Tuesday, January 15, 2019

Interest Expense In the Drachma Age vs. Interest Expense In The Euro Age

With all the challenges/problems which the Euro brought for Greece, there were also benefits which are often overlooked. One of the principal benefits was the significant reduction in interest expense. One way to measure the burden of interest expense is to put the latter in relation to the financial resources available to pay interest, i. e. tax and other government revenue. In theory, one could argue that every billion which is saved on interest expense would enable the government to make a billion of investments elsewhere. In reality, this is not the case because the government could do both at the same time when financing the 'other' billion with new debt.

Greece's debt increased dramatically from 2000 (the last year of the Drachma) to 2017, from 141,0 BEUR to 317,4 BEUR (this after a haircut of approximately 100 BEUR). A layman might assume that Greece's interest expense would have increased dramatically, too.

In fact, Greece's interest expense declined from10,2 BEUR in 2000 to 5,6 BEUR in 2017.

In 2000, the last year of the Drachma, interest expense absorbed 32% of tax revenue whereas in 2017, interest expense absorbed only 11% of tax revenue. This was due to a combination of higher tax revenue and lower interest expense.

In 2000, the last year of the Drachma, interest expense absorbed 17% of total government revenue whereas in 2017, interest expense absorbed only 6% of total government revenue. This was due to a combination of higher government revenue and lower interest expense. The statistics are below (in BEUR).

Interest Expense vs. Government Revenue
2000 2017
Taxes on income, property, etc. 13,2 18,1
Taxes on production, imports, etc. 18,5 30,8
-------- --------
Total revenue from taxes 31,7 48,9
Social contributions 17,0 26,0
Capital transfers, etc. 9,9 11,8
-------- --------
Total non-tax revenue 26,9 37,8
Total government revenue 58,6 86,7
Total debt 141,0 317,4
Interest expense 10,2 5,6
Interest expense as % of tax revenue 32% 11%
Interest expense as % of total revenue 17% 6%

What conclusions can be drawn from the above?

First, had Greece stayed with the Drachma, the interest expense would have remained high because Greece could not have taken advantage of lower Euro interest rates. Secondly, the interest expense would in all likelihood have increased because it is safe to assume that Greece's debt would have also increased. Whether government revenue would have increased substantially under a Drachma regime is anybody's guess. Probably not by much (this statement had to be revised. See the below addendum).

Put differently, interest expense as % of tax revenue, already a staggering 32% in 2000, would in all likelihood have increased. Markets might not have been concerned as long as that percentage increased to 35% or a even a bit more but once that percentage would have hit or crossed the 50% level, there would have been panic in markets. Could interest expense have hit or even exceeded 50% of tax revenue? If debt had continued on a rapid growth path and if tax revenue had remained flat, that could definitely have happened.

My conclusion is that, had Greece stayed with the Drachma, it could not have accumulated as much debt as it did with the Euro. This for the simple reason that markets would have determined long before 2010 that Greece had hit or exceeded its borrowing capacity.

Secondly, the Euro not only brought Greece lower market rates but also two additional advantages: Greece could avoid a sovereign default and, following the implementation of the programs, Greece was offered extremely below-market interest rates on the loans from its Euro partners. With a debt load of about 180% of GDP, it is miraculous that the government would only have to allocate 11% of its tax revenue and 6% of its total revenue to interest expense. Those are percentages which one finds in the strongest Euro countries. Countries like Portugal, Spain, Italy or Ireland have to allocate much more of the revenue to interest expense.


I have added the years 2008 and 2009 to the chart. The interesting point is that until 2008/09, i. e. as long as the economy was booming, tax revenue and government revenue in general had increased substantially. For example: revenue from taxes increased from 31,7 BEUR in 2000 to 50,1 BEUR in 2008, and total government revenue increased from 58,6 BEUR in 2000 to 98,4 BEUR in 2008. That seems to be a nice proof that a booming economy increases government revenue (even if it is all financed with debt).

 Interest Expense vs. Government Revenue
2000 2008 2009 2017
Taxes on income, property, etc. 13,2 19,7 20,3 18,1
Taxes on production, imports, etc. 18,5 30,4 27,8 30,8
-------- -------- -------- --------
Total revenue from taxes 31,7 50,1 48,1 48,9
Social contributions 17,0 30,6 29,3 26,0
Capital transfers, etc. 9,9 17,7 15,1 11,8
-------- -------- -------- --------
Total non-tax revenue 26,9 48,3 44,4 37,8
Total government revenue 58,6 98,4 92,5 86,7
Total debt 141,0 264,8 301,0 317,4
Interest expense 10,2 11,7 12,0 5,6
Interest expense as % of tax revenue 32% 23% 25% 11%
Interest expense as % of total revenue 17% 12% 13% 6%


  1. All your conclusions are right.

    But i have a bit different approach, social contributions are not part of tax revenues?

    The interest expense, if calculated together with social contributions and direct-indirect taxes (total tax revenues) seems reduced from 2018 but still is a bit problematic, due to various other reasons.

    PDMA publications are very good (look at page 10) but there is not explanation of calculations and not historic data.


  2. Is this some sort of joke? Interest expense in the currency that you "print" versus interest expense in the hard currency that you can't print? You can't be serious, can you Klaus? You've lost the plot.

    Here's a wake up call. Interest expense in drachmas was irrelevant. Taxation was merely a tool to rein in inflation and nothing else. The government didn't need to tax in order to finance, nor did it have any constraints in it's ability to invest (other than the exchange-rate and inflation).

    I can't believe I'm reading this. Seems that being the Eurozone (where monetary financing is forbidden, i.e. a neoliberal's wet dream) has affected people so much that they have forgotten what having your own currency means like from an operational point of view.


    1. Before the Euro, every EU country had a currency which it could print. None of these countries faced constraints in terms of budget deficits? If Drachma interest was irrelevant, every other expense on the budget was irrelevant, too. Think that through!

      A government cannot print revenues and it has to pay its expenses, even in it own currency. All the government can do is to cover a shortfall in revenues with new debt which requires investors who buy it. The Central Bank, as a last resort, can buy up government issues if no one else is prepared to buy (the US financed WW2 largely though the Fed). Do you think that might have something to do with the value of a currency (and the wealth of a nation)?

      Here is a thought: tell Venezuela they needn't worry about supply shortfalls. They should just print the money to buy supplies and to create wealth.

    2. I was clear on what I said. I said the constraints were: 1) inflation, 2) the interest-rate. Meaning, you can't "print" too much money or you'll have high inflation, and also your populace might buy too many imports which might cause your interest-rate to decline. And yes, by printing currency we all mean that the central-bank can buy the bonds if need be. However, because the domestic markets know this, they consider these bonds a safe asset and so they buy them. It's this kind of safe asset which is absent in the Eurozone.

      Returning to the issue of monetary financing, Japan has showed how much you can stretch this practice. However, I have no doubt that eventually some countries will abandon the pretense and sidestep this whole debt-based system altogether because, let's face it, it's a voluntary constraint and nothing else.

    3. Glad to hear that you accept that even in a local currency environment with 'money printing capability', there are budgetary constraints.

      I agree that there are not a lot of safe assets in the Eurozone. There are some, though. For example bonds of the EIB.

      The US has federal bonds because there are federal expenses/deficits to finance. The EU finances its 'federal' expenses differently: contributions from member states, customs duties, etc. The US federal bonds could under no circumstances be used to finance the states and their expenses (forbidden under the Constitution). Just like in the EZ, US states finance their expenses/deficits with state bonds which are stand-alone and not supported, legally or implicitly, by the federal government.

      Japan's debt overload works (so far) because it's all in their local currency and most of it is held domestically. And held mostly by Japanese people and not the Central Bank. Japan has large external surpluses and reserves so they are unlikely to ever come under pressure of international markets. But a 1-2% rise in interest rates is going to severely impact their budget. That, having low interest rates is a huge plus for Japan (the same plus as for Greece, which was one of the points of my article).

      What's my point? My point is definitely NOT that states should be run by German housewives. That would be totally wrong. But some form of financial prudence and solidity is required in the long run to avoid big disasters sooner or later.

  3. We have talked about all this before.

    The US federal government might not finance the states directly, but it does so indirectly, first by relieving them from certain obligations (like defense spending), and second by subsidizing the poorer states through a combination of benefits, investment and lower taxation. If the Eurozone wants to become viable, the richer countries must subsidize the poorer ones in one way or another. The Germans and their satellites don't want to, and this creates a permanent state of instability.

    We have talked about Japan as well. Frankly, it doesn't matter whether the debt is owned by private entities or the central-bank. The external surpluses and low unemployment rate mean that they manage their economy in a successful manner. The fact that they do so after the bursting of a big bubble tells us just how much better their handling was, and what a lousy job the Eurozone is doing.

    Going back to Greece, currently it's economy is severely underfunded, as we can conclude from the 0,6% inflation rate and 20% unemployment (much larger if we include part-time employment, discouraged unemployed and those that have left the country). And what does the Eurozone and ECB do about it? Nothing. In fact they make things worse by imposing high primary surpluses, and by keeping the banking system in a state of limbo (in contrast, the FED's TARP removed problematic assets from the banks' balance sheets).

    C'mon Klaus, let's not mince our words, what solidarity? The EMU is a total disaster. Only Germany and it's satellites win by having a low exchange-rate and capital flight from the South. Detestable.