Why Understanding Money Matters in Greece

By Robert W. Parenteau, CFA

As Greece staggers under the weight of a depression exceeding that of the 1930s in the US, it appears difficult to see a way forward from what is becoming increasingly a Ponzi financed, extend and pretend, “bailout” scheme. In fact, there are much more creative and effective ways to solve some of the macrofinancial dilemmas that Greece is facing, and without Greece having to exit the euro. But these solutions challenge many existing economic paradigms, including the concept of “money” itself.

At the Levy Economics Institute conference held in Athens in November 2013, I proposed tax anticipation notes, or “TANs”, as a way for Greece to exit austerity without having to exit the euro (see “Tax Anticipation Notes: A Timely Alternative Financing Instrument for Greece” published here last month, for an updated version of that policy proposal). This proposal is based on a deeper understanding of what money actually is, and the many roles that it plays in the economies we inhabit. In this regard, Abba Lerner captured the essence of modern fiat currencies, which are created out of thin air by modern states with sovereign currency arrangements. Lerner’s essential insight is contained in the following passage from over half a century ago (and, you will note, Lerner’s view informs much of the neo-chartalist view espoused by advocates of what is called Modern Monetary Theory):

“The modern state can make anything it chooses generally acceptable as money…It is true that a simple declaration that such and such is money will not do, even if backed by the most convincing constitutional evidence of the state’s absolute sovereignty. But if the state is willing to accept the proposed money in payment of taxes and other obligations to itself the trick is done.”

The modern state, then, imposes and enforces a tax liability on its citizens, and chooses that which is necessary to pay taxes. That means a state with a sovereign currency is never revenue constrained. In fact, the government has to first create the money before the private sector can find a way to get the money it requires to pay taxes and by government bonds. Taxes and bonds are therefore not really the source of government funding or finance. Wait, what?

The government itself ultimately is the source of money required to pay for government expenditures. Taxes simply give value to money, as households and nonbank firms cannot create money – that is counterfeiting.  Instead, they have to sell an asset or a product or a service to the government to get money, or they need to be beneficiaries of government corporate subsidy or household transfer programs to get money. 

It is in this context that one has to look at the TAN proposal.  It is important to note that the tax anticipation note is by design a debt issued by the government, just like any other bond. It is a debt instrument that could be returned by the TAN bondholder to the Treasury to settle tax payments due on a 1 TAN = 1 euro basis. By imparting a value to these TANs (i.e. letting them be used to extinguish national tax) this will ensure a natural source of demand for TANs. In addition, it is very likely that consenting adults in the Greek economy would be willing to use TANs in settling private transactions as well, and this is an important element if the TAN approach is going to provide a way out of fiscal austerity without requiring an exit from the euro.

Skeptical? Well, there are other historic examples of local currencies operating in parallel with national ones. As economist L. Randall Wray has noted, in Argentina as the financial crisis deepened after 2000, local governments began to issue “Patacones” (bonds with interest) as local currencies, paying workers and suppliers, and accepting them in tax payment. Utility companies began to accept them—knowing they could pay part of their taxes with them–and acceptance spread even to international corporations such as McDonald’s.

There are other historic examples closer to home, some of which might underline the irony of adopting this kind of approach in a “what is good for the goose, may be good for the gander” fashion.  None other than the self proclaimed “Old Wizard” Hjalmar Horace Greely Schacht – who was the Currency Commissioner of the Weimar Republic after the 1922-3 hyperinflation bust,  a President of the Reichsbank from 1924-30, and then again from 1933-39,  a highly placed executive at both  Dresdner and Danatbank , and Minister of Economics under Hitler in the 1930s, all of which is not bad for a guy named after an American newspaper editor – himself introduced the MEFO bills, which TANs bear some resemblance to, though TANs are constructed much more along neo-chartalist lines, with their value deriving from their use as a tax credit, which was definitely not the case with Schacht’s MEFO bills.

The Nuremburg trial transcripts described Schacht’s scheme as follows:

“Transactions in MEFO bills worked as follows: MEFO bills were drawn by armament contractors and accepted by a limited liability company called the Metallurgische Forschungsgesellschaft, m.b.H. (MEFO). This company was merely a dummy organization; it had a nominal capital of only one million Reichsmarks. MEFO bills ran for six months, but provision was made for extensions running consecutively for three months each. The drawer could present his MEFO bills to any German bank for discount at any time, and these banks, in turn, could rediscount the bills at the Reichsbank at any time within the last three months of their earliest maturity.”

German policymakers themselves, operating under financial constraints in the 1930’s, devised alternative government financing instruments, although Schacht’s MEFO scheme was clearly a shell game relying on the complicity of the central bank, and that is not how TANs work at all. 

For less extreme examples in the decade before Schacht, it is worth noting that the US had at least 5 forms of paper currency going at the same time in the 1920s – despite the concerns about hyperinflation generated by the horrifying Weimar experience in 1922-3.  These were used interchangeably and included:

1. Gold Certificates (redeemable in gold coin until FDR’s prohibition on private citizens holding gold)
2. Silver Certificates (redeemable for coin or bullion)
3. National Bank Notes (issued by US government chartered banks with equivalent face value of bonds deposited by bank at Treasury)
4. United States Notes (issued directly by Treasury and also called Legal Tender Notes, but with no “backing”)
5. Federal Reserve Notes (redeemable in gold on demand at Treasury or in gold or “lawful money” at any Federal Reserve Bank, until FDR’s prohibition, when it was just declared legal tender redeemable in lawful money at the Fed or Treasury).

Indeed, experiments with alternative financing instruments that can help bring economies back on line during monetary and financial crises are frequently cited by Austrian School economists, especially the Hayekian splinter group/wing that favors privatizing money. For example, clearinghouse certificates were created and spread during the Panic of 1907 and the Great Depression (see https://mises.org/library/economics-depression-scrip). So this adaptability of financing and monetary systems is much wider than we are led to believe, and it is not always government driven, which presents something for neo-chartalists to ponder.

Those who are not of a neo-chartalist persuasion might be skeptical of the claims that a 1 TAN for 1 euro exchange rate could be sustained.  Their argument centers on the fact that even if one imparted value to the tax anticipation notes by allowing them to be used to extinguish tax liabilities, TANs would still plummet in value relative to the euro and so wouldn’t do much in terms of boosting aggregate demand via their use in financing fiscal expenditures. 

Let’s consider that scenario in more detail for a moment. Say TANs plummet and start “trading” in private exchanges in Greece at 4 TANs to 1 euro or some such horrible disaster. Say you are a Greek citizen. You have tax arrears (as many do) and you hear Syriza has made tax compliance a high priority, and is required to do so by the Troika/Institutions if it is going to get any further loans from external official sources. Your tax arrears are equal to say one years’ worth of your salary. You will then use euros to buy discounted TANs and deliver them to the Treasury, who are obliged by law to accept tax payments in TANs at the prescribed 1 TAN= 1 euro. This gets you a huge effective tax deduction in the process – but one you had to earn by selling euros and buying TANs – thereby bidding up the price of TANs relative to euros.  If this is done over and over again by many citizens with tax arrears and tax payments forthcoming, whatever “depreciation” of TANs to euros has occurred will be essentially arbitraged out of the market.

As any Wall Street investor would realize, the only reason why one would not do that trade, all day, and every day, for oneself and all one’s relatives, would be if one believed that the “market maker”, the Treasury, would ever run out of its capacity or willingness to accept TANs as a means of settling tax payments, at 1 TAN= 1 euro. And recall that the market maker, in this case the Greek Treasury, has virtually unlimited authority to impose new taxes and raise existing tax rates, which directly influences the demand for TANs. Of course, there is a political constraint (recall tennis superstar Bjorn Borg threatening to emigrate from high tax Sweden in the 70s), and Greece has got to get its tax compliance dealt with properly before TANs can be implemented. But if that adjustment mechanism doesn’t do the trick, the Treasury can vary the proportion of government spending financed through TAN issuance, directly influencing the flow supply of TANs.

In other words, by design, there is a self-correcting mechanism through arbitrage that should keep the 1 TAN to 1 euro “exchange rate” in a pretty tight band, as long as it is clear that tax liabilities can and will be settled with the Treasury at a 1 TAN =  1 euro exchange rate. Anybody who works on Wall Street or the City would understand this self-correcting process.  After all, “arbs” on Wall Street scalp minuscule basis point discrepancies in various financing instruments at the speed of light these days in automated arbitrage programs and in high frequency trading. TANs have a built in self-correcting mechanism that works precisely in that same fashion.

As for the unusual hybrid structure of the TANs (as zero coupon, perpetual, bearer bonds) it is worth noting the following irony:  isn’t it peculiar how we marvel at, and handsomely reward, financial engineers on Wall Street when they create all kinds of debt instruments that get counted as equity (as an example, consider that perpetual bonds are ruled Tier 1 capital for banks under the Basel Accord rules), and all kinds of equity that look like debt? Or even better still, how we applaud the ingenuity of financial engineers when they stitch together such Frankenstein monsters as total return swaps, exchanging one set of returns on one asset for another set of returns, while never nominally changing the ownership of an asset (and remember, according to research by Jan Kregel, these types of instruments played a critical role in the 1997-8 Asian Crisis, as well as the more recent 2008 Financial Crisis).

Yet for some odd, unspeakable reason, we simultaneously refuse to entertain even the possibility of a similar level of creativity and hybridization to the realm of government finance.  Or we hand wave it away, declaring it dead on arrival, simply impossible, fraught with all sorts of inconceivably difficult complications, and bound to eventually lead to fiscal irresponsibility, outright misallocation of resources, and ultimately, the dreaded source of much hyperventilation at the Bundesbank in particular, the eruption of hyperinflation…even despite the fact more and more eurozone nations are sinking into outright price deflation (and others, like Greece, have suffered outright income deflation). 

This appears to be the case even with things we should know nations have done successfully before (like no less than five different currency types running side by side in the US in the ‘20s), but no one seems to remember, or at least no one bothers to mention this “verboten” subject.  Money matters in Greece. Understanding the nature of money, and designing financing instruments informed by that understanding, matters if we are going to find a practical and effective solution to Greece’s conundrum of trying to exit austerity without having to exit the euro. 

Ignorance, both of these essential financial principles, and of economic history, is no excuse for sadistically demanding the deepening of a humanitarian crisis, and thereby potentially creating a failed nation state, all in the name of pursuing what is called sound finance or fiscal responsibility, but upon saner reflection, is far from either of these things.  It is high time to drop the charade, and it is well past high time to solve the problem.

Rob Parenteau CFA, is sole proprietor of MacroStrategy Edge and a research associate of The Levy Economics Institute.