Varoufakis’s Jane Austen Solution to Escaping Austerity and Achieving Growth

To fortune I am perfectly indifferent, and shall make no demand of that nature on your father, since I am well aware that it could not be complied with; and that one thousand pounds in the four per cents, which will not be yours till after your mother’s decease, is all that you may ever be entitled to.

Jane Austin Pride and Prejudice Chapter 19.

The reference to ‘four per cents’ is a reference to consols – the same device the rock star economist Yanis Varoufakis plans to use to escape the Greek austerity trap.  There are precedents as it allowed Georgian England to escape the biggest debt trap in history following a debt bubble, whilst countries like France which didn’t use them fell well behind (and lost wars as a result).

A simple thought experiment – where I think Yanis Varoufakis’s mind is coming from in relation to ‘perpetual bonds’.

Perpetual bonds- perpetuities – are also known as ‘perps’, or a consol.  (The term “consol” comes from the fact that the first perpetuities were issued by the British government especially following the Napoleonic Wars to “consolidate” their war debts.)  They were issued by Canada in the 1970s for example. Churchill used them in 1927 to refinace the WWI war debt.

Extending maturity and a debt forgiveness /haircut has exactly the same impact on the NPV coupon bottom line – but the former is not a ‘credit event’ screwing up the ECB balance sheet, so to be preferred in all cases.

The Eurozone is at the ZLB and suffering deflation, so there will be a desperate rush for safe assets.  A security with a tiny yield is preferable to cash with negative interest on reserves.  Some nations are even issuing securities with negative yields and there is a ready market.

If (thought experiment) this condition exists forever it is preferable for the ECB and others to replace an ‘asset’ on their balance sheet which can never be paid with one that will be, even if is a perpetuity that never matures as a small positive yield will still yield a return.

Such would also be attractive to the markets given the rush to security and shortage of ‘safe assets’.

The problem is consol’s NPV is highly interest rate sensitive over the short term compared to conventional securities – if interest rates go up through escaping the ZLB the market will demand a switch to higher returns. Hence the idea of a GDP linked bond – known as a warrent – for which there are recent precedents n Greece.

The Economist asked where the wealth of Jane Austin heroes came from

The answer lies in the combination of Britain’s growing commercial riches and its government’s continuing poverty. There was really only one kind of investment from the South Sea Bubble of 1720 to the railway boom of the 1840s: government debt. British government debt was the only security traded on the Stock Exchange at its foundation in 1801, and remained so until 1822. Thanks to luck and skill, the government managed to finance a century’s worth of horrendously expensive wars in a way that not only did not cripple commerce but mobilised commercial resources for new challenges.

William Pitt tried to pay down the national debt during the Napoleonic Wars (really just preventing it exploding) by buying back consols through open market operations.  He took advantage of low interest rates to borrow from banks to retire consols – the theory (correct though oddly derided by some economists) was that the interest saved from the consols would compound and could be used to retire ever more consols into a sinking fund to pay off the national debt.  It worked, rather than banks lending to business, financial capital hadn’t yet been fully developed banks leant to the State who provided investment income to aristocrats who then became capitalists investing in the industrial revolution and an explosion in global trade. The national debt was not the drag anchor on the British economy it was its powerhouse.   Now banks are again reluctant to lend to industry, so expansion and refinancing of the national debt at the ZLB makes sense, recycling income to citizens who will invest (most likely these days crowdfund innovation).  Over a generation compounded high growth wipes out a national debt whose relative size now looks puny.

Bond holders should bite Mr Varoufakis’s hand off – its potentially a good deal, a debt for equity swap, in accounting terms the only real option for an entity suffering insolvency not liquidity concerns.  It gives the sovereign bondholders a stake in Greeces future and gives Greece breathing space from the disastrously deflationary 5% primary surplus every year.

“Money is the best recipe for happiness.”

 Jane Austen, Pride and Prejudice

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