Oh what a difference a President makes!

The world’s press is once again whipping up the “Greece to exit” frenzy and wheeling out all manner of mainstream economists who are issuing the most strident warnings that Greece needs the Euro and will walk the plank if it exits. Most of this is conservative hype. The reality is that while the exit would be immediately costly – the situation is currently so dire and the outlook so negative – that these “costs” have to be weighed against the almost immediate return to growth should the nation exit and default. Apparently, the Greek political elites (the President and the two main party leaders) are proposing that the recent election, which overwhelmingly rejected the Troika-led austerity, be ignored and, instead, a government of technocrats – all of whom will play ball with the Troika, be installed to rule the nation. The machinations of the neo-liberals never cease to amaze me. Greece should take a lesson out of the Iceland book. But then they had a President who seemingly cared about national interest.

Recently, Statistics Iceland provided this updated Spring 2012 Economic Forecast:

Economic growth reached 3.1% in 2011 and was due to increasing private consumption as well as investment. The forecast for 2012–2017 assumes that gradual economic recovery will continue with 2.6% growth in 2012. Positive growth is expected throughout the forecast period, though changes to the planned large scale industrial investments may affect the forecast. Economic growth will be driven by investment and consumption.

This could be Greece’s future. It is a graph taken from the Spring 2012 Economic Forecast.

Compare that to this characterisation of the Greek tragedy. I thought this was a pretty stark piece of work from Greek cartoonist Dimitris Hantzopoulos. The title of the graphic – ΤΗΣ ΗΜΕΡΑΣ means The Day.

If your geography is lagging, here is a hint:

The weekend before last, the Greeks voted to end austerity – a categorical call at the recent election. But there is confusion among the electorate because the majority also want to keep the Euro. This is an education gap – they cannot feasibly keep the Euro under current (or perceived future) conditions and avoid the painful austerity.

Further, even if they get beyond this crisis in some sort of battered shape – much poorer and with yawning social divisions – it is only a matter of time before the next business cycle swing hits them and the aftermath or vestiges of the current malaise will quickly multiply with the new strife as aggregate demand collapses again.

The EMU as it is current structured – without a credible supra-national fiscal authority with the clear mission to defend regions that are suffering from asymmetric demand shocks (positive or negative) – cannot handle a sizeable business cycle swing. A monetary system that is incapable of meeting the challenges of such swings in aggregate demand is not a reasonable basis for organising complex economies – if the prosperity of all citizens is the goal.

So if Greece wants to end austerity and use its productive base to restore growth then it has to abandon the Euro.

It seems that the political machinery of the elites in Greece (and outside) is however manoeuvring to spit in the face of the electorate and to impose some sort of technical panel to govern the country.

The recent election has ended in an impasse – such is the polarisation of the vote as the support for the main right and left middle-class parties collapsed. The Greek people might not understand the intricacies of the monetary system tyranny that is being imposed on them but they were clear on one thing – they wanted an end to the Troika-led austerity.

There can be no doubt about that. The guess is that a new election will consolidate that view even further and the two main parties will see further loss of support. There would be hope of some sort of coalition opposed to austerity which did not include Golden Dawn. But correct me if I am wrong – I am hardly an expert on Greek politics.

The Euro elites, of-course, are currently issuing all sorts of warnings and the Greek elites from President down to the leaders of the two main parties (so abysmally defeated at the recent election) are now conspiring to implant a government of technocrats and politicians. The Greek people clearly resented the installation of Lucas Papademos (under pressure from the Troika) when the elected Prime Minister indicated he would take the last bailout to a popular vote.

They should take a lesson out of the Iceland book.

Iceland soon learned that when your government is selling you out its only recourse is to get the titular head (president) to intervene. That is what happened in Iceland when the President intervened in 2010 – in line with the mood of the population – and refused to sign legislation passed by an out-of-touch government intent on big-noting itself on the world stage by pushing for EMU admission in spite of the obvious harm that would do to the nation.

The President of Iceland vetoed an act of parliament which would have seen the nation “repay” £3.4bn to Britain and the Netherlands. This repayment was in relation to the amount that the British and Dutch governments paid out in 2008 to their citizens who had deposits in a private Icelandic bank which collapsed during the height of the global financial crisis.

At present, the press hysteria is reaching new heights with all sorts of dire warnings for the Greek people if they dared leave the Eurozone and abandon Germany to Spain and Italy (and Ireland) and soon other nations.

At the time the Icelandic President intervened the press also rose to hysteric heights. The jingoistic British press made all sorts of threats against their tiny northern neighbour.

The Icelanders however were vehement and resentful that the British government had used the UK anti-terrorist act to freeze all Icelandic assets in the UK in late 2008. It was that move that was the final nail in the Icelandic banks’ solvency.

The Icelandic population considered the deal their parliament has agreed to was not in their interests and not their responsibility and they realised that the motivation of Iceland’s politicial leaders was, in fact, to walk the EMU stage, which the overwhelming proportion of the population remain opposed to.

The same could now be said about the Greek population. They have voted resoundingly to reject the imposition of austerity on them.

The Dutch and British governments bailed their own citizens out after they allowed Icesave to operate under the Passport system. They then tried to cadge the money back from the Icelandic government – there were claims that under European law there is a sovereign guarantee of deposits (that is unclear – there is no requirement of a state guarantee).

Further, they claim Iceland is being discriminatory (against European law) in that it bailed its own citizens out but refused to bail out the foreigners (also unclear). The Dutch and the Brits will not go to an independent court to let these matters be decided impartially. The reason – they would probably lose their bullying capacity to pressure Iceland to pay up.

All the same sorts of statements are being made about the Greeks – legal threats, economic threats – all vapid if the Greek government takes back control of its currency and lets it depreciate.

The problem the citizens of Iceland faced was that the Icelandic Parliament, seemingly wanting to appease those who would block its proposed entry into the EMU (Britain has been making threats), finally agreed to repay the loans. You can read more about what the people think via the In Defence home page.

It is clear that the citizens did not approve of this deal and the vast majority do not want to go over to the Euro (that is, enter the EMU). This people protest which has gathered strength in 2009 and provided the President’s with his motivation to protect the national interest. It was only the second time in the 66-year history of Iceland as a republic that the titular head has exercised this power.

Recall the national TV address the President’s made when he announced his decision to the nation. His official declaration said that after the parliament passed the law to repay the loan he:

… has received a petition, signed by about a quarter of the electorate, calling for the Act to be subjected to a referendum. This is a far larger proportion of the electorate than the criterion that has been referred to in declarations and proposals from the political parties.

Public opinion polls indicate that the overwhelming majority of the nation is of the same opinion. In addition, declarations made in the Althingi and appeals that the President has received from individual Members of Parliament indicate that the majority of the Members are in
favour of holding such a referendum …

It is the cornerstone of the constitutional structure of the Republic of Iceland that the people are the supreme judge of the validity of the law …

Now the people have the power and the responsibility in their hands.

Contrast that to what has been happening in Greece.

When the incumbent Prime Minister George Papandreou indicated he would put the earlier bailout plan to a referendum the Troika had him removed post haste. The Germans are even suggesting that Greece should retain its unelected Prime Minister indefinitely (that is, avoid the upcoming elections) in the same way that the Italians are suspending a democratic vote until 2013 at least.

It is true that Iceland had its own currency and Greece chose to use a foreign currency. The fact that Iceland has its own currency has given it tremendous leverage over the international financial markets. Greece has no such leverage. Iceland could default on foreign currency-denominated debts and let its currency depreciate.

The Greeks have to change their entire monetary system, which adds complexities – all of which are tractable.

For Iceland, the crisis imposed massive real costs on the nation but the benefits became obvious relative quickly. A more rapid return to growth was guaranteed. Greece is now in its fifth year of recession (Depression) with no end in sight.

On February 17, 2012 the rating agency Fitch upgraded Iceland’s rating and said:

The restoration of Iceland’s Long-term foreign currency rating to investment grade reflects the progress that has been made in restoring macroeconomic stability, pushing ahead with structural reform and rebuilding sovereign creditworthiness since the 2008 banking and currency crisis … Iceland has successfully exited its IMF programme and gained renewed access to international capital markets. A promising economic recovery is underway …

While I treat these ratings agency assessments with a grain of salt, they do reflect the way the bond markets think. The point is that Iceland has a place in the world that the EMU nations would envy right now.

While the Icelandic government certainly didn’t go on a fiscal spree and allowed net exports to reap the advantages of the massive depreciation, the government also didn’t scorch the economy with austerity. They have allowed growth to build its tax revenue rather than exacting harsh tolls on its citizens.

As the Spring 2012 forecast shows – private consumption and investment is now driving growth – as confidence returns – unemployment is falling, real wages are rising and aggregate demand is stable.

All of that was predictable. Modern Monetary Theory (MMT) shows that a sovereign government is never revenue constrained because it is the monopoly issuer of the currency. Which means it always has the capacity (given real resources) to improve domestic growth and employment irrespective of what is happening in the private economy and the external sector.

Moreover,a floating currency allows fiscal and monetary policy to concentrate on domestic policy without the need to engage in “official intervention” (central bank transactions in the foreign exchange market) to stabilise a given parity.

It means that external imbalances do not have to be resolved via dramatic domestic deflation (attacks on working conditions).

Here is some graphical evidence which helps support this narrative.

Real GDP growth comparison – Greece and Iceland

The following graph is constructed using the latest quarterly National Accounts data from Iceland and Greece (from their respective national statistical agencies). It compares real GDP growth (seasonally adjusted and in annual terms) from the March-quarter 2005 to the December-quarter 2011 in both nations.

There is only one conclusion – the nation that has so far resisted the European neo-liberal elites and demonstrated leadership from the top is on the way to recovery from a larger shock than Greece faced. That nation – which has increasingly bowed to the unreal demands of the same elites even to the point of installing an unelected technocrat-central-banker to the Presidency – is sinking.

I am not suggesting Iceland is all brights lights. Far from it. But it is in control of its currency and has allowed the flexibility inherent in that control to play out to its advantage (exchange rate movements, central bank interest rate setting capacity, and fiscal support).

Nominal and Real Exchange Rates

The following graph uses data available from the Central Bank of Iceland and show the USD, Euro and Broad Trade Index exchange rates against the Krona (monthly average, mid-rate) from January 2000 to May 2012.

You can read about the Broad Trade Index – HERE – but suffice to say it represents a weighted exchange parity based on the trading proportions of its partners. The Central Bank of Iceland regularly update the currencies in the “basket”, which is used to calculate the Index as trading patterns change.

In 2011, Iceland’s major trading partners were EU27 (66 per cent of total trade), Norway (6.5 per cent), United States (6.2 per cent), Brazil (4.1 per cent), and China (3.1 per cent) (Source).

The depreciation in the Icelandic currency against the major world currencies during the crisis has been dramatic. The same sort of adjustments would quickly happen in Greece should it exit the Eurozone and restore its own currency sovereignty.

But note that the depreciation is finite! Those who claim that nations which run counter to the sentiments of the financial markets will experience a currency collapse and never recover fail to understand the dynamics of an exchange rate crisis. Sure enough, major depreciations occur.

But historically, the parities stabilise and begin to improve once the structural adjustments that the depreciation brings (changing terms of trade, changing industry composition etc) start to occur.

Consider the following graph which shows the real exchange rate (that is, the nominal rate adjusted for relative price inflation). Movements in the nominal exchange rate and the relative price level (Pw/P) need to be combined to tell us about movements in relative competitiveness. The real exchange rate captures the overall impact of these variables and is used to measure our competitiveness in international trade.

The nominal parity can also be adjusted for unit labour costs. I show both in the following graph.

Please read my blog – Saturday quiz – January 28, 2012 – answers and discussion (Answer to Question 2) – for more discussion on the derivation of the real exchange rate.

The rapid drop in the real exchange rate gave Iceland a massive boost in international competitiveness. It is the same boost that Greece would get if it leaves the Eurozone. As long as it can isolate the real income effects of the exchange rate plunge – it will be finite and growth will return almost immediately.

Notice that the two ways of computing the real exchange rate – the CPI (broad inflation) and ULC (labour cost) measures – move together. This tells you that the labour costs were indeed contained as the price of imports rose in the face of the rapid nominal exchange rate depreciation. This allowed the increase in competitiveness to “stick” (using the jargon of my profession).

The EMU nations are trapped and cannot exploit the flexibility of a sovereign currency. The only adjustment to the external balances is then domestic deflation which imposes a recession bias. Adding fiscal austerity at the same time is the reason Greece’s National Accounts are in such an appalling shape.

For a government to pursue public purpose they have to have control of their own currency and that means it must float.


What about inflation? Many commentators claim that flexible exchange rates are dangerous because they will result in accelerating inflation. The claim is only partially true and forgets to take into account the internal (substitution away from imports) and external (improvement in export competitiveness) adjustments that occur when the terms of trade change – especially when they are as drastic as depicted in the graphs above.

The following graph is from the Central Bank of Iceland and shows you what happened to the annual inflation rate in Iceland between 2000 and 2012.

It is clear that there was a spike in inflation (the annual rate went from 3.4 per cent in August 2007 to the peak of 18.6 per cent in January 2009 as the Krona depreciated. Since the economy resumed growth, the inflation rate has averaged around 4 per cent per annum.

There is no evidence to support the view that the large depreciation has created an unstable high inflation environment. Most of the import cost impacts have been well-managed and are through the system now.

Depreciation is likely to have long-term implications for the price level if domestic (non-traded) wages and prices chase each other up in a profit-margin-real wage resistance spiral.

If the nation is prepared to take the real income loss that is involved in the depreciation – which is generally finite – then the parity adjustment works in its favour (increasing competitiveness).

Real Wages

Statistics Iceland also publish a Real Wage Index which is shown in the following graph (from January 2005 to March 2012). It peaked at 120.2 in January 2008 and then reached a trough in May 2010 at 103.9 (down 13.6 per cent on the peak). It has now recovered some of the loss and in March 2012 was standing at 112.1 (down 6.7 per cent on the peak).

This is a predictable pattern. The exchange rate depreciation erodes the real wage as import price rise.

The nominal wage index continued to grow in Iceland throughout the crisis although the rate of growth slowed appreciably in 2008 and 2009. This point goes to an important aspect of the dispute between Keynes and the Classical writers who urged wage cuts during the Great Depression. It also bears on what is happening in other economies as the austerity mavens push large nominal wage cuts onto workers as part of the so-called structural adjustment.

Keynes noted that workers would resist real wage cuts if they were delivered via cuts in money wages but would tolerate them if they were induced by general inflation. The rationale was that the former would disturb relativities while the latter impacted on the wage structure more or less uniformly.
But there is another reason why preserving nominal wages growth is important.

Most of our contractual commitments are denominated in nominal units ($ or whatever currency is applicable). So when real wages are being cut by rising inflation (in this case by a depreciating exchange rate) but nominal wages are preserved, workers can then make adjustments to the composition of their spending without, in the first instance, undermining their capacity to meet their weekly contractual liabilities (for example, their mortgage payments).

Attacking nominal wage levels, more readily undermines the capacity of workers to meet these nominal contractual obligations and opens the possibility for further instability (credit collapse etc).

Compare the real wages trajectory in Iceland with this story from Athens News (April 27, 2012)Real wages tumble by 25% as tax burden soars in 2011. We read that in Greece:

The Paris-based think tank said real wages before tax fell in 18 of its 34 members during 2011, with by far the sharpest annual cuts taking place in Greece, where gross salary earnings fell by 25.3 percent …

In absolute figures, the OECD annual Taxing Wages report said that average gross income declined from 20,457 euros in 2010 to 15,729 euros in 2011, which is equivalent to real reduction of 25.3 percent, taking into account a 3 percent rate of inflation.


The Greek President should show the same sort of leadership that Iceland’s titular head demonstrated when he blocked the machinations of the scheming politicians there who were intent on playing along with the European elite cabal.

The fact that Iceland also maintained their own currency allowed them to restore growth and confidence relatively quickly, notwithstanding the massive recession they encountered.

Greece is stuck in austerity with no way out. It can only grow in a robust manner and sustain that growth if it leaves the Eurozone. It should declare a bank holiday next Monday (making the declaration sometime over the weekend), default on all Euro-denominated debt, and renegotiate from the strength of its own currency.

It might also start printing tourist maps in German to cater for the swarm of northerners who would take advantage of the terms of trade shift.

Politics in the Pub

For those that live locally (I am in Newcastle at present), I am giving a talk at the Monthly Politics in the Pub gathering tonight on the Eurozone crisis.

The evening starts at 18:30 at the Station Hotel, Hamilton (just near the railway gates).

That is enough for today!

This Post Has 30 Comments

  1. Hi Bill,
    Another great blog. It’s pretty relentlessly depressing out there in economics land, and the real world, with iceland a small island of hope.

    Is there any nation (probably an island) out there that we could look to that is currently practicing MMT in an explicit or open way, I mean without pretending to be a household and dancing with the bond markets? What about Singapore, which seems to have very low taxes but spends up big on infrastructure and has low unemployment? Or perhaps some forgotten place that the elites can ignore, a pacific island, or Bhutan? Where comes closest to MMT in open practice rather than hiding behind deceptive and misleading talk?


  2. In 2010, Iceland’s major trading partners were United States (14.4 per cent of total trade), China (13.8 per cent), Russia (8.6 per cent), Switzerland (6.6 per cent), and Norway (4.2 per cent) (Source).

    You made this mistake in a previous post as well, and didn’t correct it, so I guess you copy and pasted it here. No, that’s not what your source says: those are the main EU trade partners. The main trade partner of Iceland (in 2011) was the EU with 66% of the total trade, followed at a long distance by Norway with 6.5% and the US with 6.2%.

    Also, just like the last time, your analysis of the Iceland situation is peculiarly loop-sided. Iceland received a huge loan from the IMF and the Nordic Countries right at the beginning of the crisis in 2008, which was, in per capita terms, more than comparable to the help Greece received along the way. This stand-by agreement was in fact coupled to medium-term austerity reforms that the icelanding government actually implemented, which is why the IMF has declared itself by and large satisifed by their progress.

    And while Iceland has managed to postpone settling the Icesave problem, the situation is IMO so crystal clear (contrary to what you claim) that I doubt they will win their trial before the EFTA court: basically every claim Iceland uses to weasel out is either in direct contradiction with the black-on-white text of the treaties or in direct contradiction with precedence cases already adjudecated before international courts. They will have to pay what they owe based on their international treaty agreed minimum guarantee for private deposits, and these delays only serve to postpone the inevitable – state-backed brigandism, no matter how many internal referendums support it, is not to be tolerated.

  3. As part of my education in MMT, I would be interested on how MMTers would score this strategy note from Tim Morgan at Tullet. I have been following his star for some time. I am assuming at this time that he would be described as “mainstream” in MMT terms. As he is saying that UK “austerity” is a “big lie”. Can I assume that the UK government is possibly following an MMT approach either accidentally or on purpose? http://www.tullettprebon.com/announcements/strategyinsights/notes/2010/SIN20120514.pdf .

  4. What’s most disturbing is the ability of mainstream economists and commentators to blatantly and repeatedly lie. On BBC Newsnight last night we again saw the latter claiming that a Greek exit and default meant that they would never have access to “the markets” again. Putting aside whether this is necessary or not, it’s also fundamentally untrue. The same was said of Argentina and Iceland. But after a couple of years, “the markets” are always happy to return once they see that there is money to be made.

  5. Acorn
    Your current reading list is starting to worry me a little.
    If you are determined to educate yourself you will have to ween yourself off Barrow and Tullet Neocon otherwise I fear your studies will progress very slowly.

  6. You’re ignoring some really rather important differences between Greece and Iceland.

    Iceland has a strong state apparatus, with Scandinavian levels of corruption, is ranked 9 on the World Bank’s ease of doing business index and the population explicitly agreed to the sacrifices that would have to be made.

    Greece is a weak clientilist state, with sub-Saharan levels of corruption, is ranked 100 in the ease of doing business index and in the last election support for “moderate” politicians all but disappeared.

    There are really two possible paths: either Greece will rebound relatively quickly like Iceland did or it will collapse completely, the government will lose control and end up deploying the army in an attempt to maintain order, at which point the country will effectively be in civil war.

    The situation is so volatile that it’s very hard to predict which path will be followed. However, the factors mentioned above counted very much in Iceland’s favour and count very much against Greece’s.

  7. What is Mr Morgan’s problem, that there isn’t enough austerity? That the conservative goernment is trying to pull a fast one on the poor bond holders?
    Maybe he hasn’t realised that this is an asset stripping/ social engineering project, not an effort “put our finances in order”.
    Reads like the kind of thing you see from the guardian’s inexhaustible supply of choleric trolls.

  8. Andy, I am trying to keep an open mind on these matters at this stage. Today, for instance, in conversation about the subject, I was advised “MMT, they’re all bloody Marxists”. Later it was added, I paraphrase. “MMTers all think employees have got the employers best interests at heart; we are all in this together type stuff; but, they are not, they are always out to screw you; backed by the prophets of greed and envy, the f*****g Marxist trade unions. They are only interested in bouncing you in and out of employment tribunals, to make a quick buck.”

    The lady did buy me a G&T. To be honest, I didn’t dare refuse her offer! I can understand why MMT has a marketing problem having met her and several like her.

  9. The cry of “there is no austerity” or “there are no cuts” because grossed-up government expenditure is rising or flat-lining is the last refuge of the economically insane.

  10. Acorn

    Methinks you are a bit of a fraud or a Walter Mitty.
    In any event all the information you need is on this site. All you have to is read it.

    Thanks for your heads-up about MMTs marketing problem.
    We’ll get our guys to run it up the flagpole and see who salutes.

  11. The current Greek political situation is a bit of an improvement but the Greeks still have this unrequited love affair with the Euro. When is the penny going to drop that the Euro is bad,bad medicine and that they need to grow a set in order to give the dysfunctional tenant the boot?

  12. Bill, I am always appreciative of your insightful perspective. At some point I’d be very interested to hear more detailed recommendations or predictions from you for exactly how the default in Greece should be done and what the aftermath in other EMU countries might be. What happens to the Euro-denominated debt of private Greek companies for example. If their post-default revenue is only Drachmas, do they all have to go out and renegotiate their debts or would there be some form of Greek government intervention/assistance to help them avoid their own defaults? What happens to Euro deposits in Greek banks? Are they all forcibly exchanged for Drachmas at some government-determined rate or left as they are?

    Whatever the details are, it seems possible they might set the expectation for how defaults could go in other EMU countries. Is there a consequent risk of setting off a massive flight to safety of capital from other EMU countries (maybe out of the Euro altogether)? Is there any chance of a resulting bank crisis resulting either from loss of capital or exposure via currency exchange derivatives or something like that? What would you expect to happen to the value of the Euro while all this was going on? Would you expect a rash of additional defaults/exits by other EMU countries after a Greek exit?

  13. Paul

    I think a rash of exits is what the Euro and German policitans fear. The Euro because their means of imposing their will on the member countries is effectively lost, and the Germans because a return to the Deutschmark will see their economy priced out of their European markets.

    In regards to flight to safety from other EMU countries, from what I have read this has already largely happened, and the reason why German government bonds have such a low yield.

    The Euro-denominated debts of private Greek debts will have to be renegotiated. Contracts get renegotiated all of the time. If the parties cannot come to agreement that is where the courts and bankruptacy proceedings come to play. Government involvement in the process should be limited to ensuring the infrastructure (including courts and a banking system) works so that the process can happen. The only other area of Government intervention should be providing income assistance to those individuals who may lose their jobs/income in the process – this is where a JG comes in.

    Given that most of the Greek private-sector debt is likely to be with Greek banks (or Greeks branches of international banks) then this is likely to be an easy process because the Greek bank/branches themselves have Euro-denominated liabilities namely deposits. So yes Greek bank deposits will be “forcibly” exchanged into Drachmas because it in most Greeks’ interest to do so.

    Some people may say a contract is a contract is a contract and that the liabiliities must be paid in Euros, and hence there should be no re-denominating of Greek Euro debts into Drachmas. In the case of non-bank private debt, the lender will take a haircut on the asset by amount the that drachma depreciation inhibits the borrower’s capacity to pay, plus more because the fire sale for the borrower’s assets will be at a discount plus the lawyers and accountants and other advisors will be taking their cut of the proceeds. Therefore, it is likely that the lender is better off just re-denominating the debt into drachmas because they have suffered the loss one way or the other, it is just that the quantum of the loss will differ under the different approaches.

    In regards to bank debt, i.e. deposits, if you insist that you get paid your deposit in Euro’s you will find that you accounts will be frozen with limits placed on when and how you can access the funds. This means that taking your balance now as drachmas will look enticing. Which is going to be better: guarenteed to receive 1,000 drachma now, or to receive 1,000 euros over a time period of the bank’s discretion as funds allow?

    Will there be a bank crisis? Yes, like after the Lehman Brothers crash. A freeze because of fear of the unknown. But if Governments through their Central Banks and Treasuries ensure that liquidity is maintained and therefore, the payments system keeps functioning, and bad banks nationalised and restructured (and liquidated in an orderly manner if required), then any fall out will be prevented from infecting too much of the real economy.

  14. Andy, bugga I have been rumbled again. Being serious, if MMT became “mainstream”, assuming you toned down Bills rhetoric and made him more market friendly; what would the end game look like? Would we still be paying taxes and buying “guilts” from the government for our pension funds, if they are just mechanisms for removing excess reserves from central bank accounts? If not, would the central bank be paying ever higher interest rates on those reserves and/or issuing ever more reverse repos each night to stop the commercial banks using that high powered money? Every night a little bit more free money being added to the reserves system.

    In theory, the central bank is supposed to extinguish the money it created as the stuff they financed pays off; shrink the balance sheet as they say. It appears that the US FED has decided it does not have to and has used the money to go into the sub sub prime mortgage business. Would MMT see that as a problem or not? All the best Acorn 😉 .

  15. Dear Stan (at 2012/05/16 at 23:28)

    Thanks for your comment.

    The analysis you present is fine. I think your summary – “it could have been much worse” rather than “things are beautiful” is apt. The reality of living in an import-dependent nation when the exchange rate dips significantly and mortgage debt is indexed and denominated in foreign currencies is harsh indeed. But at least the government now has the capacity to stimulate domestic demand somewhat. The Greek government does not have that capacity and the internal devaluation being imposed on the people is equivalent to the depreciation anyway.

    best wishes

  16. Could someone, preferably Bill Mitchell, address Andrei’s comment please? Suppose Iceland has to repay a guaranteed minimum on UK bank losses. It may not affect the substance of the issue: Argentina has repaid some of its default debt now without disaster (so far, and as far as I know). And what’s the significance of the IMF loan stuff?

  17. Bill,

    Yanis Varoufakis wrote a piece outlining why he thinks Greece is not comparable to Iceland or Argentina and that the shift to a drachma could result in hyperinflation.


    He notes the hoarding and smuggling out of Euro currency currently underway in Greece and thinks that a reintroduced drachma could become so devalued that those Greeks without adequate hard currency reserves would experience hyperinflation.

    What are your thoughts?

  18. “Suppose Iceland has to repay a guaranteed minimum on UK bank losses.”

    How does it ‘have to pay’?

    There is no law without enforcement. If the Icelandics refuse to pay, then what is the ‘wronged’ country going to do about it?

    International law is implemented by agreement. There may be outstanding resolutions that Israel has to leave the West Bank, but without military might to enforce that they can ignore it and carry on regardless.

    So the reasons for ‘paying back’ defaulted debt are entirely political – to get more favourable access to markets and the like.

    Now what we really need out of this disaster is international agreement on how a country goes bankrupt – and what the ringfenced assets are in that situation. Then those lending the money know that there is no absolute guarantee if they lend in a ‘foreign’ currency – in the same way that they know there is no absolute guarantee if they lend to a limited liability company.

    What we need is an agreement on limited liability for sovereign nations.

  19. Robert

    I don’t see how the existence of Euro accounts outside Greece and Euro notes under mattresses and in freezers is going to cause hyperinflation as long as all debts (public and private) to the Greek Government are payable in the new drachmas only.

    In fact I think that it is likely that once the initial devaluation has occured, you are likely to see some pullback or increase in the value of the drachma as those Euros are exchanged into drachmas to pay taxes etc to the Government.

  20. nealb,

    I agree that the scaremongering is overdone, but I would like to see a detailed description of how the transition to the drachma would be best accomplished. I don’t want to speak for Yanis, but I suppose that he expects some sort of massive underground economy based on the Euro to develop, along the lines of the former Warsaw Pact countries, in which those who had access to hard currency could buy all the goods they needed, and those who only had local currency could buy vinegar.

    Under that scenario, taxes would be paid in the relatively worthless drachmas, while the real economy would continue largely outside of state control and based on the Euro. Would we then see a crackdown on the liberties of the Greek people in order to curtail the underground economy?

    Could this happen? I honestly couldn’t guess at how likely that scenario is. Greece doesn’t have their currency pegged to another like Argentina or Iceland did, so I think Yanis is right that we should be careful when we draw comparisons.

  21. Neil:If the Icelandics refuse to pay, then what is the ‘wronged’ country going to do about it? In the old days, send some warships & make ’em cough up. The UN Charter outlawed that. So it was consciously “an agreement on limited liability for sovereign nations.’

    Andrei:state-backed brigandism, no matter how many internal referendums support it, is not to be tolerated. In the old days & still now, in the current golden age of piracy, the idea is that the pirates are hostis humani generis, not their home port. This is still a good idea. Try to get the dough from the banksters, Icelandic or otherwise. What do these guys have to do? Hoist the Jolly Roger from their superyacht? Walk around with an eyepatch & a parrot on their shoulder, and complain that people still don’t recognize his profession, like Terry Pratchett’s Reacher Gilt?

    But if the world really didn’t tolerate state-sponsored brigandage, then the real, the big brigands called the IMF would be in the docket, with them & their state backers paying immense reparations to their innumerable victims.

  22. Robert

    There may need to be a carckdown in the enforcement of their tax laws – but that would be the case either way. But this could and should be done without infringing civil liberties.

    I think that the drachma will drop 2 to 3 to the Euro. I saw some piece a month or two ago where they calculated a re-introudction value based on its value at the time of switchiung to the Euro, and they said that the drachma would go to something like 2000 to the Euro. If it went to this level the cost of living in Greece for Northern European’s with Euros would be that cheap, that there would be a massive drain of populations to Greece.

    Ultimately, the value will depend on how displined the Government is in dealing with the winners and losers in the process. If the Government starts giving Government employees and welfare receipients monies so that they retain a Euro equilivant and/or adjust tax rates and thresholds accordingly there will be a problem. If however, the Government sits back and largely keeps tax rates and thresholds the same (some adjustments would be required to ensure property tax values reflect market movements in property prices and costs of living for their imputed income calculations) and only provides assistance to enable people to exist at a basic level (which for the employable would be best delivered through Bill’s JG) then the outcome will be a short sharp adjustment period and then they can start recovering.

    The inflation outcome is not driven so much by the return to the drachma, but how the Government and the people treat the winners and the losers of the process.

  23. nealb,

    I’m not sure you dealt with the central issue. If civil servants are paid in drachmas and the populace must pay taxes in drachmas, and drachmas are relatively worthless, then tax revenues will be extremely low in Euro terms. Those holding Euros, both locals and foreigners, will be able to buy up all the valuable goods and assets in Greece, unless there are repressive rules put in place to prevent this.

    I’m looking for a mechanism to avoid the possibility of an extremely weak drachma creating an ungovernable underground economy.

    I agree that eventually the drachma will find its proper level, but if that takes 6 months, you might be looking at either an widespread anarchy or an authoritarian state as a response to the transition.

  24. Robert

    Whilst the taxes in Euros might be low, in drachma, the only currency they would be payable in they would be high.

    For example, just say that you buy something now of 123 euro. This includes vat of 23 euro. The Greek government takes that 23 euros and gives to a pensioner.

    Post drachma-isation, you still buy the samething for 123 euro (because you and the seller which is continue the euro). However, just say that using a doomsday scenerio the euro buys 10 drachma in the FX market. Translated in drachma your tansaction is 1230 drachma including 230 drachma in vat to remit to the government. If the Governmnet is still only paying pensioners the 23 drachma then your seller has a problem in that he has too pay 230 drachma but the Government has only put into circulation 23 drachmas.

    Similiarly, if you own property in Greece, and you wish to sell it now for 200,000 euro – the transfer duty is going to be about 16,000 euro. However, if you sold post-drachma-isation and the exchange rate was 10 to 1, and you still did the transaction at 200,000 euro, then for transfer duty purposes the value is 2,000,000 drachma, and the duty payable will be 196,000 drachma. Which means that you will need to find 196,000 to have the ownership change registered which is a problem if only 16,000 have been put into circulation.

    Basicially, if the transactions continue to take place in an appreciated euro, then the drachma value of the transactions increase, and the taxes due to the Governement increases because these are calculated in drachma, which means if the Governement is disciplined on the expenditure side will see budget deficits fall and the demand for the drachma increase. So really the ability for an underground economy to exist depends on the tax collection agency’s desire and ability to police the tax collection laws of the country.

  25. I understand your points, but….

    What will happens to the people who are paid in drachmas, have little access to Euros, and suddenly find that they can’t buy anything because everything that has any value is being purchased by those with Euros?

    I think there needs to be a strictly controlled crawling peg devaluation over a one-year period. The state will guarantee an exchange of 1.2 drachmas to the euro to start, two months later it may slip to 1.4, then 1.6. After one year, with a drachma rate of 2 to 1 to the euro, the drachma will be set free to float.

    This kind of process will still hurt the ordinary citizen, but it might avoid the worst effects of a sudden change to the drachma and the possible dissolution of civil society that could follow.

    This situation is sufficiently different from any previous one that I don’t think anyone knows what will happen. Pretending to know what the effects will be is nothing but unwarranted confidence.

  26. Andrei,

    Please help me understand abt Iceland: The entities that owe money to British and other depositors are British-based subsidiaries of Icelandic, private banks. Isn’t this correct? The operation of foreign banks in a country’s soil is supposed to be regulated and monitored by said country’s authorities. Isn’t this, too, correct as far as Britain and Iceland are concerned? After the Icelandic banks collapsed, the Icelandic government decided, on its own free volition and without being obliged to do anything, to hand out to Icelandic depositors the money they lost. This, to me, is equivalent to the government handing out free money to the victims of a natural disaster. If there’s an earthquake in Iceland and the government decides to compensate only Icelanders, that’s the government’s prerogative. Foreigners can complain about the unfairness of it but do they have a case in court? I think not.
    So, please xplainI cannot understand on what basis you call Iceland’s position on the issue of the failed banks “state-backed brigandism”. Are you saying that if a Deutche Bank subsidiary in Somalia goes belly up, the German government will somehow owe money to Somali depositors?
    Vassilis Serafimakis

  27. Vassilis:

    The entities that owe money to British and other depositors are British-based subsidiaries of Icelandic, private banks. Isn’t this correct? The operation of foreign banks in a country’s soil is supposed to be regulated and monitored by said country’s authorities. Isn’t this, too, correct as far as Britain and Iceland are concerned?

    No, that is not correct.

    Iceland is a member of the European Free Trade Association and the European Economic Area since 1970 and respectively 1994. These memberships allow Iceland to fully participate in the EU internal market, including of course the free trade zone. In return, Iceland have obliged themselves to implement all EU legislation relevant to the workings of the internal market. One of those regulations is the Directive 94/19/EC of the European Parliament on deposit guarantee schemes, which, as the description tells you, is a directive targetted at harmonizing regulation about minimum deposit guarantees across the EU internal market. This directive was duly adopted by Iceland as national law in 1999.

    This directive establishes, amongst other things, that branches of financial institutions operating abroad will still fall under the supervision of their home state relevant authorities and their solvency will be guaranteed by the home state’s solvency guarantee scheme. How this scheme should function in detail is left at the discretion of each state, but it has to guarantee a uniform minimum amount for deposits. In the case of Icesave, neither the UK, nor the Netherland authorities had any insight into the workings of the Icelandic bank branches, because they both fell under the supervision of the Icelanding deposit guarantee scheme.

    After the Icelandic banks collapsed, the Icelandic government decided, on its own free volition and without being obliged to do anything, to hand out to Icelandic depositors the money they lost. This, to me, is equivalent to the government handing out free money to the victims of a natural disaster.

    The Icelanding government was obliged to guarantee a minimum amount of those deposits to everybody, Icelanding depositors or British depositors – that is part of the legislation that they implemented as their national law in 1999. If the Icelanding government had refused to pay at least the minimum amount guaranteed, the Icelanders had the option of suing their government both in national courts and in european courts to get their money back.

    What the Icelanding government did actually do out of their own “free will” (more like to avoid being burned down or staked) was to not only repay the deposits to the minimum amount guaranteed (about 20k € at the time), but to repay them in full, for their own citiziens at least. The foreigners of course could go screw themselves. Or so the Icelanders thought.

    If there’s an earthquake in Iceland and the government decides to compensate only Icelanders, that’s the government’s prerogative. Foreigners can complain about the unfairness of it but do they have a case in court? I think not.

    Alas, you think wrong. The EU directive specifies that the minimum deposit guarantee goes for every client of the banks, no matter if they are domestic or foreigners, clients of the home bank or of a branch abroad. Not only that, but one of the fundamental parts of the EEA agreement that Iceland signed (specifically Article 4) specifically forbids governments to selectively apply their legislation in order to protect just their citizens and discriminate against foreigners – that’s a basic rule within the common market, since free trade can only exist and function properly if there is a guarantee of uniform treatment.

    The Icelanders were of course aware of all this, so they used a legal trick to try and get around this rule: they didn’t repay the deposits of the original Icelanding banks – no, they can say that nobody became a cent, neither the Icelanders nor the foreigners. What they instead did, was split their banks overnight into two entities, the “Old Bank” and the “New Bank” – in the new bank landed all the domestic deposits, which were then state guaranteed and repaid in full, and in the old bank landed all the foreign deposits, which haven’t since a cent from Iceland since.

    Of course, even a child can see through such a transparent embezzlement scheme, which is why the complaint (see above to a link to the proceedings) against Iceland by the supervising comission before the EFTA Court concerns itself also with this clear case of discrimination against foreigners, which is clearly and obviously in contradiction with the legally binding agreements Iceland signed as part of the deal to gain access to the EU internal market.

    Hence, state brigandism.

    Are you saying that if a Deutche Bank subsidiary in Somalia goes belly up, the German government will somehow owe money to Somali depositors?

    I don’t think Germany and Somalia are part of any free trade zone agreements with specific agreements on deposit guarantee schemes, so I am not exactly sure why you employ such faulty analogies?

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