If the EU Doesn’t Loosen Its Deficit Limits, Greece Should Leave the Euro
If the EU Doesn’t Loosen Its Deficit Limits, Greece Should Leave the Euro
Michael Nevradakis interviews Warren Mosler
Published by https://truthout.org/ on Dec 25, 2015
Six years into Greece’s economic crisis and following successive “bailouts,” there still seems to be no light at the end of the tunnel. Greece’s economy continues to shrink and unemployment remains at record high levels while the Syriza-led government coalition has reneged on its promises of radical change and ending austerity. The troika, in turn, continues to insist that strict austerity measures, including budget cuts and mass privatizations, be enforced in Greece.
In this interview with Michael Nevradakis, economist Warren Mosler, a leading figure in the field of modern monetary theory and the cofounder of the Center for Full Employment and Price Stability at the University of Missouri-Kansas City, discusses money, debt and the role of the European Union’s deficit limits in perpetuating the crisis, and shares the proposals he believes could help lead Greece out of its crisis.
Let’s begin with a question that might seem obvious, and yet is something that few people understand. What is money and how is it actually created?
Different economists will give you different definitions. I actually don’t even use the word, but our currencies – those are just the things that are needed to pay taxes. They’re no different than a tax credit you might get for solar energy, where the US government might give you a million-dollar tax credit. The currencies we generally talk about are basically just tax credits.
Another topic that is often misunderstood is the role of the central banks. What are they, who operates them, how do they operate and do they actually create money, or tax credits?
They are the scorekeeper for the currency and the government’s fiscal agent. They have a spreadsheet, and they put in debits and they open accounts for the member banks and for foreign governments. When the government spends, they put credit into the appropriate account. When it taxes, they debit the appropriate account. They also regulate and supervise the banking system to some degree.
They’ve also been given the job of determining the appropriate interest rate. There’s no such thing as the market determining rates. In a floating exchange rate, the natural rate of interest is zero, and it’s up to the government, if it wants to support a higher rate, to take action to do that. That comes in the form of either paying interest on balances at the central bank, interest on reserves or selling treasury securities, which are just interest-bearing accounts at the central bank.
What, then, is public debt?
What we call the public debt are the dollars spent by the government that haven’t yet been used to pay taxes. When the government spends, they credit bank accounts, and when they sell treasury securities, which is called borrowing, dollars shift from one type of bank account to another type of bank account called a government bond. A government bond is just a bank account at the central bank; they call them securities accounts; it’s just like a savings account at a normal bank. That’s true in any country that has its own currency and issues bonds.
Is the crisis in Greece a debt crisis, as it’s often described?
It is, under the current rules and regulations. It’s a political choice to have a debt crisis. If the ECB [European Central Bank] guarantees the debt, then there’s no debt crisis. If they don’t guarantee the debt, there is a debt crisis. In saying there’s no default, they’re saying the debt is guaranteed. Before 2012, when [president of the ECB] Mario Draghi said, “We will do what it takes to prevent default,” all the countries were about to come apart because of a “debt crisis,” but once the central bank guaranteed the debt, the idea of the debt crisis really goes away, interest rates come down, so there’s no debt crisis.
There’s a conditionality here; you have to obey the fiscal rules of the EU, and if you violate the fiscal rules, then you’re no longer under the umbrella of the ECB guarantee. When there was some risk that Greece would step out of fiscal compliance, then there was risk that the debt would not be guaranteed, suddenly interest rates shot up and you had a debt crisis. So yes, there is a potential debt crisis, but it’s a political decision.
You have argued that the EU’s deficit limits are the cause of the continentwide crisis. What is the solution that you have proposed?
There’s a theory of macroeconomics that says that governments should balance their budgets and then the central bank can use interest rates to control the economy. If the economy is bad, you lower interest rates and that causes the economy to do better.
The reality is that using interest rates to control the economy doesn’t work. Japan tried that for 20 years and it hasn’t worked; the Federal Reserve has been doing it for seven years and is still fighting deflation, and the EU, for six years. Governments are net payers of interest to the economy, and that’s income for the economy. The economy is just spending. GDP is total spending in the economy. Cutting interest income reduces income to the economy.
When the central bank buys bonds and holds them, that’s called quantitative easing. The central bank holds those bonds and is earning the interest instead of the economy. What does the central bank do with the money? They turn it back to the government, but the government doesn’t spend it. They use it to reduce the debt. It’s a drain on income.
What if everybody decided not to spend any of their income? What would happen to the economy? The answer is it goes to zero. There’d be nothing sold; there would be no jobs, no income, no economy. The economy is dependent on people spending their income, and what follows from that is, for anyone who spends less than their income, somebody has to spend more than their income to make up for it, or sales don’t hold up, output doesn’t get sold, and you have unemployment and serious economic problems.
Governments could easily adjust to spend more than their income. Depending on your politics, you could either reduce taxes or you can increase public spending. But governments can’t do that in the EU because they’re limited by 3 percent deficits, and that’s not enough given the lack of private sector credit and the natural desire to save. Europeans are very good savers, so this income goes unspent and the economy suffers.
You have proposed the loosening of the EU’s deficit limits, to allow countries to run larger deficits …
They don’t want to do that because they think we just need to wait longer for interest rates to work. What I’m saying is: use the deficit limit as the thermostat to control the economy. The interest rate is going to stay at the ECB policy rate, so the markets have nothing to say about this. You change the deficit limit from, say, 3 to 8 [percent], and that will add approximately 3 to 5 percent to GDP. Then, each member could decide to reduce taxes or increase public spending. Unemployment will immediately drop from 11 percent to 9 or less, and GDP growth will increase from near zero to 3, 4, 5 percent.
The policy makers don’t think it’s necessary. They believe we just have to wait more time for these interest rates to kick in. What I’m saying is, make the fiscal adjustment; if the interest rates do kick in, just reverse the adjustments. If the economy starts getting too hot and unemployment drops too far and everybody is worried about inflation, then go back to 3 percent.
What is the real debt solution for Greece, as you have proposed it?
In the last PSI [2011-12 debt haircut] the debt was reduced by 100 billion euros. What happened to the economy? It got worse. Why? Because what was the debt? The debt is Greek bonds. What are Greek bonds? Greek bonds are savings accounts in the ECB system, at the Bank of Greece. When you reduce the debt by 100 billion euros, you’ve reduced an important part of the money supply – what I call base money – by 100 billion euros. The answer is not, right now, to remove the money supply to tax the economy. Debt reduction is a tax; it makes it worse.
What Greece needs is to reduce taxes to increase private sector spending, or increase public spending, or some combination. But the problem in Greece is the Greeks are very good savers. They save a higher portion of their income than other Europeans. There has to be some entity that’s allowed to spend more than its income to make up for the people spending less than their income, otherwise the output doesn’t get sold. Because they’re good savers, they should be entitled to a larger budget deficit, lower taxes and higher public spending, because the private sector is not doing the spending.
The irony is that the deficit limits in the EU reward the bad savers and punish the good savers. Any country that requires larger savings than 3 percent because of its institutional structure suffers the consequences of high unemployment, and the countries that have high private sector debt and therefore don’t have high net savings desires, benefit. What sense does that make?
When the public sector spends a euro, it means there’s private sector income of one euro. When they say there’s public sector debt of 100 billion euros, that means there’s private sector savings of 100 billion euros. The public sector debt is the accounting record, the number of euros in bank accounts at the ECB system, of the private sector. That’s how accounting works; there’s a debit on one side and a credit on the other side of the ledger. The public sector is one side; the private sector is the other side; it’s a mirror image.
If you look at the countries that have the highest private sector savings, it’s always the countries that have the highest public sector debt. That’s how they accounted for the high private savings. Loans create deposits, debt funds savings, not the other way around.
You have described modern economics as “banana republic economics.” What do you make of the economic policies that are currently being implemented across the EU?
The EU has decided that export-led growth is the way to go, and they looked to Germany as the example. These “bailouts” are designed to reduce costs in Greece, to make them more competitive so they can export. [There are] a couple of issues with that. One of them is a macro issue: The whole world can’t be exporters, because somebody’s got to import. Where is it going to go, to the moon? All the trade in the world adds up to zero. For every export, there’s an import.
Apart from that, the real wealth of any region is everything produced domestically plus everything the rest of the world sends to you, minus what you send to them. Imports are real benefits, exports are real costs, and you use the monetary system to optimize that. That used to be called real terms of trade. If you’re going to export, you try to get as many imports as possible for your exports. The idea that export-led growth makes sense is out of context with today’s realities. That did make some sense under mercantilism, where the game was to get as much gold as possible.
All that aside, if you’re going to do it, the way it’s done is … you can look at the old German export-led growth model. You use tight fiscal policy to suppress domestic demand and you have structural reforms and deals with unions and labor to keep wages down to keep competitiveness, and that helps your exports. What that does is it makes your currency go up, so what Germany used to do is, they would buy dollars to keep the deutsche mark down. They even bought lire, to keep the mark down versus the lira. Part of the export-led growth strategy is, you have to buy the other guy’s currency whether you like it or not to keep your competitiveness, otherwise your currency appreciates and your policy is self-defeating.
The problem in the EU with this strategy is that buying dollars, for example, ideologically they can’t do it because then it would look like the ECB is building dollar reserves and in fact they would be. It would give the appearance that the dollar is backing the euro, when they want the euro to be the reserve currency, so they just don’t do it. Instead, they generally let the euro go up.
More recently, the ECB has been tricking the world’s portfolio managers into selling euros by doing things that they think are inflationary and expansionary, and those are negative interest rates and quantitative easing. All the world’s Western-educated now, and they all know that pumping up the money supply through quantitative easing and negative rates makes the currency to go down and it causes inflation. They’re wrong though. Those policies remove interest income; they’re taxes on the economy; they cause the currency to get stronger; you get deflationary pressures instead of inflationary pressures. We’ve seen the deflationary pressures on the euro right now. Quantitative easing and negative rates have not eased that.
Now, why has the euro gone down? It’s because they’ve frightened portfolio managers worldwide into selling their euro because of the quantitative easing and negative rates. That’s temporarily kept the euro from appreciating, which it would have otherwise done because the lower euro has driven trade into massive surplus. What happens when you are running a trade surplus is the world is selling dollars to buy euros in order to buy products. This puts continuous upward pressure on the euro, which in this case has been offset by massive portfolio selling. You can look at the drops in central bank holdings from near 30 percent to under 20 percent reserves in euro right now. At some point that dries up.
You have presented a solution regarding how Greece could exit the eurozone without an explosive devaluation of its new currency. How could this occur?
I wouldn’t call it necessarily a solution, but it’s an option. The solution is larger deficits. If the EU won’t allow larger deficits and force spending cuts and taxes, then the option’s to sit there and suffer and watch your civilization be destroyed, or to go back to your own currency.
If you’re going to do it with your own currency, I have proposals on how to do that in a way that I think actually works. First, you start taxing and spending in the new currency. When you do that, you’re just changing your tax liability from euro to drachma. And you leave the number the same: If it was 100 euros, it’s now 100 drachma. Then, you start paying public employees in drachma, and if it was 100 euros, it’s now 100 drachma. You haven’t broken any treaties or defaulted on any debt or converted any bank deposits, and specifically, I say don’t convert bank deposits. If the banks have euro deposits, leave them alone. If the debt is in euros, leave it alone.
The easiest way to explain that is to assume that, say half the people want to hold the euro but half the people want to hold the drachma. If you convert everything to drachma, now you’ve got half the depositors that are unhappy. They wanted the euro, they don’t want the drachma, so they will sell the drachma to buy euro. That will drive the new currency down 30, 40, 50 percent; then you start getting inflation; then the central bank doesn’t know how to deal with this so they raise rates, and unemployment rises and you’re right back in this disaster that the Greeks have known so well. That’s what happens when you convert deposits; you get back into that mess that politicians and technocrats can’t deal with.
If, however, you don’t convert the deposits, you leave them in euro, the people who wanted euro, they’re okay, but the other half need drachma to run their businesses, run their lives, pay their taxes. They need to sell euro to buy drachma, because there aren’t any drachma out there. So they’re selling euro to buy drachma, and now the drachma is a strong currency. You’ve created probably the biggest short squeeze in history, because everybody needs this stuff and there isn’t any. That allows the government to sell drachma at a slight premium to the euro. That keeps the currency stable and gives the government a source of euro income to service their debt for some period of time. It gives them breathing space to deal with the new economy without having to deal with a currency that’s collapsing.