In this interview James Galbraith explains our Modest Proposal for Resolving the Euro Crisis, argues that the Eurozone’s dismantling is a bad idea, discusses money and debt (in the context of Modern Money Theory) and, finally, comments on current developments in the US social economy. The interview was conducted by Roger Strassburg
RS: So you had a fairly good conference at the beginning of the month – referring to the Eurozone Conference at the LBJ School of Public Affairs, at the University of Texas at Austin
JG: It was excellent. It was a very intense and lively event with a lot of serious contributions.
RS: It seemed to me that Heiner Flassbeck made it fairly clear that it’s going to be very difficult to come up with a way to convince Germany to buy into any solution.
JG: That is a difficulty. However, the first path of people in our situation is to help frame what the proposal would be, and to make it as airtight and plausible as we can.
RS: Would you care to describe that proposal again?
JG: The Modest Proposal has by now gone through several iterations. It was originally co-authored by Yanis Varoufakis and Stuart Holland, and I’m now a co-author. It lays out steps that should be taken within the framework of existing European treaties to deal with the major issues that are threatening the euro zone, and those are, first of all, the question of the sovereign debt, secondly the question of the banks, thirdly the need to get a round of investment going, particularly in the European periphery and fourthly, the need to deal with immediate human needs and humanitarian crises in certain parts of the euro zone.
On debt our proposal is to have a bond issued by the European Central Bank. This is in line with established central bank practice and within the European Central Bank’s powers. That would lower the effective borrowing costs facing any of the peripheral countries on the Maastricht-compliant portion of their debt.
RS: The ECB issuing a bond, does that mean the ECB actually borrows money?
JG: Sure. And uses the proceeds to service the part of member-states’ bonds that they were allowed to have under the Maastricht Treaty. The member-states then undertake to redeem, in full, the ECB bonds upon their maturity.
So that’s point number one.
Point number two is that the banks should be dealt with – not by waiting for the banking union, which is a little bit of a mirage – but on a case-by-case basis, using European institutions to deal with insolvent banks in parts of the periphery and to break the link between those banks and their governments, a toxic link that is creating an oligarchy of kleptocrats in Greece and elsewhere.
The third piece is to enable the European Investment Bank to act on some of the plans and resources which it already has – but which it cannot use in the current conditions because recipient countries can’t meet matching fund requirements.
The fourth is a solidarity fund. This would deal particularly with food needs and some other issues like unemployment insurance, necessary to give the most stressed populations in the Eurozone a sense that the European Union is acting to address their most urgent needs. That would stabilize incomes to those people and their regions, helping to stabilize the larger economic situation.
RS: These are direct transfer payments you’re talking about.
RS: What do you think in terms of the debt? Are they going to have to forgive some of that debt? Is there going to have to be a haircut?
JG: No, I don’t think that our proposal demands a haircut on the debt. It would, of course, lower the borrowing costs. That’s because you would be putting it through an institution that has a low borrowing cost. So it’s no more than a rolling over of debts which are largely already held by the major European institutions. In the case of Greece, most of the public debt is in public hands.
RS: That sounds a lot like the euro bond proposal.
JG: It’s got some differences with the eurobond proposal in that it doesn’t have this joint-and-several guarantee feature. The point is to do something that is within the framework of the existing European charter, but that does not require of Germany to guarantee anyone’s debt and does not come with the kind of financial fragility that some of the other proposals would bring.
RS: How is it going to be secure without the joint-and-several feature?
JG: The bonds would be a European Central Bank liability. And each country would pay their share of the interest required, on a super-senior basis. Moreover, the ESM could guarantee this payment scheme so that the European Central Bank is certain never to be out of pocket – which then solidifies its creditworthiness.
RS: So it is a financing through the ECB, but it’s just getting around it by buying a bond first.
JG: Right. But do note that the ECB does not print a cent in the process. It just acts as a go-between money markets and member-states
RS: The ECB isn’t allowed to directly buy bonds from individual countries.
JG: That’s right. But in our scheme it won’t have to. It will be issuing bonds, not buying them! Besides, the Greek debt is already in public hands to a large extent while the ECB’s OMT program is based on a promise to buy bonds – something the Modest Proposal does not need.
RS: Do you think Greece is ever going to be able to pay its debt back?
JG: No, of course not, not on the present terms. That’s the whole point of the proposal, to create a situation where you’re at least closer to debt-sustainability than you are now.
RS: What do you think about – there’s been some different opinions on this – if push comes to shove, of having countries actually exit the euro zone. Heiner Flassbeck has actually written a while back that – though he doesn’t think it’s a good idea – he’s beginning to think that that may be the lesser of all evils.
JG: We are not in favor of a euro zone exit strategy on the part of any peripheral country. The costs of that are very high and the populations of the Mediterranean countries are still strongly opposed to it.
RS: The creditors are undoubtedly going to lose on that. If they exit, they’re not going to pay the debt.
JG: Right. The problem is the disorderly nature of a breakup of the euro zone. The question of whose currency your liabilities would be denominated in is immediately posed. How do you maintain ordinary commerce when the Greek automobile distributor wishes to pay BMW in Drachmas and BMW wishes to be paid in euros? These things tend to be very messy and they can go on for a long time. They can have very severe consequences for the financial viability of private businesses. So that’s not an outcome that anybody should be cavalier about.
RS: What about the possibility of Germany exiting (which I don’t think would happen, either)?
JG: That is easier to imagine because German commercial interests are generally creditors rather than debtors, and so they would be accepting to be paid in the debtors’ issue, which would presumably be the euro, but devalued. That would mean that the debts would be easier to pay; on the other hand, they’d be worth less to the creditors. It’s easier to imagine that being non-disruptive from a legal point of view. However, I can’t imagine that German manufacturing interests would be very attracted to the idea of having their receivables depreciate.
RS: No, it doesn’t seem very logical, though some businessmen are a part of the AfD, which I think you’re familiar with by now.
JG: Yes, and depending on what the disposition of your assets and liabilities is, it might be to your advantage. If your holdings are overwhelmingly in the appreciating currency, I can see why you’d place a political bet on that outcome.
RS: It might be okay for domestic business.
JG: That’s right, sure.
RS: That, in fact, would probably help them because it would appreciate the currency.
JG: They may be looking down the road and be prepared to take some losses on their euro receivables in order to get the advantage of being in a rising currency later on.
RS: Where is the debt, actually? I’ve gotten the impression here that the Greek debt, for example, that was held by banks by the time of the haircut was essentially in the hands of European countries.
JG: That’s correct. That’s my understanding, as well. A small amount is in the hands of the private sector and that amount can be paid.
RS: It isn’t just government debt we’re talking about here, of course. We have business debt, which of course would suddenly be a problem if, for example, a peripheral country were to exit.
JG: Yes. That is what I’m most concerned with.
RS: They’d be immediately out of business.
JG: Many would be. The government can negotiate down or even default on its obligations once they’re in a foreign currency, but private business becomes very disrupted.
RS: It would help them, of course, if Germany left and their debts were still in euros. That would be a different matter.
RS: I wanted to talk a little bit about debt on the other side of the pond, too. It’s been a big topic lately, as we all know, going through the shutdown last month and the repeating showdown on the debt limit and all of that. Where do think that stands right now? Do you think that there’s any possibility that we’re going to see a reasonable agreement being reached by the time this comes up again?
JG: The kind of agreement that might be reached would not be reasonable, but I think the good news is that it will not happen. We have moved quickly beyond this to the Obamacare fiasco. The so-called debt issues are off the radar screen at the moment. My feeling is that the terms on which they were resolved in this last go-around will be the terms on which they will be in the next one, because basic principles were conceded by all sides, that nobody is going to press the United States to a disruption in the Treasury’s legal authority to make payments, and I suspect that the reason for that is that nobody knows exactly – and not even the Treasury – what they would do under those circumstances. The Federal Reserve was still trying to figure it out as they got close to the date what they would do. The Republicans did not have the votes to press that issue, and if they didn’t have the votes in September, they’re not going to have them in February, either. So my view is that’s that, for the time being, on this question. We may have another ginned-up drama for the entertainment of the population, but the outcome is no longer in doubt.
RS: How much damage do you think there was from the shutdown?
JG: To overall growth, the Council of Economic Advisors has made some estimates. I imagine that they are honest estimates, and they do identify some specific level of damage due to the fact that there was some curtailment of public spending as a result of this. That’s now being made up, so now we’ll see a bounce back in the data. However the sequester goes on, with depressing effect.
RS: You’ve recently stated that a country doesn’t actually have to borrow money to pay its bills. If I understood you correctly, it just tells a bank to credit your account.
JG: Technically when a country wishes to make a payment, the Treasury just sends a signal to your bank to credit your account, and money is created. The act of so-called borrowing that happens is because the bank then has a free reserve upon which it would prefer to earn interest. So the Treasury kindly makes available a bond that converts that cash at zero interest into an asset that is earning a little more than that. That’s the transaction. The Treasury in making its payment does not consult anybody as to whether there is enough cash to do so. It doesn’t need cash, it just consults whether it has an authorization or an order to make the payment, and it makes it. End of story.
RS: So you’re saying that the Treasury actually creates money.
JG: Well of course it does.
RS: Then it raises the question of why we get into this mess.
JG: Well, this was not always the case, and it’s not always the case for all governments. Back in the days of the gold standard, the Treasury issued bonds, brought in revenues and then spent them, incurring big interest charges along the way. But that’s not the way the greenbacks worked, and not the way an electronic banking system works. Causality, or at least the time sequence, is reversed these days. The Treasury makes a payment on an authorization, and then the money is there, which it can then issue a bond, if you like, to sop it up.
RS: But the bond is essentially borrowed money, isn’t it?
JG: Technically, it’s a debt, sure. But suppose the Treasury did not issue a bond. The free reserve would be sitting in the banking system. Suppose the Treasury, having issued the bond, finds that the Federal Reserve buys it back. Now the bond is sitting in the Federal Reserve, the Treasury owes interest to the Fed, which then returns the payment to the Treasury in a nice act of round-tripping. And the banking system has cash. So the debt, in the formal sense of what is public debt is not in the hands of the public any more. It’s in the hands of the Federal Reserve, and the public has cash.
RS: Debt to the Federal Reserve counts to the debt ceiling, doesn’t it?
JG: It does legally count against the debt ceiling. But it is debt that the government owes to itself. It has no economic impact at all, and in fact no financial impact on the Treasury because of this round-tripping feature. The Treasury makes payment to the Federal Reserve, the Federal Reserve then uses that for its operating expenses, which are some fraction of the interest earnings, and returns the rest of it to the Treasury on a line called surplus.
RS: Does debt that the government owes itself, I’m talking about real internal debt. Debt to the Social Security system, for example, is a big part of it. Does that count as part of the indebtedness towards the debt limit?
JG: That’s a good question. I believe it does, but I’d have to check that as a matter of law.
RS: That seems odd, but of course on the other hand the debt is there because it is a future liability to Social Security that has been loaned.
JG: This is just a question of what the Congress in its wisdom in 1917 defined as the debt of the United States and how that is applied. It’s not designed to have any particular economic effect.
RS: We’re getting a little bit into the school of MMT. Do you consider yourself part of that school of thought?
JG: Well, the MMT group is a group younger than myself with a certain amount of coherence that has done a lot of work explaining how the monetary system works. I’m not a contributing member of the group, but I’m friendly to it.
RS: It’s been fairly controversial among liberal economists who are really not that friendly toward MMT. As I understand MMT, it is basically that the government doesn’t need to borrow money, it doesn’t need to tax. Is that correct?
JG: No, that’s not correct. The government certainly needs to tax. The purpose of taxation is to control the total level of demand. It’s very important to do so. If you spend without taxing, then you have no reason to want to hold on to the money. And if you don’t want to hold on to the money, but are constantly dumping it in favor of assets, then the value of the money collapses, so taxation is essential.
But the purpose of taxation is not to raise money in order that the government can spend it. Those two activities, though both essential, are quite disconnected.
RS: So MMT basically is that the government wouldn’t need to tax in order to fund its activities.
JG: That is just a description of how monetary systems operate. Spending is done by crediting accounts, and taxing is done by debiting accounts.