Second thoughts on miniBOTs

I generally operate on the principle that if people can show me how I’ve misunderstood something I will take that as a win. If they can do this without making me feel a complete fool, that’s an unnecessary but welcome bonus.

After blogging a couple of early (fairly negative) thoughts about miniBOTs yesterday, I had a bit of feedback. What followed was a brief epiphany during which I realised I was wrong and miniBOTs could actually be an awesome idea.

The epiphany was based on the notion that if there is slack in the Italian economy (which there surely is), and that this slack could be engaged without crowding out the private sector by the government doing generally helpful-to-long-term-human-goals-sort-of-stuff (again, likely true). This could be upgrading infrastructure, developing human capital, regional/ sectoral development financing, that sort of thing. And (importantly) the financing vehicle – miniBOTS – could be used by the government in a manner that was revenue-neutral or even revenue-accretive.

It would work like this:

  • Step 1: government puts out tender for xyz contract, payable in a certain value of miniBOTs;
  • Step 2: contractors bid for and win contract, then sell miniBOTs to folks owing large back-taxes at a discount.
  • Step 3: government collects back-taxes (and/ or taxes on the grey/ black economy that now steps into the sunlight with lower effective tax rates) that were otherwise lost. So debt doesn’t actually rise.

Reckoning that miniBOTs might trade sub-par (because, you know, some other government might turn up and think the whole idea was a bit whacko and stop accepting them as taxes in lieu of euros), contractors would probably want a few more miniBOTs than plain old euros for a given job, implying a financing yield (in terms the ratio of miniBOTs to Euros, or rather discount to par).* In other words, I believe that this new good-for-Italy-using-up-slack expenditure would cost more in miniBOTs than it would otherwise have done in plain euros.

But costing more miniBOTs than euros could be okay if a) it deploys slack productively; b) it is making investments that are possible that would have been impossible without miniBOTs, and; c) would ultimately be financed by gathering back-taxes/ black economy taxes. (The folks owing back-taxes buy the miniBOTs because – now there is a discount to par value of a potentially temporary nature – it costs them less, and they seize their chance.)

So rather than being an interesting money thing, it could actually be a bit of an elaborate tax amnesty/ tax cut in which government contractors also get a little richer than they otherwise might.

However, this epiphany lasted only 53 seconds.

My mind had sort of taken a temporary leave of absence, and I’d forgotten Gresham’s Law: the idea that bad money drives out good.

In other words the miniBOTs get bought by ordinary folk at the point at which they pay their taxes (and they then deliver them to government in lieu of euros), and there is no reason why back-taxes/ black economy taxes ever get touched.

The government still has to pay more miniBOTs than euros for stuff (because otherwise why would people take them) and legit taxpayers would buy them at a price below par (because otherwise why bother). And so the whole thing becomes self-defeating as miniBOTs collect in the Italian treasury rather than among the population as a whole, who prefer to amass monetary assets in euros unless tempted by discounts to par (and hence higher implied financing rates for the state) on miniBOTs. (And the scheme introduces scope for political favours to be awarded to connected contractors who might even repay this political debt through future party funding.)

Meanwhile, the Commission would likely look at miniBOTs as debt (because selling future receivables look very much like debt, as any credit card receivable securitization analyst will tell you), and given they look to be zero-coupon, would likely see them as tradable to next put date (see footnote), which is to say having very short term structure no matter how irredeemable they profess to be.

There is a second way that miniBOTs are interesting, and that is as an asset conjured our of nothing that has value to people in such a way as to create demand for a permanent stock (eg, a currency). In such a light, the scheme looks pretty identical to the creation of a new form of Outside Money, but as a Chartalist myself I think that for it to actually properly work the state would need to require the payment of taxes in miniBOTs rather than simply accept the payment of taxes in miniBOTs. In accepting rather than requiring, we get back into Gresham’s Law problems: the miniBOTs would need to have an implicit financing cost. And because of this the state would endure a weaker fiscal position than it would otherwise have (paying more miniBOTs than it would have needed to pay euros, but receiving back an equal number of miniBOTs to the number of euros it would otherwise have received in tax revenue). If the state chose to only accept taxes in the form of miniBOTs this changes things. But I think that this then touches on the legal tender issues discussed in the previous blog.

I’m still up for being persuaded of their merits. And if I wanted to shoe-horn Italians out of the Euro without actually bothering to make and win the case with them that this was what they would be doing (stirring up a fight with Brussels, maybe demonizing them along the way to the domestic population), miniBOTs seem a reasonable thing to introduce.

Absent this motivation, I still can’t see these merits right now. There could be a decent portion of folks who reckon a tax amnesty or tax cut would be self-funding. I know there is a decent minority of the population who think that Italy should leave the Euro. Advocates of these positions should make their case without engaging in bait and switch tactics.

Chances are you’ve thought about this more than me. If you can communicate simply and coherently why miniBOTs make senses in a way that doesn’t involve leaving the Euro please blog it (in English, sorry).

* It has been put to me that miniBOTs won’t have a term (ie a date at which they will necessarily turn into euros) and so my whole blog is somewhat off-base. But if I bought an irredeemable zero coupon euro-denominated security that was puttable at par, I would consider the term to be the first put date, and then measure its yield as a function of the discount to par and distance from par. (To get a bit more technical the first put date is the date at which it is advantageous for the holder to put the securities to the issuer, and this will actually depend on the price of all of the other securities on that issuer’s yield curve as well as the put date). I can’t think why anyone else (including the Commission) would not do the same.

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Update: the Bank of Italy has put out a PDF with their initial take on miniBOTs. It is the clearest thing I have read, and I was surprised and delighted that it did not contradict my understanding as conveyed in this blogpost and it’s predecessor.

Quick thoughts on mini-BOTs

So everyone in London has got excited about mini-BOTs – Italy’s prospective parallel currency after Munchau on Monday and then Dizard today have written about them in the FT.

A quick recap:

  • Italy has been a growth laggard (average GDP growth since 2004 has been 0%, although there has been steady slow growth since 2014), and has high levels of debt (c.130% of GDP).
  • March 4 saw the Italians go to the polls. Conventional wisdom saw the outcome as a likely stalemate unless the right-wing populist Lega Nord (the League) and the left-wing populist Five-Star Party could come together in coalition. As someone on Twitter put it, this would be like imagining the audience of BBC Question Time putting aside their differences and forming a government.
  • Five Star wants things like a Universal Income; The League wants things like flat taxes. In each party’s mind their own favoured policies probably pay for themselves with an exploding renaissance of growth. In everyone else’s minds (including each others) these policies probably lead to an exploding renaissance of debt issuance.

So there is this idea kicking around that they fund their wish-lists not by issuing currency (which they can’t do because the ECB is the monetary sovereign), and not by issuing bonds (which I guess they reckon the markets won’t like and the Commission will get prissy about as it will break all manner of rules). Instead they want to issue mini-BOTs – small-bill government debt that looks and feels very like Euro notes. And look and feel very much like money.

But would mini-BOTs be money?

They don’t look like they would be legal tender. But this might not be a big deal. Legal tender is a pretty narrow legal definition. My basic understanding is that it means something that law courts understand as being unlawful to refuse in payment of a debt. And in the Euro area, the Commission is pretty blunt about how only the euro is legal tender here. They also (helpfully) explain that although non-official (euro) currencies “have no legal tender status, parties can agree to use them as private money without prejudice to the official currency”.

In the UK we use lots of things as money that have no status as legal tender. Scottish and Northern Irish banknotes are not actually legal tender. Furthermore, 1p and 2p coins are legal tender for sums only below 20p, 50p coins are legal tender for sums not exceeding £10.

This isn’t the first time we have seen this sort of thing. Even in Italy there is some precedent for creatively using local currencies that are backed by state obligations as a currency, albeit at a local level. This nice story via Lorcan Roche Kelly tells of a local community that introduced a local currency that was backed by state debts. In fact, it looks in many ways to be a municipal version of mini-BOTS which provided credit to the local government and liquidity to the local economy.

But governments don’t usually do this sort of thing unless they are in trouble. So the signalling is pretty terrible.

  • Argentina issued one-year small-bill bonds (nicknamed Patacones) to its civil servants in a short-lived effort to keep its currency pegged to the US dollar. These were widely accepted (at a discount to US dollars) and McDonalds quickly launched their Patacombo meal. Patacones could be used to settle tax obligations with the state, just like mini-BOTs.
  • California issued state IOUs under Schwartzenegger in 2009 in a similar effort to cover its gaping budget holes, just as it had in 1992 and 1993. These IOUs were paid to vendors doing business with the state as federal law prohibit IOUs to state employees. I don’t know whether there is any European Directive that prohibits Eurozone countries from doing the same but somehow I doubt it. California didn’t turn out too bad? Well, banks only accepted these IOUs for five days before closing down this option according to wiki. The California Budget crisis rolled on until both spending was cut and taxes (and university tuition costs) were raised, as well as the rebound in the (national) economy that boosted tax takes.

Despite this, mini-BOTs might actually qualify as money by the rules of some monetary bean-counters (depending on their term). Whether they were used as a unit of account would determine where they sat in my Venn. Mini-BOTs would look and feel like money, but if they have a term to them (a date at which they can be redeemed for actual euros) I reckon that they just have just a lot of euro-moneyness.

In fact, they would likely turn out to be a strong reminder that the Italian state is not the monetary sovereign, and the subject of a big fight in Brussels as the Commission (rightfully IMHO) called them out as debt which would need to be included in Eurozone-specific debt numbers. And it is the prospect of this incipient fight that is roiling markets.

Moneyness of betting tips

In a gently mocking (but good-natured) tone, Lorcan Roche Kelly asked me yesterday (rhetorically) how much moneyness I thought a tip on the horses had. Answering rhetorical questions tends to win few friends, but I think it is an interesting one.

As background, money tends to be thought of as the stuff that functionally happens to satisfy three conditions: serving as store of value, unit of account, and medium of exchange. I still quite like this old Venn I made for a talk I gave on money:

In a conventional monetary aggregate sense, definitions of money vary from jurisdiction to jurisdiction, and within jurisdiction over time. The grey shaded sections in the two tables below show how UK M4 and Eurozone M3 monetary aggregates are defined and differ at a high level.

So, for example, UK households’ deposits with agencies of the UK central government don’t count as money to a UK monetary bean-counter, while Eurozone household deposits with agencies of Eurozone central governments do count as money to Eurozone monetary bean-counters. To someone less interested in counting monetary beans this seems a bit silly, but follows from having to draw the line somewhere – and the Bank give a nice primer on this here.

If you reflect that there are many many shades of grey, the appeal of an approach that recognises the extent of this gradation is significant. Hence the attraction of moneyness.

I think that maybe all Stuff apart from notes, coins and bank reserves administered by the central bank (ie, the stuff that sits in the part of the Venn that takes medium of exchange and store of value) has some money-like quality, however tiny, and that this portion of its value is its moneyness.

I like to think that the moneyness of a thing as being some function of its duration, creditworthiness and secondary market liquidity.

So I consider a small sight deposit in a highly creditable bank to have near full moneyness. A bond due to be repaid in thirteen months by a monetary sovereign (eg, UK government) would also (in my understanding, although not in a monetarist’s sense) have very high amounts of moneyness. The amount of moneyness would be lower for debts with more distant maturities, although longer-dated securities’ moneyness can be bolstered by the degree to which they are accepted and can be borrowed against as high quality collateral. Changing collateral haircut schedules in repo flowing from a change in view from a credit rating agency or central bank can quickly change the moneyness attached to long-duration instruments; changing secondary market liquidity conditions or changing regulations regarding rehypothecation could also be a big deal for aggregate moneyness. Shadow-banking folk have been banging on about this (perhaps using different terms) for years.

So, back to Lorcan’s dig. I actually think it is a genius of a question because it takes things to an extreme (the moneyness not even of a betting slip but of a betting tip!).

The tip in question was for Circus Couture, which was offered at 12/1 on the 4:20 at Ascot. According to our tipster these odds were far too good. Maybe 4/1 was fair. Is there moneyness attached to this tip? Sounds silly, but let’s take it apart.

We can think of a betting slip as a really really short-dated super-high yield ultra-junky bond. A 12/1 outsider is like a zero coupon bond offered at 7.70 and maturing the same day at par. If the bid-offer spread that is the raisin d’etre of bookmaking did not exist, there was perfect liquidity in this choice market and the odds were stable I can see that there is a case to be made that the slips value would be close to its moneyness at somewhere close to 7.7% of par. This recognizes for the market a role in altering the moneyness of contracts as information develops, and this strikes me as a not unreasonable characterization of real life.

But no-one bets on a horse based on the view that the odds are fair. A bookie’s whole business model is to get on the inverse of punter-facing odds to extract a steadyish return for services rendered, and this is hardly a secret. And I think punters walks into a betting shop seeking excess returns (as well as leisure services), and am not sure they are even risk-neutral. So I wonder to what degree the moneyness of the betting slip (and, actually, the moneyness of any credit security) should not be discounted using a rate higher than that used to value it to account not only for the perceived risk of pay-off, but also the uncertainty of pay-off. (There is probably a big literature on how financial markets proxy uncertainty as risk so that they can get it into models, but I haven’t sought it out.)

Moving on to the tip itself, if I put a bet on Circus Couture with the view that 4/1 was the fair price, this would be akin to buying a bond at 7.70 with a view that the fair price was 20. The value of the tip to me and anyone who believes the tipster is around 12.3 cents in the dollar. But the moneyness of the tip is zero, precisely because it accounts for my differences with the market.

I think this is just be a long way of saying that a tip is not ‘Stuff’, so it has no moneyness in the framework I set out. But given that money is a medium by which subjective views as to what value constitutes is triangulated (on a monetary wealth X conviction-weighted basis) *as well as a thing*, it feels weird to say that each and every of the individual subjective views that together coagulate into a market price are themselves without measurable worth (or measurable moneyness). Or rather that the worth of each view corresponds precisely to its market impact (the degree to which it moves the market price), and any account of moneyness that includes market price will be correspondingly impacted.

This leads me to the view that a good betting tip* (that is ultimately right) has no moneyness even if a bad betting slip (attached to an ultimately losing horse) does (prior to the race!). But if there was a way to securitize betting tips…

* In the end the tip was bad – the horse came in fifth – so maybe zero worth