Mosler Bonds: Isolate Default Cost to the Defaulter - Prevent Default

September 29th, 2011
in Op Ed

by Warren Mosler

greekruins-2 The proposal is simple: The ECB should turn the bonds it buys into Mosler bonds, which provide the feature requiring the government 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 government of issue.

With the ECB holding Mosler bonds the default option will shift from the issuer to the ECB,as in the case of non payment, andthe ECB would have the option to make it's holdings available for sale to tax payers of that nation.  This would allow taxpayers to offset their taxes.  Therefore, conversion to Mosler bonds will ensure that the ECB's holdings of national government debt are 'money good' without regard to external credit ratings, and give the ECB control over the default process.

Follow up:

This process makes sense because (from the EU's point of view) 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.  Finally, funding Greece facilitates the purchase of German exports to Greece.

Funding Greece in this manner 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.  Austerity is a built in feature of the Mosler bond construction.

That means Greek taxes will be approximately equal to Greek government expenditures, not including interest, which will then be largely payments to the ECB.  Thus, if default is not allowed, the Greek government 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, as currently presumed, 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 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, however, 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.

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About the Author

Warren Mosler is co-founder and Distinguished Research Associate of The Center for Full Employment And Price Stability at the University of Missouri in Kansas City. CFEPS has supported economic research projects and graduate students at UMKC, the London School of Economics, the New School in NYC, Harvard University, and the University of Newcastle, Australia. He is Associate Fellow, University of Newcastle, Australia.

Warren is the founder and principal AVM, L.P., a broker/dealer that provides advanced financial services to large institutional accounts. He is also founder and principal of Illinois Income Investors (III), specializing in fixed income investment strategies for 29 years. He is presently located in the U.S. Virgin Islands where he heads Valance Co, Inc., the corporation that owns the shares of III Offshore Advisors and III Advisors, the companies that manage AVM and III.

Warren has a degree in economics from the University of Connecticut. He has 38 years of experience in a variety of fixed income markets, including derivatives. He writes at his blog and widely in the press and blogosphere. Warren is considered to be the founder of Modern Monetary Theory (MMT). You can read a longer bio here.

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