By William K. Black
Quito: June 25, 2015
The BBC came up with a good “hook” for a story on the troika’s assault on the Greek economy and people. “Yanis Varoufakis, the Greek finance minister, spent his academic career … studying game theory.” Professor Marcus Miller, a UK economist (U. Warwick) wrote an article for the BBC premised on how Varoufakis would apply game theory to Greece’s negotiations with the troika (the IMF, ECB, and the European Commission). Miller is a colleague of the great Robert Skidelsky and has co-authored with him an article explaining the economic illiteracy and self-destructive nature of the troika’s (and UK’s) infliction of austerity in response to the Great Recession.
The BBC, however, is such a great fan of austerity that one rarely reads why the vast majority of economists think that using austerity to respond to a Great Recession is akin to the quackery of bleeding a patient to make him healthier. Miller’s article in the BBC about game theory has the wrong title (recall that the author often does not get to choose the title), the wrong game, the wrong concept, and the wrong payoffs. The title of the article is: “Can game theory explain the Greek debt crisis?” The article does address that issue. It is limited to the issue of the new Greek government’s negotiations with the troika concerning a crisis that they inherited.
The game that Miller uses is the “prisoner’s dilemma.” That is the wrong concept and the wrong game and should actually be called the “prisoners’ dilemma” because it requires at least two prisoners. The “prisoners’ dilemma” game is used to explain (1) why cooperative behavior – by criminals – would be their optimal strategy, (2) why prosecutors and the police should prevent that cooperation, and (3) how prosecutors and the police can shape the prisoners’ incentives to encourage them to confess. As conventionally pictured, and Miller falls into this trap, the game does a poor job of explaining the third point. Real life prosecutors, police, and criminologists in the U.S. do a far better job of optimizing the incentives than do economists – and did so long before game theory was developed.
Here is Miller’s explanation.
The most famous game of all is the Prisoner’s Dilemma. Imagine two prisoners have to choose between confessing and staying silent. If they both stay silent, they both go to jail for one year. If one confesses and the other stays silent, the first goes free and the second gets 20 years. If both confess, they both get five years.
As anyone with even the faintest understanding of the U.S. criminal justice system knows, which includes anyone who has watched a U.S. police drama on television, Miller’s description is deeply suboptimal. It misses the key element of timing. The actual dynamic, which optimize the incentive to confess, is whoever rats out his confederate first gets a far better deal. It would be nuts to give both the same sentence (“five years”) if they “both confess.” It is common for both defendants to confess.
But the deeper problem is that this is not the proper game for analysis of either the Greek crisis or Varoufakis’ negotiations with the troika. Greece, and the Greek people, are not criminals, no one is trying to get a confession, and the “game” everyone should be using is a “cooperative” game rather than prisoners’ dilemma – which is premised on preventing cooperation.
If anyone is using prisoners’ dilemma as its game theory in the Greek context it would have to be the troika. The logic would go like this. Greece’s position in favor of a “troubled debt restructuring” (TDR) and an end to austerity is in the interests of the peoples of Europe (and the world). The appropriate cooperative “game” would be to (a) strike a deal to end austerity in response to recessions throughout the EU and (b) to negotiate TDRs in Spain, Italy, and Greece. That cooperative “game,” however, is being blocked by the troika and is bitterly opposed by conservative leaders in Spain, Italy, the Baltic States, and Ireland. Part of this refusal to enter into a win-win cooperative game on the part of the troika is ideological. Part of the troika’s refusal is reputational. If the leaders of the troika were to end austerity and the EU’s economy were to improve more rapidly it would be undeniable that their economically illiterate infliction of austerity had caused massive, gratuitous suffering.
Similarly, the opposition of conservative political leaders in various EU states to employing a cooperative “game” in Greece is that it would threaten their power and reputation. Spain’s conservative party would fall from power in 24 hours if its leaders ever admitted that austerity forced Spain into Great Depression levels of unemployment and that austerity was the problem rather than the solution. The Prime Minister of Spain is eager to have Greece fail to convince the troika to adopt a cooperative “game.” He would love to see the troika force the Greek government to inflict even greater austerity on the Greek people in order to discredit the Greek government and his Spanish anti-austerity opponents, the surging Podemos party.
Miller and Skidelsky know these facts and have put them in writing. If Greece were a corporate debtor, its creditors would have routinely negotiated a TDR with it seven years ago – precisely because normal creditors understand that their interaction with a debtor who cannot repay the full debt on its original terms should take the form of a cooperative “game.” Normal creditors, if the troika is not involved and thinking in extortionate terms, realize that they should cut their losses through a deal that reduces and stretches out the payments and lowers the interest rate on the debt.
This is why a firm like Elliot Management, Paul Singer’s vulture hedge fund, which tries to profit from, and therefore discourage, TDRs – see its attempt to extort Argentina – is so odious and bad for the world. Richard Zabel, the number two (non) prosecutor of the elite banksters that led the three great epidemics of accounting control fraud that drove the crisis in the U.S. Attorney’s office for Manhattan, just announced that he will soon take a job with Singer. In a grotesque act, while still a purported prosecutor, he issued an ode to Singer’s vulture ethics that was quoted by the New York Times. Zabel’s ode is a further proof of our family rule that it is impossible to compete with unintentional self-parody.
“Elliott has a long record of success and relies on the rule of law as a pillar of its investment philosophy,” Mr. Zabel, who will leave his prosecutorial job at the end of June, said in an interview.
Hedge fund owners are the wealthiest people on Wall Street, so this is the new nature of the revolving door that helps produce immunity for elite banksters and the ethics-free world of the hedge funds. The NYT article explained the (non) prosecutors’ quest for “Wall Street riches.”
[Zabel’s] move also reflects a broader shift on Wall Street, where hedge funds and private equity firms, rather than law firms, are increasingly recruiting federal prosecutors, enticing them with the promise of Wall Street riches. Steven A. Cohen’s Point72 Asset Management — the successor to his SAC Capital Advisors, which pleaded guilty to insider trading charges in an investigation overseen by Mr. Zabel — recently hired a former United States attorney for Connecticut.
Zabel was an important contributor to eliminating the “rule of law” for elite banksters and will enjoy “Wall Street riches” precisely because Singer views him as helping to fend off any (unlikely) effort by the government to rein his depredations. In game theoretic terms, Singer’s strategy is designed in a manner that discourages cooperative “games” that make the world better off.
The oddest aspect of Miller’s description of his hypothetical application of what he terms the “prisoner’s dilemma” to Greece’s negotiations with the troika are the “payoffs” he assumes to the different decisions. His description makes no sense given his article with Skidelsky.
Imagine Greece moves first to avoid default by putting a plan on the table. This plan involves new taxes on the wealthy and changes to pensions – avoiding spending cuts and and having some of its debts written off in exchange. If this plan is accepted by the rest of the eurozone, then Greece is content. Let’s give its payoff a score of 1.
To work out how the rest of the eurozone will respond, one has to see what they stand to gain by accepting Greece’s plan, or by rejecting it.
If the eurozone accepted this deal, the monetary union would remain intact, but it would have to ease its strict rules on fiscal policy and take a loss on holdings of Greek debt. Let’s give the eurozone payoff a score of ¾. So the overall payoff is (1, ¾ ).
But Miller and Skidelsky have explained why these payoffs are incorrect. They have explained that if the EU were to end austerity as a response to a Great Recession the results for the EU would be enormously positive. So, the payoff from a cooperative “game” with Greece that would end self-destructive austerity would be exceptionally positive for the EU and positive for Greece. The EU is much larger than Greece, so its payoff from cooperating with Greece would be far larger than Greece’s payoff. Miller also knows that it is wrong to think that the EU would lose due to “having some of its debt written off in exchange.” Like other creditors, the EU would get more from cooperating with Greece and negotiating a TDR than forcing Greece into a default on its debts. TDRs are negotiated routinely in the private sector because cooperative “games” benefit both parties. So, “the overall payoff” of a cooperative “game” with Greece would be something on the order of (1, 5). Both Greece and the EU would gain, but the EU’s gain would be much larger. The EU’s gain would be greater still if it were to enter into similar cooperative “games” with Spain, Italy, Portugal, and the Baltic states.
Austerity is a coercive, non-cooperative “game” that makes both parties worse off (but aids the EU’s worst politicians). It is terrible economics, and represents a “dismal [non] science.” Game theory is largely devoted to demonstrating the benefits of cooperation. Precisely because Varoufakis is an expert in game theory, and as we can see throughout the new Greek government’s negotiations with the troika, the effort has been to try to get the troika to escape from its self-destructive dogmas and debilitating political urge to punish the Greek people, and see that it is in the interests of the Greek people and the peoples of the EU to cooperate by ending austerity and negotiating a TDR.
The troika’s game theoretic strategy in dealing with the 100 million people of Spain, Italy, and Greece that it has gratuitously forced into Great Depression levels of unemployment is a nasty variant of the “Dictator” game. The conventional dictator game works like this. The dictator makes an offer to divide up $1. Economists define his “rational” offer as 99 cents for him, and one penny to the other player. The other player gets only one choice – he can refuse or accept the dictator’s offer. If he rejects the offer he gets nothing. Economists define the recipient’s rational response as accepting the penny. But there are three striking results of studies of people’s response to the dictator game. First, when the dictator offers a penny, or any very unfair division, people overwhelmingly reject the offer even though they know that this will mean they get nothing. Second, people playing the role of the dictator typically offer to split the $1 evenly, which leads to routine acceptance. Third, the exception to this result is economists and economics majors. They are much more likely than human beings to respond by being nasty little dictators and passively accepting drones who agree to take a penny. Normal human beings care a great deal about fairness and are willing to suffer personal losses rather than give in to dictators like the troika.
The language of the troika and of German politicians about the troika’s mode of dealing with the Greek government is strikingly similar to the dictator game. But there is a vital way in which the troika’s game theoretic approach is far worse than the dictator’s game. In the conventional dictator’s game the other party is made better off, albeit by only a penny. The troika insists on making Greece worse off by insisting on austerity and trying to block a cooperative TDR that would benefit the creditors and the debtors. The game that the troika is playing against the people of Grace and the EU embraces all the imperialism inherent in the dictator’s game – but it is a “negative sum” game that makes the peoples of Greece and the EU worse off. Cooperative games typically are “positive sum” games that make both parties better off.
I take this opportunity to bring up a couple of questions about MMT theory:
(1) Fullwiler and Wray (2010) indicate that QE was not inflationary because banks can’t lend from their reserves, so, no matter how big their reserves got, that would not cause increased lending, causing more money to enter into circulation.
I agree with that point, especially their noting that private banks create money out of thin air and do not have to first determine that their reserves exceed the minimum required before making a loan: that is, fractional reserve banking no longer applies.
But is there not a more decisive reason why the banks cannot lend the money it gets added to its reserves when the Fed buys the US Treasury securities with money it gets out of thin air: that money was extinguished when it bought the securities from the banks. The money obtained and spent by the Treasury in selling the securities to the banks (IOU’s to the banks) still remains in circulation, but is now debt-free (except for the ordinary obligations of the government to honor the dollars of citizens in paying taxes, fees and fines to the government).
The basis for my question is the following taken from a book on British banking, which I think also applies to most banking with fiat money, where banks create money out of thin air when they make loans (a point that Fullwiler and Wray also make):
“Just as banks create new money when they make loans, this money is extinguished when customers repay their loans as the process is reversed. Consequently, banks must continually create new credit in the economy to counteract the repayment of existing credit. However, when banks are burdened by bad debts and are more risk averse, more people will repay their loans than banks are willing to create new ones and the money supply will contract, creating a downturn.”
Ryan-Collins, Josh, Greenham, Tony, Werner, Richard, & Jackson, Andrew (2012). Where does money come from? London: New economics foundation.
Available in Kindle format from Amazon.com
Ordinarily bank loans are paid off with money the borrower extracts from money already in circulation. It seems reasonable that that money goes out of circulation when the loan is paid off, effectively extinguishing the money lent originally, by reason of the fungibility of money.
What is unique about the Fed paying off the loan is that its money was not in circulation until it created it in the act of paying off the loan (buying the securities). Thus that money is distinct from the money already in circulation, spent by the Treasury in deficit spending into the economy. Thus it still gets extinguished in paying off the loan when the Fed buys the securities, while the original money remains in existence.
As a consequence the Fed’s money in buying the securities by depositing the money in the banks’ reserves cannot be inflationary either, since it no longer exists once it is extinguished in canceling the bank’s loan to the Treasury in buying the securities. What would potentially be inflationary is the original loan, as it would be the case with all bank loans that are subsequently spent into the economy and then paid off from money in circulation or elsewhere.
(2) I have not seen (which doesn’t mean it may not exist somewhere) indications in MMT writings that when the Treasury has deficit spending to do it must, by law borrow from the banks. (That law has been in existence since 1917, when the Treasury’s power to issue US Treasury Notes (greenbacks) as dollar bills without borrowing was usurped by this law of 1917). So, now when Congress has a deficit to spend, the Treasury must come up with the money by borrowing it from (I presume) US banks.
I think everyone knows this. What is not well-known is how the Treasury manages the national debt, i.e. how does the Treasury deal with the consequential debt?
I think there are many supposedly knowledgeable people and politicians who think the debt must be paid back by raising taxes and budgeting from taxes this money. Hence the “myth” that we are obligating our succeeding generations with a horrific debt they must pay off.
But a former Deputy Secretary of the Treasury in the Clinton Administration, an eminent banker and post-Kinseyian economist, Frank N. Newman, (2013 Freedom from National Debt. Minneappolis, MN: Two Harbors Press), [available from Kindle] points out that the Treasury just rolls over the debt by creating new securities with new future maturity dates and swaps these for the banks’ mature securities generated to pay the deficits. In other words, the Treasury never will pay off the principal on this deficit debt. It will pay off the interest at each swap.
And where does the interest come from? Taxpayers? No, the Treasury gets it in the same way as it gets the deficit money, by borrowing the interest money from the banks. And it will handle that debt in the same way, by rolling it over and over with security swaps. And this is not a Ponzi scheme because the banks will always be able to create the money out of thin air to lend it to the Treasury. (The Ponzi scheme collapses when there is no one to lend the money to the borrower; but banks will always be able to do this since they create the money for loans out of thin air).
So, the principal on the deficit spending loans is never paid. Hence it is not a true debt. And all parties seem content with this fact. The banks go along with this because they get an endless stream of debt-free dollars in interest money. The Treasury likes this because it never has to pay off the principal. And it can just borrow the interest also from the banks. This is a never ending process.
In the process, the deficit spending money becomes effectively ‘debt-free money’, almost just like the money the Treasury used to issue with its US Treasury Notes (greenbacks).
But there is that added interest to pay. Still, bank loans never issue all the money the borrower will need to pay back the loan. He/she has to pay also the interest, and where is that money getting into the economy? Well, it may well be coming in through the interest the Treasury is paying the banks, debt-free.
But then what about the Fed’s QE again? The Fed has been going through the US banks looking for US securities to buy and it has been buying up all those mature securities, just to make the banks less vulnerable to default. Well, that’s the story the Fed makes. But let us face it: The Fed is paying off the national debt by buying all these deficit securities. Any time it buys a US security it cancels the government’s debt to the entity that held it. And as we noted above, its dollars used to buy the securities get automatically extinguished in the act of purchasing the security (the loan IOU of the government to the banks).
Ah, but you say, what about the obligation to pay the Fed for its securities that it has piled up from QE.
Well, the Fed is going to take those mature securities to the Treasury and swap them for some new securities issued by the Treasury. The Treasury can then extinguish the mature securities. What will the Fed do with the new securities? (It will do this when there is inflation). It will sell them to banks and investors to drain excess money out of circulation.
In effect the Fed is not profiting from these purchases of securities. It gets 6% of the interest on the transaction it makes to get them to fund Fed operations. It is acting more as a custodian and then agent of the government to use these new ‘immature’ securities to sell to fight inflation.
Finally, we need to note that the deficit spending portion of the national debt is only a very small proportion. The growth in the national debt is not due mainly to deficit spending, but investors’ buying US Treasury securities, because they are a safe haven for dollars. The investors’ dollars are not used to fund government operations. Deficit spending dollars are quite separate from that and are held by banks. These securities are held by investors. The Fed cannot get to them directly by QE or open-market operations unless the investors put them up for public auction. So, they are not bought by the Fed when it does QE. To see what are most likely deficit spending and interest borrowing by the Treasury, look at the amount of US Treasuries held by banks. Currently, they are close in value to the previous years’ deficit spending plus interest paid on the debt. In 2010 the banks had about 4% of the national debt. The Fed held about 9% of the debt in securities. and 87% was held by investors.
The investors’ money was not spent into the economy but stored in time-deposit accounts at the Fed. So the investors’ portion of the national debt, which makes up most of the national debt, already exits and ready to be returned to the investors when their securities mature. So, there is no problem there for paying off that portion of the national debt.
Furthermore the government seems to offer these investors US securities for a purpose: to keep money out of circulation that would otherwise cause inflation were it to be in circulation when other efforts by the government to deficit spend were in effect: e.g. defense spending, infrastructure spending, discretionary spending.
I think the big thing MMTers can note is that the Fed has been paying off the debt on the deficit-spending portion of the national debt. There is no need for platinum coins to pay off the deficit debt or the investor’s debt (to do the latter would be inflationary).
So, the national debt is not a problem, certainly not for the taxpayers nor their offspring and their offspring in turn.
I’d like confirmation or correction of the facts on which I base the above thesis.
China lifted ~600 million people out of poverty, while the Eurozone dunks dozens of millions into poverty. (Over 100 million?)
The real proofs are with us, they are not just some dusty mathematical abstractions in some old library books. Austerity can’t improve economic conditions. China proves that the troika and the Eurozone get the Darwin prize, they are going the way of the dodo. In Europe’s history also is the proof, how to improve economic conditions, after the war.
From Professor Varoufakis:
Following my intervention (see above) the Eurogroup President rejected our request for an extension, with the support of the rest of the members, and announced that the Eurogroup would be issuing a statement placing the burden of this impasse on Greece and suggesting that the 18 ministers (that is the 19 Eurozone finance ministers except the Greek minister) reconvene later to discuss ways and means of protecting themselves from the fallout.
At that point I asked for legal advice, from the secretariat, on whether a Eurogroup statement can be issued without the conventional unanimity and whether the President of the Eurogroup can convene a meeting without inviting the finance minister of a Eurozone member-state. I received the following extraordinary answer: “The Eurogroup is an informal group. Thus it is not bound by Treaties or written regulations. While unanimity is conventionally adhered to, the Eurogroup President is not bound to explicit rules.” I let the reader comment on this remarkable statement.
For my part, I concluded as follows:
Colleagues, refusing to extend the loan agreement for a few weeks, and for the purpose of giving the Greek people an opportunity to deliberate in peace and quiet on the institutions’ proposal, especially given the high probability that they will accept these proposals (contrary to our government’s advice), will damage permanently the credibility of the Eurogroup as a democratic decision making body comprising partner states sharing not only a common currency but also common values….”
“Normal human beings care a great deal about fairness and are willing to suffer personal losses rather than give in to dictators like the troika.”
People know when they are being treated fairly, or not.
There’s a reference for something like this in (can’t remember the exact page):
Economists and the Powerful: Convenient Theories, Distorted Facts, Ample Rewards
Paperback – October 1, 2012 by Norbert Häring and Niall Douglas
I have a question relevant to the Greek debt situation.
How does the European Euro differ from the United States dollar? Both systems have central banks,
a legislature, and fiat money (of a sort).
But what I have gathered from occasional reading about the way the euro works, is that the eurozone
banks still practice fractional reserve banking and lend from their reserves. Furthermore when the central bank does quantitative easing it lends euros rather than the way the Fed buys securities or the Congress passes laws for granting money for certain purposes that will be spent in the various states, debt-free.
Is it the case that when the euro was put into effect, a finite amount of euros was created for each country, and that quantity of euros could never be augmented with additional euros? So, banks have to use fractional reserve banking and borrow from their depositors’ deposits.
The ECB (European Central Bank) does do “quantitative easing”, but does that mean it does it by
lending money? (My view on the Fed is that when it buys securities the Fed’s dollars created by it out of thin air are extinguished as they cancel the loan to the Treasury in buying the securities. So there is no real additional money going into circulation from the Fed’s purchase of these securities? Does the ECB’s quantitative easing function in the same way or is it a quite different process?
It seems to me that the fatal flaw (if my account of the Euro above is correct) of the European euro is
that they have a fixed quantity of money in circulation, and if there are those who incur debts, they have to get the money to repay the debts from what is already in circulation–let alone existence. The system will ultimately deflate to collapse because as euros get taken out of circulation into various forms of savings and buying of imports and governments’ running surpluses, the quantity of money in circulation will become less and less.
Perhaps a country like Germany which ends up lending and then having collateral claims on assets in the borrowing countries, will have savings sufficient to buy up all the debtor countries’ assets. (I think the Greeks think that is what the system is designed to do: to fleece them of their assets. There go all their
resorts and tourist attractions into foreign ownership. No help is given to educate and train workers in new skills).
In the US the states can’t create money, but the central government through Congress has the power to create money and spend it, and if there is a depression, Congress can (if it has politicians with the brains and knowledge to do so) deficit spend on various programs, like infrastructure projects, and introduce new debt-free money into the system.
The euro strikes me as an anal retentive’s dream of a money system.
Insightful post! I enjoyed reading it!
It’s true that there is a law stating that the US must sell securities dollar-for-dollar with deficit spending, but logically this law would not need to exist if what were actually happening were “Treasury [coming] up with the money by borrowing it from… banks.”
No law need be made that you or I must secure financing for our deficit spending because that is an operational requirement of our deficit spending. In the case of the US Treasury, there is no need to secure financing because the UST is the issuer of the dollar. The statutory requirement that Treasury must sell securities dollar-for-dollar with deficit spending is just that – a statutory requirement. In no sense is Treasury “coming up with” money by doing this.
Also, you describe QE as “The Fed has been going through the US banks looking for US securities to buy and it has been buying up all those mature securities, just to make the banks less vulnerable to default.” This is confusing QE with TARP. QE has nothing to do with bank solvency – it is a type of allegedly aggressive monetary policy designed to stimulate the economy through the so-called “balance-sheet channel.”
The idea is that the rebalancing of private positions in the wake of QE has a stimulative effect.