Prof.Richard Werner:Solutions for Greece-other than default, euro exit or giving up national sovereignty

Centre for Banking, Finance
& Sustainable Development Management School

Solutions for Greece
– other than default, euro-exit or giving up
national sovereignty

Richard A. Werner
Centre for Banking, Finance and Sustainable Development
University of Southampton Management School

Athens University of Economics and Business

Athens

24 January 2013

Richard A. Werner 2013


How did Greece get into trouble?

• We all know, it started by Greece giving up control over its
money and joining the euro
• Since then, the ECB has been making monetary policy in Greece.
• What sort of monetary policy did it pursue?
• What is the best way to measure monetary policy?
• What is money?

Richard A. Werner 2013 1


What is Money?

Textbooks and central banks do not tell us clearly:
 “It is much harder to measure than one would have first thought.” (p. 119)
Chamberlin and Yueh (2006)
 “Although there is widespread agreement among economists that money
is important, they have never agreed on how to define and how to
measure money” (Miller and Van Hoose, 2004:42)
 Today, even the Federal Reserve cannot tell us just what money is:
“there is still no definitive answer in terms of all its final uses
to the question: What is money?”



What is the Role of Banks?

Textbook View of Banks as Financial Intermediaries

RR = 1%

Saving Banks Investment
& other financial
intermediaries
(Lenders, = “indirect finance” (Borrowers)
Depositors)

Purchase of Newly Issued Debt/Equity
= “direct finance”/disintermediation

Thus when the financial crisis hit, the leading economics models and
theories did not include banks as they were not considered
important or special.
3


What Makes Banks Special?

But empirically, it had been found that banks are special!
Their function cannot be easily replaced by other financial players or markets.
- Fama (1985) shows that banks must have monopoly power
compared to other financial institutions.
- Ashcraft (2005) shows that the closure of small regional banks
significantly hurts the local economy.
But economic theory could not explain why.

Here is why.



Where Does Money Come From?
 Over 80% of the population thinks that it comes from the central bank
or the government.
 No money comes from the government.
 Only about 3% of the money supply comes from the central bank.
 Who creates the remaining 97% of our money supply and who allocates
this money?

The ‘leading’ economic journals and textbooks are silent on this.

Answer: The banks
 They are not financial intermediaries but the main creators of money.
They have a license to create money out of nothing.



Banks Do Not Lend Money
Balance Sheet of Bank A

Step 1 Deposit of $100 by customer at Bank A
Assets Liabilities

$100

Step 2 $100 used to increase the reserve of Bank A
Assets Liabilities

$100 $100

6


Banks Do Not Lend Money, They Create it!
Step 3 Loan of $9,900 granted, by crediting borrower’s bank account. Where do
the £9,900 come from? From nowhere. The borrower is treated as if
she/he or the bank had actually deposited the money, but no money
was deposited or transferred from anywhere else.

Assets Liabilities

$100 $100 NB: No money is
+ + transferred from
$9,900 $9,900 elsewhere

There is no such thing as a ‘bank loan‘.
Banks create money through ‘credit creation‘.
This is how 97% of the money supply is created.
7


Bank Credit Creation: Not in Economics Textbooks,
but Admitted by Central Banks:

“The actual process of money creation takes place primarily in banks.”
(Federal Reserve Bank of Chicago, 1961, p. 3);

“By far the largest role in creating broad money is played by the banking sector
... When banks make loans they create additional deposits for those that have
borrowed.” (Bank of England, 2007)

“Over time… Banknotes and commercial bank money became fully
interchangeable payment media that customers could use according to their
needs” (ECB, 2000).

“The commercial banks can also create money themselves… in the eurosystem,
money is primarily created by the extension of credit… ….” (Bundesbank, 2009)


/

Banks are Not Financial Intermediaries

RR = 1%
Saving Banks Investment
(‘Financial (Borrowers)
(Lenders,
Depositors) Intermediaries’)
=“indirect finance”
$99
$100

“direct finance”

They are the Creators of the Money Supply.
And they decide who gets the money and for which purpose it is used.
This decision shapes the economic landscape.
Banks thus decide over the economic destiny of a country.
Credit creation is the most important macroeconomic variable.

9


The Quantity Theory of Credit (Werner, 1992, 1997):

 Money is best measured by its credit counterpart (C) which created it.

 Financial transactions are not part of GDP.

 If we want a link to GDP, we must divide money/credit into two streams:

Credit used for GDP transactions, used for the ‘real economy’
(‘real circulation credit’ = CR)
C
Credit used for non-GDP transactions (‘financial circulation credit’ = CF)



The Quantity Theory of Credit (Werner, 1992, 1997)

∆(PRY) = VR ∆CR ∆(PFQF) = VF∆CF
nominal GDP real economy credit creation asset markets financial credit creation

YoY % YoY % YoY % YoY %
12 12 80 40
70 35
10 10
60 30
8 8 25
50
Nationwide Residential 20
6 6 40 Real Estate Land Price (R)
Credit (L) 15
nGDP (R) 30
4 4 10
20
2 2 5
10 0
0 0
0 -5
83 85 87 89 91 93 95 97 99
-2 -2 -10 -10
CR (L) 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01
-4 -4
Latest: H1 2001
Latest: Q4 2000

Real circulation credit determines Financial circulation credit determines
nominal GDP growth asset prices – leads to asset cycles
and banking crises


Bank credit creation determines economic growth.
The effect of bank credit allocation depends on
the use money is put to

Case 1: Consumption credit Investment credit
(= credit for the creation of new
Result: Inflation without growth
goods and services or
productivity gains)
Case 2: Financial credit
(= credit for transactions that do Result: Growth without inflation,
not contribute to and are not part even at full employment
of GDP):
= productive credit
Result: Asset inflation, bubbles creation
and banking crises
= unproductive credit
creation


Credit for financial transactions explains boom/bust
cycles and banking crises
 A significant rise in credit creation for non-GDP transactions
(financial credit CF) must lead to: 30%
- asset bubbles and busts 28%
- banking and economic crises 26%

24%
 USA in 1920s: margin loans rose CF/C
22%
from 23.8% of all loans in 1919 20%
to over 35% 18%

 Case Study Japan in the 1980s:
16%

14%
CF/C rose from about 15% at the
12%
beginning of the 1980s to almost 79 81 83 85 87 89 91 93

twice this share Source: Bank of Japan

CF/C = Share of loans to the real estate
industry, construction companies and non-
bank financial institutions



Warning Sign: Broad Bank Credit Growth > nGDP Growth

YoY %
This Created Japan's Bubble.
20
Broad Bank Credit
15

10 Excess Credit Creation

Nominal GDP
5

0

-5

-10
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11
Latest: Q3 2011



Out-of-control CF is the problem, creating the Bubbles
and Crises in Ireland, Spain

Broad Bank Credit and GDP (Ireland) Broad Bank Credit and GDP (Spain)

100 30
90
25
80
70 20
60
15
50
40 10
30
5
20
nGDP
10 0
0
nGDP
-5
-10
-20 -10

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
/ Q /Q / Q / Q / Q / Q /Q / Q /Q / Q /Q / Q / Q / Q / Q /Q / Q /Q / Q / Q / Q / Q / Q
87 988 989 990 991 992 993 994 995 996 997 998 999 000 001 002 003 004 005 006 007 008 009
1 9 /Q 1
1 9 /Q 3
1 9 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
2 0 /Q 3
2 0 /Q 1
3
/Q

19 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2
98
98
99
99
00
00
01
01
02
02
03
03
04
04
05
05
06
06
07
07
08
08
09
09
19

Broad Bank Credit Growth > nGDP Growth


Greece: 1993-2009: over 10% credit growth
1995-97: over 20% credit growth

nGDP

Broad Bank Credit Growth > nGDP Growth


What happened in 1993/4? And in 2000/1?

• The Bank of Greece was established by League of Nations (Annex
to the Geneva Protocol of 1927) in 1928, as a Société Anonyme

• In 1994, the Bank of Greece was made more independent from
the government, and monetisation of government policy stopped.
“As of 1994 the Bank of Greece no longer provides finance in any form to
the public sector. …prohibition of monetary financing.” (Bank of Greece)

• In 2000, the Bank of Greece was made fully independent from
the government, without democratic accountability.
• In 2001, the Bank of Greece became an integral part of the ECB.
• Note: the ECB is independent of and unaccountable to any
government or democratically elected assembly in Europe



The Great Greek Asset Bubble of 1994-2009

• was created by the policy of excessive credit creation by the
Greek central bank and the ECB.
• increased tax revenues and economic growth projections.
• encouraged the government to overspend and undersave significantly
• the bubble was unsustainable – as they always are – and thus would,
without fail, result in a banking crisis and a fiscal crisis
• what happened since 2009 has been predictable and was caused
by the monetary policy of the central bank and the ECB.



Greece: 1995-97: over 20% credit growth

Independence ECB control
from govt



The Solution, as told by the ECB:

• Greece must increase its debts by borrowing more from the
IMF/EU/ECB.
• An exit from the euro or full default must not happen.
• Greece must implement deep fiscal and welfare cuts.
• All must tighten their belts.
• The ESM must be established and fiscal policy controlled
centrally by the EU/ECB (loss of national sovereignty).

BUT: No policies to stimulate growth and employment!



What must happen with shrinking credit creation?
A deepening slump and higher unemployment

Bank credit
creation:
-7.2% YoY



The same is happening in Ireland, Portugal, Spain & Italy

Bank credit: -17% YoY Bank credit: -6.6% YoY

Bank credit: -1% YoY Bank credit: -0.3% YoY



But there is a solution – without costs and fiscal pain,
producing a recovery and lower unemployment

• the policy proposal would have reduced government debt and deficits
• it would solve the funding problem in the bond markets
• it would help the banks and increase credit creation without extra
costs
• no need for centralisation of fiscal policy or issuance of European gov’t
bonds



How to Create A Recovery After a Banking Crisis:
Werner-Proposal of 1994:
A new policy called “Quantitative Easing” = Expansion in
Credit Creation = Total Effective Purchasing Power
Richard A. Werner, Create a Recovery Through Quantitative Easing,
2 September 1995, Nihon Keizai Shinbun (Nikkei)



Applying this Framework to Solving the
European Sovereign Debt Crisis
Werner-Proposal of 2011
 Greece, Ireland, Portugal, Spain and Italy need to stimulate economic
growth. This means stimulation of credit creation.
 Their governments need to save money and reduce borrowing costs.
 Bank credit growth needs to expand and banks need a safe way to
expand their business and their returns
 Here is how all of this can be achieved:
 Governments need to stop the issuance of government bonds
 Instead of borrowing from the bond markets – who do not create
money – governments should fund their borrowing requirements
entirely by borrowing from all the banks in their country.

25


Werner-Proposal: The solution that maintains the euro and
avoids default

 Governments should enter into 3-year loan contracts at the much lower
prime borrowing rate.
 Eurozone governments remain zero risk borrowers according to the
Basel capital adequacy framework (banks are thus happy to lend).
 The prime rate is close to the banks’ refinancing costs of 1% - say 3.5%.
 Instead of governments injecting money into banks, banks create
new money and give it to the governments.

26


Why fiscal spending programmes alone are ineffective
Fiscal stimulation funded by bond issuance
(e.g. : ¥20trn government spending package)

Non-bank private sector
　 (no credit creation）
　　　　
-¥20trn +¥20trn
Funding
via Fiscal
bond stimulus
issuance 　
Ministry of Finance

(no credit creation)

Net Effect = Zero



How to Make Fiscal Policy Effective

Fiscal stimulation funded by bank
borrowing
(e.g. : ¥20trn government spending package)

Bank sector deposit Non-bank private
　

(credit creation power) sector
Assets　　　　　　 Liabilities (no credit creation)
¥20 trn ¥20 trn
+¥ 20 trn
Fiscal
Funding
MoF stimulus
via bank
Loans (No credit
creation)

Net Effect = ¥ 20 trn



Advantages of this Proposal

 The proposal will not increase aggregate debt.
 Each country remains in charge of and liable for its debts.
 No further ECB intervention required or purchases by the EFSF/ESM
 The immediate savings will be substantial, as this method of enhanced
debt management reduces the new borrowing costs, even below post-
ECB-purchase yields (E 10bn in the coming year for Italy alone).
 This helps the banking sector, as its core business, to extend credit, is
expanded, thus increasing retained earnings.
 These can then be used by banks to shore up their capital. Thus there
are substantial savings to the taxpayer as new bank rescues become
unnecessary.

29

Advantages (II)

 This proposal addresses the core underlying problem: slowing growth
and the need to stimulate it. The proposal will boost nominal GDP
growth – and avoid crowding out from the bond markets.
 This is a problem as tight fiscal policy and tight credit conditions slow
growth, with bank credit shrinking: Germany (-0.1%), Greece (-3.5%),
Spain (-0.5%), Ireland (-14%).
 Bank credit extension adds to the money supply. From the credit model
we know that the proposal will boost nominal GDP growth – and avoid
crowding out from the bond markets.
 This increases employment and tax revenues.
 It can push countries back from the brink of a deflationary and
contractionary downward spiral into a positive cycle of growth, greater
tax revenues and falling debt/GDP.

30


Prime Rate vs. Market Yield of Benchmark Bonds: Portugal

18.00% 18.00%
16.00% 16.00%
14.00% 14.00%
12.00% 12.00%
10.00% 10.00%
8.00% 8.00%
6.00% 6.00%
4.00% 4.00%
2.00% 2.00%

Latest July 2012
03

03

04

05

06

07

08

09

10

11

12
20

20

20

20

20

20

20

20

20

20

20
Portugal Prime Rates on Existing Loans to Non-Fin. Crops., Over 5 Year Maturity (%)
Portugal 10y Government Benchmark Bid Yield - Redemption Yield (%)
Portugal 5y Government Benchmark Bid Yield - Redemption Yield (%)

Source: Thomson
Reuters Datastream, ECB


Prime Rate vs. Market Yield of Benchmark Bonds: Spain

6.70% 6.70%

5.70% 5.70%

4.70% 4.70%

3.70% 3.70%

2.70% 2.70%

1.70% 1.70%
03

04

05

06

07

08

09

10

11

12
Latest July 2012
20

20

20

20

20

20

20

20

20

20
Spain Prim e Rates on Existing Loans to Non-Fin. Corps., Over 1 Year Maturity (%)
Spain 5y Governm ent Benchm ark Bid Yield - Redem ption Yield (%)
Spain 10y Governm ent Benchm ark Bid Yield - Redem ption Yield (%)

Source: Thom son
Reuters Datastream , ECB


Prime Rate vs. Market Yield of Benchmark Bonds: Greece

62.00% 62.00%

52.00% 52.00%

42.00% 42.00%

32.00% 32.00%

22.00% 22.00%

12.00% 12.00%

2.00% 2.00%
03

04

05

06

07

08

09

10

11

12
Latest: July 2012
20

20

20

20

20

20

20

20

20

20
Greece Prime Rates on Existing Loans to Non-Fin. Corps., Over 5 Year Maturity (%)

Greece 10y Government Benchmark Bid Yield - Redemption Yield (%)
Greece 5y Government Benchmark Bid Yield - Redemption Yield (%)

Source: Thomson
Reuters Datastream, ECB


Other solutions exist

 Bad debts in the banking system: can be extinguished at zero cost by
central bank purchases at face value (and not marking to market). As
done by the Bank of England 1914 and Bank of Japan 1945
 Central banks should be made accountable to parliaments
– This was the lesson from the Bundesbank. Normally it is said that the ECB is a
good central bank, because it is modelled on the successful Bundesbank.
– This is not true. The lesson from the Bundesbank was to make the central bank
accountable to parliament – its predecessor was not, and it was one of the most
disastrous central banks (Reichsbank).
– The ECB is the revived Reichsbank, unaccountable to parliaments

 Bank credit should be monitored to prevent harmful speculative
credit creation and encourage productivity (credit guidance – the
secret of the success of Japan, Taiwan, Korea and China).

34


Solutions exist

 Redesign the banking sector so that it consists of not-for-
profit, local banks (like in Germany, public savings and
cooperative banks) Regional,
foreign,
other
banks Local cooperative
17.8% banks (credit unions)
Large, nationwide
Banks 12.5% 26.6%

Local gov’t-owned
Savings Banks
42.9%

 The monetary system should be changed: do banks need to
be the creators of the money supply?
35


State Money: Less Debt, Lower Taxes, More Growth,
More Equality and Fairness

China: Government-issued paper money (Kublai Khan)
Zero Government Debt, Zero Interest Payments
36


State-Issued Money

太
政 Dajōkan
官
satsu
札

Japan: Government-issued paper money: 1868
37


State-Issued Money

Colonial Scrip in North American British Colonies
“In the Colonies we issue our own money. It is called Colonial Scrip. …we
control its purchasing power, and we have no interest to pay to no one.”
(Banjamin Franklin, quoted by Senate Robert Owen, National Economy and the Banking System, Senate
document 23, Washington DC: US Gov’t Printing Office, 1939, p. 98) 38


Colonial Scrip Banned by
Britain (Currency Act
1751 and 1764,
forbidding scrip to be
designated legal tender
and to settle private debt.)

Was the War of Independence fought over taxes on tea? (‘Boston Tea Party’)
Or over new English legislation forcing colonies to abandon their paper
money and use gold and silver?
“The Colonies would gladly have borne the little tax on tea and other matters had
it not been that England took away from the Colonies money, which created
unemployment and dissatisfaction” Benjamin Franklin (as quoted by R. Owen, 1939, op. cit).

39

State-Issued Money
President Lincoln issued United States Notes

1863 United States Notes, aka ‘Greenbacks’
1862, President Lincoln signed the First Legal Tender Act
“The underlying idea in the greenback philosophy… is that the issue of
currency is a function of the government, a sovereign right which ought not
to be delegated to corporations.” 40
Davis Rich Dewey (MIT, 1902)


State-Issued Money

Deutsches Reich: German government-issued paper money41


Britain

1917

UK: Government-issued paper money: 1914-1928


Centre for Banking, Finance State-Issued Money

The standard
‘Federal
Reserve Note’

JFK’s 1963
‘United
States Note’:
No Fed seal

43


Further Reading:

Basingstoke: Palgrave Macmillan, 2005 New Economics Foundation, 2011


Weitere Details:

München: Vahlen Verlag, 2007 M. E. Sharpe, 2003

Prof.Richard Werner:Solutions for Greece-other than default, euro exit or giving up national sovereignty

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