Monthly Archives: December 2011

When talking about the future weight of pensions as part of state debt and sustainability issues, commentators often proceed with a flawed methodology. They discount future “liabilities” based, broadly, on the following factors, assumed to be constant:

  1. pension rights of current pensioners or people who are now becoming pensioners
  2. population trends (ratio of pensioners to workers, population growth)

This is deeply flawed. There is no reason to think that current pension regimes will remain set in stone forever. Pension “rights” change all the time, indeed if you compare your pension projections based on the state of affairs a couple of years ago with that of today, it’s probably already markedly different, and so for most people in the developed world, and so one can imagine how much it can change on time scales of several decades.

When the entity we’re looking at the liability of is a state, they both pay and make the rules. Sometimes pension rules are enshrined in constitutions which some people say make them unassailable. This is silly: first constitutions can be changed, it just typically takes a broader political consensus to do so, and secondly, it is always possible to work around monetary rules given the flexibility of financial arrangements. If I’m finance minister in a country or region whose constitution says I must pay you 1000 per period as a pension, but I really want to give you 800, I just create a tax or remove a service somewhere else worth 200 that touches you (exactly or by proxy people like you, with a bit of collateral damage) so that you get 1000 nominally but 800 net.

The very idea of pension “rights” is misleading, when projected to the distant future. States make promises they may or may not realise. Politics is about reconciling expectations and reality somewhere in the realm of the possible, and by nature successful politicians tend to be those with ambitions some way ahead of achievable reality. In fact, there’s no such things as formal future pension rights in most jurisdictions, there’s just current rules that apply if you retire now or are currently retired. What you’ll get as a future retiree is similarly open ended as the law is on every over topic (the status of any activity that is currently outlawed, or encouraged by law, may change in the future).

Where this applies is for private entities which are not directly lawmakers (ignoring for a moment that a few large domestic companies with a pension problem could successfully lobby for the law to be changed), but there there is no “problem” to speak of even there. If a private corporation has pension liabilities which become unmanageable with regard to the current size of the business, it goes through a bankruptcy restructuring where incumbent shareholders, and possibly bondholders, are wiped out and the leftovers given to the pensioners, as was done with GM in the US. If there’s not enough leftovers, tough luck, pensioners are just creditors higher up in the pecking order. This sort of liability is not a systemic problem, it just may be unwise to invest in a company with a large legacy pension issue.

The issue is even easier to manage given that the elderly tend to be a compliant lot. Hard to go rioting when you can barely move. So they are unlikely to prove hard negotiators. They merely might end up bitter, if they had expectations above what can be practically realised. And even then, it could be that fancy pension expectations are really a one-off phenomenon that may not survive the passing of the baby boomer generation.

Point (2) is perhaps less controversial, but depends on so many factors that it’s hard to predict reliably, projecting current trends to the future is a gross approximation at best.

A better way to think about pension liabilities is to treat them like any other public service. Every budget cycle, a government raises money from the citizenry (via taxes or seigniorage)  and allocates the proceeds to its social programme, e.g. schools, roads, fire engines, etc. Allocating some money to old people is part of this, and the amount old people get will always, ultimately, be the result of political bargaining with the other claimants for a given amount of resources available.

It is not possible for old people’s share to detach from reality. In absolute terms, they can get no more than the entire cake, and practically the slice of the cake they can get is the result of a political process, the intersection of what they want and what other stakeholders will be prepared to give them.

Even if somehow pensioners or pro-pensioners were to take control of politics, and award a disproportionate share of the polity’s resources to pensioners, the society in question would collapse as non-pensioners would have a strong incentive to move away to less taxing places. For instance, if a US federal state was to be markedly more generous than its neighbours with its pensioners and fund it by raising punitive taxes or providing exceptionally poor services on working citizens, they would be very likely to move to neighbouring states to escape this burden, leaving the state with only pensioners. This vicious cycle is obvious enough that the state would have to reverse course long before the last worker has left.

The issue can also be understood by trying to define the limits of states’ liabilities: if we were to accept treating public support for old people as a discounted liability, why don’t we discount everything else the state does and is expected to keep doing in the future? Many people who have young children “expect” state schools to be there until the kids are grown up. People expect roads to be maintained in the future, etc. Basically we could discount more or less the entire public expenditure as a perennial liability. This would make for entertainingly large numbers, but provide no useful insight whatsoever.


Warren Mosler tries to guess how a typical eurozone banker might react to the call to buy their own country debt and seems to go with the usual mental picture people have of a market, that of a crowd of anonymous agents each operating more or less rationally in a large system they don’t control.

The thing is the banking sector is highly concentrated, and even more so within the eurozone if you consider the tight links between each country’s government and its locally registered bankers. Each eurozone country has three or four, or fewer for smaller countries, systemically important major banks, so it’s a very small “market” indeed. The elites of European countries tend to be tightly knit and most people within the top of the political and business trees know each other, having navigated within the same circles and been educated in a handful of institutions. The social rules of such a network are more likely to be like that of a village than that of an anonymous modern city.

To give an illustration, here’s a picture of a vehicle large enough to hold all the important decision makers on the Italian sovereign bond market, that is: the Italian prime minister, the heads of Unicredito and Intesa Sanpaolo. There’s a spare seat for a representative of the minor banks, if they care to invite one.

The market for Italian sovereign bonds fits therein

This is true of the whole eurozone, each major country has two to four systemic banks, and the minor countries fewer. About 20 banks are 95%+ of the banking sector. So the entire market for eurozone sovereign debt would fit in such a vehicle:

A spacious transport for all the decision makers in the eurozone sovereign debt market

Besides, to some extend it could be said that in highly regulated environments, systemically important banks are more akin to joint ventures between their government and the private shareholders than truly independent institutions (the government sets operational parameters via regulation and guarantees deposits, the private sector provide capital and oversees managers) even if governments have been reluctant to use their power explicitly in recent times. Now that most banks are weak and have a low market capitalisation by historical standards, a systemic role, and an angry public opinion, it would be relatively cheap, and politically expedient, to take an actual controlling share and nationalise them.

So it is likely that most heads of banks will above all want to keep their job and maintain the formal private sector status of their institution, which is well away from what the manager of a non-systemic hedge fund would do.

On a foreign adventure on the shores of macroecomonics, the Psy-Fi blogger  is telling us that the German trade surplus with Greece is a transfer of wealth from Greece to Germany.

If we look back at operational flows it seems to be a bit debatable:

  • A car is manufactured in Wolfsburg
  • At the end of the process, there is +1 car on the car park outside the factory, Germany is wealthier: it has one more car
  • The car is exported to Greece: there’s -1 car in Germany and +1 car in Greece

So, a car has been moved from Germany to Greece, and it’s Germany that’s getting wealthier? Of course, one could argue that euros have flown back the other way. This is correct, but that’s just a ledger entry in a digital account book somewhere. But what is a ledger entry useful for? You can’t eat, ride, or fuck a ledger entry. This ledger entry is a token for future wealth, it’s a claim on future Greek work or assets, but it will become real wealth only if the claim is ever effected, and transformed from a ledger entry into wealth and claimed back by the Germans who made the original car or their proxies.

Will they ever do so, and if so will they do it in a way that they get something that’s worth at least as much as the car, plus a reasonable compensation for the time value?

That’s doubtful. People who run surpluses tend to get short changed, because they’re exposed to their debtors failing to deliver their promise of future work or assets on the appropriate scale. Even ignoring the fact that states can use various tricks to escape paying back debt, any debtor can choose to remain poor to avoid paying back debt (it is the rational behaviour in the face of a debt mountain commensurate with or higher than their expected lifetime productivity), or being stuck there through mere bad luck.

Will the Chinese ever get back what the trade surplus they are having with the rest of the world is worth in actual goods and services? Probably not in the lifetime of any Chinese alive today. They shouldn’t run a surplus in the first place, and rather buy at least approximately as much stuff as they export and enjoy it or use it for further development. For a deficit country, the bargain is reversed: it gets real wealth in exchange of mythical future wealth.

On a tangent, we’re also told:

German industry offers high quality products of superb design at fiercely competitive prices. The country is modern, efficient, possessed of wonderful communication links and a superb technical education system. Its government bureaucracy is staffed by intelligent and incorruptible officials who believe that serving their country is the highest duty.

It makes you wonder if our correspondent has ever been to Germany. The country is doing OK, but there’s plenty of inefficiencies to be observed just walking around the place. Bureaucracy might be less corruptible than elsewhere but it’s also quite rigid, which can be fair but counterproductive, there’s so much you can do with formal rules, however intelligent and well meaning, and administering a rule system is always a cost. The education system is not doing too well either, being middling in most international rankings, and rightly so. Germany’s current comfortable position is at least in part due to fortunate headwinds that may not last: due to an effective internal devaluation within the eurozone (tight salaries, no minimum wage) which may not last to the same extent as German workers may at some point claim their dues; the efficient export industries are probably at most a quarter of the economy, and very sensitive to a global slowdown. In the long term it’s also sensitive to other technical countries reducing the competitive gap.

Everybody is having a proposal to solve the eurozone crisis, so I can as well come up with one, for fear of being left out, with apologies to Yanis Varoufakis for the title.

Executive summary:

  • Do an Iceland.

In more details, this would entail a programme like:

  1. Organise panic: the eurozone governments would announce, on a Sunday, that they are thinking of defaulting in a major way. It could be, say, a major Italian default, or perhaps announcing every member state with debt above the Maastricht criteria will default by what it takes to take them back within (60% of GDP, etc). The announcement is just about discussions, no decision is actually taken, but it has to be a credible threat. The aim of the proposal is to take at least one major eurozone bank close to insolvency.
  2. The consequence of the previous point should be that on the Monday market opening prices for bank shares collapse, as fears of contagion from one bank insolvency to another spread. The eurozone banking sector is currently worth approximately 300 billion euros, this should take it down to below 100, hopefully lower.
  3. On Monday evening, or whenever the panic has suitably set in, nationalise the eurozone banking sector (either the top 20 that covers 95% of the sector, or all licensed banks if need be, the small players are a sideshow anyway), paying private shareholders the now collapsed market price for their shares, aka peanuts. At the end of the day, all eurozone banks are now technically subsidiaries of a eurozone-wide quango (the EFSF or the EIB could be repurposed to fill this function). This eliminates any problem on the interbank markets as it is effectively abolished: there’s only 1 bank, let’s call it the EuroBank, whose internal netting can be coordinated.
  4. Split the EuroBank into two: new banks operating deposits and other payment processing type functions, by slicing out the narrow banks out of the former universal banks. Put all the rest in a “bad bank”. All the banks’ assets and liabilities not necessary in the narrow banks are there, as well as much sovereign bonds as possible.
  5. We end up with a bad bank that has assets like the worst eurozone govies, and liabilities such as the former banks corporate bonds, among others. The eurozone govies are then revalued down by what it takes to take the eurozone debt down to sustainable levels. Eurozone member state debt not held by the bad EuroBank does not default. Then comes the good bit: the bad EuroBank is now insolvent and can default on its own liabilities like corporate bonds, ETNs, commercial paper, etc. If it can’t be done within the current legal framework, pass emergency bank insolvency legislation, which should be doable quickly at the member state level without EU treaty changes.
  6. Clean up: progressively sell remaining valuable assets of the bad banks, like investment banking, preferably to operators outside the eurozone, so that the next investment banking disaster is someone else’s problem. A proportion of the junk could be sold to the UK, for instance, using a carefully spin on the “jobs for the City” idea. Narrow banks are also later re-privatised, under new regulations preventing them from becoming universal again.

So, the core idea is that the eurozone does reduce debt by defaulting, but not by defaulting on its own bonds owned by the public (non-eurozone government entities), but by having nationalised eurozone banks default on their corporate bonds and other emissions. Basically, by nationalising its banks at a bargain basement price, the eurozone buys back its own debt at a tremendous discount and then defaults on secondary obligations that are not so intensely systemic, even if the process is likely to be quite agitated. Incidentally, CDS on sovereigns shouldn’t even be triggered; CDS on eurozone banks will, and that’s OK.

And at the same time the process can be used to wipe out and restructure a parasitic sector, by extracting back the useful functions and closing down or selling away the harmful ones.

It may be argued that the process, a massive private banks default, will cause seismic waves with non-eurozone operators who own enough eurozone bank debt to take them down. So be it. At worse, other countries just have to do the same process, and nationalise their own banking sectors. We can, in a couple of weeks, get rid of the dominant character of a toxic industry that has resisted reform for more than three years after it caused a major crisis at great public cost. What is not to like about this?

The Streetwise Professor asserts that German plans for fiscal discipline in the eurozone via financial sanctions can’t work. He’s totally right if they’re implemented via fines: if some entity goes broke, trying to get them to pay fines on top of their existing debt mountain obviously won’t work. But in a group you can allocate blame positively: reward the good guys. For instance, when distributing the proceed of say eurobonds, you simply overweight the good members. So, for instance, you flood Estonia with money to compensate for the Greek economy going down. As long as they manage to spend it, zone balance can be maintained, rewarding good past behaviour in the process. It’s  operationally practical because it doesn’t involve taking something by force from someone who doesn’t have it, but redistributing something you do have.

It would be even easier in a MMT framework: if the Eurozone governments had most of their spending supplied by an ECB-set zonewide printed allocation, sized based on the inflation target each period; a fiscal authority could then adjust the weighting of how much of the allocation goes where based on merit.