Home > debt crisis > An illiquidity trap in Greece

An illiquidity trap in Greece

from Merijn Knibbe

I’ve been naïf.  Based on this information, I stated that total debt (government, households, companies, banks) in Greece was comparatively low. But it isn’t. Total formal debt is low, indeed. But informal debt is increasing fast. And it’s increasing because Greece finds itself in the very opposite of a liquidity trap: an illiquidity trap. This is a vertical supply function of money. Even very high interest rates do not entice lenders to lend to Greece, or to Greek households or companies. Cash is scarce, credit and even debit cards don’t work anymore and people will therefore tend to hoard cash – just like they did in the seventeenth, eighteenth and nineteenth century (well, ‘they’, I mean the non-poor). And the Greek economy is responding to this eighteenth century illiquidity situation in an eighteenth century way.

According to today’s De Volkskrant, a Dutch nespaper, a kind of ‘tally stick’ credit system was dwindling rapidly but still somewhat functional in Greece, before the present crisis. A charming ancient relic of a world which in fact already had disappeared. These ‘tally stick’ credit systems – which were commonplace in eighteenth, nineteenth and even twentieth century Europe – are not based upon formal banking credit and bank accounts but are based upon personal contacts and ‘individual banking’ – providing credit had not yet disappeared as an economic function of the household. ‘Regular laborers’ for instance often received their wages once or twice a year, when their boss had finally got his money from his debtors (according to the accounts I have investigated this could even take as long as three years in bad times). The laborers were implicitly lending quite some money to their employer. The other side: they also received credit from the local bakery, butcher, landlord and the like.

This still happened in Greece, to an extent. Wages were, according to the newspaper, often paid too late. To state this the other way around: employees were lending money to their employer. Guess what happens in the present illiquidity trap: this system is making a come-back and expanding rapidly. Guess what households will do – these will, in their turn, extend their lines of formal and informal credit to the breaking point. Guess what happens when the taxman comes – who won’t take no for an answer and who only accepts formal money – workers will be forced to accept 20 or 30% rebates on the money due to them. Whoever told you that nominal interest rates can’t turn negative?!

  1. September 26, 2011 at 4:02 am

    “Guess what happens when the taxman comes – who won’t take no for an answer and who only accepts formal money – workers will be forced to accept 20 or 30% rebates on the money due to them.”

    As much as it pains me to say this: Probably the best argument yet why all working people should own a fire-arm, and know how to use it. But then again, I am an American.

    The remainder of your post reminded me of working in my maternal grandparent’s grocery store – my god, the War Against Vietnam was still going – and the rack of credit-books, filed alphabetically, on the shelf beneath the cash-register; and the number of times my grandmother let somebody a nickel short, a dime short, “slide” when she knew their circumstances…but now I am being self-indulgent….

  2. Dave Taylor
    September 26, 2011 at 9:04 am

    Interesting is this story is, its unaccounted-for credit is just the tip of the ice-berg. Anyone working the now-usual month in hand for an employer is giving the employer credit for a month’s work. But surely the answer is not guns? It is to make the tax-man redundant!

    Trying to make Huber and Robertson’s point in yet another way, it is for governments to print their own credit notes (money) and NOT to mortage the nations they represent by selling “bonds” wholesale to crooks who rent them out retail (i.e. lend out at interest money THEY have printed). Like everyone else, those engaged in the business of government then would borrow as they used credit notes to buy things, and all that is necessary is for nature to grow and citizens to do enough work to replace the resources government uses.

  3. merijnknibbe
    September 26, 2011 at 10:08 am

    The John Schmitt post on this blog is of course highly consistent with this story – this kind of credit is, historically, characteristic of small companies like those in Greece. https://rwer.wordpress.com/2011/09/25/which-country-has-the-smallest-small-business-sector-in-the-world%e2%80%99s-rich-economies/

  4. September 27, 2011 at 5:33 pm

    The Greek economy would revive quickly if it did this:
    1. Keep the euro but quit the EU.
    2. Issue a parallel currency the New Drachma, 1 ND=1 euro, and give every Greek citizen !0,000 ND in currency, convertible to euros five years from now.
    3. Replace VAT and all other taxes with a tax on all land value equal to 80 percent of the potential rent.
    4. Postpone interest payments on sovereign debt for one year while the new system kicks in.
    5. Radically decentralize democracy to a small-group, multi-level, bottom-up system.

  5. Dave Taylor
    September 28, 2011 at 9:45 am

    I find myself largely agreeing with this, Fred, except for the land tax. (See the reaction of Greek peasants to this – “the Government wanting to sell off Greece” – and the arguments in my response today on Steve Keen’s new project).

    Greece’s quitting the EU might encourage people to remember that it began as a cooperative Economic Community, not a competitive rat-race. Perhaps the same thing needs to happen in the United States? (I understand Vermonters have some interest in seceding). Certainly the world ought to opt out of being ruled by unaccountable unknowns in the IMF and World Trade Organisation.

  6. September 28, 2011 at 5:14 pm

    The new property tax enacted by Greece is needed to reduce the deficit and comply with the conditions for more help from Europe. The property tax will be much less vulnerable to evasion than VAT etc. Why would one think that VAT is better than a tax on land? Yes, many Greek property owners will find it a burden to pay higher property taxes. A complete shift to land value taxation and the abolition of VAT, income taxes, and other taxes, would result in a net gain for most Greeks and would stimulate rapid growth. If all Greeks got 10,000 New Drachmas each, that would ease the transition. Also, Greeks invented democracy and now need to reconstruct their corrupted system with radical decentralization.

  7. Dave Taylor
    September 28, 2011 at 9:08 pm

    Fred, if you were a peasant surviving on growing your own food on your own land, perhaps swapping a little and making beer money on the side, which would you rather have: VAT on things you couldn’t buy anyway or a tax on your livelihood you had no money to pay with?

  8. MH
    September 29, 2011 at 12:46 am

    The problem with “property” taxes is they are applied to the homestead value. This is inexcusable since a person has a homestead in the absence of government just as any animal possesses territory from which it derives calories to sustain it. So NATURALLY people resent “property taxes”. They aren’t legitimate without some sort of compensation.

    The only situation in which it is legitimate to tax homestead property value is when there is a citizen’s dividend whose net present value is equal to the median price of a home plus the median capitalization of a job. In this situation the economic rent stream received by the citizen is compensation for his investment of his homestead in the body politic.

    Self-assessment is inferior to in-place liquidation value assessment as determined by the highest bid placed in escrow for the property right. It is then up to the owner of the property right to either accept the bid and transfer title, or pay the interest on the escrowed bid. When the government places the high bid it receives the stream. Bank accounts are, of course, assets whose liquid value is by definition their balance. If there is no citizen’s dividend then savings accounts collect the interest up to the homestead limit — replacing FDIC.

  9. September 29, 2011 at 2:27 am

    If I were a poor peasant, I would rather pay the lump sum tax on my land rather than pay extra for goods with a VAT. My land would have very little market value, and my tax on the land value would be low. Even peasants buy and trade, so they do pay VAT taxes whey they buy and their goods are made more expensive when they sell. For the whole economy, getting rid of the VAT and other trade barriers would raise wages, making such peasants better off. The reforms in China began with peasants paying a rent tax on their own plots and getting to keep what they grew. China’s economy zoomed up ever since. The Japanese economy grew rapidly after its tax on land in 1868, and Taiwan prospered after putting in its land tax in 1950.

    • Dave Taylor
      September 29, 2011 at 9:49 am

      Okay, Fred, and Merijn (below) has a point too. When (as in China) the land has been “nationalised” (i.e. the government has taken on the responsibilities of the landlord), an annual rent or land tax is of course much more efficient than VAT on daily transactions. Perhaps that’s what really needs doing: taking land out of the market. Then the responsible landlord can charge more rent for already developed down-town sites. The problem in the US and UK is that the land has not been nationalised, and our government Treasuries are in bed with the banks.

  10. merijnknibbe
    September 29, 2011 at 9:06 am

    @MH, what would you prefer to own, an acre in down town New York or an acre somewhere in North Dakota? And why is an acre in New York so much more expensive than an acre in North Dakota? Why is its rental value so much higher? Is that due to the work of the owner – or is it caused by ‘location, location, location’? If it’s caused by ‘location, location, location’, doesn’t it make sense to tax this unearned rent, which is caused by all kind of public and private investments in infrastructure and whatever, as a kind of citizens dividend? A tax which might not entirely rule out speculative increases in land prices (often showing up as housing bubbles) – but would at least mitigate these, therewith channeling investments towards productive endeavours instead of sterile purchases of existing land?

  11. Robert Dulin
    September 29, 2011 at 6:00 pm

    I still do not understand the fascination with land tax. To make it the only tax to replace all others it would have to be so high that individuals could not pay it and would be forced to sell their property. We have property tax in Texas and it only funds a portion of the schools and city and county budgets. It causes people to have to sell their homes when their income changes. To add insult to injury there is an agricultural exemption, that allows larger land holders to essentially pay no tax. But even if they had to pay like everyone else it would not cover all taxes (federal, state and local) by an order of magnitude.
    I understand that it would have probably worked when the population were mostly farmers and government needs were much lower.
    The limiting factor of production has always been, here and in Greece, money to conduct business and trade. Money is what is being hoarded and lent (rented instead of spent) just like the land was. Why not a tax on any property that should be a public good because of it’s nature, (land, money, water, ect) only when it is rented, not when it is used by the owner in daily business.
    Included interest causes price inflation which must be countered by money shortage deflation or the lenders make no money.
    I like the idea of issuing new currency in Greece. But lay a tax of 80% on any interest payments received on any brand of money lent.
    Thanks, Robert

  12. September 30, 2011 at 2:42 am

    A tax on land rent cannot be higher than the rent, and the existence of rent usually indicates ability to pay. The burden is only during the transition, because after that, the price of land falls and the tax replaces the mortgage. In a properly done land tax, if the title holder has a loss of income, he could postpone the tax payment. There should be no exemptions or reductions of the tax rate for particular uses. Please provide the evidence that the rent would not be sufficient to pay for government. Have you read http://www.foldvary.net/works/policystudy.pdf ?

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