summary of the Greek debt crisis.

He sees government printed IOUs as a much better solution to the banking and payments crisis than for Greece to exit the euro and try to reestablish the Drachma. I agree entirely.

His summary goes back to the beginning, and reminds us that Greece did not get bailed out; Greece's creditors (mainly european banks) got bailed out.


  1. The IOUs sound like "bills of credit" like the American colonies issued. And they had value because you could use them to pay your taxes. Oh wait . . .

    1. The only problem is that Anil believes that the Greek government should use the "bills of credit" as a form of public employee compensation.

      Yes that will stop the bleeding in terms of new debt issuance, but does nothing to reverse the trend.

      To reduce debt (payback the Troika), the Greek government needs to sell those "bills of credit" for Euros. Proceeds from the sale can then be used to retire existing debt.

    2. I really don't see much difference in outcomes between IOUs/bills of credit and drachmas, which are also IOUs in a fiat system.

      The most likely scenario for the IOUs is that Greeks will arbitrage them for what few taxes they pay. Get paid in the private sector with a mix of euros and IOUs, keep the euros for private transactions, and use the IOUs to pay taxes at a discount.

      You can count on Greece to issue far more IOUs than it gets back in tax revenues, so the IOUs will inflate away just like the resurrected drachma would. Ironically, this would functionally cut government wages and pensions - something the Greek government has fought tooth and nail during negotiations with the troika. It should come as no surprise that a government would resort to that tactic.

      Nobody in their right mind would accept those IOUs in exchange for euros except at a steep discount which means Draghi will figure out a way to pay full price for them if it preserves the power structure of the EU/ECB. Everyone is starting to walk back the tough talk already: Schauble says Greece can stay in the euro if it defaults, Juncker wants to keep the deal in play, Greece is courting the ESM.

      They WILL find a way to compromise because none of the people in power want to lose power. Josh brown said this in August 2012:

      "But here’s the part where I help you. Because while I have no special expertise or experience in forecasting the vicissitudes of core European diplomacy and socioeconomic policy, I do know white people. And I know wealthy white people, in particular. And wealthy white people, American or otherwise, can always be counted on to compromise at the last moment so as to preserve the status quo. And that compromise will typically involve whichever option is the least painful, even if it means that more work must be done in the future (the proverbial can-kick). And we know that euro printing, even if it means a bit of inflation for the German middle class to wrassle with, is probably worth it if the task is preserving the hegemony of the creditors, rentiers, landed gentry and aristocracy.

      And so eventually, no matter how scary the headlines become or how volatile markets become in the short-term, you can expect a compromise that the wealthy and powerful elites (read: the markets) can live with."

    3. JB,

      "I really don't see much difference in outcomes between IOUs/bills of credit and drachmas, which are also IOUs in a fiat system."

      The difference is that drachmas would be used as a medium of exchange to purchase goods / services. That need not be the case with "bills of credit".

      "Nobody in their right mind would accept those IOUs in exchange for euros except at a steep discount which means Draghi will figure out a way to pay full price for them if it preserves the power structure of the EU/ECB."

      The Greek government would only need it's own citizenry to purchase them.

    4. A government bill of credit is intended to function in similar fashion to a banknote and circulate as money (see, e.g., discussion by the SCOTUS in Briscoe v Bank of Kentucky).

      Why else would Greece issue bills of credit if not for exchange? Why would the citizens accept them if they were useless for the conduct of business?

      Furthermore, the citizens wouldn't "purchase" them. They'd be given bills of credit in lieu of true currency as wages and pension payouts or as payment to vendors. Sure has a fiat-like ring to it.

      Early American history shows that this doesn't work and tends to lead to massive inflation, which is why the Constitution prohibits states from "emitting bills of credit".

      Whether it's a bill of credit or a fiat currency, it's still a claim on the creditworthiness of the issuer. Issuing too much of either paper currency or bills of credit leads to inflation.

    5. JB,

      "Why would the citizens accept them if they were useless for the conduct of business?"

      As a savings vehicle. Buyer gives up media of exchange now for a positive return on investment later. That return on investment can be guaranteed (bonds / debt) or not-guaranteed (equity).

      "Issuing too much of either paper currency or bills of credit leads to inflation."

      Issuing too much of any type of media of exchange can lead to inflation. Selling too many savings vehicles for a media of exchange - unlikely.

    6. You keep thinking of these IOUs as bonds, which they are not. They are like any fiat - an IOU that pays no interest, like the dollars in your pocket.

      They are NOT selling the IOUs. They would issue them in lieu of euros. Maybe you could buy them at a discount on a secondary market and hope for appreciation but they are by no means an investment per se.

    7. JB,

      Please read the article by Anil Kashyap - page #6, item #12:

      "Issuing IOUs which are not officially touted as a currency is a better option for Greece for now."

      Since they are not currency and they are labeled as I. O. U. (I Owe yoU), how can they be anything other than a savings vehicle?

  2. Printing IOUs may be a much better solution for Greece but what about for the other europeans?

  3. The greek debt to private creditors was restructured in 2012. Euro100 billions were wiped out from the debt mountain

  4. Isn't "printing IOU's" the same thing as a zero (or at least low) interest bond issue? Even if the Greek government forced public employees to take these bonds, what private business would accept them, given that their bond market is already essentially dried up? Even if there was some chartalist domestic value, it'd be heavily discounted in comparison to the cash Euros that Greeks currently hold, and of almost zero value to foreign parties. Maybe the Greek government could force this as some sort of short term expedient bridge currency with a crazy high seigniorage , but it's hard to see how it solves any actual problems.

    1. That is why the Greek government should not force people to take them, It should sell them (for Euros) instead. A private business (or individual) might purchase them if they have a positive rate of return and could be used to extinguish a future tax liability.

      It solves an actual problem (too much external debt) when it uses the proceeds of that sale to retire the external debt.

  5. I think Kashyap misses the bigger point - that is Greece's problems emerge from structural trade and balance of payment's deficits - not government deficits. The problem lies with the country's industrial structure. Countries like the US or UK can get away with running government deficits, even with external payments deficits; small open agrarian economies whose export receipts are substantially less than imports cannot sustained continually large government deficits and are at the mercy of foreign creditors. These are the sort of things economic theory cannot explain well and you need to know some history and basic political science about why this is true for some countries and not others.

    Allowing a default and a return to the Drachma will give a temporary solution. But it is only a return to the pre-Euro situation in Greece. It is not a recipe for lasting prosperity.

    1. Good point. The United States in it's infancy (1776 to early 1900's) was like this as well. Prior to 1913, the U. S. government relied primarily on customs duties and excise taxes to fund itself.

      But since you will be hard pressed to find any economist recommending that Greece impose large import duties to correct it's balance of trade, you need another solution.

    2. The only solution is political and fiscal union in Europe. This was derailed in the early 2000s by the expansion eastwards (ex-communist bloc) which added over 100 million much poorer countries to the union. The rushed entry was a British led effort concerned about French domination of the EU. However Britain now has political problems related to the huge Polish influx of cheap workers which is behind the rise of far right parties and anti-immigration and anti-EU sentiment in the UK and elsewhere. This has forced the UK into referendum on EU membership in 2017.

      What could happen is a two-speed Europe, where the Eurozone goes into fiscal/closer political union and the non-Euro periphery which includes the UK stays in a less integrated periphery.

    3. Paul Krugman is at it again. He just thinks that a devaluation will solve Greece's problems.

      Pre-Euro, devaluation and default never solved Greece's problems. It simply cannot afford the imports it needs to produce the exports it needs to get the foreign exchange to buy those imports. It is not a long term solution. It actually worsens your trade deficit and is highly inflationary, devaluing the purchasing power of your currency further. This was the catch -22 of pre-Euro Drachma Greece. A story of endless defaults, inflation, and little industrial development.

      The bigger point here though is the problem of people who take gadgets off the shelf to look at real world problems without country specific or historical knowledge. It is a big problem with the education of many economists and policy makers.

    4. Paul Krugman seems to want to prove the virtues of Open Economy ISLM and Optimal Currency Area Theory with a vengeance. His latest now is to connect the problems of Finland to the Euro and economic policy "straightjacketing". The problems of Nokia and Finland is basically one where a small economy let a company get too large and it became dependent on it. This has very little to do with the Euro, and nor would a devaluation be likely to fix this problem.

      Austerity for sure is a tragedy for the Greek people of which they should not be expected to further submit to, and I hope the US intervenes to put an end to it. However, a return to the Drachma is not the long term answer. Hopefully the present Eurozone (not the whole of the EU) will now push towards fiscal and political union.

  6. Kashyap's Primer is generally good, but omits to mention the previous haircut imposed on private sector holders of Greek bonds (but not on public sector holders).


    Didn't Greece get a big writedown on their outstanding debt in 2012 or am I missing something?

  8. For Greece to stay in they'd have to have a debt moratorium, be allowed back in the ELA and get fresh money. That solution would last as long as the moratorium given current economic policy. If they reformed, they'd have a chance to grow again. If they stay with Syriza, things may come unstuck again.

    Fundamentally, unless Greece stops being Greece, economically speaking, they'll eventually have to Grexit.

  9. See this about the primary surplus:

  10. Great summary! Thanks for posting!

  11. If there's one thing I feel confident about as we ride the manic-depressive on-again-off-again roller coaster it's that the EZ and Greece have one thing in common: both sets of leaders want to preserve their power, and that means Greece stays in the EZ.

    Juncker wants to protect his EC power. Merkel is afraid Greece will fall into the arms of Vladimir Putin. The Greeks want to stay in the euro because they don't realize that the agony of inflation under the drachma and the agony of austerity under the euro leave them with pretty much the same level of economic desolation and daily misery. Their brief flirtation with nirvana in the early days of the euro is gone forever.

    Greece and its adversaries are coming at it from different directions but keeping Greece in the euro is the one thing they can agree on at the leadership level. What their respective citizens think is secondary to the retention of power at the top.

  12. In simply monetary terms, a Greek default or way out from the Eurozone would be very nearly a nonevent for whatever is left of Europe or the world: With an expected total national output of about $250 billion, the nation's economy speaks the truth the measure of Connecticut or Louisiana. The default by Greece on its universal obligation, which formally happened Tuesday at midnight Central European Time, 3 p.m. Pacific, won't make any difference much to all that really matters of such real lenders as the European Central Bank.

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