Beware Of Greeks Bearing Bonds

by: John Cochrane

Once again, the news is full of opinions that Greece might be forced to leave the Euro. Once again, it makes little sense to me. U.S. corporations, municipalities, and even states default, and do not have to leave the dollar zone as a result.

Most recently, the story goes, if Greek banks can't use their Greek government bonds as collateral with the ECB, the Greek government will have to leave the euro so it can print Drachmas to bail out the banks. There are of course many ways in which this makes little sense - if the bank has promised Euros, then a Drachma bailout does not stop a default. The government would have to pass a law "converting" euro deposits to Drachmas. But consider the story anyway.

Another common story right now: If Greece were to default, it would have a hard time borrowing to fund primary deficits. By leaving, it can print up Drachmas to pay bills.

OK, here's the obvious solution: Greece can print up small-denomination zero-coupon bearer bonds, essentially IOUs. They say "The Greek government will pay the bearer 1 euro on Jan 1 2016." Greece can roll them over annually, like other debt. Mostly, they would exist as electronic book entries in bank accounts, but Greece can print up physical notes too.

Who will buy? Most of Greece's spending is transfer payments, to pensioners, health care, government workers, and so on. Greece can pay all of these with IOUs. It can "recapitalize" or lend to banks with these.

Sure, they'll trade at a discount. Probably a hefty discount. If Greece accepted the IOUs at face value for tax payments, however, the discount might not be that large. Mostly, the discount would reflect risks that Greece either change its mind about accepting its own debt for tax payments, or that it would suspend the roll over, essentially defaulting on this new class of debt.

Yes, this proposal amounts to creating a separate or dual currency, while staying on the euro. That is exactly the point. Not only does a country in default not need to change currencies, in modern financial markets, a country doesn't even need the right to print money in order to, well, print money! Bonds are money these days. There's the Drachma conversion, devaluation and inflation so many commenters desire, can happen (the latter when promises are inevitably broken) all without leaving the Euro.

I gather California did something similar recently, paying bills with transferable IOUs and thus avoiding the prohibition on states printing money. Commenters let me know if you remember the details.

To be clear, I don't recommend this path! This is a theoretical possibility blog post, not an advice-to-Greece blog post (Advice remains, stop fooling around, massive structural reform tomorrow morning, grow like crazy, pay off debt). And yes, it would be a horrible fate for government workers and pensioners. However, maybe better than the alternative: "leaving the euro" means having bank accounts (what's left after the run) transformed to inconvertible drachmas, and being paid in drachmas, with the whole point is to inflate away the value of the same government claims. So promises for euros might be better. Who knows, maybe eventually the Germans and the IMF might pay these off too.

This works nicely as a matter of economics. If readers know what would stop Greece from doing it legally, I would be curious to know. Of course, "the Germans aren't that dumb" is one good answer, and such debt would count against the debt and deficit limits. But that doesn't really get at the question. The question is, do the legal restrictions against Greece printing money and spending it in the euro would stop Greece from printing up "debt" and paying bills directly with such debt rather than raising euros on capital markets? Opinions?