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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

Mosler Bonds for the ECB, and reasons why Greece will not be allowed to default

Posted by WARREN MOSLER on September 28th, 2011

First, The ECB should turn the bonds it buys into Mosler bonds, by requiring the govt of issue to legally state that in the case of non payment, the bearer on demand can use those bonds for payment of taxes to the govt of issue.

The ECB holding Mosler bonds will shift the default option from the issuer to the ECB, as in the case of non payment,
the ECB would have the option to make it’s holdings available for sale to tax payers of that nation to offset their taxes.

Therefore, conversion to Mosler bonds will ensure that the ECB’s holdings of national govt debt are ‘money good’ without regard to external credit ratings, and give the ECB control over the default process.

Second, I see several substantial reasons Greece should not be allowed to default, which center around why it’s in the best interest of Germany for Greece not to default.

Sustaining Greece with ECB purchases of Greek debt costs German tax payers nothing.

The purchases are not inflationary because they are directly tied to reduced Greek spending and increased Greek taxes, which are both deflationary forces for the euro zone.

Funding Greece facilitates the purchase of German exports to Greece.

Funding Greece does not reward Greek bad behavior.
Instead, it exacts a price from Greece for its bad behavior.

With the ECB prospectively owning the majority of Greek debt, and, potentially, Greek Mosler bonds, Greece will be paying interest primarily to the ECB.

The funding of Greece by the ECB carries with it austerity measures that will bring the Greek budget into primary balance.

That means Greek taxes will be approximately equal to Greek govt expenditures, not including interest, which will then be largely payments to the ECB.

So if default is not allowed, the Greek govt spending will be limited to what it taxes, and additional tax revenues will be required as well to pay interest primarily to the ECB.

But if default is facilitated, Greece will still be required to spend only from tax revenues, but the debt forgiveness will mean substantially lower interest payments to the ECB than otherwise.

And while without default, it can be said that the holders of Greek bonds have been bailed out, the euro zone will be considering the following:

The ECB buys Greek bonds at a discount, indicating holders of those bonds have, on average, taken a loss.

The EU in general did not consider the purchase of Greek bonds as bad behavior that is rightly punished with a default.

In fact, it was EU regulation and guidelines that resulted in the initial purchases of Greek bonds by its banking system.

Therefore, I see the main reason Greece will not be allowed to default is that not allowing default serves the further purpose of Germany and the EU by every measure I can think of.

It sustains the transfer of control of fiscal policy to the ECB.
It’s deflationary which helps support the value of the currency.
It provides for an ongoing income stream from Greece to the ECB.

Note, however, that not long ago it was not widely recognized as it now is that the ECB can write the check without nominal limit.

Before the EU leaders recognized that fundamental of monetary operations, Greek default was serious consideration for financial reasons as it was believed the funding of Greece and subsequently the rest of the ‘weaker’ euro zone nations would threaten the entire euro zone’s ability to fund itself.

It is the realization that the ECB is the issuer of the currency, and is therefore not revenue constrained, that leads to the conclusion that not allowing Greece to default best serves public purpose.

(as always, feel free to distribute, repost, etc.)

35 Responses to “Mosler Bonds for the ECB, and reasons why Greece will not be allowed to default”

  1. Chad Starliper Says:

    Warren

    While what you describe does offer one form of a solution to the liquidity crisis, how does it make Greece more able to exit the depression? Their problem is that their debt/gdp ratio is too high. They cannot ever grow with this much debt. The only way to do is lower the principal value of their debt by forcing creditors to writedown defaulted debt — however that is restructured. Letting them default by forcing writedowns on their creditors is the natural way of setting things in balance.

    Your plan seems sound if the goal is to continue the status quo: 1) allow Germany to keep exporting to debt-laden periphery; 2) Keep Greece in a depression; 3) protect private bondholders from ever taking the losses they rightfully earned; and 4) by doing 3, instead force the adjustment onto the private citizens.

    What am i missing?

    Reply

    WARREN MOSLER Reply:

    it doesn’t

    there are two issues, the solvency/liquidity issue and the economic issue.

    my plan only addresses the first.

    the second requires fiscal relaxation/growth and stability pact modifiication, etc

    Reply

  2. Philip Pilkington Says:

    Do you think that the European authorities recognise all this, Warren? Is it now in the mainstream the monetising Greek debt is actually a good way forward?

    Reply

    WARREN MOSLER Reply:

    i see the understanding beginning to seep in but not yet dominating

    Reply

  3. Kostas Kalevras Says:

    Dear Warren,

    I know that Fed is allowed to place non-competitive bids in US Treasury auctions in order to maintain its securities portfolio. I haven’t been able to find out if ECB is allowed to do the same thing. Do you know anything on that?

    Also, if the ECB continues its bond purchases it could easily lower the interest that Greece is paying through rebates: Greece would pay ECB the deposit facility rate plus a few bp (so that ECB covers its expenses) and the rest would be rebated directly to the Greek government/Bank og Greece. That would lower interest paid on ECB holdings to around 1% from the current 4-5%.

    Reply

    Ramanan Reply:

    @Kostas Kalevras,

    Yes, the Fed is allowed to do that as you said in order to maintain its securities portfolio.

    The NCBs, on the other hand, cannot place bids because they have less government debt to start with and the ones held are due to historical reasons and they are usually non-marketable and have to be redeemed in annual installments over many years.

    The exception is that recently, the ECB relaxed this and asked the NCBs to purchase government bonds in the open market via the “Securities Market Progammme”. I doubt if they can bid when these bonds mature.

    The counterparts of NCB liabilities on the assets side are not government bonds as in the United States but Claims on Credit Institutions.

    Reply

  4. Ralph Musgrave Says:

    I still don’t get this Mosler bond idea.

    Under Mosler bonds, where Greek taxpayers pay tax with bonds instead of cash, the Greek govt is left short of cash. Unlike a monetarily sovereign country, it cannot just print money. So where does the Greek govt get money to pay its expenses? It could raise taxes, but that’s what it’s trying to do anyway – right now. But that reduces AD in Greece.

    Re the idea that “Sustaining Greece with ECB purchases of Greek debt costs German tax payers nothing”, Greek exports to Germany are only viable because of what are euphemistically called “loans” from Germany etc. If those loans are eventually paid back, there is no “cost” to German etc taxpayers. But the reality is that Greece cannot pay back the loans. A loan which is not paid back is a cost to the lender.

    Reply

    Peter D Reply:

    @Ralph Musgrave,

    Ralph, isn’t it about just relieving the risk of default due to the vicious cycle of ever increasing interest rate on the bonds? The market believes that Greece can default because of too high interest rates and interest rates get even higher because of that. So, Mosler bonds attempt to severe the vicious cycle by making sure that Greek debt is always redeemable for something, extinguishing the tax liabilities, for example.
    Another way of looking at it is that it makes the Greek bonds a backdoor fiat currency for Greece.
    This is my understanding, I could be off…

    Reply

    ESM Reply:

    @Peter D,

    “Another way of looking at it is that it makes the Greek bonds a backdoor fiat currency for Greece.”

    Yeah, but defaulted Greek bonds are already equivalent to a fiat currency for Greece. And so are undefaulted bonds that Greece is at risk of defaulting on. The Mosler bond tweak doesn’t really change very much. It’s certainly not going to turn them into “money-good” bonds like Warren stubbornly writes above.

    Even in the US, transferable tax credits don’t trade at par. And a tax credit against Greek taxes, which will not be accepted by Germany as a credit against German taxes, is sure not going to trade at the same level as a German tax credit.

    Defaulted Mosler bonds will be approximately drachma. To the extent that they trade a bit higher than drachma (or other Greek bonds), it will only have the effect of allowing Greece to dig a deeper hole.

    Greece should default and if the EU wants to bail out banks that were encouraged to take the risk of owning Greek bonds, then the ECB can bail them out. The history of sovereign default is that it works out extremely well for the deadbeat.

    Reply

    WARREN MOSLER Reply:

    correct on the interest rate part.

    mathematically, greece can easily handle 200% debt to gdp, much like any borrower might be able to afford
    a home mtg that’s twice his income, if the interest rate is reasonable.

    Reply

    Geoff Reply:

    @Ralph Musgrave,

    The Greek govt gets cash (Euros) when they originally issue the Mosler bonds.

    Reply

    Geoff Reply:

    Ralph, just to follow up on my statement above. Think of both Euros and Bonds (Mosler or otherwise) as govt liabilities. Therefore, paying taxes using either vehicle will have the same result. Govt liabilities will be reduced.

    Reply

    WARREN MOSLER Reply:

    yes, mosler bonds assure investors their bonds are ‘money good’

    they make it harder for greece to default on it’s promise to pay back its debt

    Reply

  5. JKH Says:

    The statement “Greece is insolvent” makes no absolute sense. To the degree that the ECB chooses or is instructed to buy Greek debt, the situation regarding solvency is no different to that of a currency issuer like the US. If the ECB is willing to act on Greece’s behalf, Greece is a de facto a currency issuer.

    Unfortunately I still believe Mosler bonds have an element of adverse logic to them. Every redemption of M bonds for taxes is a non cash accounting event, requiring an equal and offsetting cash injection over and above the stated Greek deficit otherwise. Other things equal, new debt must be issued to offset every redemption. The ECB’s participation makes no difference to this particular dynamic. Whether or not the ECB supplies M bonds to taxpayers, the government must fund the amount of M bond redemptions in cash, over and above the Greek deficit. Notwithstanding price support offered by the M bond redemption option, that new replacement debt still has to be priced in the market, net of any redemption pricing benefit in the current period. The ECB can buy again the same amount of bonds in the secondary market, of course. The net result would be that the ECB’s holdings would be unchanged.

    Reply

    Chad Starliper Reply:

    @JKH,

    The problem, JKH, is that this it does not write down the level of debt, only provides ongoing funding for the outstanding debt. While that process plays out, Greece’s economy just keeps shrinking as government and non-government sectors all attempt to net save.

    So, my complaint with this whole mess is still that bankers get bailed out, keep on scalping upside volatility bonuses, while the normal person on the street is told to eat the losses in the form of depression and falling standards of living.

    Pre-packaged bank nationalizations strip away the operating entity, force writedowns on shareholders (zero out) and bondholders (haircuts and debt-for-equity swap), and recapitalize the banks without much taxpayer money. Greece then no longer needs the ECB to write the check.

    Reply

  6. Save America Says:

    “taxes to the govt of issue” I think of people like Richard Hatch, the first survivor on that famous TV show, who went to jail because of tax issues (so much for being a survivor), and then Wesley Snipes of Demolition Man who to jail because of TAX issues, but TAX CHEAT timmy who is top monetary guy!! I fear some of you academics up in your ivory towers are not seeing that the TAX SYSTEM is DESTROYING human lives all over this planet. TOM HICKEY told me the elites often blow up the system they have created trying to control all the little people. I am In croatia right now, will be in Greece next week, these people are not going to pay anymore taxes, they are THROUGH with paying taxes. So if you give them money, and then think you can stop inflation by TAXING that money away, that is not what I am seeing down here in the foxholes. Rick Santelli said tea parties were gonna start breaking out all over this blue ball, and I am meeting people all over europe who are not gonna pay ANYMORE taxes and in fact are getting so disgusted with the whole damn system, aren’t even paying the taxes they have paid up til now. All you academics, would you support TAXES that destroy families and human lives all over the planet, or would you support the HUMANS at the cost of the tax system? Which is more important? I would rather wesley snipes was out making good movies again that made me laugh and cry instead of sitting in jail for three years getting gang raped because a financial structure (taxes) was more important than his life and art – do you all disagree?

    Reply

    Save America Reply:

    @Save America, sorry, up above should say “NOT tax cheat timmy.” Is America and the world her people, her creations and art, and thier rich and joyous lives of freedom, liberty and happiness pursuit, or is America her tax code and her rules and her financial system? If you want to save America, what are you really trying to Save? If Greece people are falling over dead left and right from stress and BS financial structure, how does complicating thier lives even more enrich this planet or them? They are not going to pay those taxes like your models predict, I am certain. Even as Warren often has told me, all of society rests on the THUG with a GUN who is going to blow your head off if you don’t pay taxes, or in his example, You are in a room with a gun and to get his mosler cards you have to do some work, but there are some greece guys outside who are gonna use thier plane as a missle and blow up that room, so what do you do Citizen? Rush the guy with the gun and a few of you die, but the majority live, or all die after the plane blows up?

    Reply

  7. RJ Says:

    “Funding Greece does not reward Greek bad behavior.
    Instead, it exacts a price from Greece for its bad behavior.”

    What bad behaviour

    Reply

    Save America Reply:

    @RJ, Trying to live a life of liberty and pursuing happiness is a terrible Behavior if it doesn’t in some way enrich someone higher up the pyramid scheme, the system has become so corrupted that innocent teenagers are being locked up while judges are paid off by private prison contractors to do this travesty of justice. Warren is a true visionary, the financial sector is a lot more trouble than it is worth :(

    Reply

    John O'Connell Reply:

    @RJ,

    I’m no expert, but I believe it has to do with “unfunded liabilities”. In particular, Greek government workers were promised generous pensions and full retirement at ? 52 ? – some very early age – years old. No money was “set aside”, as a non-fiat-currency-issuer must do to fund future liabilities, and now despite tax increases there is not enough tax revenue to keep those promises, and the workers and retirees are rioting in the streets because of the higher taxes and because they believe they will not get their promised benefits, and because their financial plans which were based on those benefits are failing.

    Reply

    WARREN MOSLER Reply:

    violating eu deficit rules

    Reply

  8. John O'Connell Says:

    “First, The ECB should turn the bonds it buys into Mosler bonds, by requiring the govt of issue to legally state that in the case of non payment, the bearer on demand can use those bonds for payment of taxes to the govt of issue.”

    Why would they not require that on all Greek bonds? Indeed, why should not all governments make that a feature of all their bonds? Andy why should any bond buyer buy a bond that lacks such a feature, if others are available that have it?

    Or, conversely, if a government has borrowed money with a promise to repay it with interest, and breaks that promise, why should an investor believe that it would keep this promise?

    Reply

  9. Jose Says:

    I agree that it’s hard to “get” the Mosler bond idea.

    If the market doesn’t believe that Greece will be able to honor its bond commitments and is thus asking – indeed imposing – a huge default premium on Greek bonds, why should it believe in a further promise by the same government that in case of default (broken promise) it will accept some bonds as payment for taxes?

    If Greece defaults it will because it is insolvent – short of euros. If Greece then honored its Mosler bonds it would be even shorter of euros – and would be forced to quickly introduce new taxes of an amount equivalent to outstanding Mosler bonds. The holder of Mosler bonds would use them to pay taxes and would afterwards risk being taxed again, this time in euros, after the first payment!

    I’d guess Mosler bonds if introduced would soon lose credibility and command a risk premium as high as that on present day straight bonds issued by the Greek government.

    An insolvent government cannot make credible promises of payment, either in euros or in non recovered taxes.

    Reply

    Geoff Reply:

    @Jose,

    Honoring Mosler bonds would not cause Greece to be shorter of Euros. Greece would have already received the Euros when it issued the bonds in the first place! Nor would honoring the bonds cause it to go in insolvent. Quite the opposite. Honoring the bonds means they would be extinguished, i.e. debt would be reduced.

    Mosler Bonds are a govt liability. When a taxpayer redeems them, the liability disappears.

    Reply

    Jose Reply:

    @Geoff,

    The Greek government would be shorter of euros in the sense that instead of receiving euros for taxes it would receive pieces of paper called Mosler bonds.

    But the Greek government would still have to pay its expenses in euros, not bonds.

    So it would have to raise new taxes for this purpose.

    Mosler bond holders, after discharging their old tax obligations with bonds would then run the risk of being taxed again – this time in euros.

    Reply

    Geoff Reply:

    @Jose,

    Do you understand that Mosler bonds would replace regular bonds?

    Mosler Bond scenario: Greek govt raises +100 million Euros at issue, taxpayers later redeem -100 million Euros. Net to zero.

    Regular Bond scenario: Greek govt raises +100 million Euros at issue, Greek govt later pays -100 million Euros to bondholders at maturity. Net to zero.

    Conclusion: same thing.

  10. Rodger Malcolm Mitchell Says:

    KISS. The EU should give (not lend) euros to the euro-using countries, to be used to pay down their debts.

    That’s exactly what the U.S. federal government should do with all the U.S. states. Any time any government cuts spending or increases tax collections, that economy will suffer. Austerity is the brainchild of economic ignorance.

    Rodger Malcolm Mitchell

    Reply

  11. pebird Says:

    A government default of debt is not going to be happy times for anyone. At least those who hold Mosler bonds would have a potential recourse to use to extinguish tax liabilities or sell to someone who has Greek tax liabilities. Holders of regular bonds will look forward to 0 or a severe haircut. And the government can always generate new tax liabilities, accept the Mosler bonds and reduce their overall debt.

    Now, if the government refused to accept the M bonds as payment for taxes, there would be a legal crisis. It is one thing if you can’t raise the funds to pay bond holders, there is no money. No one is responsible for breaking the law.

    It is WHOLE other thing when you refuse to accept something as payment when you said you would. That is a public, conscious violation of law – maybe we could actually see some Finance Ministers behind bars.

    With regard to Greece having problems raising Euros, remember we assumed Greece was in default. I doubt that they would be able to raise funds regardless of what bonds are being issued.

    I think there would be an active market in M bonds during a default and severe pressure on the government not to renege on them.

    But the point of the M bonds is to avoid default in the first place by containing risk, thereby reducing interest rates and getting over part of the crisis. It is not a fix that will solve everything.

    And it does put Greece’s government under more constraints – specifically because if they default, they will get their own paper back in return for tax liabilities and not Euros.

    Reply

  12. Save America Says:

    http://www.zerohedge.com/news/deputy-pm-says-tax-limits-greek-society-exhausted

    You can raise tax rates, you can issue new tax laws, but that does not mean citizens are going to comply, or that you have the military power to FORCE them to do so.

    Reply

  13. Luigi Says:

    http://www.corriere.it/economia/11_settembre_29/trichet_draghi_inglese_304a5f1e-ea59-11e0-ae06-4da866778017.shtml?fr=correlati

    The original ECB letter to Italian Government.

    Reply

  14. RSG Says:

    Warren, I’m not convinced the powers to be fully understand monetary operations…do you?

    Reply

    WARREN MOSLER Reply:

    i am far from convinced

    Reply

  15. Winslow R. Says:

    ‘Parliament approved a new emergency property tax Tuesday to be added to electricity bills later this year, ”

    Time to go off grid solar!

    Reply

  16. PZ Says:

    Are there any legal constraints to launching a parallel currency?

    Because it would seem most logical solution, euro exit is messy, it most likely involves default with unknown implications for the EZ banking system, tough staying in euro is even worse because of collapsing output makes servicing debt that more difficult not to mention and colossal reduction in living standards.

    But introducing new, local currency alongside euro would help governments take power back from the markets, restore national output and full employment and make servicing even the euro debt that much easyer because more there is production more there is something to tax.

    We need concrete, working policy proposals that can restore livelihoods of millions of peoples in euro area. We need a solution to this mess.

    Reply

    Tom Hickey Reply:

    @PZ,

    Some local currencies have already been introduced. Don’t have a follow up on it though. Could make it work by accepting local currency for local taxes.

    Reply

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