Default ≠ Drachma

I’ve been saying for a while that people should stop assuming that a Greek default implies leaving the euro for a new currency. Much of the media coverage of the negotiations continues to assume that the two are inseparable — that, in effect, the negotiations are over Greece remaining in the euro system. But there is no logical necessity for a default to be followed by the creation of a new currency; indeed it’s hard to see any reason why the former should lead to the latter.

Finally the consensus that default must mean exit seems to be breaking down. Here’s John Cochrane:

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.

Cochrane’s political views are one thing, but he is a very smart guy. And in this case, I think the Walrasian view of money as numéraire is helpful. It’s important to remember that euros are not physical things, they are simply units in which contractual commitments are denominated.

And now in today’s FT, Wolfgang Munchau writes:

The big question — whether Greece will leave the eurozone or not — remains unanswerable. But I am now fairly certain it will default. My understanding is that some eurozone officials are at least contemplating the possibility of a Greek default but without Grexit. … 

On whom could, or should, Greece default? It could default on its citizens by not paying public-sector wages or pensions. That would be morally repugnant and politically suicidal… it could default on the two loans it received from its EU partners, though it is not due to start repaying those until 2020… Defaulting on the IMF and ECB is the only option that would bring genuine financial relief in the short term. … 

Default is not synonymous with exit. There is no EU ruling that says you have to leave the eurozone when you default on your debt. The link between default and exit is indirect; if a country defaults, its defaulting securities are no longer eligible as IOUs for the country’s banks to tender at ECB money auctions.… 

So to default “inside the eurozone” one only needs to devise another way to keep the banking system afloat. If someone could concoct a brilliant answer, there would be no need for Grexit. 

… The economic case for a debt default is overwhelming. … Full servicing would require huge primary surpluses — that is, surpluses before payment of interest on debt. It would leave Greece trapped in a debt depression for a long time. The scheduled primary surplus for 2016 is 4.5 per cent, which is bordering on the insane. Athens absolutely needs to default. At the same time, there is a strong case for remaining in the eurozone.

This hits all the key points. First, there is no logical connection between defaulting and creating a new currency. (Probably better to use that wording, rather than “exit.”) Second, default would open up significant space in Greece’s fiscal position, and would not hurt the its external position. This follows from the fact that Greece currently has a substantial primary surplus and a slight positive trade balance. [1] Third, the only reason there is any link is that default might cause the ECB to cease accepting new liabilities from Greek banks, and it might be hard for the Bank of Greece and/or Greek government to take the ECB’s place under the existing rules of the eurosystem. So, fourth, the real problem with default is the need to ensure that the Greek payments system continues to operate even if the ECB tries to sabotage it. 
The phrasing of that last point might seem hyperbolic. But imagine if, during the Detroit bankruptcy negotiations, the Fed had announced that if the city did not pay off its creditors in full, the Fed would use all its regulatory tools to shut down any banks operating in the city. That’s a close analogy to the situation in Europe.
Maintaining interbank payments within Greece does not necessarily require the Greek government to issue any new liabilities. And it certainly doesn’t require that Greek bank accounts be redenominated. All that is necessary is that if someone with a deposit in Greek bank A wants to make a payment to someone with an account at Greek bank B, there is some system by which bank A can transfer a settlement asset to bank B, acquiring the asset if necessary by issuing a new liability. The technical aspect of this is not challenging, and even the practical aspect, since the Bank of Greece already performs exactly this function. As far as I can tell, the only problem is a political one — given that the Bank of Greece is run by holdovers from the former Greek government, it’s possible that if the ECB told them to stop facilitating payments between Greek banks they would listen, even if the Greek government said to carry on. 
Now some people will say, “oh but the Treaties! oh but the Bank of Greece isn’t allowed to accept the liabilities of Greek banks if Brussels says no! oh but the ELA rules!” [2] Obviously I think this is silly. In the first place, the “rules” are hopelessly vague, so if the ECB’s does shut off liquidity to Greek banks in the event of a default, that will be a political choice. And on the other side, Greece is a sovereign nation. It may have delegated decisionmaking at the Bank of Greece to the ECB, but that also was a political choice, which can be reversed. More to the point, the rules definitely don’t allow for exit. Nor for that matter do they allow for default — and as Munchau correctly points out, cuts to the salaries and pensions of public employees are also a form of default. Rules are going to be broken, whether Greece creates a new currency or not. And it is not at all clear to me that the demands on the Greek state from recreating the drachma, are any less than the demands from maintaining payments between Greek banks in the absence of ECB support — which is all it takes to default and continue using the euro. If anything, the former seems strictly more demanding than the latter, since Greece will need its own central bank either way.
This all may seem pedantic, but it is important: The threat of ejection from the euro is one of the most powerful weapons the creditors have. And let’s remember, the only direct consequence of a breakdown in negotiations, is a default on Greek government debt.
Now there is another argument, which is that exit is positively desirable since a flexible currency would allow Greece to reliably achieve current account balance even once income growth resumes. I think that is wrong — but that’s a topic for another post. (I discussed the issue a couple years ago here.) But even if, unlike me, you think that a flexible exchange rate would be helpful for Greece, it  doesn’t follow that that decision is bound up with the debt negotiations.
[1] It is possible that the apparent primary surplus is due to manipulation of the budget numbers by the previous government. I think that the arguments here would still apply if there were really a primary deficit, but it would complicate things.
[2] Or, “oh but that would be ungrateful.” In one of its more disingenuous editorials I can recall, the FT last month wept crocodile tears over the fact that “default on Greek debts would deter wealthier voters from ever again helping their neighbours in financial distress.” Apparently German banks didn’t care about the interest on all the Greek government bonds they bought; they only lent so long out of kindness, I suppose. Also, it doesn’t seem to have occurred to the editorialists that deterring the financing of large current account deficits might be a good thing.

UPDATE: This seems important:

A country that defaults would not have to leave the euro, the European Central Bank’s vice president said on Monday…  

Vitor Constancio discussed the possibility of a debt default and controls on the movement of money, saying neither necessarily meant a departure from the currency bloc. “If a default will happen … the legislation does not allow that a country that has a default … can be expelled from the euro,” he told the European Parliament… 

Constancio also touched on the possibility of capital controls. “Capital controls can only be introduced if the Greek government requests,” he said, adding that they should be temporary and exceptional. “As you saw in the case of Cyprus, capital controls did not imply getting out of the euro.” … 

“We are convinced at the ECB that there will be no Greek exit,” he said. “The (European Union) treaty does not foresee that a country can be formally, legally expelled from the euro. We think it should not happen.” … 

“If the state defaults, that has no automatic implications regarding the banks, if the banks have not defaulted, if the banks are solvent and if the banks have collateral that is accepted,” Constancio said.

Maybe they were worried that Greece would call their bluff. Or who knows, maybe the culture of the place has changed under Draghi and they are no longer ready to serve as austerity’s battering ram. In any case, it’s hard to see this as anything but a big step back by the ECB.

UPDATE 2: Martin Wolf is on board as well. (Though he doesn’t like my Detroit analogy.)

The Greek Crisis and Monetary Sovereignty

Note: This post only really makes sense as a continuation of the argument in this one.

It’s a general rule that the internal logic of a system only becomes visible when it breaks down. A system that is smoothly reproducing itself provides no variation to show what forces it responds to. Constraints are invisible if they don’t bind. You don’t know where power lies until a decision is actively contested.

In that sense, the crises of the past seven years — and the responses to them — should have been very illuminating, at least if we can figure out what to learn from them. The current crisis in Greece is an ideal opportunity to learn where power is exercised in the union, and how tightly the single currency really binds national governments. Of course, we will learn more about the contours of the constraints if the Syriza government is more willing to push against them.

The particular case I’m thinking of right now is our conventional language about central banks “printing money,” and the related concept of monetary sovereignty. In periods of smooth reproduction we can think of this as a convenient metaphor without worrying too much about what exactly it is a metaphor for. But if Greece refuses to accept the ECB’s conditions for continued support for its banks, the question will become unavoidable.

We talk about governments “printing money” as if “money” always meant physical currency and banks were just safe-deposit boxes. Even Post Keynesian and MMT people use this language, even as they insist in the next breath that money is endogenously created by the banking system. But to understand concretely what power the ECB does or does not have over Greece, we need to take the idea of credit money seriously.

Money in modern economies means bank liabilities. [1] Bank liabilities constitute money insofar as a claim against one bank can be freely transferred to other units, and freely converted to a claim against another bank; and insofar as final settlement of claims between nonfinancial units normally takes the form of a transfer of bank liabilities.

Money is created by loan transactions, which create two pairs of balance-sheet entries — an asset for the borrowing unit and a liability for the bank (the deposit) and a liability for the borrowing unit and an asset for the bank (the loan). Money is destroyed by loan repayment, and also when the liabilities of a bank cease to be usable to settle claims between third parties. In familiar modern settings this lack of acceptability will be simultaneous with the bank being closed down by a regulatory authority, but historically things are not always so black and white. In the 19th century, it was common for a bank that ran out of reserves to suspend convertibility but continue operating. Deposits in such banks could not be withdrawn in the form of gold or equivalent, but could still be used to make payments, albeit not to all counterparties, and usually at a discount to other means of payment. [2]

To say, therefore, that a government controls the money supply or “prints money” is simply to say that it can control the pace of credit creation by banks, and that it can can maintain the acceptability of bank liabilities by third parties — which in practice means, by other banks. It follows that our conventional division of central bank functions between monetary policy proper (or setting the money supply), on the one hand, and bank regulation, operation of the interbank payments system, and lender of last resort operations, on the other, is meaningless. There is no distinct function of monetary policy, of setting the interest rate, or the money supply. “Monetary policy” simply describes one of the objectives toward which the central bank’s supervisory and lender-of-last-resort functions can be exercised. It appears as a distinct function only when, over an extended period, the central bank is able to achieve its goals for macroeconomic aggregates using only a narrow subset of the regulatory tools available to it.

In short: The ability to conduct monetary policy means the ability to set the pace of new bank lending, ex ante, and to guarantee the transferability of the balances thus created, ex post.

It follows that no country with a private banking system has full monetary sovereignty. The central bank will never be able to exactly control the pace of private credit creation, and to do so even approximately except by committing regulatory tools which then are unavailable to meet other objectives. In particular, it is impossible to shift the overall yield structure without affecting yield spreads between different assets, and it is impossible to change the overall pace of credit creation without also influencing the disposition of credit between different borrowers. In a system of credit money, full monetary sovereignty requires the monetary authority to act as the monopoly lender, with banks in effect serving as just its retail outlets. [3]

Now, some capitalist economies actually approximate to this pretty closely. For example the postwar Japanese system of “window guidance” or similar systems in other Asian developmental states. [4] Something along the same lines is possible with binding reserve requirements, where the central bank has tight operational control over lending volumes. (But this requires strict limits on all kinds of credit transactions, or else financial innovation will soon bypass the requirements.) Short of this, central banks have only indirect, limited influence over the pace of money and credit creation. Such control as they do have is necessarily exercised through specific regulatory authority, and involves choices about the direction as well as the volume of lending.  And it is further limited by the existence of quasi-bank substitutes that allow payments to be made outside of the formal banking system, and by capital mobility, which allows loans to be incurred, and payments made, from foreign banks.

On the other hand, a country that does not have its “own” currency still will have some tools to influence the pace of credit creation and to guarantee interbank payments, as long as there is some set of banks over which it has regulatory authority.

My conclusion is that the question of whether a country does or does not have its own currency is not a binary one, as it’s almost always imagined to be. Wealth takes to form of a variety of assets, whose prospective exchange value can be more or less reliably stated in terms of some standard unit; transactions can be settled with a variety of balance-sheet changes, which interchange more or closely to par, and which are more or less responsive to the decisions of various authorities.  We all know that there are some payments you can make using physical currency but not a credit or debit card, and other payments you can make with the card but not with currency. And we all know that you cannot always convert $1,000 in a bank account to exactly $1,000 in cash, or to a payment of exactly $1,000 – the various fees within the payment system means that one unit of “money” is not actually always worth one unit. [5]

In normal times, the various forms of payment used within one country are sufficiently close substitutes with each other, exchange sufficiently close to par, and are sufficiently responsive to the national monetary authority, relative to forms of payment used elsewhere, that, for most purposes, we can safely speak of a single imaginary asset “money.” But in the  Greek case, it seems to me, this fiction obscures essential features of the situation. In particular, it makes the question of being “in” or “out of” the euro look like a hard binary, when, in my opinion, there are many intermediate cases and no need for a sharp transiton between them.

[1] Lance Taylor, for instance, flatly defines money as bank liabilities in his superb discussion of the history of monetary thought in Reconstructing Macroeconomics.

[2] Friedman and Schwartz discuss this in their Monetary History of the United States, and suggest that if banks had been able to suspend withdrawals when their reserves ran out, rather than closed down by the authorities, that would have been an effective buffer against against the deflationary forces of the Depression.

[3] Woodford’s Interest and Prices explicitly assumes this.

[4] Window guidance is described by Richard Werner in Masters of the Yen. The importance of centralized credit allocation in Korea is discussed by the late Alice Amsden in Asia’s Next Giant. 

[5] Goodhart’s fascinating but idiosyncratic History of Central Banking ends with a proposal for money that does not seek to maintain a constant unit value – in effect, using something like mutual fund shares for payment.

What Has Happened to Trade Balances in Europe?

It has gradually entered our awareness that the Greek trade account is now balanced. Greece no longer depends on financial markets (or official transfers, or remittances from workers abroad) to finance its imports. This is obviously important for negotiations with the “institutions,” or at least it ought to be.

I was wondering, how general is this shift toward a positive trade balance. In the FT last week, Martin Wolf pointed out that over the past five years, the Euro area as a whole has shifted from modest trade deficits to substantial trade surpluses, equal to 3 percent of euro-area GDP in 2013. He does not break it down by country, though. I decided to do that.

Euro area trade ratios, 2008 and 2013. The size of the dots is proportional to total 2008 trade.

Here, from Eurostat, are the export-import ratios for the euro countries in 2008 and 2013. Values greater than one on the horizontal axis represent a trade surplus in 2008; only a few northern European countries fall in that group. Meanwhile, in seven countries imports exceeded exports by 10 percent or more. By 2013, the large majority of the euro area is in surplus, while not a single country has an excess of imports over exports of more than 5 percent. The distance above the diagonal line indicates the improvement from 2008 to 2013; this is positive for every euro-area country except Austria, Finland and Luxembourg, and the biggest improvements are in the countries with the worst ratios in 2008. The surplus countries, apart from Finland, more or less maintained their surpluses; but the deficit countries all more or less eliminated their deficits.

So does this mean that austerity works? Yes and no. It is certainly true that Europe’s deficit countries have all achieved positive trade balances in the past few years, even including countries like Greece whose trade deficits long predated the euro. On the other hand, it’s also almost certainly true that this has more to do with the falls in domestic demand rather than any increase in competitiveness.

This is shown in the second figure, which gives the ratio of 2013 imports to 2008 exports on the vertical axis, and 2013 exports to 2008 imports on the horizontal axis. (This is in nominal euros.) Here a point on the diagonal line equals and equal growth rate of imports and exports. Most countries are clustered around 15% growth in imports and exports; these are the countries that had balanced trade or surpluses in 2008, and whose trade ratios have not changed much in the past five years. Only one country, Estonia, has export growth substantially above the European average. But all the former deficit countries have import growth much lower than average. (As indicated by their position to the left of the main cluster.) It’s evident from this diagram that the move toward balanced trade in the deficit countries is about throttling back imports, not boosting exports. This suggests that it has more to do with slow income growth than with lower costs.

Again, the sizes of the dots are proportional to 2008 trade volumes.

Still, the fact remains, trade deficits have almost been eliminated in the euro area. Liberal critics of the European establishment often say “not every country in Europe can be a net exporter” as if that were a truism. But it’s not even true, not in principle and evidently not in practice. It turns out it is quite possible for every country in the euro to run a trade surplus.

The next question is, with whom has the euro area’s trade balanced improved? Europe outside the euro, to begin with. The country with the biggest single increase in net imports from the euro zone is, surprisingly, Switzerland, whose deficit with the euro area has increased by close to 60 billion. Switzerland’s annual trade deficit with the euro area is now 75 billion, about a quarter of the area’s overall trade surplus. Norway and Turkey have increased their deficits by about 15 billion each. The rest of the increase in net exports are accounted for by increased surpluses with Africa (26 billion), the US (27 billion), and Latin America (35 billion, about half to Brazil), and a decreased deficit with Asia (135 billion, including a 55 billion smaller deficit with China, 30 billion smaller with Japan and 20 billion with Korea). Net exports to Australia have also increased by 10 billion.

Why do I bring this up? One, I haven’t seen it discussed much and it is interesting.

But more importantly, the lesson of the Europe-wide shift toward trade surpluses is that austerity can succeed on its own terms. I think there’s a tendency for liberal critics of austerity to assume that the people on the other side are just confused, or blinkered by ideology, and that there’s something incoherent or self-contradictory about competitiveness as a Europe-wide organizing principle. There’s a hope, I think, that economic logic will eventually compel policymakers to do what’s right for everyone. Personally, I don’t think that the masters of the euro care too much about the outcome of the struggle for competitiveness; it’s the struggle itself — and the constraints it imposes on public and private choices — that matters. But insofar as the test of the success of austerity is the trade balance, I suspect austerity can succeed indefinitely.

UPDATE: In comments Kostas Kalaveras points to a report from the European Commission that includes a similar breakdown of changes in trade balances across the euro area. There’s some useful data in there but the interpretation is that almost all the adjustment has been structural rather than cyclical. This is based on estimates of declining potential output in the periphery that I think are insane. But it’s interesting to see how official Europe thinks about this stuff.

“The Idea Was to Create a Modern Gold Standard”

My view on the euro is that it has become a project to restore the rule of money over humanity. To move us back toward a world where in every sphere of life, and especially in collective choices made through government, the overriding question is, “what is most consistent with the accumulation of money claims?” or, “what will the markets think?” The euro is a project to roll back social democracy and to reimpose the “discipline of the market” on the state — or in other words to restore the logic of the gold standard, whose essential condition was that preservation of money-claims had priority over democratic government. From this point of view, crises are not a failure of the system but an essential part of its functioning, since discipline requires that punishment be sometimes visibly meted out.

This kind of Polanyian perspective is typically found on the left. But it’s increasingly clear that many of those on the other side think this way too. Here is a striking recent op-ed from the FT, by one Thomas Mayer:

Germany relied on the Maastricht treaty to make it possible to share a currency without sacrificing political accountability. The idea was to create an economic framework that was in some ways the modern equivalent of a gold standard. Monetary decisions would be made by the European Central Bank, whose only goal would be price stability. The lack of shared political institutions did not matter, because the ECB was to operate in total independence from all political influence. It would never lend to member states, even ones that were at risk of going bankrupt. 

Despite these provisions, the Germans did not entirely trust their partners’ fiscal discipline, so they imposed strict limits to government budget deficits and debt…. With the benefit of hindsight, it was all rather naive. Germany should have insisted on a procedure for government insolvency, and a way of showing the door to states that were unable or unwilling to respect the rules. 

Mayer, the head of a German think tank, does not mention that in the first decade of the euro Germany was one of the most frequent violators of the “strict limits” on fiscal deficits. But it’s helpful to see the idea of the euro as a new gold standard stated so plainly by a supporter. And he makes another important point, which is that even under a new gold standard, the discipline of the markets is unreliable, and needs to be supplemented with (or simulated by) overt political authority.

From early 2010, when a Greek default was narrowly avoided, until early 2012, Angela Merkel, the German chancellor, attempted to re-establish the Maastricht model … and contemplated the possibility that Greece might leave the euro. But she is risk-averse by nature and, confronted with the incalculable risks, she changed course in the spring of 2012. The Greek debt restructuring, she now said, was “exceptional and unique”. Leaving the euro was out of question for any member country. Since this decision meant markets would no longer pressurise governments into sound economic policies, she built a pan-European “shadow state” — a web of pacts to ensure that countries followed policies consistent with sound money. 

It has not worked. From Greece to France, countries resist any infringement on their sovereignty and refuse to act in a way that is consistent with a hard currency policy. The ECB is forced to loosen its stance. Worse, it has allowed monetary policy to become a back channel for transfering economic resources between eurozone members. This is Germany’s worst nightmare… 

A century ago, Eugen Böhm-Bawerk, the Austrian economist and finance minister, proclaimed laws of economics to be a higher authority than political power. Some Germans say that a hard currency is an essential part of their economic value system. If both are right, politicians will be powerless to prevent Germany’s departure from a monetary union that is at odds with the country’s economic convictions.

The essential points here are, first, that the goal of the euro system to create a situation where markets can “pressurise governments into sound economic policies,” meaning first and foremost, policies that preserve the value of money; second, that this requires limits on national sovereignty, which will be resisted by democratic governments; and third, that this resistance can only be overcome through the threat of a crisis. In this sense, from Mayer’s perspective, the steps that were taken to resolve the crisis were a terrible mistake, and required the use of direct political control by a “shadow state” to substitute for the blunted threat of financial catastrophe. This is all very clarifying; the one piece of mystification still intact is the substitution of “Germany” as the social actor, rather than European wealth owners as a class. 
Mayer is just one guy, of course, but presumably he speaks to some extent for his old colleagues at Deutsche Bank, Goldman Sachs and the IMF. [1] And anyway this kind of language is everywhere these days.

The FT’s review of “Lords of Secrecy,” for instance, acknowledges that we increasingly seem to be subjects of “a vast secret state beyond control.” That sounds bad! But the reviewer concludes on a cheerful note:

The “lords of secrecy” do need to be kept in check, of course. But that may soon happen anyway. After all, principles go only so far in holding the clandestine arms of the state to account; money goes a lot further. But money is one thing that is not quite so freely available in Washington, or many other capitals in the west, no matter how many secrets they have.

Here, subservience to the bond markets doesn’t just require limits on democracy or the rule of law, it makes them superfluous.

Returning to the euro, here, via Bill Mitchell, is Graham Bishop on the “revolutionary political implications” of unified interbank payments in the euro area:

While payments are an intensely technical area, the political implications are immense… SEPA establishes an effective ‘referendum veto’ to be exercised by citizens whose national governments might contemplate leaving the euro. In SEPA, citizens are empowered to embed the freedom and the choices associated with the single market so deeply in the economy to make it impossible for any EU government which adopted the euro to abandon the common currency. It is hard to imagine that citizens and enterprises accustomed to these choices would want to leave the euro once they considered what they individually would give up by way of returning to narrow, national offerings for trade in goods and services. 

With SEPA, any citizen who fears that his home state is about to leave the euro to implement a major devaluation can protect themselves by transferring their liquid funds into a bank in another euro country – in an instant and at negligible cost. In effect, this is a free option for all citizens and amounts to an instantaneous referendum on government policy. Such an outflow of retail liquidity from a banking system would cause its rapid collapse. The quiet run out of deposits in the Irish banks last year demonstrated the power of depositors to force radical political change.

There’s not much to say about that unctuous, preening first paragraph, with its cant about freedom and choices, except to hope that some future novelist (or screenwriter, I guess) can do justice to the horrible people who rule us. (Also, notice the classic bait-and-switch in which the only alternative to complete liberalization of capital flows is autarchy.) But what’s interesting for the argument I’m making here is the claim that the great political innovation of the euro is that it gives money-owners the right to a veto or referendum over government policy — up to the point of forcing through “radical change,” on pain of a bank crisis. And to be clear: This is being presented as one of the great benefits of the system, and an argument for the UK to join the single currency.

(Also, if I’m correct that the effect of a withdrawal of ECB liquidity support for Greek banks would just prevent transfers to banks elsewhere, this suggests the threat is self-negating.)

The masters of the euro themselves talk the same way. The “analytic note” just released by European Commission President Jean-Claude Juncker, “in close cooperation with Donald Tusk, Jeroen Dijsselbloem and Mario Draghi,” begins with the usual claims about the crisis as due ultimately to lack of competitiveness in the southern countries, thanks to their “labor market rigidities.” (They don’t say what specific rigidities they have in mind, but they do nod to a World Bank report that identifies such distortions as minimum wages, limitations on working hours, and requirements for severance pay.) “While the Maastricht Treaty was based on the assumption that market discipline would be a key element in preventing a divergent development of the euro area economies and their fiscal positions, with increasing government bond interest rates having a signalling effect.” But in practice divergent policies were not prevented, as bond markets were happy to lend regardless. Then, “when the crisis hit… and markets reappraised the risk and growth potential of individual countries, the loss of competitiveness became visible and led to outflows.” [2] What’s most interesting is their analysis of the political economy of removing these “rigidities” and restoring “competitiveness”:

The policy commitments of euro area countries, made individually or collectively, to growth-enhancing structural reforms have not been implemented satisfactorily. Often, commitments are strong in crisis times and then weakened again when the overall economic climate has improved. In this sense, the stabilising effect of the single currency has certain counterproductive effects with regard to the willingness of national governments to start and implement the necessary structural reforms…

Naomi Klein couldn’t have said it better. Crises are a great time to roll back “employment protection legislation” and force down labor costs — the unambiguous content of “structural reforms” in this context. If your goal is to to roll back protective legislation and re-commodify labor, then resolving economic crises too quickly is, well, counterproductive.

A couple years ago, Paul Krugman was expressing incredulity at the idea that prolonging the European crisis could be a rational act in the service of any political agenda. Last week, he was still hoping that Draghi would emerge as the defender of European democracy. No disrespect to my CUNY colleague, who understands most of this stuff much better than I ever will. But in this case, it seems simpler to take Draghi at his word. Restricting the scope of democratic government was the entire point of the euro system. And since the automatic operation of bond markets failed to do the job, a crisis is required.

UPDATE: Schauble today: “If we go deeper into the [debt] discount debate, there will be no more reforms in Europe. There will be joyful celebrations in the Elysée and probably in Rome, too, if we go down this path.” Thee is not even a pretense now that this is about resolving the crisis, as opposed to using the crisis as leverage to promote a particular policy agenda. It’s surprising, though, that he would suggest that the Euro zone’s second and third largest economies are on the side of the debtors. Would that it were so.

[1] It’s almost too good that he hosts a lecture series on “The Order of Money.”

[2] The funny thing is that, after talking about the “misallocation of financing” by markets, and describing the crisis as “a crisis of markets in terms of their capacity to price risk correctly,” they go on to recommend the removal of all remaining restrictions on capital flows: “we need to address remaining barriers to investment and the free movement of capital and make capital market integration a political priority.” Reminds me of the opening paragraphs of this Rodrik essay.

What If the ECB Pulls the Trigger?

Over the past week, it’s become clear that the real leverage the European authorities have over Greece is via the banking system. What does Greek need continued loans for? Not to pay for public expenditures, thanks to the primary surplus. Not to pay for imports — Greece has a (small) trade surplus. Not to service current debt, if it defaults. What does need to be financed, is the flow of deposits out of Greek banks to the rest of Europe.

So what happens if that financing is cut off, as the ECB is threatening? The usual answer is collapse of the Greek banking system, followed immediately by a forced exit of Greece.  But the other night I was talking to some friends about the situation, and we found ourselves wondering: What concretely are the mechanics of this? What is the exact chain of events from an end to ECB financing to Greek exit from the euro? I don’t know the answer to this, but the more I think about it, the less confident I am in the conventional wisdom.

What concretely does it mean that the ECB is providing liquidity support to Greek banks? As far as I can tell, it is this. When a holder of a deposit in a Greek bank wants to make a payment elsewhere, either to purchase a good or asset outside Greece or to move the deposit elsewhere, the Greek bank must transfer an equal quantity of settlement assets to the bank receiving the deposits. These settlement assets are normally acquired on the fly, by issuing a new liability in the interbank market, but if other banks are unwilling to accept the liabilities of Geek banks, they can be borrowed directly from the ECB, against suitable collateral. This is the lending that the ECB is threatening to cut off.

What if the Greek banks can’t acquire settlement assets? Then other banks will not accept the deposits, and it will be impossible to use deposits in Greek banks to make payments. Depositors will find their accounts frozen and, in the normal course of events, the banks would be shut down by regulators.

But Greece still does have a central bank. My understanding is that much of the day to day business of central banking in Europe is carried out by the national central banks. In principle, even if Greek banks can’t acquire settlement assets by borrowing from the ECB, they can still borrow from the Greek central bank. This doesn’t help with payments to the rest of Europe, since reserve balances at the Greek central bank won’t be accepted elsewhere. But I don’t see why the Greek central bank can’t keep the payments system working within Greece itself. If the Greek central bank is willing to provide liquidity on the same terms as the ECB, what’s going to force the Greek banks to shut down? It’s not as though there’s any Europe-wide bank regulator that can do it.

In a sense, this is a kind of soft exit, since there will now be a Greek euro that is not freely convertible into a non-Greek euro. But I don’t see why it has to be catastrophic or irreversible. Transactions within Greece can continue as before. And for routine trade it might not make much difference either, since the majority of Greek imports come from outside the EU. Where it would make a difference is precisely that it would prevent Greek depositors from moving their funds out of the country. [1] In effect, by cutting Greece off from the European interbank payment system, the ECB will be imposing capital controls on Greece’s behalf. You could even say that, if the threat of cutting off liquidity support can trigger a run on Greek banks, actually doing so will ensure that there isn’t one.

Now maybe I’m wrong about this. Maybe there is a good reason why the Greek central bank can’t maintain the payment system within Greece. But I also think there’s a larger point here. I’m thinking about the end of the gold standard in the 1930s, when breaking the link with gold was considered an unthinkable catastrophe. And yet the objective basis of the money system in gold turned out to be irrelevant. I think, in the same way, the current crisis may be revealing the reflexive, self-referential nature of money. On a certain level, the threat against Greece comes down to: “You must make your money payments, or we will deprive you of the means to make your money payments.”

The rule of the money system requires that real productive activity be organized around the need for money. This in turn requires that money not be too freely available, but also that it not be too scarce. Think of Aunt Agatha in Daniel Davies’ parable. Suppose her real goal is to run her nephew’s life — to boss him around, have him at her beck and call, to know that he won’t make any choices without asking if she approves. In that case she always has to be threatening to cut him off, but she can’t ever really do it. If he knows he’s getting money from her he won’t care what she thinks — but if he knows he isn’t, he won’t care either. He has to be perpetually unsure. And in keeping with Davies’ story, the only thing Jim actually needs the money for, is to continue servicing his debt to Aunt Agatha. The only real power she has is a superstitious horror at the idea of unpaid debts.

In this way I’ve tentatively convinced myself that all Syriza needs to do is hold firm. The only way they can lose is if they lose their nerve. Conversely, the worst outcome for the ECB and its allies would be if they force Greece into default — and everyone watches as the vengeful money-gods fail to appear.

UPDATE: It turns out that Daniel Davies is making a similar argument:

Capital controls are arguably what Greece needs right now – they have
balanced the primary budget, and they need to stop capital flight.
From the ECB’s point of view, I’d agree that the move is political, but
it also means that they are no longer financing capital flight.

There’s
a sensible negotiated solution here – with a lower primary surplus than
the program (in which context I think Varoufakis’ suggestion of 1.5% is
not nearly ambitious enough), a return to the structural programs (the
Port of Piraeus really does need to be taken out of the political
sphere), and an agreement to kick the headline debt amount into the far
future (in service of which aim I don’t think all the funny financial
engineering is helping).

The fall-back is a kind of soft exit,
with capital controls.
But the massive, massive advantage of capital
controls over drachmaisation is that they  preserve foreign exchange.
Greece imports fuel and food. With capital controls, it can be sure of
financing vital imports.

The fact that Davies is thinking the same way makes me a lot more confident about the argument in this post.

[1] Greek banks would also presumably be limited in their ability provide physical cash to depositors, but I don’t think this is important.

What It’s About

I’m as thrilled as anyone by Syriza’s first week in government. The European bourgeoisie has declared war on social democracy, with the euro as its weapon to re-subordinate society to the logic of the market. And now — shades of Polanyi’s double movement — society is pushing back. It’s amazing to see Varoufakis declare that the “troika” has no legitimacy and that Greece is done negotiating. (As my friend Harry says, maybe what’s amazing that Dijsselbloem and the rest thought that Syriza would roll over. But I suppose that’s what’s happened before.)

Here’s what I think is the most important point in all this: The debate now is not about claims on real resources, but about power — who decides, and on what basis.

Daniel Davies:

Don’t think of the Greek debt burden, either in cash € terms or as a ratio to GDP, as an economic quantity. It basically isn’t an economically meaningful number any more. The purpose of its existence is as a political quantity; it’s part of the means by which control is exercised over the Greek budget by the Eurosystem. The regular rituals of renegotiation of the bailout package, financing of debt maturity peaks and so on, are the way in which the solvent Euroland nations exercise the kind of political control that they feel they need to have… 

It is, therefore, totally inimical to the Eurosystem to hold out any hope of the kind of debt writedown that Syriza wants, as opposed to some smaller, cosmetic face value reduction or maturity extension. The entire reason why Syriza wants to get a major up-front reduction in the debt number is to create political space to execute the rest of their program. The debt issue and the political issue are the same issue. Syriza understands this, and so does the Eurosystem. The people who don’t understand it are the ones writing editorials in the business press which support the debt reduction but don’t think that Syriza should be given carte blanche to do everything it wants.

One man’s “carte blanche to do everything it wants” is another man’s “freedom to make decisions as a sovereign, democratically elected government.” But this gets the stakes of the negotiations just right.

Krugman is also very good, especially here.

at this point Greek debt, measured as a stock, is not a very meaningful number. After all, the great bulk of the debt is now officially held, the interest rate bears little relationship to market prices, and the interest payments come in part out of funds lent by the creditors. In a sense the debt is an accounting fiction; it’s whatever the governments trying to dictate terms to Greece decide to say it is

… the aspect of the situation that isn’t a matter of definitions: Greece’s primary surplus, the difference between what it takes in via taxes and what it spends on things other than interest. This surplus … represents the amount Greece is actually paying, in the form of real resources, to its creditors… Greece has been running a primary surplus since 2013, and according to its agreements with the troika it’s supposed to run a surplus of 4.5 percent of GDP for many years to come. What would it mean to relax that target? 

… let’s think of a maximalist case, in which Greece stopped running a primary surplus at all (this is not a proposal). You might think that this would let the Greeks spend an additional 4.5 percent of GDP — but the benefits to Greece would actually be much bigger than that. Remember, the main reason austerity has been so harsh is that cutting spending leads to economic contraction, which leads to lower revenues, which forces further cuts to hit the budget target. A relaxation of austerity would run this process in reverse; the extra spending would mean a stronger economy

This makes three important points. First, Greece now has a primary surplus, meaning that the public budget is no longer dependent on foreign borrowing to maintain its current operations; default would allow for a higher level of public spending with no increase in taxes. [1] Second, the size of these transfers is a political decision, no less than the scale of the transfers under, say, the Common Agricultural Program. Third, while these flows are — unlike the notional stock of debt — objective economic facts, they are not the most important thing about the debt payments. The most important thing is the policies the Greek government has to adopt to keep generating those flows. It’s a problem that Greece is making payments to the richer parts of Europe, and will do so indefinitely if the troika gets its way. But the bigger problem is that the overriding need to generate those payments prevents the Greek state from taking any positive action either to end the current depression or to foster longer-term economic development.

One issue where Krugman and Davies disagree is if a default on the Greek debt would automatically lead to a collapse of the Greek banking system (in which case exit from the euro would uncontroversially follow) or if this would require a positive decision of the ECB to withdraw support from Greek banks. [2] I don’t claim any expertise here, but Krugman’s position seems more plausible. And in general, one of the welcome effects of the crisis is that supposedly natural economic constraints are forced to take form as explicit political choices.

Maybe the best short overview I’ve seen is this piece by Mark Weisbrot. The key point he makes is that the big fear of the current of Euroland’s rulers is not that economic catastrophe will follow Greek exit from the euro. It’s that it won’t.

And yes, it’s published in VICE. These are strange days.

[1] There’s a certain slippage in these conversations between “Greece” meaning the country as a whole and “Greece” meaning the government. It is true that the Greek government budget is in primary surplus (if the official numbers can be trusted, which probably shouldn’t be taken for granted — leaving aside questions of fraud, there are non-recurring revenues from privatization.) But if we are talking about Greece the country, the relevant number for real resource flows is the trade balance, which is close to zero. But it’s still true that there is no net flow of real resources into Greece to be financed, which is important in thinking about the consequences of default.

[2] As far as I can understand, the Greek banking system could collapse in two ways. First, if it loses access to the interbank payment system, and second, if it faces a run because it becomes clear that the ECB is no longer willing to offer Greek banks liquidity support. Both of these events can happen just as easily if Greece is current on its debt as if it defaults.

Priorities

The Syriza victory as a Rorschach test for U.S. politicians:

Mayor De Blasio and President Obama both called Tsipras this morning to congratulate him. According to the press release from the Mayor’s office,

Mayor Bill de Blasio called Greek Prime Minister Alexis Tsipras Thursday morning to congratulate him on his victory, and to commend him for forcefully raising the issue of inequality during his campaign. The Mayor expressed New York City’s solidarity with Greece in the joint struggle against inequality, and commented on how the Prime Minister’s victory sends a powerful message to progressives across the world. The Prime Minister expressed his admiration for New York City, and called it one of the most extraordinary cities in the world. The Prime Minister invited the Mayor to visit Greece, and the Mayor expressed interest in visiting in the future.

And here’s the one from the White House:

The President spoke with Prime Minister Tsipras today to congratulate him on his recent election victory. The President noted that the United States, as a longstanding friend and ally, looks forward to working closely with the new Greek government to help Greece return to a path of long-term prosperity.  The two leaders also reviewed close cooperation between Greece and the United States on issues of European security and counterterrorism

In this context, there’s something sinister about the words “long-term.”