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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.

euro denominated debt consideration

Posted by WARREN MOSLER on April 19th, 2012

So if all the member nations stop taxing in euro and start taxing in their own currencies, the value of the euro goes to 0. And all the national govt debt denominated in euro goes worthless, along with all other euro denominated debt, thereby eliminating it.

51 Responses to “euro denominated debt consideration”

  1. RSG Says:

    Why do you bring this up…is there some contemplation of this somewhere in the eurozone?

    Reply

    Jacob Goense Reply:

    @RSG,

    Well, there is the Wolfson Economics Prize for the best way to break up the euro zone. I see mosler didn’t make the short list ;)

    Reply

    WARREN MOSLER Reply:

    i think my submission was too short. couldn’t stretch it to the 15,000 word minimum but sent it in anyway

    Reply

    dave Reply:

    @WARREN MOSLER, was it not complicated enough? just add some big fancy words, that should do the trick

  2. walter Says:

    1. The scenario won’t be: euro’s in Germany will be converted to new DM, in France to new FRfr, etc?
    2. As long as at least one member state will continue with the euro it won’t go to 0?

    Reply

    WARREN MOSLER Reply:

    yes, euro taxes anywhere will give it value

    Reply

    cig Reply:

    @walter, lots of euros are not, as such, located anywhere. Imagine california and texas introduce their own currency. So you convert “californian US$” to CA$ and “texan US$” to TX$. How does one know which is which?

    Reply

  3. LetsGetItDone Says:

    It doesn’t have to go to zero to give nations no longer using it the capacity to repay their Euro-denominated debts. With far less demand for Euros, the currency will be severely devalued, the ECB can then try to prop up the price. But the more they do the more they’ll cut into the export business of key states. The Germans won’t tolerate that for long before they go back to the Mark.

    Reply

  4. Ben Says:

    Nevertheless, today the euro seems to be a save haven

    Reply

  5. jonf Says:

    Still debt in Euros? Inflation?

    Reply

  6. Save America Says:

    Warren I have a question for you, given the below info, how does central bankers diversifying into GOLD make star trek or star gate atlantis cities come about? How does diversifying into gold make moonbases or cancer cures? Central bankers and big money managers are usually expected to be very smart people (more on that in the next post) but I need you to explain to me how central bankers diversifying into GOLD makes the world better for most people? I don’t get it.

    ……….

    Central bank reserve managers responsible for trillions of dollars of investments are shunning euro assets and questioning the currency’s haven status because of the region’s sovereign debt crisis, research has found, according to the FT.

    Among the most conservative of investors, central bankers have tended to keep much of their fx reserves in high quality euro and dollar denominated assets, such as government bonds.

    However, a survey of reserve managers at 54 central banks responsible for portfolios worth $6 trillion, almost half the world’s total, signals that the sovereign debt crisis has sparked a reversal of that trend.

    More than three-quarters said the sovereign debt crisis has had a profound impact on their reserve management strategy, with their central banks pulling back from eurozone counterparties and reconsidering attitudes toward the single currency.

    Signifying the mood of caution among the world’s central bankers, 71% of those polled said gold was a more attractive investment than it had been at the start of last year. Central banks made their largest purchases of gold in more than four decades last year and have continued to buy the precious metal in the early months of 2012.

    Central bank demand is set to continue and may accelerate as the global debt crisis deepens in the coming months.

    Reply

    Save America Reply:

    @Save America,

    When the ship begins to sink, who gets saved, how does diversifying into gold Save these central bankers? (they all sound like mad sociopaths to me – as you have documented many times on this blog Warren)

    http://www.zerohedge.com/news/doug-casey-sociopathy-running-us-part-two

    I recently wrote an article that addresses the subject of sociopaths and how they insinuate themselves into society. Although the subject doesn’t speak directly to what stock you should buy or sell to increase your wealth, I think it’s critical to success in the markets. It goes a long way towards explaining what goes on in the heads of people like Bernie Madoff and therefore how you can avoid being hurt by them.

    But there’s a lot more to the story. At this point, it seems as if society at large has been captured by Madoff clones. If that’s true, the consequences can’t be good. So what I want to do here is probe a little deeper into the realm of abnormal psychology and see how it relates to economics and where the world is heading.

    If I’m correct in my assessment, it would imply that the prospects are dim for conventional investments – most stocks, bonds and real estate. Those things tend to do well when society is growing in prosperity. And prosperity is fostered by peace, low taxes, minimal regulation and a sound currency. It’s also fostered by a cultural atmosphere where sociopaths are precluded from positions of power and intellectual and moral ideas promoting free minds and free markets rule. Unfortunately, it seems that doesn’t describe the trend that the world at large and the US in particular are embarked upon.

    In essence, we’re headed towards economic and financial bankruptcy. But that’s mostly because society has been largely intellectually and morally bankrupt for some time. I don’t believe a society can rise to real prosperity without a sound intellectual and moral foundation – that’s why the US was so uniquely prosperous for so long, because it had such a foundation. And it’s also why societies like Saudi Arabia will collapse as soon as the exogenous things that support them are pulled away. It’s why the USSR collapsed. It’s the reason why countries everywhere across time reach a peak (if they ever do), then stagnate and decline.

    This isn’t a matter of academic contemplation, for the same reason that it doesn’t matter much if you’re in a first-class cabin when the ship it’s in is taking on water.

    Reply

    Jason Reply:

    @Save America,

    I’m confused. Is Doug Casey really posting on Warren’s blog? Gold’s champion is posting on an MMT blog. Now this is bizarre!

    Reply

    MamMoTh Reply:

    @Save America,

    it doesn’t matter much if you’re in a first-class cabin when the ship it’s in is taking on water.

    the survival rate of women travelling 1st class on the Titanic was about twice that of those travelling 3rd class.

    Reply

  7. Jacob Goense Says:

    Worthless for tax purposes, the unwinding of debts is going to be interesting though. Just like the infighting to get a piece of ECB assets.

    Reply

  8. DOB Says:

    @WARREN,

    I disagree: all the loans (repos, LTROs, etc.) made by the ECB still have to be repaid. The ECB presumably enjoys the same coercive power of the court systems to enforce repayment from debtors as a govt trying to get payment of taxes. This should create demand for the EUR during the debt unwind process. Depending of the dynamics of the unwind, which as Jacob points out should be very interesting, the value of the EUR could be a lot or very little, but why would it be 0?

    Reply

    WARREN MOSLER Reply:

    it would be 0.

    lots of currencies have had heaps of outstanding debt and none the less gone to 0.

    and lots of currencies have experienced double and triple digit inflation with heaps of outstanding debt

    in fact, when it happens the commentators often point to the debt as the cause for the inflation.

    goes back to my point that issuing/selling tsy secs vs leaving the funds as clearing balances makes no difference with regard to
    aggregate demand

    Reply

    DOB Reply:

    @WARREN MOSLER,

    Lots of currencies have had “heaps of debt” and NOT gone to zero too, so clearly this isn’t the determining factor. I think sorting this out is going to be easier through argumentation than historical references:

    If lent you a token and we contractually agreed that you would return it to me after a year, or get thrown in jail. Would you then hand over that token at 0 cost to someone else?

    If you had “sold” the token to someone and the maturity of our agreement was approaching, would you not be willing to pay a price to purchase it back from the market in order to avoid jail?

    Why would the EUR be any different than that token?

    Reply

    WARREN MOSLER Reply:

    if i owe you a bus token and the bus company closes down that token isn’t worth anything

    DOB Reply:

    @WARREN MOSLER,

    This token does not give you the right to ride a bus, it gives you the right to not get thrown in jail when you repay it.. As long as the jail doesn’t close down, I would think the token retains some value (low/high based on how hard it is to get your hands on the remaining tokens out there..)

    WARREN MOSLER Reply:

    you don’t ‘repay’ bus tokens? you just give them to the bus driver when you get on, right?

    DOB Reply:

    @WARREN MOSLER,

    I’m using the word ‘token’ here as in ‘money’, not as in ‘bus token’.

    One does repay (borrowed) money or face the wrath of bankruptcy courts..

    WARREN MOSLER Reply:

    if you borrow bus tokens from a friend you have to pay them back

    but if you have a token loan outstanding and the company goes bust,
    they don’t have any value to him or anyone else, so if you don’t pay him the court will rule there are no damages.

    DOB Reply:

    @WARREN MOSLER,

    There is no bus. There is no bus company. There never was in this example.

    There is just a (collateralized) loan, made by a central bank in a currency that it issues, to someone. That someone must repay the loan. This creates demand for the currency even if taxes aren’t payable in that currency anymore.

    WARREN MOSLER Reply:

    no it doesn’t.

    Many nations had scads of outstanding loans with currencies that went worthless, for example.

    it was an analogy. the govt is the ‘company’ and the dollar it’s token needed to pay taxes, just as the bus company’s
    tokens are collected to ride the bus. Failure to pay means you lose your house, car, life, etc. analogous to failure to pay meaning you can’t ride the bus.

    DOB Reply:

    @WARREN,

    Ah sorry I thought you were working with my example because you re-used the word token, where in fact you were just building your own.

    In your analogy, the bus company going bankrupt and discontinuing the provision of service would be equivalent to the ECB going bankrupt. The ECB provides no service (other than returning your collateral). There’s no reason for it to bankrupt even if all nations cease to use the Euro.

    In any case, I still don’t buy the vague historical argument that says “it’s going to happen again because it has happened before”. It’s the same as saying: “MMT doesn’t work, look at Weimar”. It establishes causality where there is none.

    WARREN MOSLER Reply:

    no, discontinuing the need for a token to ride the bus was eqiv to the state dropping it’s penalty for non payment of taxes

    the company going out of business was equiv to the state no longer requiring/enforcing tax payment

    WARREN MOSLER Reply:

    the point remains that when tax collection ceases entirely for a given currency it’s value goes to 0 in short order, even when there is outstanding debt.

    DOB Reply:

    @WARREN MOSLER,

    Ok, but this analogy does not capture the richness of the situation because the ECB figures nowhere in it. Let’s drop analogies since that does not seem to help the discussion.

    Where are the folks who borrowed the monetary base from the ECB going to find those Euros to close out the repos? Why would these folks not have to chase Euros to close it out. Why would this not cause demand for the Euro?

    Would appreciate if you could tell me were my argument goes wrong from a mechanical/operational/logical standpoint, not with a historical reference.

    DOB Reply:

    @WARREN MOSLER,

    “the point remains that when tax collection ceases entirely for a given currency it’s value goes to 0 in short order, even when there is outstanding debt.” =>

    That’s just a regurgitation of plain vanilla MMT which, by your own admission, does not apply in the Eurozone. There is no (implicit or explicit) commitment from the ECB to repo govt bonds in unlimited size at their target rate, so it stands to reason that the ECB has more control over EUR inflation than the Fed has with USD. It does not delegate as much of its power to the fiscal authorities.

    Would still like to hear why the obligation to repay the ECB or face bankruptcy is not a source of demand for the EUR.

    WARREN MOSLER Reply:

    it’s a source of notional demand but not a source of value.

    the source of value is what you have to do to get the euro from the issuer.

    the old pesos, for example, went to a zillion to one vs the dollar even with zillions of peso debt outstanding.

    DOB Reply:

    @WARREN MOSLER,

    “it’s a source of notional demand but not a source of value.” => not sure what the difference is between notional demand and just demand.

    “the source of value is what you have to do to get the euro from the issuer.” => ECB is free to ask for whatever it wants to give Euros.

    Right now it’s just collateral with haircut + interest payments.

    Tomorrow if the Eurozone breaks off they could just say no more new Euros will be created and they can start rolling off repos.

    In the extreme case where they roll off all repos immediately, would you not agree that it would be a massive squeeze on Euros and that the value of the currency would shoot up as debtors chase it (much like if a state had raised taxes and citizens where chasing the currency to pay the tax)?

    In the other extreme, where the ECB lets the money supply grow despite lack of use for the currency, the EUR would indeed to 0.

    Somewhere in between there must be a path where the EUR winds down while retaining a somewhat of stable value, no?

    Please no historical examples, just constructive arguments.

    WARREN MOSLER Reply:

    the source of value today is what the euro member nations- the ones taxing- say one must do to get their spending.

    yes, it’s a peculiar arrangement but that’s what it is. If they all stop taxing in euro and no one is left taxing in euro the value of a euro goes to 0, for all practical purposes.

    DOB Reply:

    @WARREN MOSLER,

    Sorry but those are still just affirmations not arguments. Just like the historical examples, they’re leaving me very much unconvinced..

    WARREN MOSLER Reply:

    sorry, missed your last request for non historic.

    Assume you’ve read my ‘general framework’ paper with the horizontal and vertical components?

    Suppose the euro nations stop taxing and spending in euro.
    And I owe you euros and you want delivery of actual euros and there aren’t any.
    We go to court where the judge decides how many dollars I owe you, as legal discharge in the US is in dollars.
    Payment in kind wouldn’t apply here- it only applies to special cases such as art work you may have in your possession. And if the artwork has been destroyed the judge has to determine a dollar settlement.
    So the judge will be expected to award you enough dollars to be able to buy what the euro can buy in the market place.
    I’m saying the euro probably will be worthless as without taxation there are both no taxpayers who need it and no issuer who defines value with his terms of exchange.
    You are saying they will be worth something because of the outstanding debt.
    But the lender doesn’t determine exchange value. He only calls for nominal repayment.
    So there’s no ‘channel’ for his demands for nominal repayment to tie to real goods and services.
    And there will be residual holders of euro- the total cash in circulation, for example- who will be happy to get anything
    above 0 for their euro. And the first lender to get repaid is then in that same position of hoping to get anything for his euro.
    So in theory the repayment of one euro can cause it to ‘go around enough times’ (velocity, etc.) to keep the value at or near 0 even as all the debt is either repaid or forgotten.

    Which, even though you don’t want any history, is what always happens when taxation ceases.

    DOB Reply:

    @WARREN MOSLER,

    Sorry for the delayed answer but thinking about all this is taking me quite deep into monetary theory, and is taking me a while.

    I’m putting together a document to explain my position on this, and will submit it to you when it’s ready, but for now, let me just say that I believe a currency can exist without any government taxing/spending in it, with a central bank looking after it. The Euro would be just that after the countries all exit.

    Since you mentioned there are many historical examples where currencies have collapsed after taxation has ceased, despite a strong central bank, could you name a few?

    While I’m not done writing my document, let me point out one cute example I stumbled upon while thinking about all this.

    Let’s assume 2 countries, that are identical in *every way*, go “full fledged” MMT and implement job guarantees, management of inflation/unemployment through net deficit spending, etc.

    Country A bought your 0% “natural” interest rate argument, but for whatever reason, Country B didn’t and decided to set rates at 5% (correct me if I’m wrong, but according to MMT, this doesn’t change anything I said previously: full employment and low inflation can still be achieved with the right level of deficit) — this is the only way in which the countries differ.

    Today, the exchange rate of country A vs B is 1.0 and purchasing power is at parity. But the 10y forward FX rate is 1.00 * (1.05/1.00)^10 = 1.63. Given that both countries have credible inflation expectations of 2% annually, it stands to reason that over the long run, purchasing power should remain at parity and FX rates should remain within some band. Savvy investors then, will short the hell out of country A’s currency vs country B’s and expect to make, on average 5% of notional annually (the carry trade).

    This will put inflationary pressure in country A. But not to panic: all we’ve got to do in that case is reduce net spending. Meanwhile country B is suffering from unemployment from the overvalued currency. Again, no panic, let’s let the deficit rip!

    Conclusions from this example:
    a) Different levels of interest rates lead to different levels of deficit to achieve the same level of employment/inflation
    b) Contrary to your interest income channels argument, the country with the low interest rate actually had to run a lower deficit than that with the high interest rates
    c) Somehow those currency speculators are making money because rates have been locked at arbitrary values and it’s not clear where that wealth is coming from, but it’s got to be from the people of country A and/or B (probably ‘and’)
    d) Country B (with its stronger currency) enjoys a comparatively higher standard of living (like U.S. vs China)

    What are your thoughts on this example?

    DOB Reply:

    @WARREN MOSLER,

    Warren, any views on the example above?

  9. Chaz Says:

    This is a tautology.

    So if all the member nations stop taxing in euro and start taxing in their own currencies,

    When you’ve proposed this before, you’ve paired it with a default on the euro debt. In that case you don’t need the other steps; default obviously wipes out the debt.

    Alternatively, countries could try to keep paying the euro debt. With no euro tax revenue they would presumably have to do this by selling their own currency to buy euros.

    the value of the euro goes to 0.

    If they defaulted, yes.

    If they are buying euros to pay the debts, no. The euro purchases will support the value of the euro even in absence of euro taxes.

    And all the national govt debt denominated in euro goes worthless, along with all other euro denominated debt, thereby eliminating it.

    As above, if you defaulted, yes. If not, then the euro still has value and so does euro debt. And the debt would be just as burdensome or unsupportable as it is now–the only change would be that the euro would be an official foreign currency instead of just a de facto one.

    If you default then you don’t have to pay your debts, and if you don’t default then you do. Simple.

    Reply

    WARREN MOSLER Reply:

    it’s the difference between one country ceasing to tax in euro and all countries ceasing to tax in euro.

    Reply

  10. cig Says:

    May I suggest a somewhat simpler thought experiment: imagine the ECB take the e200 and e500 notes out of circulation. Will all holders redeem their notes before the deadline? Given the mostly underground use, no, lots of DEM 1000 notes never got redeemed. Do those notes then go to 0 on the deadline because they are not acceptable for paying taxes anymore, or do they keep a non-zero value on the grey market, for possibly a long while, as synthetic gold (random easy to carry thing in finite and fixed supply)?

    Reply

    WARREN MOSLER Reply:

    i’d call that an asset tax on those specific notes, if i’m reading you correctly.

    and if they aren’t eligible for tax payment their value would be 0

    Reply

    cig Reply:

    @WARREN MOSLER, yes it is an asset tax from a macro viewpoint, but the main point I wanted to make is that if they don’t go to zero on the day they stop being accepted by the ECB/government, then your theory that money is exclusively given its value through its role as a tax voucher may need to be nuanced.

    Given the fixed supply, existing practices, and the force of convenience, I’d expect the value on the unofficial market to take years to decline rather than instantly go to zero.

    (It’s not as such a euro point, I’d expect the same would happen on withdrawal of any high denomination note being widely used in the unofficial economy, e.g. the US $100 note. The euro example is just a bit more interesting as the top notes are more dominated by unofficial use than the $100 note is.)

    Reply

    WARREN MOSLER Reply:

    all the national currencies went to 0 when the national govs switched to taxing in euro

    the only way you could get value for them was via those national govs exchanging them for euro.

    Neil Wilson Reply:

    Warren,

    Did the pre-existing currencies exchange for the Euro, or did they convert to the Euro?

    That’s an important distinction isn’t it?

    The national currencies continue to have value because of the conversion mechanism into a currency that has a tax driven pump running in it.

    It’s like being able to take an old £5 note to the Bank of England and have it converted into a new style one. The old one is destroyed and a new fiver is handed over.

    And of course as those old coins and notes become rare they stop being tokens and start having intrinsic value as collector’s items. They become assets in their own right.

    You can see where the confusion comes from.

    WARREN MOSLER Reply:

    i don’t think old lira notes, for example, are still convertible?

    and, to the point, if the italian govt. won’t convert them for euro, no one else will either

    but yes, there may be collector value

    Neil Wilson Reply:

    Yes you still can, and its the same process as an obsolete Bank of England note.

    You have to go to the particular central bank and get them to swap it for you.

    After all its just a receipt for their liabilities…

    Jacob Goense Reply:

    @cig,

    In essence the value of a fiat currency is 0 when the tax pump stops.

    Of course there is a lot of nuance left out here. As long as eg. banks for whatever reason insist on euro mortgages being settled in euros and get the judiciary to agree there will be a euro trinket circus kept alive. As in `pay me these worthless trinkets or we will auction off your house to whoever bids the most worthless trinkets’.

    One of the reasons the BitCoin has some value despite it not being taxed in is its scarcity. Euro M3 minus euro M1 being greater than euro M1 alone the euro some scarcity in case everyone insists on settlement of debts.

    What happens to net ECB assets is overlooked, in theory it could be used to give chartal/giral euros some tiny intrisic value, in practice it will we robbed clean by governments and member central banks. If the ECB stays true to its mandate (price stability, at infinity in this case) they could offer everyone as many giral euros as they want and end any trinket circuses quickly.

    @WARREN MOSLERi don’t think old lira notes, for example, are still convertible?

    It is different for every country. Historically Dutch guilder notes can be converted at the Dutch central bank for 30 years after they go out of circulation. Providing you did not obtain the guilders by business activity after 27th januari 2002 you can still convert them to euros. They have value when you grandma has some hidden in her mattress and take them to the DNB, they become worthless when you do transactions with them. Here is a nice overview.
    http://www.dnb.nl/betalingsverkeer/guldens-inwisselen/overzicht-in-te-wisselen-biljetten/index.jsp
    Most are convertible until 2032.

    WARREN MOSLER Reply:

    how’s the value of a bit coin doing?
    seen the history of it’s conversion value?
    total outstanding?
    doesn’t seem like you could spend/convert them in any size?

    once nations all leave the euro it means their new currency will be ‘legal tender’ in the sense that court judgments will be discharged in the new local currency.

    So if you owe a million euro the court will order you to pay the value in lira, marks, etc. depending on where you reside, and that payment will be at current conversion
    rates which will likely be 0

    Neil Wilson Reply:

    @cig,

    “One of the reasons the BitCoin has some value despite it not being taxed in is its scarcity. ”

    Not sure that’s the case at all. The BitCoin has value because a group of people have decided to incur debts denominated in it.

    And that’s the key. People are voluntarily incurring debts in it, which means that it will have value until those people refuse to incur debts denominated in it.

    They want this to work because they believe in anarcho-crypto-currency. So it has value and will circulate amongst those individuals.

    But because those debts are voluntary, the slightest wobble in the system and the currency will drop to zero. It is very easy to repudiate. Faith is a fragile flower.

    Whereas as a state currency has vast legal power at its disposal to unilaterally impose debts on people in a third party liability, and enforce them. Which means repudiation of that currency requires the destruction of the state’s coercion mechanisms or appalling bad management of them.

    Neil Wilson Reply:

    @WARREN MOSLER,

    Bit coins are limited to a fixed number – 21 million I think.

    So the question then is whether they are a currency, or more like works of art from a painter that has died (or perhaps more accurately near the end of their life).

    I could write up a debt contract to be settled in the works of Picasso, but does that make the works of Picasso a currency?

    Reply

    Jacob Goense Reply:

    how’s the value of a bit coin doing?
    seen the history of it’s conversion value?
    total outstanding?
    doesn’t seem like you could spend/convert them in any size?

    The bitcoin is consistently trading above 0. Just like the current euro and dollar they are not convertible. IIRC about 8/21th of mineable bitcoins are out there with a mtm value of around 40mln USD total.


    once nations all leave the euro it means their new currency will be ‘legal tender’ in the sense that court judgments will be discharged in the new local currency.

    So if you owe a million euro the court will order you to pay the value in lira, marks, etc. depending on where you reside, and that payment will be at current conversion
    rates which will likely be 0

    This does not happen by the governments just starting to tax in their own currencies. Unlike under English common law legal systems under Dutch German and French contract law the demand for a specific performance is the primary remedy. The principle of pacta sunt servanda. As long as the system (TARGET2, exchanges, accounts etc.) keep functioning the judiciary has nothing on the books to resort to remedies like damages in tax currency du jour or even termination instead of the primary remedy.

    Comparing the size of euro M1 to the size of M3 and the OTC derivatives markets it will take a few more tricks than just quitting taxation to drive the conversion rate to 0 fast.

    The added tricks to get the lira and other currencies to 0 was a forced conversion by law at fixed rates combined with a 100% devaluation of chartal money used in transactions after a certain date. Unused liras could be swapped for euros till the first of march this year btw. The paper DM has no end date afaik and is still a value store useless in trade other than with the German central bank.

    Reply

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