tag:blogger.com,1999:blog-20151655624019493062024-03-13T06:04:38.126-07:00Greece Economy WatchUnknownnoreply@blogger.comBlogger74125tag:blogger.com,1999:blog-2015165562401949306.post-82501690386156327922015-05-17T13:35:00.004-07:002015-05-18T00:07:51.634-07:00Are The IMF and the EU at Loggerheads Over Greece?Everything has a cost, or so the story goes, especially time. In the Greek case we now know an additional item on the mounting bill: the country is back in recession. The issue is who - apart of course from the long-suffering Greeks themselves - will pay the extra costs of the latest imbroglio.<br />
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<h3>
The Cost Of Not Finding A Solution</h3>
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It is now clear that Greece's economy has been going backwards over the last 6 months, and that it has once more fallen back into recession. Greek GDP fell by 0.4% in the last three month of 2014, and by a further 0.2% in the Jan - March 2015 period. As a result at the end of March Greek GDP was only 0.3% above the year-earlier level. This is a lot lower than expected in IMF forecasts, and - perhaps more importantly - well out of line with what is needed to maintain the 2022 debt sustainability targets on which continuing Fund support for Greek programmes depends.<br />
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Indeed "Greece is so far off course on its <a href="http://www.ft.com/cms/s/0/520ec4f0-f004-11e4-bb88-00144feab7de.html?siteedition=uk">€172bn bailout programme</a> that it faces losing vital International Monetary Fund support unless European lenders write off significant amounts of its sovereign debt", <a href="http://www.ft.com/intl/cms/s/0/72b8d2ae-f275-11e4-b914-00144feab7de.html#axzz3aHdRghat">Peter Spiegel wrote</a> in the Financial Times on 4 May 2015. The reason for this is obvious: IMF regulations prevent the Fund continuing to make tranche payments to countries where there is a foreseeable financing shortfall during in the coming twelve months. The worsening in the Greek economic outlook and the consequent reduction in the revenue outlook effectively guarantee this shortfall. <br />
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But the sort of debt write-off the IMF is demanding of its European partners goes much deeper than that. Future IMF participation in any new Greek programme <b>after June is also in doubt</b> because without additional pardoning the debt will not be on a sustainable trajectory in terms of the objectives set down and agreed upon in November 2012. So you reach a point where extend and pretend hits the proverbial fan. You can, of course, do more extend and pretend till the next time it happens, but at this point the IMF seems reluctant to do so. On the other hand austerity-type spending cuts which only make the economy smaller and the growth path lower simply don't help in this context, since what they give with one hand (debt reduction) they take away with the other (in the form of lower GDP).<br />
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The background to the current stand-off is to be found in <a href="https://t.co/GXLcHbiOF2">the debt targets the Eurogroup agreed</a> with the IMF in November 2012 and which effectively made the current programme possible. Given the latest recession these targets are clearly now not attainable. On the other hand Greece is totally bust, so the only way the negative effects of the negotiating gridlock can be paid for is by someone else "coughing up" (or rather "pardoning" debt). This someone will need to be the Euro partners (who else is there), and the longer the stand-off goes on the higher the cost. Naturally the other alternative would be allowing Grexit, but arguably the cost of Grexit would be much higher to the Euro partners, and by a large multiple.
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The issue of the growing IMF/Eurogroup divergence came to general public attention over the weekend when an IMF internal memo <a href="http://blogs.channel4.com/paul-mason-blog/imf-leak-signals-progress-greece-threat-default-june/3695">was leaked to Channel 4 News</a> (UK). The key point in the memo, which is hardly news, is that Greece is running out of money. “There will be no possibility for the Greek authorities to repay the whole amount unless an agreement is reached with international partners," referring to a series of June repayments to the IMF amounting to roughly 1.5 billion euros. <br />
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This impression is also confirmed by details of the letter that the Greek Prime Minister Alexis Tsipras wrote to International Monetary Fund Managing Director Christine Lagarde at the start of May (see details in <a href="http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_17/05/2015_550106">this Kathimerini article</a>) to inform her that Athens would not be able to pay the 750 million euros due to the Fund on May 12 unless the European Central Bank allowed Greece to issue more T-bills. It appears that at the time of writing the letter (which also went to EU Commission President Jean-Claude Junker and ECB President Mario Draghi) Mr Tsipras was not aware he could temporarily use the 650 million euros held on reserve at the Fund to make the payment, which he subsequently did. It's not unreasonable to assume that it was the IMF itself who advised him on this.<br />
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The inter-institutional tensions are evidently reaching a critical stage, although in fact the issue has now been knocking around for some weeks,<a href="http://www.wsj.com/articles/standoff-between-greece-and-creditors-over-bailout-deal-tests-imf-1429743220"> as Simon Nixon reported in the WSJ</a> on April 22.The IMF, he said, "appears to have blinked".<br />
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<span style="font-weight: normal;">The general impression being given is that the IMF is contemplating a much lower bar for agreement, and then possibly disengagement from any post June programme. The Euro partners are evidently anxious to avoid this outcome, but they are caught between a rock and a hard place.</span><br />
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<h3>
On Or Off The Hook? </h3>
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In order to understand what is going on between the Eurogroup and the IMF it is necessary to go back to a 2013 document entitled: The Third Review Under the Extended Arrangement Under the Extended Fund Facility (what a mouthful that is, henceforth the Third Review). In particular the following paragraph in that document off a key:<br />
<blockquote class="tr_bq">
<i>The macroeconomic outlook, debt service to the Fund, and peak access remain broadly unchanged and euro area member states remain committed to an official support package that will help keep debt on the programmed path as long as Greece adheres to program policies. Capacity to repay the Fund thus depends on the authorities’ ability to fully implement an ambitious program. It continues to be the case that if the program went irretrievably off-track and euro area member states did not continue to support Greece, capacity to repay the Fund would likely be insufficient.</i></blockquote>
Now all of this may sound - at least to the uninitiated - like a load of old bureaucratic mumbo-jumbo, but actually there are a number of key statements here which may help to put the current internal Troika tiff in some sort of broader and more intelligible perspective.<br />
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The cited paragraph talks about three issues: the macroeconomic outlook, the commitment of euro area member states to support Greece and keep the debt on the programmed path as long as Greece adheres to the programme's requirements. It also warns of the danger that should the programme go "irretrievably off track", and euro area member states not give the necessary support then the country's capacity to repay the Fund would clearly be insufficient - ie the IMF would be left holding the can, and Fund employees would be faced with the complicated task of explaining to its non-European members why losses had been incurred.<br />
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Crudely put the position is this - as long as the IMF continue to write reviews stating the Greek programme is on track then the euro area member states are <b>on the hook</b> to cover any shortfall in Greek debt performance in order to make the 2020 and 2022 targets (see above) achievable. This is a commitment they undertook during negotiations on the second bailout agreement.<br />
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On the other hand, if the IMF were to start producing reports stating that the programme was <b>off-track</b> because of Greek <b>non-compliance</b>, rather than for example arguing that the numbers were out of whack due to faulty macroeconomic forecasts (and of course the recent economic relapse makes those forecasts even less realistic), then the euro area member states would be <b>off the hook</b> from additional stepping up to the plate with the result that the IMF would end-up taking a loss. <br />
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Well the present recession makes it evident that those targets are even less achievable than they were previously, and that future debt sustainability analyses will have to reflect this. Bottom line: the IMF has a clear interest in enabling Greece to sign successfully off the current programme (due to end in 2016) and they thus have more interest in giving the country a "pass" note than the Eurogroup ministers do.This is why, in Simon Nixon's words, they are blinking, to the great discomfort of the Eurogroup partners.<br />
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<h3>
Bottom Line: When You're Bust, You're Bust</h3>
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A lot of attention is being paid at the moment to the idea that Greece is running out of money, and indeed there is a lot of chuckling about just how much grasp Yannis Varoufakis actually has of game theory. But at the end of the day it is also true that when you have lost everything (in the bankruptcy sense) you have relatively little still to lose. To some extent the idea that the Greek government might be deploying this strategy - known technically as coercive deficiency - was explored <a href="http://russeurope.hypotheses.org/3395">by Jacques Sapir back in February</a>. In my humble opinion far too much energy may have been wasted on laughing at Mr Varoufakis (which might precisely have been his intention) and far too little invested in trying to think through what he might have been up to.<br />
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If delays in negotiations mean a large bill is run up on your credit card (figuratively speaking) at the end of the day you can't pay it, so someone else will have to. This is the situation Greece is now in. If non performing loans start to rise with the new recession eventually these will have to be written off, and the bank recapitalization costs will go on someone else's account. <br />
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The IMF memo in fact draws attention to this issue, and states that “non-performing loans are at very high levels and – going forward – the system might suffer from important stress." Indeed they go further and point out how "staff also noted a dramatic deterioration in the payment culture in the country”. This is what you would expect to find in a country steadily, and day by day, going bankrupt.<br />
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It's no longer clear that even if progress was made in the next two weeks towards some sort of fudged compromise deal - the so called "quick and dirty outcome" that the IMF oppose - that this would be able to get the necessary agreement from all EU parties and the IMF before the June payment. That is not necessarily an insurmountable issue, but it does highlight just how near to a potential brink (or "accident") we are, and it also serves to draw attention to the point that the longer all this goes on the greater the cost for Eurogroup members. Reforms will bring a bit more growth, but only in the longer run. Whatever the package of structural reforms the Greeks sign on to it won't do that much to mitigate the effects of the hit the Greek debt sustainability profile just took.<br />
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But then there is the other alternative - just allow the momentum of the present impasse to carry Greece straight out of the Euro Area. That would solve the problem of getting a deal, but the cost, when you come to think of EFSF and IMF loans plus ELA would hardly be negligible, not to mention the as yet unquantified geopolitical and contagion effects. <br />
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Whatever way you look at it, the next few weeks are certainly likely to be interesting. <br />
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-15177929864949023622015-05-05T09:28:00.000-07:002015-05-05T09:42:54.690-07:00If Greece Had Not Existed, Europe’s Leaders Would Have Had to Invent Itδεῖ δ’ αὐτὸν ἐς φάρμακον ἐκποιήσασθαι - He must be chosen from among you as a scapegoat. Hipponax<br />
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One of the more intriguing aspects of the whole modern Greek drama is the tragicomic way the country seems to be constantly condemned to live out well known themes which come from its own mythology. The latest example is the way what was once the cradle of European civilization has allowed itself to be converted into the role model for everything its fellow Europeans are not. Or at least, this is the story we are supposed to believe. <br />
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Greek culture and historiography is replete with references to a figure - the pharmakos, or scapegoat – who needed to die that others might live. In fact, the pharmakos ritual is probably as old as human experience itself. In classical Greece it was the custom in times of crisis for some poor unfortunate to be singled out to serve as a whipping boy, the one whose chastisement served to make the wounded demos whole. <br />
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The unlucky victim, according to the texts, was first beaten with fig branches, and then ceremonially led through the assembled community to receive a bout of verbal abuse prior to the execution of sentence, which invariably meant being either sacrificially killed or permanently banished. The whole process has normally been interpreted by anthropologists as the means of purifying the group of some kind of perceived pollution, some sort of plague or great misfortune which has inexplicably befallen them. The source of the evil is first accumulated in the victim - the scapegoat - who is then sacrificed in order that it may in this way be extirpated and the city cleansed.<br />
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According to the nineteenth century British classicist Jane Harrison the pharmakos was viewed as an “infected horror”, even to the extent that the kindest thing might be “to put an end to a life which was worse than death”. The resonance of all this with the recent history of the Euro Area should not be hard to discern. For many Greece has come to incarnate all that is bad within the monetary union. Due to its own laxness it has been transformed into the rotten apple that endangers the rest of the barrel. It needs to be set apart, if need be even expelled. Hypocritically or otherwise some even go so far as to suggest it would be in the country’s best interest to meet this fate, to have Grexit forced on it as an act of kindness, in a way which is all too reminiscent of the arguments used to justify terminating the scapegoat’s suffering . Such a life was, after all, "worse than death".<br />
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The line in the sand that has been drawn around the country is slowly but surely becoming an impermeable frontier. The logical step for the country to take now is "capital controls", or so we often hear, as if such a measure were to help the country remain inside the currency whereas in reality it is the obvious stepping stone on the road to exit.<br />
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Extraordinarily those who are most praised for being "not like Greece" often turn out, on inspection, to be only milder versions of the same. They have debts which are almost as unsustainable as the Greek one (Italy or Portugal), they run far higher fiscal deficits (Spain), they need more labour and pension reforms just like Greece, and without doing more are surely stuck in similar kinds of “growth traps”. Yet far from the others being subjected to harsh austerity and pressure for “tough love” reforms, they are big beneficiaries – without any kind of conditionality – of central bank bond purchases, a backstop for guaranteeing ultra-low interest rates and the kind of market access from which the transgressor country remains frustratingly cut off from. Given that Greece is so obviously the weakest member of the group, what kind of bizarre logic leads the EU’s leaders to impose the most difficult of conditions, especially given how much is at stake for all of us?<br />
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Looked at from a suitable distance it isn’t that hard to argue that if Greece hadn’t existed it would probably have been necessary to invent it. Amongst so many squabbling parties Greece’s presence has served to unite, to let the others know who they are by enabling them to say who they are not. Whatever his shortcomings, the fact that Finance Minister Varoufakis found himself in an 18 to 1 minority in Riga speaks volumes: Greece is the tie that binds.<br />
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So Greece has suffered greatly so that Europe might save itself. And this has now happened twice.<br />
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The first occasion was when the country’s debt was consciously not restructured in 2010, provoking an impossible fiscal adjustment which was inevitably followed by an ultra-deep recession. This decision, as is often noted, allowed Europe’s banks to be saved, while at the same all the other struggling countries had their economies talked up, simply on the basis of their not being "Greece". Indeed the much vaunted European Banking Union is very much a by-product of the Greek travails, as was Draghi’s currency-saving promise. Without the threat of contagion from Greece to support the case for it would this have ever been made?
And now, before our eyes, history is being repeated. The second time is just as much a tragedy as the first one was. Greece is being starved of cash, while everyone else is receiving substantial debt support and enjoying seeing their interest payments reduced to extraordinarily low levels by ECB QE bond buying. Fiscal deficits targets in countries like France, Spain, Italy and Portugal have been relaxed, and in any event no longer attract the investor attention they once did. Everyone wants to ride the Draghi wave, not push back against him. And how exactly was QE pushed so easily through an otherwise deeply divided ECB governing council? It couldn't possibly be because those who were most opposed to it were also those most in favour of forcing Grexit, could it? <br />
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Could there have been some kind of "unholy alliance" between hawks and doves at the central bank since QE put in place the essential "cordon sanitaire" firewall, even while many were busy denying there was any real deflation risk. Naturally it is the presence of this QE firewall which would be absolutely essential to the existential well-being of the common currency should the worst come to pass in negotiations with the new Greek government.
How can it be, at the end of the day, that those who are deemed strongest get most support, while those who are weakest are left exposed – like frail babies in a world long past – to wolves and inclement weather, just to test if they are strong enough to survive before being fed?<br />
<h3>
<b>The First Bailout Enabled a Firewall to Be Built</b></h3>
Greece undoubtedly suffered as a result of the delay in accepting that the country’s original debt dynamic was unsustainable. In fact technical staff at the Fund were convinced of this from the outset, but EU leaders were opposed and from the Greek vantage point critical time was lost. As the IMF explain in their review of the first bailout programme; “An upfront debt restructuring would have been better for Greece, although this was not acceptable for the Euro partners.”<br />
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It would have been better for Greece since it would have enabled the IMF to lend over a longer period, which would have meant that the rate of reduction in the fiscal deficit could have been slower. In plain language the austerity applied would have been less severe, and the economic adjustment more manageable. This is the philosophy being pursued at the present time with the Spanish and French deficits. These two countries are being given longer to bring the overspend down below the critical 3% of GDP stipulated in the Maastricht Treaty, and there is a consensus that this is a good thing.<br />
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An earlier recognition that Greece was insolvent would certainly have helped the Greeks, but it would not have been welcomed by other EU governments who would have had to help their banks – the ones who had been financing the excesses in the first place. "Contagion from Greece was a major concern for euro area members,” the IMF explain, “given the considerable exposure of their banks to the sovereign debt of the euro area periphery.”<br />
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So a programme where there were serious doubts about long term debt sustainability was adopted due to the risk of contagion elsewhere in the Eurozone. The result was that Greece's correction had to be carried out more quickly (or an attempt had to be made to do so) resulting in a much steeper than absolutely essential recession. This way of doing things is not desirable, but even less desirable is to do it, and then fail to accept responsibility for having done so.<br />
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The objective of the line of argument being laid out here is not to support the world view of Syriza or the current Greek government, rather it is to suggest that mistakes made earlier are what has produced a climate in which Syriza-type arguments prosper. Simply to blame the Greeks for this is a travesty. Europe's leaders need to look beyond the current Greek government, and think about the long term interests of the Greeks themselves. Starving the Greek government of cash and crashing the economic recovery - which will only foment more radicalism later - is not the way to do things.<br />
<h3>
<b>How Serious Is Recession Risk Now In Greece?</b></h3>
Getting hard data on Greek economic performance since February is still difficult, since all the important developments are far too recent. However, what information we do have all points in the direction of serious weakening in the economy. Economic sentiment has been falling in recent months, and April's drop was particularly pronounced. The economy contracted in the last three months of last year, and it has surely contracted again in the first three months of this one, making a new recession well nigh a certainty.<br />
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The Greek Parliament Budget Office declared at the end of April that in its opinion Greece was at risk of a new recession. “An agreement with creditors is urgent because the country is in danger of falling into deep recession and the government’s lack of strategy harms the economy”, they say in their latest quarterly report. In fact the economy is almost certainly relapsing and has been in a recessionary trajectory since the last quarter of 2014. Bank deposits have dropped by 26 billion euros since then and outstanding debts to the state have risen by almost 3.5 billion euros in the first quarter of 2015.<br />
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Most businesses are having serious financial problems and huge difficulties with foreign suppliers and clients. Non-performing loans are increasing and the retail sector is suffering, while new investments are almost non-existent. The economy has reached a point where even healthy businesses are in danger, the report says. Some evidence to back this view has also come from the Greek Commercial Register which reported a 21.8% annual drop in new business creation in the first three months of the year.
As the Parliament budget office notes, the economy is starting to suffer from a shortage of cash and liquidity. The banks have suffered a severe deposit loss, and although much of this is covered by emergency liquidity assistance (ELA) obtained via the ECB the fact of the matter is people will be holding on to their hard currency Euros just in case Grexit occurs. This in itself slows activity down.<br />
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But in addition the Greek government itself is short of cash, which means it is not paying suppliers punctually, if at all. Those suppliers then need short term working capital loans from banks who themselves are short on capital, and so on. Basically the economy is suffering a severe cash and credit crunch and it is hard to see how this won't have a severe negative effect on economic activity. The lasts EU Greece forecasts recognizes this state of affairs, and lowers the 2015 GDP growth forecast from 2.5% to 0.5%. More ominously it also raised the debt outlook for this year from 170.2% of GDP to 180.2%. Since Greece is effectively bankrupt this inevitably means more debt pardoning from the country’s Euro Area partners if it is to remain in monetary union. A point which is picked up by the IMF in signs of growing tensions within the Troika itself over how things are being handled.<br />
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Under existing bailout targets, Athens was supposed to run a primary surplus — government receipts net of spending, excluding interest payments on sovereign debt — of 3 per cent of GDP in 2015. But according to the Financial Times, the IMF Greek representatives Poul Thomsen told EU Finance Ministers in Riga that initial data showed Athens was on track to run a primary budget deficit of as much as 1.5 per cent of gross domestic product this year.<br />
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As the FT’s Peter Spiegel puts it: “With the large surplus now turning into a sizable deficit, Greece’s debt levels would begin to spike again. This would force either Athens to take drastic austerity measures or Eurozone bailout lenders to agree to debt write-offs to get Athens’ debt back on a sustainable path. Officials said Mr Thomsen specifically mentioned the need for debt relief during the three-hour meeting.”<br />
<h3>
The Politics of Fear</h3>
The question is, what will be the longer term political consequence of crashing the economy again? The sharp growth in support for Syriza over the last couple of years can be seen as the one of the side effects of an overly deep recession/depression. Sending the Greek economy down further is only going to complicate the political scene even more, and make finding consensus even more difficult.<br />
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Too much EU policy emphasis has been placed on "defeating" Syriza, rather than securing the long term stability of Greece, and its people. Too many EU politicians have even been playing games, using the specter of Syriza to fight domestic populism at home. Naturally the cases of Spain and Portugal come immediately to mind. But does this lack of flexibility serve the long term interest of Europe? Greece's problems are still long term, and can't all be resolved in negotiations between now and June. Releasing bailout money to pay the IMF and the ECB - or rather paying it direct - would have made sense, using these payments as a way of pressuring Syriza by strangling the Greek economy doesn't.<br />
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While growth returned in 2014, it was very modest growth in relation to the fall which preceded it. In addition the country's economy is still suffering from deflation, with consumer prices falling by 1.9% in March over a year earlier, the 24th consecutive month of negative inflation. What the country needs from the EU and the IMF is not a bed of nails, but rather support in moving the economy back onto the path of stronger growth momentum. Rather than treating the country as a scapegoat, as an example of what not to do, Greece badly needs the kind of positive support Portugal, Italy and Spain have been receiving in order to start to attract some constructive investment. All have to serve, but not all are being forced to serve as an example.<br />
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What is needed is not a lesson in morality - from either side - but some plain old fashioned pragmatism. If Greek GDP really does constitute a negligible part of Euro Area GDP where's the big deal? Do US politicians make such a fuss about states like Alabama, or similar? It's in everyone's best interest, and you know it makes sense.<br />
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Greece has already made a very substantial adjustment to its fiscal and external balances. On the fiscal side <a href="http://krugman.blogs.nytimes.com/2015/01/26/internal-devaluation-in-greece/">Paul Krugman estimates it amounts to around 20% of GDP</a> between spending cuts and tax hikes. What a pity if for want of the final nail the whole kingdom were to fall. Greece's has now lost less competitiveness than Finland since the year 2000. This doesn't mean that the one is more competitive than the other, Finland was a lot more competitive at the turn of the century, but it does suggest that the country has made a lot more progress than the anti-Syriza bias in statements on Greece is giving its citizens credit for at the moment. <br />
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Naturally the country "cheated" on its partners, and sacrifices were inevitable but surely a more pragmatic and equitable solution could have been found. Simply punishing a country for what is perceived to have been "wrong doing" on the part of its elected representatives accomplishes little and may put a great deal at risk, including amongst those not directly involved.
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-34519647280818609812014-12-29T23:16:00.000-08:002014-12-29T23:16:40.138-08:00It's Baaack: Looming Greek Elections Threaten To Re-ignite the Euro CrisisIf at first you don't succeed, try, try again...... aka third time unlucky.<br />
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The Euro crisis has all the signs of being back amongst us, and this time it may be here to stay. After two earlier false alerts - one in July <a href="http://theconversation.com/the-espirito-santo-crisis-threatens-a-new-phase-of-european-bank-anxiety-29110">around the collapse of the Portuguese Banco Espirito Santo</a>, and another in October <a href="http://www.cnbc.com/id/102089687#.">over the state of the Greek bailout negotiations</a> - the announcement in early December that the Greek presidential selection process was being brought forward to the end of the month sent markets reeling off into a complete tizzy.<br />
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In a development reminiscent of the heady days of 2012 yields on Greek 10yr bonds surged over a percentage point in the two days following the announcement, while the stock market fell by the most on a single day since 1987. 5yr CDS on Greek debt were also up sharply, and even more significantly, the yield curve inverted with 3 year debt started to move above that on ten year debt. Yield inversion on sovereign bonds is often seen as a symptom of potential default as investors demand ever more for holding short term debt. <br />
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And the chaos continued all week with 10 yr bond yields rising above 9% and stocks falling another 7.35%, taking the total drop in equities to over 20% (chart from <a href="http://www.businessinsider.com/greeces-election-chaos-is-sending-stocks-crashing-again-2014-12">Mike Bird at Business Insider</a>). <br />
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The reason for the market panic is obvious, since investors didn't need long to study the Greek constitution and realise that should the current government be unable to summon sufficient votes for their candidate to be approved in the final vote on 29 December, then general elections would become inevitable.<br />
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With yesterday's vote this possibility has now become a reality and elections are to be held on 28th January 2015. What's more there is a significant possibility that the radical left coalition - Syriza - will win, and in that eventuality some sort of confrontation or stand-off with the EU Commission and the Troika would become inevitable.<br />
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What is worrying investors most is not the fact that Syriza have renegotiation of the country's debt in their programme - with government debt at over 175% of GDP and the economy in deflation some sort of restructuring is inevitable - but the kind of economic programme the new government would try to implement since it would surely be based on a kind of "anti Troika" formula - higher salaries, higher pensions, more government employees, and repeal of the new labour law, just for starters - and these kind of "reverse reform" measures would be hard for Europe's leaders to swallow.<br />
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Formally the party do not seek to leave the Euro, their aim is rather to run an alternative economic model within the Euro structure, based on the assumption that faced with the threat of Greek exit Europe's leaders would back down and become more flexible. Investors are nervous since they fear that they may not do so, and that Greek exit may actually ensue.<br />
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<b>Long Term Depression </b><br />
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Despite the fact Greece's economy grew by 1.6% over a year earlier in the 3 months to September (making for the third straight period of quarterly growth) this welcome "green shoot" comes on the back of six years of contraction during which time the economy fell by around 25%. The country - and it's citizens - is a lot poorer now than it was then, not to mention the fact that it has been burdened with a lot more debt.<br />
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So while growth has returned, it is very modest growth in relation to the fall which preceded it. In addition the country's economy is suffering from deflation, with consumer prices falling by 1.2% in November over a year earlier, the 21st consecutive month of negative inflation. The IMF now forecast that Greek GDP will grow by 0.6% in 2014, but prices will fall by 0.8% meaning that nominal (non inflation adjusted) GDP will be stationary. And this kind of situation could go on for years and years as the country exists a horrendous recession only to enter an extended period of secular stagnation.<br />
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Despite the timid, but much applauded, recovery, the macroeconomic data is far from being encouraging, as this screenshot taken from the statistic office website illustrates.<br />
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Industrial output is back where it was in 1976, and was down 1.7% over a year earlier in October.<br />
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Greece's current account has made huge strides in the right direction, and the balance was even positive in 2013, but this improvement has largely been the result of a reduction in imports (and living standards) and not due to export growth.<br />
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As a result the country still runs a sizable goods trade deficit.<br />
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So Greece isn't having an export lead recovery, which is what the country really needs. In fact massive sacrifices have been made, many people's lives have been made a misery, yet there is really very little to show for it all. Which is why Syriza is doing well in the polls. With 26% unemployment continuing, surely (the thinking goes) anything would have to be better. Why not try a long shot in the dark?<br />
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<b>Whom The Gods Would Destroy They First Make Mad</b><br />
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The horrid little secret about the common currency experiment is that it provided a structure wherein it was very easy to get into trouble (cheap interest, good credit ratings, no current account supervision) but desperately hard to get out of it (no currency to devalue). The big problem for Greece now is to find a way to get the country back to where it was before they got into the current mess while staying inside the currency union? Some would say quite simply they can’t and the conclusion to be drawn is that they should leave the Euro. This isn’t as easy or as obvious a solution as it seems, and in addition many of the other member countries are effectively counter-parties on much of the large external debt that has been accumulated, so in the event of non-payment part of the problem would simply change hands.
Any decision by a member country to cut loose from the Euro is unlikely to be welcomed by the creditor nations, making the idea of a voluntary, negotiated departure pretty unlikely, particularly after Mr. Draghi made his promise. The exiting country would have to do so unilaterally, and face the consequences on debt default and sustained lack of access to international capital markets.
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It would be a very messy affair, and in some ways not a decision a person applying a rational calculus would be likely to arrive at. There are so many losses to offset against the gains. Under these circumstances the only conceivable way a deliberate decision to leave could credibly be envisioned would be as a result of one or more of the respective agents being effectively driven “insane” by the constant painful efforts involved in trying to carry out the very large competitiveness correction required while remaining within the currency union. This indeed was the argument I advanced in my essay submission to the Wolfson Prize: a procedure for orderly exit is essentially a worthless document since if anyone does leave the affair won't be orderly, but bitter and fraught with conflict. And this phenomenon of growing political instability was what characterized Argentina before it went careering off the tracks in December 2001.<br />
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So just because many might question the rationality of such a decision doesn't mean it won't happen, or couldn't happen as an unwanted side effect of a conflict which gets out of control. Economies on the southern periphery are not recovering (in any normal sense of that word), they are condemned to either frequent recessions or one very long depression, depending on how you classify things, together with protracted deflation and unacceptably high levels of unemployment. The degree of lost competitiveness that was inflicted during the early years of the century - and which is as much an institutional and reputational issue as it is a price one - imply that a decade or more may pass before daylight is seen.<br />
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If it ever is.
This outcome is proving very painful for the respective populations. Too long and too painful, which is why we are now seeing a surge in support for organizations like Syriza, or Podemos in Spain, or the 5star movement in Italy. Confidence has steadily eroded in the old political elites, who were trying to convince voters that pigs really could fly (while in many cases lining their own pockets in the process) and more radical political movements are emerging. It isn't that hard to understand. This was always going to happen.<br />
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Some, <a href="http://www.ft.com/intl/cms/s/0/577efe3a-8080-11e4-9907-00144feabdc0.html#axzz3LZX9n8GY">like the FT's Kerin Hope</a>, try to draw comfort from the idea that Syriza may be moderating as the responsibility of holding power looms. <br />
<blockquote class="tr_bq">
"<i>....the recent market panic belies the fact that Mr Tsipras has softened his rhetoric since Syriza came first in May’s European elections, cementing its lead over the governing New Democracy party in opinion polls.
He professes devotion to the euro while his economic team now holds regular international conference calls in an effort to reassure fund managers that a leftwing government would be able to tackle Greece’s debt problem and would not oppose foreign investment</i>."
</blockquote>
But this may be mistaking tactics for strategy. These movements are not about to get incorporated in the mainstream. And the key issue is not likely to be the debt one. As I explained (<a href="http://edwardhughtoo.blogspot.com.es/2013/06/the-second-battle-of-thermopylae.html">here</a>) in the summer of 2013 formulas exist for handling this question. What is most likely to divide Athens and Brussels if Syriza win the elections is the nature of the economic model the country will adopt. In this sense <a href="http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/11286477/Greek-candidate-willing-to-call-European-leaders-bluff.html">Ambrose Evans Pritchard has this one right</a>.<br />
<blockquote class="tr_bq">
<i>As matters stand, it is more likely than not that a defiant Alexis Tsipras will be prime minister of Greece by late January. His Syriza alliance vows to overthrow the EU-IMF Troika regime, refusing to implement the key demands.
A view has taken hold in EU capitals and the City of London that Mr Tsipras has resiled from these positions and will ultimately stick to the Troika Memorandum.... But the fact remains that he told Greek voters as recently as last week that his government would cease to enforce the bail-out demands “from its first day in office”.</i></blockquote>
In fact they go further, describing Troika representatives as "criminals" who work to convert the periphery into "German colonies". If you listen hard enough you can hear Podemos leaders saying similar things in Spain.<br />
<br />
As Ambrose also points out, Mr Tsipras will be banking on the idea that the EU leaders will back down, and talk turkey. But what if they don't? Their room for manoeuvre on this front is far more limited than it is on the debt one, since others in the south would surely want to follow a similar path if they thought they could. Grexit may be something that no one actually wants to happen, but sometimes things no one wants to happen do.<br />
<br />
<b> Postscript</b><br />
<br />
The above arguments are developed in detail and at far greater length in my recent book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-72581405808913647352014-05-19T06:23:00.000-07:002014-05-19T08:24:54.165-07:00Greek Re-entry (or Grentry) Not The Game Changer Many Think It IsThere is no doubt that Greece's recent bond sale was an exciting and even invigorating moment for many people. The WSJ's Simon Nixon, for example, <a href="http://online.wsj.com/news/articles/SB10001424052702303663604579499573719422130">called it</a> "a symbolically important moment for the euro crisis". <a href="http://www.reuters.com/article/2014/04/01/greece-markets-bonds-idUSL5N0MO4QH20140401">Reuters' Marius Zaharia suggested</a> the speed of the come back could even be a game-changer for the heavily indebted southern European country. Certainly there can be little doubt that, as Nixon puts it, the turn round in market fortunes was a remarkable achievement, illustrative of just "how far market sentiment toward Southern Europe has changed". <br />
<blockquote class="tr_bq">
"For the country at the center of the crisis to draw €20 billion ($27.77 billion) of foreign demand for a five-year bond yielding under 5% shows that the market now believes Greece will stay in the euro zone, that it won't collapse into chaos and that any further debt relief will be provided by official rather than private lenders."</blockquote>
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The pace of the fall in Greek bond yields has been little short of astonishing, and Nixon is surely right, market participants now believe that the country isn't about to collapse into chaos (although we'll have to wait and see just how far this belief survives any further evidence of<a href="http://uk.reuters.com/article/2014/05/18/uk-greece-vote-exit-idUKKBN0DY0JS20140518"> increasing support for Syriza</a>). Possibly more importantly, they are now convinced that future debt relief will come from the official and not the private sector. So swift has the turnaround been, that it is now quite probable that <a href="http://www.theguardian.com/business/2013/dec/30/greece-leave-bailout-scheme-2014">Antonis Samaras's promise</a> the country would wind-up its bailout process in 2014 may well be fulfilled.<br />
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In fact, it is hard to understand the present turnaround in Greek financial fortunes outside of the context of (i) the widespread belief that the ECB will eventually be forced into a sovereign bond buying QE programme; and (ii) the agreement by the country's Euro Area partners (pressurized by the IMF - <a href="http://greekeconomy.blogspot.com.es/2013/06/the-second-battle-of-thermopylae.html">see this post</a>) to meet any shortfall on the country's debt reduction programme over and above 110% in 2022 provided it fulfills ongoing EU Commission reform requirements. Following publicaton of the latest EU report in April the <a href="http://www.ft.com/intl/cms/s/0/8ba7c3be-cc7a-11e3-bd33-00144feabdc0.html?ftcamp=published_links%2Frss%2Fglobal-economy%2Ffeed%2F%2Fproduct#axzz2ztoSwP9i">FT put it like this</a>:<br />
<blockquote class="tr_bq">
Under a hard-fought deal reached in November 2012, Greece’s lenders agreed to provide additional debt relief after Athens achieved a primary budget surplus – which excludes interest payments. Jeroen Dijsselbloem, head of the eurogroup of finance ministers, said these talks were set to begin after the summer.
The EU official declined to speculate on how eurozone governments would help to lower Greece’s debt levels, insisting this discussion was not part of the just-completed review. </blockquote>
What this basically means is that the Greek headline Eurostat sovereign debt figure of 175% of GDP is a very misleading one. <a href="http://www.reuters.com/article/2014/04/09/us-greece-bonds-idUSBREA380OO20140409">40% of this debt is in the hands of the European Stability Mechanism</a> (ESM) on very favourable terms - capital repayments are not due for 25 years while interest payments have a waver till 2023. As Klaus Regling, head of the (ESM) <a href="http://www.reuters.com/article/2014/04/05/greece-debt-idUSL5N0MX0JO20140405">put it in an interview</a> with the Greek newspaper To Vima, "There's no debt sustainability problem for the next 10 years. This is very good news for investors."<br />
<blockquote class="tr_bq">
Greece's public debt currently stands at about 320 billion euros, or 175 percent of GDP. About 80 percent of it is in the hands of the European Union and the International Monetary Fund, at very low interest rates and on a long repayment schedule.</blockquote>
<blockquote class="tr_bq">
Regling's ESM, which holds about 40 percent of Greece's debt, is charging Athens about 1.5 percent to cover its own financing costs. ESM rescue loans to Greece have a 25-year repayment schedule and Athens starts paying interest on them 10 years after they are disbursed.
The EU and the IMF have so far extended 218 billion euros of bailout loans to Greece over the past four years and Athens stands to get 19 billion euros more by the end of the year.</blockquote>
In other words, investors, irrespective of whether or not the ECB introduce QE, can safely buy new Greek debt without worrying too much about whether they are going to be paid back. Between now and 2023 there is no real problem in that department given the de facto Euro Partners guarantee. As I point out elsewhere (<a href="http://edwardhughtoo.blogspot.com.es/2014/05/on-trail-of-italian-debt.html">On The Trail of Italian Debt</a>) Greek and Portuguese sovereign debt issues are comparatively small beer, and will not threaten the common currency, but the same cannot be said for Italian, or ultimately Spanish, debt. So Greek debt, even at current interest rates looks, frankly, attractive. Doesn't Mario Draghi constantly advise investors not to underestimate the determination of EU politicians to hold the Euro together. Well, there you are.<br />
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<b>Real Economy Hits Bottom But Muted Rebound Ahead</b><br />
<br />
Life is rather different, though, within the typical Greek "oikos" (or household). While Greece's economic slump is now hitting the bottom and while, following a pattern seen elsewhere on the periphery, there has been a great boost for the financial sector, there has been relatively little in the way of real gains for the country's hard pressed population at large. Bond yields have fallen sharply, <a href="http://www.bloomberg.com/news/2013-10-31/greek-recovery-makes-stocks-world-s-best-as-paulson-buys.html">shares are up</a> (or <a href="http://www.businessweek.com/news/2014-03-31/greece-to-italy-post-2014-s-best-stock-gains-as-bulls-buy-etfs">here</a>), and <a href="http://www.reuters.com/article/2014/04/25/national-bank-of-greece-bonds-idUSL6N0NH25U20140425">banks are even able to sell bonds</a> (for an example of what they then do with the money <a href="http://dealbook.nytimes.com/2014/05/16/greek-banks-return-to-risky-investment/?_php=true&_type=blogs&smid=tw-share&smv1&_r=0">see this NYT piece from Landon Thomas</a>), but little of this has trickled through to participants in the real economy.<br />
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The economy was down by 1.1% in the first three months of the year when compared with 2013, the lowest inter-annual Q1 drop since 2010. The economy is now something like 25% than it was at the q1 peak in 2009. Since the Greek statistics office STILL don't produce quarterly seasonably adjusted data (is that a measure of the progress they have made?) we don't know for sure, but it does look like the economy actually grew from December to March on an sa basis. <br />
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But there is little improvement visible in either retail sales or industrial output.<br />
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Unemployment has clearly peaked, but so far only fallen marginally.<br />
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A lot of the external correction has now taken place, and the current account balance was positive in 2013.<br />
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Exports turned positive on a year on year basis in March, but the country country still runs a sizeable goods trade deficit.<br />
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Credit gowth remains negative.<br />
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So, it is important to bear constantly in mind that the fact the economy has stopped contracting is not at all the same thing as it returning to growth. On that front we will need to wait and see, but there is little that is especially encouraging to date. The problem with having the Euro as a currency was never how to stop the economy contracting. It was always the difficulty which would exist in subsequently returning the economy to growth. Italy and Portugal pre-crisis didn't see their economies shrink, but they did remain stuck in low growth.<br />
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The most serious problem facing Greece right now is evidently deflation.<br />
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Inter-annual inflation has now been negative for 14 months. Curiously, in the Greek case the main problem with deflation is not going to be that debt levels are pushed up, since as we have seen above excess Greek debt is now effectively guaranteed by the Euro Area partners. A deflationary debt spiral this isn't likely to become the problem it could be in non-debt-guaranteed countries like Spain or Italy.<br />
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Deflation will, most likely, push up the level of non performing loans in banks, but even these can be recapitalized and <b>some</b> of the cost passed on to the common currency partners. The real problem in the Greek case is that people will constantly feel that the amount of money in their pockets is shrinking, which it will be (turnover can be down while sales volume is up). This creates a very important mismatch between the positive discourse about economic improvement coming from the government and the official sector generally and the amount of money people see in their tills and wage packets. Naturally, deflation in this sense is not conducive to political stability, and it is here the main risk to the Greek recovery is to be found. In the meantime, a two tier Euro divided between those who have acquired some sort of implicit debt guarantee and those who haven't has effectively been created, yet few have so far seen fit to notice the fact.
As the IMF stated in their latest (eleventh) Portugal Program Review:
<br />
<blockquote>
"While staff considers public debt to be sustainable over the medium term, this cannot be asserted with high probability. However, systemic risk from contagion to other vulnerable euro area countries, should the sovereign fail to service its debt, continues to justify exceptional access......Nevertheless, commitments by euro area leaders to support Portugal until
full market access is regained—provided the authorities persevere with strict program implementation—give additional assurances that financing will be available to repay the Fund".</blockquote>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-79893177284381501252013-06-19T00:05:00.000-07:002013-06-19T11:16:00.451-07:00The Second Battle Of ThermopylaeAccording to <a href="http://en.wikipedia.org/wiki/Battle_of_Thermopylae">legend and some historians</a>, by making a stand in the Thermopylae pass 300 brave Spartans valiantly saved the day for the entire Greek army in the face of a Persian force of overwhelming strength and manpower. More than 2,000 years later some 11 million Greeks might be considered to have carried out a rather similar operation by single handedly facing-off a massed horde of frantic global speculators on behalf of the entire Euro Area population - at no mean cost to themselves in terms of wealth, employment and general well-being. Or at least that is the conclusion which could be drawn from reading through the latest self-critical review issued by the IMF dedicated to the lessons which can be learned from the to-date handling of the country’s deep economic and social crisis.<br />
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The document, entitled <a href="http://www.imf.org/external/pubs/cat/longres.aspx?sk=40639.0">Ex Post Evaluation of Exceptional Access Under the 2010 Stand-By Arrangement</a> (henceforth referred to as the <b>Evaluation Document</b>), does not mince its words, and suggests that Greece suffered a worse than necessary recession due to the reluctance of Europe's leaders to agree on debt restructuring from the outset. The reason for this reluctance is obvious with hindsight, the Euro Area was institutionally ill-prepared for the kind of crisis which was unfolding while the interconnection of the European capital markets and the banking sectors meant the financial systems of a number of other European countries were at risk.<br />
<em></em><br />
<em></em><br />
<blockquote class="tr_bq">
<em>Contagion from Greece was a major concern for euro area members given the considerable exposure of their banks to the sovereign debt of the euro area periphery. </em></blockquote>
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<blockquote class="tr_bq">
<em> Earlier debt restructuring could have eased the burden of adjustment on Greece and contributed to a less dramatic contraction in output. The delay provided a window for private creditors to reduce exposures and shift debt into official hands. This shift occurred on a significant scale and left the official sector on the hook.</em></blockquote>
<blockquote class="tr_bq">
<em>An upfront debt restructuring would have been better for Greece although this was not acceptable to the euro partners. A delayed debt restructuring also provided a window for private creditors to reduce exposures and shift debt into official hands. As seen earlier, this shift occurred on a significant scale and limited the bail-in of creditors when PSI eventually took place, leaving taxpayers and the official sector on the hook.</em> - IMF Evaluation Document</blockquote>
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The contents of the Evaluation Document were widely reported on in the press (see <a href="http://www.reuters.com/article/2013/06/05/us-imf-greece-idUSBRE9541EM20130605">for example here</a>), and produced <a href="http://www.reuters.com/article/2013/06/07/us-eurozone-rehn-idUSBRE9560ET20130607">a swift response</a> from EU Commission representatives, including an "I don't think it's fair and just that (the IMF) is trying to wash its hands and throw dirty water on European shoulders," from Economic and Monetary Affairs Commissioner Olli Rehn. The little phrase <a href="http://www.reuters.com/article/2013/06/06/eu-imf-greece-idUSL5N0EI1XF20130606">that caused all the problems</a> was the report's assertion that "An upfront debt restructuring would have been better for Greece although this was not acceptable to the euro partners." Obviously, when a dispute becomes as public as this, something, somewhere is going on. Trying to fathom what it was I couldn't help noticing that the publication of the Evaluation Document coincided almost exactly in timing with the issuing of the Fund's latest report on the current (rather than the initial) Greek programme - The Third Review Under the Extended Arrangement Under the Extended Fund Facility (what a mouthful that is, henceforth the <b>Third Review</b>) - where curiously the international lenders let slip the significant little detail that next year Greece is expected to have a funding shortfall of some 4 billion Euros. Almost immediately denials that any kind of talks were ongoing about any kind of forthcoming debt pardoning for the country <a href="http://www.reuters.com/article/2013/06/10/germany-greece-idUSL5N0EM1J020130610">started to surface in Germany</a>, (<a href="http://www.reuters.com/article/2013/06/06/us-greece-germany-debt-idUSBRE9550ZP20130606">or see here</a>).<br />
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In my case the light dawned when reading more thoroughly through the Third Review document I came across the following paragraph:<br />
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<blockquote class="tr_bq">
<em>The macroeconomic outlook, debt service to the Fund, and peak access remain broadly unchanged and euro area member states remain committed to an official support package that will help keep debt on the programmed path as long as Greece adheres to program policies. Capacity to repay the Fund thus depends on the authorities’ ability to fully implement an ambitious program. It continues to be the case that if the program went irretrievably off-track and euro area member states did not continue to support Greece, capacity to repay the Fund would likely be insufficient.</em></blockquote>
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</em>Now all of this may sound - at least to the uninitiated - like a load of old bureaucratic mumbo-jumbo, but actually there are a number of key statements here which may help to put the recent internal Troika tiff in some sort of broader and more intelligible perspective.<br />
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Sometimes in order to get to grips with a highly complicated argument thread it helps to go to the endpoint and then work your way back. It also helps to bear in mind that the recent Evaluation Document is as much about the future as it is about the past - and in particular the scenario which will come into play in 2020 and 2022 when the current programme's debt to GDP targets are expected to be achieved.<br />
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The cited paragraph talks about three issues: the <b>macroeconomic outlook</b>, the <b>commitment of euro area member states to support Greece</b> and keep the debt on the programmed path as long as Greece adheres to the programme's requirements, and the danger that should the programme go "irretrievably off track", and euro area member states <b>not give</b> the necessary support then the country's capacity to repay the Fund would <b>clearly be insufficient</b> - ie the IMF would be left holding the can, and Fund employees would be faced with the complicated task of explaining to its non-European members why losses had been incurred.<br />
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So now I understand the nervousness a bit better. Crudely put the position is this - as long as the IMF continue to write reviews stating the Greek programme is on track then the euro area member states are on the hook to make up any shortfall in Greek debt performance. This is a commitment they undertook during negotiations on the second bailout agreement.<br />
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On the other hand, if the IMF were to start producing reports stating that the programme was off-track because of Greek non-compliance, rather than for example arguing that the numbers were out of whack due to faulty macroeconomic forecasts (some of them from the EU Commission itself), then the euro area member states would be <b>off the hook</b> from additional stepping up to the plate with the result that the IMF would end-up taking a loss. <br />
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Complicated isn't it? That is why the rule of starting out from the assumption that nothing is ever exactly what it seems to be is normally a good one to work by.<br />
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What is obvious from reading through the documentation is that the IMF is keen to highlight the guarantees given by Greece's euro area peers at the time of setting up the Extended Fund Facility (2012) that "adequate support" would be provided to bring Greece's debt down below 110% of GDP in 2022 (ie that there would be some form of debt pardoning) should the country comply with the terms of its programme and the debt dynamics still not turn out right. Since we now have a track record on all this, and since staff economists at the Fund have also recently conducted a debt sensitivity analysis which came up with the finding that given slight under-performance on GDP and inflation outcomes the debt could still be as high as 147% of GDP come 2022 , the issue is no mere trifle.<br />
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This is, in my opinion, why so much emphasis is now being placed in Washington on the fact that Greece's short term interests were to some extent sacrificed for the greater good of the eurozone, a justification which may make the bitter pill of Euro-partner losses on their loans to Greece easier to sell to their respective electorates.<br />
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Well, since nothing is really valid in this world until it is tested (like the June 2012 commitment to mutualise some of Spain's bank losses), and since 2020 is still a relatively long way away, it isn't hard to understand why the good folks in Washington might want to see the commitment in Europe tested a good deal sooner, which is where, I think, next year's 4 billion euro funding shortfall comes in. I cite the latest review document (my emphasis):<br />
<blockquote class="tr_bq">
<em>The program is fully financed through the first half of 2014, but a projected financing gap of €4 billion will open up in the second half of 2014. Thus, under staff’s current projections, additional financing will need to be identified by the time of the next review, to keep the program fully financed on a 12-month forward basis, and the Eurogroup has initiated discussions already on how to eliminate the projected 2014 gap. In this regard, the Eurogroup commitment made in both February and November 2012 <b>to provide adequate support</b> to Greece during the life of the program and beyond, provided that Greece fully complies with the program, <b>is particularly important</b>.</em>
</blockquote>
Again the essentials are hard to-get-through-to for all the bureaucrat-speak, but the last sentence says it all - "The Eurogroup Commitment...to provide support to Greece....is particularly important."<br />
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<b>A Deeper Than Necessary Recession?</b><br />
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Greece's recession has been one of the deepest peacetime recessions ever experienced in industrialized economies, and bears comparison with the great depressions of the 1930s in the US and Germany (see chart prepared by the IMF below). Overall, the economy contracted by 22 percent between 2008 and 2012 and unemployment rose to 27 percent; youth unemployment now exceeds 60 percent. As domestic demand shrank across all areas, net exports provided support largely through shrinking imports. Indeed as opposed to other countries on Europe's periphery exports actually shrank in Greece in both 2011 and 2012. The issue this raises is was such devastation really necessary in a country participating in a currency union which could have expected support from other participants?<br />
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Naturally the country "cheated" on its partners, and sacrifices were inevitable but surely a more pragmatic and equitable solution could have been found. Simply punishing a country for what is perceived to have been "wrong doing" accomplishes little and may put a great deal at risk, including amongst those not directly involved.<br />
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As the IMF points out in the Third Review, Greece was forced into one of the largest fiscal adjustments seen anywhere to date (see chart below).The primary adjustment in 2010–12 amounted to 9 percent of GDP, and was much higher (15 percent of GDP) in cyclically-adjusted terms. The same outcome could have been achieved over a slightly longer period of time had a more constructive attitude been taken. On the other hand the IMF take the view that some sort of rapid fiscal adjustment was unavoidable (but how rapid?) given that the Greece had lost market access and official financing could be considered to have been as large as politically feasible. They conclude:<br />
<blockquote class="tr_bq">
<i>It is difficult to argue that adjustment should have been attempted more slowly. The required adjustment in the primary balance, 14½ percentage points of GDP, was an enormous adjustment with relatively few precedents, but was the minimum needed to bring debt down to 120 percent by 2020. Moreover, despite the starting point being slightly worse than thought to be the case when the 2010 Stability Program was drawn up, the SBA-supported program had already extended the period over which the Maastricht deficit target would be achieved from 3 to 5 years. Since the program only ran through mid-2013, the last part of this adjustment would occur after the program and the conditionality had ended. Moreover, debt would still be increasing when the program ended.</i></blockquote>
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One of the key points to note here is the observation that <b>the program only ran through mid-2013</b>. This is a knock-on consequence of the type of program originally set up (the so-called Standby Arrangement - or SBA). SBA's are by their very nature designed and intended for short term liquidity support prior to a reasonably rapid return to market access. But Greece's needs, as is now obvious, were longer term and involved solvency issues. Had a decision been taken at the outset to set up an Extended Funding Facility (the 2012 program is of precisely this type) then the time horizon could have been longer, but part of the reason an EFF was not chosen was because the solvency issue was not recognised and debt restructuring was not on the table, so the argument at this point becomes somewhat circular. That is to say, had the will been there at the outset to use an Extended Funding Facility and had the realistic view (recognized with hindsight) that debt restructuring was inevitable been taken, then the Greek fiscal correction would still have been significant, but more extended in time, and with less overall damage to the economy's private sector.<br />
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And the damage was severe. The employment loss was dramatic (see chart) and as in other countries who have suffered a similar, if more benign, fate (Spain, Portugal) it is hard to see how earlier levels are ever going to be recovered given anticipated future growth rates.<br />
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The social and economic consequences of the over ambitious fiscal correction have gone well beyond the downsizing of the country's bloated public sector, and no part of Greek society has been spared. Among Greek households the fall in disposable income between 2009 and 2011 nearly doubled the previous debt-to-disposable-income ratio (which rose to 96 percent - higher than the peak observed in Latvia). Falling property prices have raised mortgage loan-to-value ratios from around 70 percent on average before the crisis (lower than in European peers) to close to 90 percent in 2012 (currently higher than even in Spain). House prices fell by 11.8% in the year to the end of March, <a href="http://www.telegraph.co.uk/finance/personalfinance/houseprices/10109974/House-price-falls-worsen-in-Greece-and-Spain.html">according to the residential price index published by realtors Knight Frank</a> following a 9.8% drop a year earlier. For a country which didn't really have a property boom before the crisis this is very striking. <br />
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In the non-financial corporate sector the decline in profits has affected firms’ ability to service debt, with the interest coverage ratio dropping from 24 percent in 2001 (one of the highest in Europe) to 2.4 percent in 2012 (higher only than Portugal). As a result Non-performing loans in both the household and corporate sectors have risen sharply (see chart below for the corporate case) and in 2013 are expected to pass the 30% of total loans mark.<br />
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All this distress and impairment naturally creates problems where previously few existed. The Euro firewall building process meant that most of Greece's sovereign debt risk was transferred from other European banks to Greek ones, with the consequence that when the debt restructuring finally did come these banks all needed recapitalizing by the state leading the country to have to borrow yet more money to pay for this. Now that the only external imbalance correction process is what the IMF calls the "recessionary path" (rather than a more comprehensive internal devaluation - see below) these same banks are being faced with substantially more losses on their general loan books, possibly leading to the need for yet more recapitalization, and so on.<br />
<br />
<strong>Divergences Within The Troika On Deflation?</strong><br />
<blockquote class="tr_bq">
"<em>Deflation is a protracted fall in prices across different commodities, sectors and countries. In other words, it is a generalised protracted fall in prices, with self-fulfilling expectations. Therefore, it has explosive downward dynamics. We do not see anything like that in any country</em>". <b>Mario Draghi</b> answering the question "do you see any risk of deflation in some countries in the euro area?" at <b>this months ECB press conference</b></blockquote>
<blockquote class="tr_bq">
"<em>Macroeconomic developments are broadly as expected. The economy is rebalancing apace: the current account deficit is now shrinking fast, by 6½ percent of GDP in 2012; the competitiveness gap has been reduced by about half as last year’s labor market reforms are facilitating significant wage adjustment; <strong>and deflation is finally setting in</strong></em>". - IMF Third Programme Review (my emphasis).
</blockquote>
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Leaving aside a small quibble about the definition of deflation Mario Draghi selects for himself - for self-fulfilling expectations about an ongoing fall in prices to set in prices first need to start falling - there is no doubt that in the case of Greece prices are now falling, and the arrival of this crude kind of deflation (rather than what we could call the Draghi variety) in any country is surely an issue which most of the world's central bankers beyond the confines of the ECBs governing council are certainly not blasé about, if only because unless it is handled properly it can transform itself into the kind Mr Draghi so rightly fears . According to the IMF Third Review<br />
<blockquote class="tr_bq">
<em>In response to Greece’s now high output gap, headline HIPC inflation fell to 0.3 percent at end-2012 (from over 2 percent at end-2011) and turned negative in March (-0.2 percent) and April (-0.6 percent). Core inflation (excluding energy and unprocessed food), which has been negative for some time, fell further to -1¼ percent in March. The GDP deflator also turned negative in 2012 (-¾ percent).</em></blockquote>
The striking thing, leaving aside the issue of definition, is that the IMF actually seem to welcome the fact deflation is finally arriving in Greece - due to the competitiveness impact it will have on the Greek price level. But it is here I think that one can discern some sort of difference of opinion within the Troika itself. It seems likely that the IMF would actually agree with Mario Draghi that Japanese-style deflation is probably not on the cards in Greece at the moment (although given the depth of the country's problems and the fact that the countries workforce has now started shrinking - due to demographic shifts and emigration - who the hell really knows, I certainly wouldn't put my hand in the fire one way or the other on this one). <br />
<br />
But the IMF are concerned about an ongoing fall in wages and incomes in the context of continuing increases in the price level, and hence welcome the drop in prices as part of an internal devaluation which is seen as essential to restore international competitiveness.<br />
<blockquote class="tr_bq">
<i>The far-reaching labor market reforms put in place in early 2012 have contributed to deeper wage corrections than in other recent crisis cases and substantial adjustment in the ULC-based REER. Less encouraging has been the weak and delayed response of prices to wage reductions, owing largely to product market rigidities. This asymmetry in price adjustment has led to a substantial erosion in real incomes and demand, and placed a disproportionate burden on wage earners relative to the self employed and the corporate sector. It has also left the CPI-based REER overvalued in 2012 by about 9 percent (Box 2). With the headline inflation now in negative territory and a widening inflation differential with the euro area, the extent of overvaluation is gradually reducing and relative prices between the tradable and nontradable sectors are adjusting. - </i><a href="http://www.imf.org/external/pubs/cat/longres.aspx?sk=40637.0">IMF 2013 Article IV Consultation</a></blockquote>
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So why might the other parts of the Troika - the EU Commission and the ECB - be more nervous about the consequences of this drop in the price level? They are concerned about the impact on Greek debt dynamics is the obvious answer. This drop in prices is now seen as essential and inevitable by the Fund, but is still to some extent being resisted in Brussels and Berlin. Again, the reason for the reticence is obvious, "we're on the hook" - remember, if Greek debt is above the 110% of GDP target in 2022, or reaches levels in the intervening years that make this level obviously unattainable, for reasons of lower than anticipated GDP or price growth then the Euro Area peer countries are committed to making up the difference.<br />
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The chart below shows the results of a Debt Sustainability Analysis carried out by Fund economists during the period of the first bailout. What is clear is that the two main risk items for debt snowballing are lower than anticipated GDP growth and deflation. As the IMF itself observes in the Evaluation Document: <i>Since the shocks considered were fairly mild, this sensitivity analysis demonstrated the precariousness of the debt trajectory. For example, the deflation shock considered in the DSA (3 percent more) would not have made much difference to the internal devaluation, but would have caused debt to jump to 175 percent of GDP.</i><br />
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In the Third Review the Fund goes even further on the basis of a new Debt Sustainability analysis - "<i>If nominal growth averages 1 percent lower than the 4 percent baseline projection, debt will be 134 percent in 2020 with an only modest declining path thereafter</i>". That is to say, if the sum of GDP growth and inflation is 1% less than forecast in the baseline scenario debt will rise substantially.<br />
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<b>So Whither Greece? Is Grexit About To Become An Option Again?</b><br />
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According to Citi's Chief Economist Willem Buiter, the man who coined the term Grexit, <a href="http://www.cnbc.com/id/100760299">the possibility of Greece exiting the euro zone has receded "markedly" in recent months</a>. "We still believe that there is a fairly high risk of Grexit in coming years, but no longer put it in our base case at any particular date," Citi said in a research note co-authored by Buiter published in May. Reading this assessment at the time of its publication the argument seemed reasonable to me. But after 48 hours of poring over IMF documentation on the country I am no longer so sure that this conclusion is as solid as it seems.<br />
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My feeling now is that, despite Buiter's recent pronouncements, Grexit may well come rapidly back on the agenda after the German elections.
I think markets are soothing themselves with an overoptimistic expectation of how committed German politicians are to moving towards banking and fiscal union - Draghi bond buying at the ECB is another issue, but the Greeks by and large don't have bonds to sell, they just have debt obligations to the official sector. Put another way, as <a href="http://www.ft.com/intl/cms/s/0/e4ee912c-d433-11e2-8639-00144feab7de.html#axzz2WarbhLjz">Wolfgang Munchau argues in this week's Financial Times</a>, “The OMT is not designed to address the solvency problems of various private and public entities in the eurozone”, and Greece's coming problems are surely of the solvency and not the liquidity kind.<br />
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The key issue really hangs around the obligations the Euro partners entered into with the IMF last December <b>to fund any shortfall</b> in Greek funding and debt-reduction needs as long as the IMF continues to give the country a pass mark during the ongoing reviews.<br />
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Looking over and over again through the numbers the IMF put forward it is clear to me that there is really very little wiggle room left on Greek debt dynamics, and that the IMF are fully aware of this as their Debt Sustainability exercises demonstrate, hence initial attempts to distance themselves from EU institutions in the Evaluation Document. The move reminds me of one of Leo Messi's attempts to lose his markers while languishing near the edge of the penalty box. One swift lunge and its in the net.<br />
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Now one possibility which lies before us is obviously that the IMF gives the country a <b>red flag</b> in a review. That wouldn't be so difficult given the way Greece works. Yet actually, for reasons discussed in the introductory section to this piece, the Fund has precious little interest in doing this, since the country's Euro peers could then simply walk away from their funding obligations and the IMF would be last man standing on the debt, a situation they repeatedly stress they are anxious to avoid. Nonetheless, let us assume they do throw up a red flag, what would be the consequences?<br />
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Well, not another EU backed aid programme surely. The red flag would mean the issue of possible Grexit would be directly back on the table, since core Europe would surely be extremely reluctant to accept politically unpopular losses for a country that wasn't complying, and it is hard to see what the solution to ongoing funding shortfalls coupled with non-compliance would be if it wasn't euro exit.<br />
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So now let's assume that the country gets a series of <b>continuing green flags</b>, but that nominal GDP performance is less than projected in the programme's baseline scenario - it may not be politically correct to say this, but it is hard not to get the impression that the inflation and growth numbers for 2015 to 2018 (showing nominal GDP growth of around 4.7%) have been devised explicitly to bring Greek debt into the region of 120% by 2020, at least on paper. The probability of under-performance is thus high.<br />
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Cognizant of this looming difficulty the Fund seem to be already attempting to force the issue by looking for a 4 billion Euro down-payment on their commitment from the Euro partners in 2014. Then, supposing they wanted to accelerate the Euro partners Greek bail-in process they would only have to revise down their post 2014 inflation and GDP forecasts to make even more money needed quite quickly.
But, if we think about it a bit, the political logic for ongoing debt pardoning in Greece by other EU member states isn't especially clear given that Italy, Portugal, Ireland and Spain could all easily have debt levels over 110% of GDP come 2022. So how can you justify making Greece a special case in the positive sense?
I think the more likely outcome is that core Europe will try to wriggle out of its obligations following the German elections, and that this move will lead to a surge in uncertainty about Greece's future, with Grexit once more becoming an openly discussed option.</div>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-89152363540221595192012-11-25T07:57:00.001-08:002012-11-25T07:57:11.591-08:00After The Fat Lady SingsFinancial journalists across the globe were both surprised and puzzled recently <a href="http://www.telegraph.co.uk/finance/financialcrisis/9682247/Lagarde-Not-over-in-Greece-until-fat-lady-sings.html" target="_blank">when they heard Christine Lagarde using a strange expression</a>. "You know, it's not over until the fat lady sings, as the saying goes," she told bemused reporters at a press conference in Manilla. Which fat lady, and what does she sing must have been questions going through the heads of many of those present.
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Further investigation would have lead them to discover that far from this being some new piece of feminine wisdom that the IMF DG wanted to transmit, the phrase in fact comes from the rather male world of business deals and contact-sport-commentators and is generally used to describe closely contested matches, or deals which won’t be struck till the final offer is actually made.
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Ms Lagarde naturally had other things in mind. She was referring to the state of negotiations surrounding the latest Greek bailout review, prior to the handing over of that long awaited 31.5 billion euro tranche the country so badly needs to meet its ongoing commitments. The curious thing about the holdup in this case is that it isn’t the result of a stand-off between the Troika and the Greek government. Last week the Greek parliament passed the final set of budget decrees required by the international lenders to enable the transfer. <br />
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No, in this case the dispute is an “internal affair” between the rival parties which make up the Troika, and in particular between the German government and the IMF. The issue is how to leave Greek finances having at least the appearance of being on a stable and sustainable path, which in this case is defined as attaining a sovereign debt level of 120% of Greek GDP come 2020. Delaying the country’s fiscal objectives by 2 years effectively means putting back the theoretical attainment of that objective by the same amount of time - until 2022. Jean-Claude Juncker was willing, but the IMF is digging its heals in. Any new agreement, Ms Lagarde said as she left Manilla en route for Tuesday’s Brussels EU finance ministers meeting, should be "<a href="http://www.reuters.com/article/2012/11/17/us-imf-europe-idUSBRE8AG0C720121117" target="_blank">rooted in reality and not in wishful thinking</a>.” Tut tut, Mr Juncker.
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So whence this sudden hardening in the Funds position? Well, it may be just a coincidence, but the US elections are now over. Barack Obama need not now preoccupy himself with what a hypothetical exit by Greece from the Euro would do for his campaign. Non-European members of the Fund have long been chaffing at the bit over the extent of the “kid gloves” treatment so many apparently rich countries have been receiving, and have been arguing for a much more independent and tougher approach. Now with the US starting to shift its ground the balance of opinion has clearly changed.
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Greece’s debt is evidently on an unsustainable path however you look at it. Just getting through to 2020 isn’t enough, since the following decade is going to be very challenging demographically for the struggling country. Greece needs either a much more substantial reduction in its debt levels, or a negotiated exit from the Euro. <br />
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Realists are now pushing this view, but realists are also pragmatic people, they recognize that Angela Merkel has elections looming in the autumn of 2013, and that she can only go so far at this point. So it is simply the principle of the thing that needs to be established now. We can all get down to the real details once Greece fails another review, possibly towards the end of 2013. What Christine Lagarde did make clear in Manilla is that being “rooted in reality” means is that the best way countries in the Euro Area can send a strong and credible signal they remain committed to Greece’s continuing Euro membership is by agreeing in some way shape or form - the formula doesn't matter - to reduce the debt Athens owes them. <br />
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As Deutsche Bank analyst Mark Wall so tactfully put it in his latest report on the situation, "The objective of the current round of decisions will be to 'kick the Greek can' beyond the German elections in September 2013".<br />
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So it seems to me that later, after the German elections are over, the fuller implications of this initial signal of "realism" can be fleshed out. By that point Greece’s crisis-weary population will surely be ready for neither another year of substantial austerity cuts, nor for yet another year of recession, so a solution will need to be found. Unemployment will likely be over 27% at that point, and with people possibly being asked to grin and bear a seventh year of recession, we may well be rapidly closing in on a "just how much of this can you really stand" type situation. <br />
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If the debt pardoning cannot be great enough then Grexit will be on the table as a contemplatable solution. As Citi analyst Giada Giani puts it in the their latest report, "even if a return to a semblance of sustainability is agreed for the Greek debt and the next bailout tranche is released, we doubt this will be the deal that fixes Greece once and for all. We think a Grexit scenario still has a 60% probability of occurring in the next 12-18 months."
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<br />
<strong>Calm Before the Storm?</strong><br />
<br />
So, the Euro Crisis is going to be effectively put on the back burner over the next nine months or so, or at least that is the hope in Berlin. Naturally there are no shortage of loose cannons that can come into play to make this hope just another example of what Lagarde calls “wishful thinking”, but even assuming everyone gets the time-out people are hoping for, just what is going to happen when the German election milestone is passed? To the external observer, it does look like fund managers from across the planet are being told one thing (that Germany will then take the bold steps which are so evidently needed to shore up the common currency) while German voters will be voting in the exact opposite belief, even to the extent perhaps of being lead to think that the OMT bond buying programme is merely temporary. So someone is going to be very badly disappointed, and not long from now market participants will have to start placing their bets on who they think that someone is going to be.
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<br />
But to return to where we started, just who was that fat lady, and what exactly did she sing? Well deeper investigation into the world of urban legends reveals that the woman in question is none other than Brünnhilde, shieldmaiden and valkyrie in Norse mythology, as well as heroine in Wagner's famed and fateful opera Götterdämmerung. As opera fans will remember, when the singing stops the world of Valhalla comes to an abrupt end, as Brünnhilde throws herself on a pre-prepared funeral pyre and in so doing initiates the final destruction the known world. Although the interpretation that this was some sort of "Freudian slip" for what the IMF boss actually fears could happen - namely the Greek Heracles might finally abandons his labours and descend into the nether world of Hades - is plausible and available, I prefer to think it was in fact a match of American football she had in mind. At least that way I sleep better.
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-40014393932468629722012-06-17T06:50:00.001-07:002012-06-17T23:31:33.743-07:00On The Brink Of What?This weekend I have been thinking quite a lot about what the world is gonna look like on Monday, and have come to the conclusion that it won't be that different from the way it was last Friday. The big news surprise of the weekend was in fact Greece related - since the national football team qualified for the quarter finals of the Eurocopa, beating the Russia by a resounding 1-0.<br />
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Oh yes, they also had elections in Greece, didn't they?<br />
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The most likely outcome, as far as I can see at the time of writing, is a neck and neck finish between the far left Syriza and the centre right New Democracy, with the key to the resolution of the outcome lying in the fact that whichever party comes first gets a bonus of an additional 50 seats. This will mean that if New Democracy do win, as it seems they have, they will probably be able to negotiate a deal with the other smaller parties (PASOK, for example) around some sort of face saving formula which will enable a government to be formed and a deal struck with Berlin. <br />
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On the other hand, if Syriza were to finally win no one has a clue what will happen. The party doesn't want to leave the Euro, but does want to reject the memorandum. The only problem is that the only parties Syriza could form a government with would most likely want out of the Euro too. So Syriza winning by a short head would seem to imply more elections, or... or.... some sort of pact. I vote for the latter. <br />
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I say this since I think even if Syriza were by some quirk now to win some sort of government or other would still be formed, even if it needs the military to rustle sabres in the background just to get everyone to concentrate on the issues in hand. In the game of brinksmanship which will now be played, Syriza can blackmail Berlin with the threat of instability and disorderly exit (even in opposition), while Berlin can dangle money, lot's of it I imagine, before their eyes, if only they agree to help form a government. The track record says that politicians normally, when faced with a serious punch up or going for the money will normally go for the money.<br />
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Naturally, the money I am talking here about involves EU funds, not men in black suits carrying suitcases, although if the <a href="http://rt.com/business/news/siemens-greece-bribery-payment-596/">recent 270 million fine accepted by Siemens</a> for bribing Greek officials to obtain lucrative telecommunication contracts is anything to go by, we shouldn't rule the other possibility out entirely.<br />
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Actually Angela Merkel has already hinted at this sort of solution. "This is why it is so important that, in the Greek election tomorrow ... a result emerges in which those who form a government in future tell us, yes, we want to keep to the agreements," <a href="http://www.dw.de/dw/article/0,,16031437,00.html">she told a meeting of party faithful in Darmstadt</a> this weekend, "This is the basis on which Europe can prosper."<br />
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What the forthcoming Greek government needs to do, then, is say loudly and clearly in public that it will stick to the memorandum. Say in public mind you, not necessarily follow the statement through in practice. The phrase being asked for certainly isn't an <a href="http://en.wikipedia.org/wiki/J._L._Austin">Austinian performative</a>, equivalent to saying "I do" in a wedding. In this case uttering the phrase does not constitute implementation. Another example of something which also does not constitute what the British philosopher JL Austin would have termed a performative would be the expression “I promise to pay the bearer on demand the sum of …” which appears on the back of UK bank notes, and is evidently not a promise, or even a lick. It is simply just another way of spilling ink.<br />
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So then, with the protocols safely out of the way, the real deal can be done. Francois Hollande is already talking about <a href="http://www.bloomberg.com/news/2012-06-15/eu-leaders-to-call-for-further-urgent-measures-to-aid-growth.html">an EU growth programme</a> of <a href="http://www.reuters.com/article/2012/06/17/eurozone-france-idUSL5E8HG5QU20120617">around 120 billion Euros</a>. And <a href="http://www.ft.com/intl/cms/s/0/18512fda-b643-11e1-a14a-00144feabdc0.html#axzz1xVjDHNDv">the Financial Times has revealed this weekend</a> that, "European officials are preparing to dangle a package of incentives in front of a new Greek government to convince it to stick to the country’s current bailout deal after Sunday’s high-stakes elections. The package would include further reductions in interest rates and extended repayment periods for bailout loans, as well as EU money to spur investments in Greek public works programmes through the European Investment Bank".<br />
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Naturally, and even in the best of cases, the future government of Greece will be weak, and the economic situation dire. So the agreement to be reached will only be a band aid, one which one hopes will hold until the bigger issues are faced up to over the summer. All that has been avoided this weekend is a disorderly rupture in Greece's relations with the EU and the IMF, <a href="http://www.foreignpolicy.com/articles/2012/05/31/grexit_spexit_let_s_call_the_whole_thing_off" target="_blank">and as I argued here</a>, this outcome was never really very likely. <br />
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So Greece in the short term will be staying in the Euro, although I am not sure whether a majority of observers will necessarily regard this as good news, since clearly it only postpones some sort of day of reckoning or other.<br />
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<strong><span style="font-size: large;">Sigh Of Relief In Berlin</span></strong><br />
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One venue where people will be unequivocally happy with the outcome is - although some may find this surprising - inside policy circles in Berlin. The reason for this is evident. Germany itself is at greater risk of fall out from the Greek election than even Greece itself is. Personally I think the upward trickle in German Bund yields we have been seeing over the last week or so is pretty significant. It is almost as if the market is beginning to prepare for a two stage scenario. The first stage would be Greek non exit. Then in a second stage, the EU would not be moving ahead of the curve fast enough, and the common curreny could disintegrate. Germany, as the creditor country who would not be paid, would be one of the biggest losers. <br />
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More interesting perhaps than 10 year Spanish yields hovering around 7% is <a href="http://www.ft.com/intl/cms/s/0/26aabbcc-b49b-11e1-bb2e-00144feabdc0.html#axzz1xVjDHNDv">the fact that German yields have also started rising</a>, as have German CDS and <a href="http://soberlook.com/2012/06/latest-on-sovereign-cds-activity.html">the volume of German CDS being traded</a>.<br />
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My interpretation of this is as follows. This situation can end in either of two ways. The Euro can disintegrate, or full political union can be put in place. In either case Germany's debt burden will increase. In addition the country is export dependent, and will be negatively effected by any event which damages the other Euro economies. Robin Wrigglesworth <a href="http://www.ft.com/intl/cms/s/0/26aabbcc-b49b-11e1-bb2e-00144feabdc0.html#axzz1xVjDHNDv">put it like this in the Financial Times</a>.<br />
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<em>Analysts said this was a worrying development, which indicated investors could be starting to prepare for two “tail-risks” – a break-up of the common currency bloc or moves towards fiscal union.“If we see a trend of periphery bonds, Bunds and the euro start to sell off simultaneously we’d move from concern to alarm,” said David Lloyd, head of institutional portfolio management at M&G Investments.</em></blockquote>
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Estimates of just how much the Troika are on the hook for should Greece default vary, but a common number is <a href="http://www.reuters.com/article/2012/05/17/us-ecb-greece-idUSBRE84G0DA20120517" target="_blank">somewhere in the 200 billion euro range</a>. Of course, some of this would eventually be recoverable, one day, and assuming Greece were able to pay, but in the meantime (given the super senior status of the IMF participation) it is highly likely that governments and taxpayers in the other Euro Area countries would need to cover the shortfall, and this, to put it mildly, is unlikely to be popular with voters. Yet another reason for "fudge and muddle through". <br />
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There are three main sources of Troika exposure to Greece, bailout loans, sovereign bonds owned by the ECB, and liquidity provided to the Greek central bank thorugh the Eurosystem via what is known as Target2. According to estimates by Commerzbank analyst Christoph Weil, between loans and bond purchases Greece owes a total of €194bn, which breaks down into €22bn owed to the IMF, €53bn to Euro Area countries, €74bn to the EFSF and €45bn to the ECB. On top of this there are Target2 liabilities of the Greek central bank vis-à-vis the ECB - and indirectly to the German banks - to the tune of €104bn. <br />
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<strong><span style="font-size: large;">As long as the music is playing, you’ve got to get up and dance</span></strong><br />
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It was in fact former Citigroup chief Charles Prince <a href="http://blogs.reuters.com/great-debate/2009/11/17/while-the-music-plays-funds-gotta-dance/">who used this expression</a> to characterise why, in a highly leveraged bailout (sorry, buyout) market fund managers continued to play the game, but it could equally well describe the "in for a penny in for every shilling I've got" situation German policymakers now find themselves in.<br />
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One of the silliest ideas introduced into the present Euro debate is the idea that Germany has always been a reluctant party to the common currency, and that the monetary union has acted to the country's disadvantage. <a href="http://citywire.co.uk/money/why-germans-and-dutch-will-exit-suicide-pact-eurozone/a559322">Lombard’s Chief Economist Alexander Dumas tells us</a>, for example, that ‘what you’re actually dealing with here... is a German population which has had a rotten deal – and that’s why they’re all so angry’.<br />
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Dumas's view is interesting since it highlights two popular misconceptions. The first of these is that Germany has been a long suffering victim of the spendthrift policy of its Euro Area partners, and the second is that German household consumption is so weak due to a domestic policy of wage compression. Now if we take the former argument, in fact the German economy entered the common currency in very poor shape, on the back of mid 1990s credit and construction boom, and was forced to make a substantial transition at the end from being a consumer-credit- driven economy running a small current account deficit to being an export driven one, pushed forward on the back of a large current account surplus.<br />
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If you look at the above chart, it would seem hard to argue that Germany has had a really hard time of it after joining the Euro. Just think about it. Who was buying all those German exports which are reflected in those massive current account surpluses.<br />
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This point seems so obvious it is hard to believe some people are still capable of ignoring it. It is not as if there wasn't a lot of material around pointing to this pretty evident truth. A good example of this work are the two recent and highly stimulating essays by Citi economists, Nathan Sheets and Robert Sockin, who convincingly argue that German trade performance since the start of monetary union has been significantly boosted by having a currency which was valued significantly below the valuation it would have been subjected to had the country still been using the Deutsche Mark. As a result of this systematic undervaluation Germany’s external surpluses widened significantly, led by rapid export growth. <br />
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Sheets and Sockin use a simple econometric procedure to estimate that that European monetary union, coupled with the country’s extraordinary wage restraint, has resulted in a real effective exchange rate for Germany that is currently 15 to 20 percent lower than the one which would have prevailed if Germany had had its own floating currency. And naturally the weaker real exchange rate has provided a significant windfall for Germany’s export sector. They thus find that the lower German real exchange rate has lifted the country’s nominal trade surplus by roughly 4 percent of GDP (or €100 billion) annually and the real trade surplus by about 3 percent of GDP annually. In addition, since the outbreak of the Greek crisis, Euro weakness has meant that German exports have been in an almost uniquely privileged position to benefit from strengthening global demand in the emerging market economies.<br />
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The comparison with Japan is significant in this case, since as of December 2011, Japanese exports were still running at 8% below their pre-crisis high point, while German exports were about 7% above their pre-crisis high. Since the global financial crisis German exports to China have risen most strongly, while Japanese exports to China have virtually stagnated. What could be the explanation for this strange phenomenon, since evidently Japan has efficiently produced technologically-advanced products to sell? Well, the relative values of the two currencies the countries use might offer us some part of the explanation. From the start of 2007 to mid 2008, the Japanese yen was trading in the range of 0.06 – 0.065 to the Euro. At the start of 2012 it was trading at all time record levels of just over 0.1 to the Euro – that is the yen rose versus the Euro by over 60% in just three and a half years. What German policy makers might with good reason worry is that should their country go back to the Deutsche Mark a similar fate might well await them.<br />
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Naturally in June 2008 Japan’s currency was significantly under-valued, due to its habitual use as the “carry” funding currency of preference, while Germany’s currency is currently significantly under-valued (due to the impact of the sovereign debt crisis). In July 2008 Japan’s currency valuation spiked dramatically – rising by around 30% in 3 months – as the global financial crisis took its toll and the carry trade unwound. Since that time Japan’s currency has risen steadily (as has, for example the Swiss Franc) due to the country’s safe haven status. Naturally such a state of affairs only serves to exacerbate the country’s long running deflation problem.<br />
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Taking everything into account, surely it would not be unreasonable to suggest that a Euro unwind would lead any new German currency to surge dramatically in the aftermath just as the Japanese one did in 2008, and then continue its upward path for safe haven reasons. The key point is that in the age of the global financial accelerator currency movements have a strong non-linear component.<br />
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<strong>Gazing Into The Tea Leaves</strong><br />
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I suspect events will pan out as follows. The Greek elections will give markets a mildly positive surprise, since the country will not immediately exit the Euro, nor will European money be cut off (the IMF is another matter). In fact, as I suggest above, more money may be sent to Greece than expected via EU structural funds, or the EU investment bank.<br />
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In the meantime measures will be put in place in the direction of a European banking system and closer fiscal union. But the pace will be slow, painfully slow, and much slower than markets need to see to be convinced that real changes are coming.<br />
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So German bond yields and CDS can continue to rise, and this will produce political strains in Germany. It is these tensions inside Germany that can become the undoing of the Euro, since if political pressures cause leaders to put a break on the integration process market pressures could become too great to withstand.<br />
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Thus the reason for this sudden rush to keep the Greeks happy is evident. Germany has done its sums, and found that it is at even greater risk of getting hit by fall-out from the Greek election than Greece itself is. The thing is the Germans have now cunningly boxed themselves into a corner, and whichever way things go their position can only become worse. <br />
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I think German policy from this point on will be increasingly dictated by a belated attempt to avoid just this sort of outcome, and that we will see evidence of this over the next couple of weeks. Far from being a threat, Francoise Hollande might even help get Merkel off the hook. On the other hand, Fernando Santos, the Portuguese coach who trains Greek national side, <a href="http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_17/06/2012_447445">reportedly told the press</a> his players' victory was more inspired by Greek history than by Angela Merkel. Well if I remember my Thucydides aright, most Greek cities fell to their opponents not in pitched battle, but via "informal negotiations" held somewhere close to an unguarded side gate. Talks to form a new government will start tomorrow. <br />
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This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-17565166307083800352012-05-31T03:29:00.000-07:002012-06-16T03:33:10.016-07:00Grexit? Spexit? Let's Call the Whole Thing OffOne thing we've learned as the euro crisis has unfolded is that the enthusiasm of experts in London and New York for offering advice to the struggling countries on Europe's periphery is matched only by their passion for awkward neologisms. The world was just getting used to "Grexit" (Get it? A <b>Gr</b>eek <b>exit</b> from the euro!) when "Spexit" began to rear its ugly head in the financial press.<br />
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Naturally, the events of recent days have brought Spain back to the forefront of the debt crisis, generating insecurity about the reliability of the official fiscal deficit numbers, the validity of central bank statistics, and new numbers showing capital flight reaching <a href="http://www.foreignpolicy.com/%22http://www.reuters.com/article/2012">alarming levels</a>. Only this week, Spain announced that the central bank governor, Miguel Angel Fernandez Ordoñez, <a href="http://www.reuters.com/article/2012/05/29/us-spain-centralbank-idUSBRE84S17O20120529">will be leaving early</a> as part of a government effort to restore its credibility. Some are now anticipating that Spain's exit from the eurozone will <a href="http://www.foreignpolicy.com/%22http://www.cnbc.com/id/4761">come before Greece's departure</a>.<br />
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I would hope that those clamoring for these countries to go their own way are at least better intentioned than they are informed, since normally they exhibit a singular lack of understanding about how political systems in southern and eastern Europe actually work.<br />
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It is now essentially <a href="http://www.foreignpolicy.com/%22http://www.ft.com/cms/s/0/4bdda8a0-9dad-11e1-">conventional wisdom</a> in the British and American press that Greece needs to return to the drachma. British journalists are even racing to <a href="http://www.independent.co.uk/news/business/news/no-word-yet-on-drachma-job-for-de-la-rue-7800972.html">hunt down</a> the London printing works that have supposedly been given the contract to print New Drachmas, the putative local replacement for the euro. The only snag is, according to all <a href="http://www.pewglobal.org/2012/05/29/chapter-2-views-of-european-unity/">opinion polls</a>, the Greeks themselves are not happy with the euro but have no interest in dropping it. (Perhaps the perfect Solomonic solution here would be to have the New Drachma introduced as a non-convertible currency for use only within Fleet Street bars and the boundaries of the City of London.)<br />
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The Greeks, naturally, are tired of austerity, and of a stupid EU/IMF bailout plan that has only served to totally collapse their economy, explode their debt, and destroy what semblance of external reputation Greek companies had. The Greeks are tired of austerity in the way many in the United States have tired of fiscal stimulus in the run-up to the next presidential election. But no one would suggest that this weariness is an indication that Americans want to drop the dollar.<br />
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As an economist, I have always argued that the common currency was a mistake. I am a "euro" skeptic, but not a "Euroskeptic," and I think it important that people outside Europe understand that this distinction exists. There is no doubt that the euro, <a href="http://business.blogs.cnn.com/2011/09/22/dr-strangelove-and-the-euro-doomsday-machine/">like Dr. Stangelove's doomsday machine</a>, is an infernal device destined to blow up one day, but also so designed that any attempt to dismantle it simply detonates the bomb. This is why, tired as they may be, those who live on Europe's southern fringe have little appetite for leaving or taking part in yet another experimental new currency order. Better put, they have little appetite for leaving in a disorderly fashion. And disorderly the leaving would have to be, since if core Europe has<a href="http://www.foreignpolicy.com/%22http://www.reuters.com/article/2012/05/24/us-ecb-greece-idUSBRE84G0DA201"> little appetite for assuming the cost</a> of keeping the eurozone together, it will surely have even less for paying the much larger bill associated with exit and default.<br />
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The media's increasing scrutiny of Spain is similarly misguided. Despite the many voices now recommending a "Spexit," few are really knowledgeable about daily life here in Spain, and even fewer are actually to be found inside the country. <br />
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The story of how Spain got to this point is well-known. There was a huge property bubble (could we say the mother of all of them?), a decade of above-EU-average inflation, a massive loss of competitiveness, a huge current account deficit, and an unprecedented stock of external debt. All of this now needs to be unwound, but here's the rub: It is very easy to structurally distort an economy within the framework of a currency union, but very difficult to correct the distortions once generated. This is why so many rightly say that in Spain it is all pain as far ahead as the eye can see. It is not that the Spanish people like this, but just that they don't see any clear and better alternative. And indeed, while only 37 percent of Spaniards believe having the euro is a good thing, <a href="http://www.pewglobal.org/2012/05/29/chapter-2-views-of-european-unity/">according to a recent Pew poll</a>, 60 percent favor keeping it.<br />
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The departure of Ordoñez, the central banker, may seem more dramatic from the outside than it does from within. Certainly Mafo, as he is called, bears a heavy responsibility for Spain's continual failure to get a grip on the rot in its financial system, and for the disastrous decision to allow the insolvent Bankia conglomerate to <a href="http://www.foreignpolicy.com/%22http://www.bloomberg.com/news/2012-05-16/bankia-ipo-leaves-shareholders-2-billion-poorer-after-bailout.html">go to IPO last year</a>, losing shareholders more than $2 billion and badly damaging the credibility of the country's banking sector. But his is only one name on what should be a very long list of putative villains, including members of the present government, the previous one, the EU Commission, the European Central Bank (ECB), and last but not least the IMF, where ex-Bank of Spain deputy director Jose Viñals has been busying himself for months <a href="http://blog-imfdirect.imf.org/bloggers/jose-vinals/">writing reports</a> suggesting the condition of Spain's banks was not all that bad.<br />
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The real question is what happens next. Spain, like the euro itself, is both too big to rescue and too big to fail. Spain's banks need capital from the government, but the government itself can't finance them. Foreign investors are leaving in droves, but no matter how many liquidity offers they get from the ECB, the country's banks simply can't buy all the debt. So the country needs European (read: German) money. The problem is that if this takes the form of an injection of bank equity, then Germany could end up all but owning Spain's banks, which would expose German taxpayers to considerable potential losses should the situation deteriorate further. At this point Berlin could firmly put its foot down, and we will have another impasse.<br />
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At the end of June, Europe will face what many consider to be a perfect storm: results of the Greek elections and details of the new, independent, Spanish bank valuations, which are sure to find that significantly more money will be needed for recapitalization. This will undoubtedly be a make-or-break moment in the ongoing debt crisis, and, if things were to spiral hopelessly out of control, a Spexit could become a real possibility. My advice to all those external well-wishers would be: Be careful what you ask for, since you might not like what you finally get. <br />
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This article <a href="http://www.foreignpolicy.com/articles/2012/05/31/grexit_spexit_let_s_call_the_whole_thing_off?page=0,0" target="_blank">originally appeared in the magazine Foreign Policy</a>.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-18757755493555532452012-05-20T03:33:00.000-07:002012-05-20T13:01:25.016-07:00Can This Really Be Europe We Are Talking About?In recent days I have been think a lot, and reading a lot, about the implications of Greece's recent election results. <br />
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At the end of the day the only difference this whole process makes to the ultimate outcome may turn out to be one of timing. If Alexis Tsipras of the anti bailout, anti Troika, party Syriza won and started to form a government then the second bailout money would undoubtedly be immediately stopped. On the other hand if the centre right New Democracy wins and is able to form a government, <a href="http://www.google.com/url?sa=t&rct=j&q=greece+polls&source=newssearch&cd=1&ved=0CC8QqQIwAA&url=http%3A%2F%2Fwww.independent.co.uk%2Fnews%2Fworld%2Feurope%2Fgreece-poll-boosts-austerity-politicians-7767043.html&ei=ULu3T8jmHdKDhQfj0LTsCA&usg=AFQjCNEvzqUzi8rbSEKzVSP73KFYUJjRMw">as the latest polls tend to suggest</a>, then the country would quite possibly try to conform to the bailout conditions, but in trying it would almost certainly fail, and <strong>then</strong> the money would be stopped. Before the last election results, it will be remembered, this was the main scenario prevailing. <br />
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Indeed <a href="http://www.reuters.com/article/2012/05/17/greece-troika-idUSL5E8GGH9420120517">reports coming out of Greece</a> suggest that the end point may be reached more quickly than even previously thought, since the main impact of recent events is that the reform process in the country has been put on hold, meaning that slippage on implementation by the time we get to June will be even greater than it otherwise would have been. <br />
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<blockquote class="tr_bq">
"The only thing we are doing is waiting," said a government official who declined to be named. Another Greek official close to bailout negotiations said ministers in the outgoing cabinet have not been authorised to negotiate with Greece's lenders since the May 6 election. A senior party official said the caretaker government would not publish any decrees and all tender procedures were suspended. <br />
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<span id="articleText">Even before the May 6 election, many reforms were put on the backburner to avoid antagonising voters, officials involved in bailout talks say. These include a plan to slash spending by over 11.5 billion euros in 2013-2014, which Greece must agree by late June to meet a key bailout target.</span><br />
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Other measures Greece should have taken by the end of June include a plan to improve tax collection by 1.5 percent of GDP in 2013-2014, a review of social spending to identify 1 percent of GDP in savings, and a pay cut for some public sector jobs by an average of 12 percent.<br />
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One key measure is the budget deficit. Athens was broadly on track in the first quarter with a primary surplus on a cash basis of 2.3 billion euros excluding interest payments on debt, versus a 0.5 billion primary surplus in the same period in 2011.<br />
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But low value added tax collection and increased transfers to the social security system to offset weak business and employee contributions continue to be soft spots.<br />
<br />
Another problem - which the EU and IMF will check before giving any green light on the accounts - is government arrears. Unpaid debts to third parties for over 90 days stood at 6.3 billion euros at end-March or 3.1 percent of projected GDP this year, according to economists at EFG Eurobank.<br />
<br />
<span id="articleText">EU and IMF policymakers, exasperated by repeated delays on all reform areas over the two years of a first, 110-billion euro bailout, have warned they will not deliver any more aid under the new bailout if Athens veers off the reform track yet again.</span></blockquote>
Looking at the above list, it is hard not to come to the conclusion that it might be in the interests of all concerned for Syriza to win the elections and force the issue. Putting together another weak government that can't implement will only lead to more fudging, and put us back where we are now in three or six months time. <br />
<br />
<strong><span style="font-size: large;">Grexit Ahoy?</span></strong><br />
<br />
Either way, it is what happens next that leads to all the speculation. The international press has been full all though the last week of statements from one European leader after another suggesting that Greece may need to exit the Euro. The latest to add his name <a href="http://www.blogger.com/goog_176961312">has been the Slovenian Finance Minister </a><span id="articleText"><a href="http://www.reuters.com/article/2012/05/19/us-greece-exit-slovenia-idUSBRE84I08I20120519">Janez Sustersic</a>, but before him there has been a long list of leading personalities including EU<span id="articleText"> Trade Commissioner Karel De Gucht who told the press that the European Commission and the European Central Bank were working on scenarios in case the country had to leave. European Central Bank President Mario Draghi even entered what are unchartered waters for the institution he leads <a href="http://www.bloomberg.com/news/2012-05-16/draghi-signals-ecb-won-t-keep-greece-in-euro-area-at-any-cost.html">and acknowledged that Greece could end up leaving the euro area</a>, although if it did he stressed the decision would not be taken by the ECB.</span></span><br />
<blockquote class="tr_bq">
While the bank’s “strong preference” is that Greece stays in the euro area, “the ECB will continue to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet,” Draghi said in a speech in Frankfurt today. Since the euro’s founding treaty does not envisage a member state leaving the monetary union, “this is not a matter for the Governing Council to decide,” Draghi said. </blockquote>
This is all a long long way from the days of "Hotel California", and the Euro as an institution where you can check in but you can't check out, and other such sentiments which typified the Trichet era, which now seems to far behind us. The decision would not be an ECB one, but what if preserving the integrity of the central bank balance sheet implied cutting of the lifeline to Greece's banking system? The decision might then be nominally Greek, but at the end of the day it would have been forced on the country by a proactive ECB.<br />
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<strong><span style="font-size: large;">In The Name Of God Go!</span></strong><br />
<br />
While Mario Draghi may have been being strongly diplomatic, ECB Executive Board member Joerg Asmussen was far less so, and told Handelsblatt newspaper on May 8 that if Greece wanted to remain in the euro, it had “no alternative” than to stick to its agreed consolidation program. The influential German magazine <a href="http://www.spiegel.de/international/europe/why-greece-needs-to-leave-the-euro-zone-a-832968.html">Der Spiegel went even further</a>. Under the header "Time To Admit Defeat, Greece Can No Longer Delay Eurozone Exit", the magazine said what had previously been the unsayable: "After Greek voters rejected austerity in last week's election, plunging the country into a political crisis, Europe has been searching for a Plan B for Greece. It's time to admit that the EU/IMF rescue plan has failed. Greece's best hopes now lie in a return to the drachma"<strong>.</strong><br />
<br />
The inconvenient problem is that things don't look that way in Athens, where even the anti-establishment Alexis Tsipras is only talking about ending austerity, and renegotiating agreements, at the same time making it abundantly clear he has every intention of staying in the Euro. The fact of the matter is that there are very few Greeks who actually want to leave, and it is hard to believe that those arguing the country's best hopes are either this, or that, really have the true interest of the country and its citizens at heart. <a href="http://www.ft.com/intl/cms/s/0/748f4152-a0b7-11e1-9fbd-00144feabdc0.html#axzz1vCdySJeT">The FT's John Dizard sums the situation up thus</a>: "There has been an astonishing quantity of nonsense written in the past couple of weeks about the prospect of “Grexit”, or Greece's exit from the Euro". <br />
<br />
One of the key additional reasons that much of what has been written has been "nonesense" is that few have stopped to think about what the real cost to core Europe would be of a Greek default (see below). But then, they never have been that strong on financial arithmetic in Berlin.<br />
<br />
So whether push comes to shove at the next review, or the one after, no one is really clear what gets to happen next, and this is part of the reason why there is so much nervousness in the markets at this point. Many assume that after the tap is turned off the country would quickly run out of money, but there are a variety of devices that the Greek government, in conjunction with the central bank, could use to keep the cash flowing. Some think the country would follow the Argentinian example, and start issuing internally valid scrip money, like the ill fated Patacos or Lecops. But Argentina was not in a currency union with the United States, the country had simply unilaterally decided to peg the Peso to the Dollar. Argentina could not print Dollars, but Greece can - in a variety of ways, the best known being Emergency Liquidity Assistance (ELA) - generate its own Euros, and enable the government to, for example, sell T Bills to Greek banks in order to pay pensioners, civil servants, government suppliers etc.<br />
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Then, so the story goes, the ECB would have no alternative but to shut Greece off from the Eurosystem. To some this might seem like an act of war. This wouldn't be Greece leaving, this would be Greece being turfed out. Yet this secnario was just what the markets got a scare about this week, <a href="http://www.bloomberg.com/news/2012-05-16/ecb-stops-lending-to-some-banks-as-draghi-talks-exit-correct-.html">when the ECB announced it was cutting off liquidity to four Greek banks</a>. Ominous echoes of Mr Draghi's words about the ECB protecting the integrity of its balance sheet. As it turns out, the move was less sinister than it seemed, since part of the problem was that the Greek government bureaucracy was inefficiently holding up the recapitalisation of some Greek banks, a move which had left them with negative capital, and the ECB was understandably reluctant to continue accepting collateral from them under these circumstances. Part of the problem here is that very few people, <a href="http://ftalphaville.ft.com/blog/2012/05/16/1003391/shifting-ecb-liquidity-to-ela-greek-bank-recap-edition/">as FT Alphaville's Joseph Cotterill points out</a>, really understand what ELA is, but this is not really surprising as the ECB itself has hardly been forthcoming with information and details on how ELA is being used. <br />
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In any event, continuing the supply of liquidity to Greek banks, and including or excluding the Greek central bank in/from the Eurosystem are likely to become key issues as we proceed. As Mr Draghi argues the issue is a political one, not a banking one, which means the bank is going to be very constrained if it wants to act as a bank without the relevant authority. This is the kind of hot potato which is likely to be passed from one desk to the next (Yes, Mr President, but...) with no one really being willing to go down in history as the person who might have torn Europe apart, which leads us to the conclusion that the "muddle through and fudge" stage might last quite a bit longer than many are expecting.<br />
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<strong><span style="font-size: large;">If I Owe You 10 billion I have A Problem, But If I Owe You 300 billion..........</span></strong><br />
<br />
As John Paul Getty famously said, "If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem". Never a truer word was said in the Greek case, and it is the reality that Mr Tsipras and those around him have, I suspect, understood. Now I fully appreciate that the Troika are a group of people who are motivated largely by principles not by money, but when your principles could cost you, and those providing you with the money you spend, 200 billion Euros, 300 billion Euros, or whatever, then dare I suggest there is food for them to think.<br />
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<br />
Estimates of just how much the Troika are on the hook for should Greece default vary, <a href="http://www.reuters.com/article/2012/05/17/us-ecb-greece-idUSBRE84G0DA20120517">but a common number is somewhere in the 200 billion euro range</a>. Of course, some of this would eventually be recoverable, one day, and assuming Greece were able to pay, but in the meantime (given the super senior status of the IMF participation) it is highly likely that governments and taxpayers in the other Euro Area countries would need to cover the shortfall, and this, to put it mildly, is unlikely to be popular with voters. Yet another reason for "fudge and muddle through".<br />
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There are three main sources of Troika exposure to Greece, bailout loans, sovereign bonds owned by the ECB, and liquidity provided to the Greek central bank thorugh the Eurosystem via what is known as Target2. Now according to estimates by Commerzbank analyst Christoph Weil, between loans and bond purchases Greece owes a total of €194bn, which breaks down into €22bn owed to the IMF, €53bn to Euro Area countries, €74bn to the EFSF and €45bn to the ECB. On top of this there are Target2 liabilities of the Greek central bank vis-à-vis the ECB - and indirectly to the German banks - to the tune of €104bn.<br />
<br />
As Christoph says in his report: "It would undoubtedly be bitter for the German government to have to tell taxpayers they would have to fork out €75bn if the debts were not repaid, but the alternative of continuing to throw good money after bad, would not make it any more popular either". Methinks he is being a bit too blasé here, since while it is surely the case that a 75 billion Euro bill for the German taxpayer would cause a furore, I'm not sure he has grasped just what a problem this would then present for continuing with further bailouts as needed with other troubled countries.<br />
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<strong><span style="font-size: large;">Can This Really Be Europe?</span></strong><br />
<br />
Nonetheless, despite the fact that Mr Tsipras would now appear to have Germany's leadership by the short and curlies (something Barack Obama's US advisers will surely have been spelling out to them in Camp David this weekend), it is not at all clear what turn events will take from here on in. History is, after all, often more about the unintended consequences of unexpected accidents than it is about plans.<br />
<br />
Nevertheless, several things are clear. In the first place, the Greek economy is in unremitting decline, under the weight of the healing measures being applied by the IMF and its European partners. GDP was down by approximately 17% at the end of 2011 from its Q3 2008 high. Not as steep as the Latvian 25% fall - but then the IMF are still forecasting a further 5% decline in 2012, and without devaluation don't expect any sharp bounce back. Both reputationally and infrastructurally the country is being quite literally destroyed. The medicine has evidently been worse than the illness, and maybe it is just coincidental, but the Marshall Plan type aid which the country now obviously needs was originally applied in Europe following the destruction of WWII. <br />
<br />
But in Greece it's going to be worse, since no one back then had the kind of ageing population problems the country is now about to face. And while the problem remains awaiting resolution, industrial output and retail sales continue in what has all the appearance of terminal decline, while unemployment - which hit 21.7% in January, second only in the EU to Spain - is still on the rise. <br />
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<br />
So something patently isn't working, and excuse me for saying it, but I find it hard to think of a leading applied macroeconomist who wasn't warning about this right from the start. But no, the creed of the the micro people and their structural reforms (which, <a href="http://www.economonitor.com/edwardhugh/2011/05/15/greece-last-exit-to-nowhere/">as I keep stressing</a>, are needed) was preferred, and we have ended up where we have ended up.<br />
<br />
Right now there are two, and only two, options on the table as far as I can see: help Greece with an orderly exit from the Euro (and crystallise the losses in Berlin, Washington, etc), or print money at the ECB to send a monthly paycheck to all those Greek unemployed. This latter suggestion may seem ridiculous (then go for the former), but so is talk of printing to fuel inflation in Germany (go tell that old wives tale to the marines). If Greece isn't allowed to devalue, then some device must be found to subsidise Greek labour costs and encourage inbound investment - and remember, given the reputational damage inflicted on the country this is going to be hard, very hard, work.<br />
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In fact, as I jokingly suggested on my Facebook (and this is a joke, really) on one reading you could come to the conclusion that what lies behind Paul Krugman's recent tantalising play on the association between Wagner (<a href="http://krugman.blogs.nytimes.com/2012/05/13/eurodammerung-2/">Eurodammerung</a>) and Coppola (<a href="http://www.nytimes.com/2012/05/18/opinion/krugman-apocalypse-fairly-soon.html?_r=1&smid=fb-share">Apocalypse Fairly Soon</a>), is Ben Bernanke's idea of a helicopter drop. <br />
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<br />
Could it be that the message he was trying to subliminally sneak in to camp David this weekend was that unable to afford either Greek exit (colloquially known as Grexit) or Greek Euro Membership, the world's leaders now find themselves trapped in a Gregory Bateson-type double bind. <a href="http://en.wikipedia.org/wiki/Double_bind">According to Wikpedia</a> "a <b>double bind</b> is an emotionally distressing dilemma in communication in which an individual (or group) receives two or more conflicting messages, in which one message negates the other. This creates a situation in which a successful response to one message results in a failed response to the other (and vice versa), so that the person will be automatically wrong regardless of response. The double bind occurs when the person cannot confront the inherent dilemma, and therefore cannot resolve it or opt out of the situation".<br />
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The only viable way to cut the gordian knot without confronting and resolving the underlying problem which at the end of the day afflicts many of the countries on Europe's periphery (devaluation and aided default) would be the organising of weekly helicopter drops of freshly printed Euros all along the beaches of southern Europe (oh, we will fight this one on the beaches, and in the chiringuitos, Mr Tsipras told a shocked group of assembled journalists) at a stroke resolving a large part of the youth unemployment problem, and generating demand for products from core Europe (after all, who would go and work in a dreary old factory when you can get the same income lying on the beach). I can just here them over at the ECB, "whohay, am I on a roll man!", as the printing presses go to work.<br />
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And to cap it all, I can just see Paul requesting to fly one of the choppers. "The surfing looks pretty good down there at the moment, Mr President". As one commentor said, you can just smell those Euros burning through the morning mist.<br />
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But of course, joking apart, Krugman does have a point. The G8 leaders are now in a ridiculous situation, one they should never have put themselves in. Apart from the cost of disorderly Greek exit, just imagine how Spanish or Italian deposit holders would react to the sight of Greek Euros being forcibly converted into New Drachma, or some such.<br />
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Then <a href="http://www.guardian.co.uk/business/2012/may/13/greece-leave-eurozone-five-difficult-steps?newsfeed=true">there is the Guardian's Julia Kollewe</a>, who last week spelt out for us a number of highly unpleasant consquences which would follow, including a rush for the door by a lot of young Greeks. Kollewe indeed paints a bleak picture of Europe's future:<br />
<blockquote class="tr_bq">
The Argentinian example shows that a Greek debt default and exit from the eurozone are likely to have dire economic and social consequences, at least in the short term. The country will become isolated. With lending drying up and accounts frozen, small businesses will go bust, exports plunge and the country will lurch deeper into recession. "Consumption could drop by 30%," says Nordvig. "There will be some pretty extreme effects."<br />
<br />
"Mass unemployment is likely, as is an exodus of young skilled workers. If tens of thousands of Greeks headed to the borders, they might even be closed. Greek soldiers patrolling the roads and ports to keep their fellow citizens in? It is not impossible".</blockquote>
In fact, the last time something like this happened – in Argentina in 2001 – 175,000 Argentinians arrived in Spain alone.<br />
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So I ask myself, is this Europe we are talking about here, or is this some kind of dream I am having? Is this where all those high minded ideals of a European Community have lead us, to a Greece where the young people get locked in, like in the old days of the USSR, or locked out as in the days before Schengen. Is this what the real outcome of the election of Francoise Hollande as President of France is going to mean? I hope not, since if it is it would surely split Europe right down the middle, and not just by drawing a line running from East to West.<br />
<br />
<br />
This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-32590690672206813902012-02-21T11:54:00.000-08:002012-02-21T15:05:04.546-08:00For Whom The Bailout Tolls<blockquote class="tr_bq">
"On an optimistic view, that a deal was struck implies that neither side was ultimately willing to risk a Greek exit because they recognise that no one fully understands all the ramifications of such a decision. Under this scenario, when pressure again builds, the authorities will do the same: let Greece remain in the euro, even if it fails to keep to its adjustment programme. So, the reality of “bail-out II” means that, if the situation becomes critical, there will be a bail-out III". Sushil Wadhwani, <a href="http://www.ft.com/intl/cms/s/0/12c2145c-5c80-11e1-8f1f-00144feabdc0.html?ftcamp=published_links/rss/markets/feed//product#axzz1mu9LfvtQ">writing in the Financial Times</a></blockquote>
So Greece has finally been awarded a second bailout. One may wish the country will live to tell the tale.<br />
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<a href="http://www.cbc.ca/news/business/story/2012/02/21/greece-deal-reaction.html">According to IMF DG Christine Lagarde</a>, speaking at the post agreement press conference, "It's not an easy (program), it's an ambitious one,". Never a truer word was said, and certainly not in jest. Not only is the program an ambitious one, it is more than probably a "pie in the sky" one too. The objective of 120% for Greek debt in GDP is totally unrealistic, not because it won't be attained (it won't), but because even if it were the country would still be in an unsustainable situation in 2020. So this is hardly something to be proud of, or look forward to.<br />
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And then there is growth. Ah yes, growth. Noone really has any idea how this will be achieved, and of course without it even the (un)ambitious 120% goal is way out of reach. But beyond the details, I have serious doubts whether Greece itself is now rescuable. I don't mean the financial dimension, I mean whether or not the country will even raise its head again. The social fabric and the country's reputation is being so destroyed, that it is hard to see serious investors getting back into the country again, with or without that much needed internal devaluation. <br />
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Young people will simply vote with their feet and leave, leaving an ever more unsustainable pension and health system. A common story these days along Europe's periphery, but still, Greece definitely seems destined to be the worst case scenario.<br />
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Perhaps the best simple summary of what just happened was written by Annika Breidthardt and Jan Strupczewski <a href="http://www.cbc.ca/news/business/story/2012/02/21/greece-deal-reaction.html">in their Reuters report</a>:<br />
<br />
<blockquote class="tr_bq">
"The complex deal wrought in overnight negotiations buys time to stabilize the 17-nation currency bloc and strengthen its financial firewalls, but it leaves deep doubts about Greece's ability to recover and avoid default in the longer term". </blockquote>
We have just bought some time for the rest of us, while Greece is sent off to default and beyond. The Troika representatives didn't "sign off" on the new deal, they effectively washed their hands of the whole messy situation. Naturally Greece won't be able to comply with the conditions, and at the next review, or the one after, the country will be face to face with the inevitable.<br />
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<strong>The Details</strong>.<br />
<br />
<ul>
<li>Greece has agreed to be placed under permanent surveillance by an increased European presence on the ground, and it will have to deposit funds in an escrow account to service its debt to guarantee repayments. effectively this will rule out future defaults against the private sector. This is why Europe's leaders think this agreement will end contagion, there will be nothing to "contage". But the problem simply becomes worse, since any default now will be against the official sector, and they are not nice, friendly people to default on.</li>
</ul>
<br />
<ul>
<li>The European Central Bank agreed to help the process by distributing its profits from bond-buying. A Eurogroup statement said the ECB would pass up profits it made from buying Greek bonds over the past two years to national central banks for their governments to pass on to Athens "to further improve the sustainability of Greece's public debt." <span style="font-size: x-small;"><span style="font-size: small;">The bond holdings of the ECB and national central banks from their investment portfolios (about 12 billion Euros) and the Security Markets Programme (around 40-45 billion Euros) are to be swapped for instruments that appear to be exempt from any future Collective Action Clauses. They will be repaid at face value, albeit with an understanding that the profits accruing from this repayment plus coupon payments will be transferred to governments via the various National Central Banks. This money can then be passed to Greece in the form of a transfer. The importance of this arrangement is that it reinforces the subordination of private sector bond holders to central bank buying. Moreover, it is not clear that there is any obligation for the national governments to give these income flows from Greek restructuring back to Greece, and if this proves to be the case this outcome would simply amplify the subordination of private investors.</span> </span></li>
<li>Private bondholders are being asked to accept more losses than originally postulated. Private sector holders of Greek debt will take losses of 53.5 percent on the nominal value of their bonds. They had previously agreed to a 50 percent nominal writedown, which equated to around a 70 percent loss on the net present value of the debt. This being said, all is still far from clear. The IMF document detailing the underlying economic assumptions for Greece assumes a 95% participation rate in the PSI. This outcome seems unlikely, especially in light of the increased haircut for private investors in the new deal, which was implemented in order to reduce Greek debt/GDP to the targeted 120% by 2020 from the 129% it would reach according to earlier PSI assumptions. What this implies is that those dreaded Collective Action Clauses may still be needed sometime early next month to ensure no hold-outs, and if this happens it is quite possible that CDS will trigger. So we are not out of the woods yet, it seems.</li>
</ul>
<br />
<ul>
<li>The latest IMF document reaffirms its view that Greece is unlikely to be able to access the market in its own name during the programme period until at least 2020, "and it is assumed that financing needs are met by Greece’s European partners on standard EFSF borrowing terms", if good policies are maintained. One problem the IMF mentions here is important, and that is the fact that future debt issuance would be subordinated to the currently being restructured pool of debt. This would obviously make it hard to sell bonds to new investors even in the most favourable of circumstances.</li>
</ul>
<br />
<ul>
<li>As if this wasn't enough in the way of headaches, the latest IMF document also suggests that Greece is likely to need additional funding well before 2020. The Fund outlines two scenarios: a "base" case whereby Greece may need an additional 50 billion Euros during the period 2015-20 given that the new 136 billion Euro support package will only meet Greece’s funding needs until 2014. They also cite a more bearish case involving slower-than-targeted growth and fiscal consolidation, whereby debt/GDP only declines to 160% by 2020 rather than the targeted 120%, in which case Greece would require a further 109 billion. Hence far from having put Greece off the EU radar, the new debt deal only marks the end of the beginning, and we still need to get through to the beginning of the end. <span style="font-size: x-small;"></span> </li>
<li><span style="font-size: x-small;"></span>In terms of timescale, the private creditor bond exchange is expected to be launched on March 8 and complete three days later, according to Greek sources. That means a 14.5-billion-euro bond repayment due on March 20 would be restructured, allowing Greece to avoid default. </li>
<li>We still have no decision on the IMF’s contribution to the new package. Some of the IMF’s non-European board members have been expressing frustration with the continuing need to keep channelling funds to the Euro area – and seem worried that the IMF is taking to big a risk on Greece, as the IMF loans to Greece already far exceed the size of any previous IMF loan package. A figure which has been mentioned is 13 billion Euros and an extension of maturities on existing IMF loans – this contribution will be well below the 30 billion Euros contributed to the first Greek program, and should begin to warn participants that the Fund's tolerance for the inability of Europe's leaders to sort out their problems is going to encounter hard limits at some point.</li>
</li>
</ul>
<ul></ul>
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At the end of the day the important point to note is that the vast majority of the funds in the current program will be used to finance the bond swap and ensure Greece's banking system remains stable; some 30 billion euros will go to "sweeteners" to get the private sector to sign up to the swap, 23 billion will go to recapitalize Greek banks. A further 35 billion or so will allow Greece to finance the buying back of the bonds. As <a href="http://news.yahoo.com/second-greek-bailout-reach-funding-gap-narrows-015256172.html;_ylt=AiUXgM68sHQ1PUf2hSBfHvGyBhIF;_ylu=X3oDMTRlN2U4aW84BGNjb2RlA3ZzaGFyZWFnMgRtaXQDSnVtYm90cm9uIEJ1c2luZXNzU0YEcGtnAzUyMjEzZGZlLWExNjctMzA5Zi1hZDZmLTBkZjkyNWJhN2EzMQRwb3MDMQRzZWMDanVtYm90cm9uBHZlcgM3YWJiNDlmNC01YzQyLTExZTEtODQ5Yy1kZjAwYWMyMTA3Nzc-;_ylg=X3oDMTFzNDRyYzYyBGludGwDdXMEbGFuZwNlbi11cwRwc3RhaWQDBHBzdGNhdANidXNpbmVzcwRwdANzZWN0aW9ucwR0ZXN0Aw--;_ylv=3"><span class="fn">Annika Breidthardt and Jan Strupczewski</span> point out in their article</a><em>, </em>next to nothing will go directly to help the Greek economy. <br />
<br />
The main purpose of exercise - apart from trying to close off contagion - was to reduce Greece's debt to a point that the IMF would be able to continue funding. It will be recalled that the whole second bailout issue was put on the table when the IMF reported that it would be unable to continue with the first bailout since its own regulations stipulated it could not continue with programme payments to a country whose debt path was not sustainable. Their economists must have had to swallow some to be willing to sign off on the sustainability of this one. But such are the political pressures people are facing.<br />
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<strong><span style="font-size: large;">The Sacrificial Lamb</span></strong><br />
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It is hard to remember a time when such an important decision was taken where so many of those participating were expressing the view the solution was not going to work. Thus conservative leader Antonis Samaras, a strong contender to become next prime minister, stressed that the rescue package's debt-reduction targets could only be met with economic growth. "Without the rebound and growth of the economy ... not even the immediate fiscal targets can be met, nor can the debt become sustainable in the long-term."<br />
<br />
Hardly inspiring words from the person who is most likely to have to take responsibility for all of this.<br />
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Naturally Europe's leaders are more concerned about their own backyard than they are about what actually happens to the Greeks. "It's an important result that removes immediate risks of contagion," Italian Prime Minister Mario Monti is reported as telling a news conference. <br />
<br />
Swedish Finance Minister Anders Borg effectively summed the cynicism of the whole position up like this: "What's been done is a meaningful step forward. Of course, the Greeks remain stuck in their tragedy; this is a new act in a long drama. "I don't think we should consider that they are cleared of any problems, but I do think we've reduced the Greek problem to just a Greek problem. It is no longer a threat to the recovery in all of Europe, and it is another step forward." <br />
<br />
But as Sushil Wadhwani suggests, rather than overcoming contagion, what the agreement does is give a whole new twist to the issue of contagion. In particular, the general impression that has been generated is that Germany’s leadership will now make almost any concession in order not to have to look for the Euro exit door, and the others, starting with the highly intelligent Mario Monti, are beginning to sense this. Even Spain’s Mariano Rajoy has caught-on, and seen he can negotiate a relaxed deficit target for 2011, despite the fact that the country missed last year’s target by a large margin. So we may well now see a chain of events were one country after another sets out to test the patience of the "core". And in addition (see below), the Greek contagion problem is a long way from being over.<br />
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<strong><span style="font-size: large;">Eternal Life on LTRO "Cool Aid"?</span></strong><br />
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Meawhile, the impact of recent policy changes at the central bank should not be underestimated. In particular, the latest decision to implement two 3 year Long Term Repo Operations has been very important, and is a short term game changer. <br />
<br />
Distressed sovereigns can, for the time being fund themselves, even if the commercial banks are only really inclined to bid at the short end, and may well be exaggerating the extent of relief provided by buying short term bonds in an attempt to store liquidity to meet their own future wholesale financing needs. <br />
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Basically, the liquidity provided, in conjunction with the all important flexibilisation of the collateral rules, has enabled banks to make provision for their wholesale funding needs right through from now to 2015, at which time there will doubtless be another round of LTROs, and who knows, they could even have a longer term than a mere three years. The days when banks saw it as a stigma to have recourse to ECB liquidity, and when journalists entertained themselves making fun of packaged used car loans being offered as collateral in Ireland by the Australian bank Macquarie are now long gone, as are the times when anyone really imagined that any sovereign bond from a country losing the minimum rating qualification of at least a single A from one agency would not be available for use as collateral at the central bank. <br />
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And this liquidity policy knocks yet another of the old chestnut endgames straight out of the window too, since it makes deposit flight within the Euro Area as a whole a much smaller problem. German and other core country deposits can be recycled - via wholesale finance provided at the ECB - as a substitute for the missing peripheral ones. Naturally this measure does not unblock the credit crunch problem, but it does reduce immediate systemic pressure. So, if the Euro system is inherently unstable, and unsustainable, a mire from which no one wants to exit since fear of the unknown always trumps hatred of the known, how does it all finally unwind? The implicit market assumption that Portugal will follow Greece into default comes as no surprise. If Greece is to be given an ongoing debt pardoning programme then surely in Portugal is going to want one too. And then there will be Ireland, and so on. Yet all of this is contemplatable, what is not contemplateable is that the people who live in these unfortnate countries will continue to accept whatever is trown at them, come what may. You only need to look over in the direction of Hungary to see that these no-growth austerity programmes have a sell-by date. But what will follow will surely please no one.<br />
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<strong><span style="font-size: large;">The Club No One In Their Right Mind Would Leave</span></strong><br />
<br />
<br />
But what about Greece itself? Logic suggests that they will be unable to meet the terms of their new agreement, and that we will soon be back to where we started, or will we.<br />
<br />
Feelings that what we are seeing today will only be a short interlude are based on a combination of three factors: a) a recognition that even a reduction of debt to GDP to 120% by 2020 may well not be sustainable; b) a recognition that after the formal bailout is awarded there will still be ongoing programme reviews, and the country will struggle to comply with the conditions; and c) the fact that the implementation of the Private Sector Involvement debt swap will probably mean changing the jurisdiction under which Greek debt is denominated from mainly Greek law in the majority to international law in the totality. This latter point is undoubtedly the most important, although being able to grasp its full implications implies an understanding of the first two. <br />
<br />
Essentially, if the unsustainability of the Greek debt path and the inability to comply with conditionality are accepted, then a further default will be inevitable, but such a default will undoubtedly be a very, very hard one, and most likely an uncontrolled one. In the first place if the country were to leave the Euro after the debt swap, then the new Greek bonds could not be converted to New Drachma (or equivalent) by a weekend session of the Greek parliament, and the country would have to default on bonds denominated in Euros, which would presented them with all kinds of problems. <br />
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Secondly, given the terms of the debt swap, and the condition of an escrow fund to protect the interests of private bondholders, then the only liabilities on which the country could still default would be those commitments it has with the official sector, which means defaulting on the IMF, the ECB, the EU and Germany. These would not be especially nice people for the country to default on, since if Greek reaches such a point the country would almost surely be made an example of, which means effectively establishing a pariah state. <br />
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The EU certainly wouldn't be sending in the social workers and psychologists to help them cope with this massive tragedy, which also implies that investors generally would be inclined to steer clear. Realising this, and having taken the decision not to default now, short of seeking allies among other rogue states (the North Korea path) the country’s leaders have probably taken the decision to stay in as long as they can. But then it is worth remembering the old Greek saying that “whom the gods would destroy, they first make mad”, by which I mean we could well see extreme factors at play in Greek politics - the extreme right, the extreme left, and the military - before they then all go rolling off the cliff together. <br />
<br />
Or maybe Greece will decide to default and stay in the Euro, printing its own Euros at the national central bank along the lines of the Emergency Liquidity Assistance precedent. That would surely create a mighty mess, (they could even carry out the internal devaluation by subsidising Greek wages) and would leave the onus of kicking them out on their European partners.<br />
<br />
Whichever the appointed path, such a scenario would have important geopolitical implications, since surely the EU could not let Greece become a nice place, given that then Portugal would immediately say "I want one of those", and so on and so forth along the daisy chain. In the meantime private capital will be steadily forced out of periphery sovereigns like Spain and Italy, and the ECB will ultimately have to provide. But we have already crossed the Rubicon on this, and there is no real turning back. Ongoing debt restructuring will continue, as none of the really troubled economies can either grow or sustain their existing debt. I mean, who can now really believe that Spain won't be asked in six months time to prepare another set of reforms (the latest batch have "destined to fail" written all over them), and six months later another one, and so on, until eventually the country is where Greece is now?<br />
<br />
And if the private sector either can’t, or won’t accept the degree of involvement being asked of it, then the ECB will be taken out of the official sector, and somehow or other find a way to swallow the losses. At least that's the way things could work for the time being. <br />
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<br />
<strong><span style="font-size: large;">Destroying European Democracy?</span></strong><br />
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<br />
The principal issue impeding exit is not the one of the presence of sunk costs from years of membership, but rather existence of non-linear credit and currency impacts - in either one or the other direction – impacts which could not be envisaged in the pre-Euro era during which most of the critics of the common currency cut their theoretical teeth.<br />
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The only conceivable way a deliberate decision to leave could actually be taken would be as a result of one or more of the respective agents being actually driven “insane” by the constant painful efforts involved in trying to retain the pin in that grenade they are holding as they are driven to ever more desperate efforts in a vain attempt to try to stop it going off in their face. Could, for example, Hungary’s leader Viktor Orban be about to offer us an early prototype for the kind of road map which some of the participants might need to follow in order to reach the point whereby they actively decide to leave? In Hungary’s case, of course, the departure would be from the EU, not the Euro, but the point is effectively the same, since the farewell party would most certainly acrimonious, where the possibility of regulating the exit would be limited, and where the end product would almost certainly be the creation of a pariah state.<br />
<br />
For the inevitably defaulting participants, given the total determination not to have official sector restructuring, leaving the Euro would more or less automatically mean a sharp break with both the EU and the IMF and in all probability the United States. If we take Greece as an example, and assuming the currently proposed PSI debt swap goes forward, the country will almost certainly see the jurisdiction of its debt shifted from national to international law, making converting sovereign debt instruments into New Drachma (or whatever) impossible, and given the creation of an escrow account to pay the private sector creditors, the only meaningful possibilities for default would be against the official sector – the ECB, the IMF and the EU member states – and clearly such a development would not be well received, among other reasons due to the precedents which could be created for other struggling countries who might wish to follow the same path.<br />
<br />
So the list of probable allies for an exiting country – Venezuela, Bolivia, and North Korea come to mind, or nearer home Serbia, Belarus and Ukraine – would not be entirely alluring. The difficulty is that after the ending of the cold war, the world is rather short of role models for developed economies who want to pursue unorthodox policies, especially if they are engaged in a disorderly default causing considerable discomfort for most of their “first world” peers..<br />
<br />
On the other hand, those with more stable, internationally competitive economies will not readily wish to surrender this condition, and since they have clearly benefited significantly from membership of the currency union they will be unlikely to offer themselves as candidates for departure. In a post Euro world they would face the likelihood of trying to export their way forward while labouring under the constraint of a substantially over-valued currency.<br />
<br />
So with no one leaving, and everyone elbowing the other in the rush to say "I'm not going" there really only is one way all this can end, isn't there?Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-80683658557701775192011-05-15T14:34:00.000-07:002011-05-16T01:05:58.868-07:00Greece: Last Exit To Nowhere?<blockquote>"Some economists, myself included, look at Europe’s woes and have the feeling that we’ve seen this movie before, a decade ago on another continent — specifically, in Argentina" - Paul Krugman: <a href="http://www.nytimes.com/2011/01/16/magazine/16Europe-t.html?pagewanted=1">Can Europe Be Saved</a><br /><br />"Think of it this way: the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling."<br />Paul Krugman - <a href="http://krugman.blogs.nytimes.com/2010/04/28/how-reversible-is-the-euro/">How Reversible Is The Euro?</a></blockquote><br />Krugman is certainly right. Looking over towards Athens right now, you can't help having that horrible feeling of deja vu. Adding to the uncomfortable feeling of travelling backwards rather than forwards in time (oh, I know, I know, when history repeats itself it only piles one tragedy onto another) is the uncomfortable presence of Charles Calomiris, a US economist of Greek origins. I can still remember reading, back then in the autumn of 2001, an article by the then Argentine Economy Minister Domingo Cavallo published in the Spanish newspaper El Pais which proudly proclaimed that everything was going well, and that the country's reforms were being generally well received with the regretable exception of "a small number of neurotic US economists who continue to insist that we will default and break the peg". He was, of course, referring to Calomiris, and at the time we were only a matter of weeks away from the dramatic moment when Adolfo Rodríguez Saá (the man who was President for a mere 8 days) would enter both history and the Argentine parliamentary chamber to utter the now immortal phrase "vamos a coger el torro por los cuernos" (we are going to take the bull by the horns). A phrase which was obviously belonged to the class of so called <a href="http://en.wikipedia.org/wiki/Performative_utterance">Austinian performatives</a>, since at one and the same time as uttering it he effectively ended the peg. Well today Calomiris is again with us, and he is still hard at work going through the numbers, only this time round he is using his special insights to scrutinise his family homeland, for which he is prophesying not only eventual default, but also the generation of sufficient contagion <a href="http://www.foreignpolicy.com/articles/2011/01/06/the_euro_is_dead">to bring the whole Euro project itself to an untimely end</a>. In an article in Foreign Affairs entitled "The End Of The Euro", he tells us:<br /><br /><blockquote>Europe is living in denial. Even after the economic crisis exposed the eurozone's troubled future, its leaders are struggling to sustain the status quo. At this point, several European countries will likely be forced to abandon the euro within the next year or two....The only way out of this conundrum is for countries with insurmountable debt burdens to default on their euro-denominated debts and exit the eurozone so that they can finance their continuing fiscal deficits by printing their own currency. Here's a hint for Europe's politicians: If the math says one thing and the law says something different, it will be the law that ends up changing</blockquote>Really, I don't think of Calomiris as a prophet (or even as a Cassandra), I don't even think of him as an especially insightful economist when it comes to the macro problems of the real economy, but I do think he has one exceptionally strong merit: he can do the math, and as he says, if it gets down to a battle between legal details and arithmetic, arithmetic will always win.<br /><br /><b>Easy Said & Easy Done, Down the Argentina Path We Go!</b><br /><br />As it happens, the issue of Argentina as a reference case for Greece has surfaced again this week, in the form of <a href="http://www.nytimes.com/2011/05/10/opinion/10weisbrot.html?_r=1&hp">an Op-ed in the New York Times by the co-director of the Center for Economic and Policy Research Mark Weisbrot</a>.<br /><br />Weisbrots's argument is not new, but it is different, not only because he thinks Greece would be better off leaving the euro (many economists share that opinion), but because of the apparent eulogy he makes of the Argentine case.<br /><br /><blockquote>"For more than three and a half years Argentina had suffered through one of the deepest recessions of the 20th century......Then Argentina defaulted on its foreign debt and cut loose from the dollar. Most economists and the business press predicted that years of disaster would ensue. But the economy shrank for just one more quarter after the devaluation and default; it then grew 63 percent over the next six years. More than 11 million people, in a nation of 39 million, were pulled out of poverty"</blockquote>.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1vWLArdaZ_7B3hVpE1UZVmgl2gGcLUlVsriip4SQ1VyqmNNsRPuIjtLge92zph4RZNjXnnHNkNKHkNDDgjgKW7084EHJnERDGI0SpFpaGZ9BxG0MVulOtUPaca3zWUm68Sve5hIClKox6/s1600/Chile+and+Argentina.png"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 213px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1vWLArdaZ_7B3hVpE1UZVmgl2gGcLUlVsriip4SQ1VyqmNNsRPuIjtLge92zph4RZNjXnnHNkNKHkNDDgjgKW7084EHJnERDGI0SpFpaGZ9BxG0MVulOtUPaca3zWUm68Sve5hIClKox6/s400/Chile+and+Argentina.png" border="0" alt="" /></a><br /><br />Now these are strong claims. But let's leave aside the issue of whether or 11 million people were pulled out of poverty or not, and dig a bit deeper into what actually happened in Argentina, and let's do this by comparing it with another country, one which arguably has similar social and economic development characteristics, Chile (see chart above). At the turn of the century Chile had a population of more or less 15 million, as compared with the 39 million Argentinians mentioned by Weisbrot. Now in 1998, just before Argentina entered its depression, Chilean GDP was some 79 billion dollars, while Argentina's was 299 billion dollars. Now let's fast forward to 2010, Argentina's GDP at the end of last year was 370 billion dollars, and Chile's 203 billion. That is to say, between 1998 and 2010 Argentina's GDP (as measured in dollars, we'll come back to this) increased by 24%, while Chile's increased by 156%. As they say in Spanish "no hay color" (there is simply no comparison). Especially when you take into account when that Chile has only 38% of Argentina's population, while it has 55% of Argentina's GDP. So over the 12 years between 1998 and 2010 Chile (which maintained a floating currency throughout) evidently did a lot better than Argentina (despite Argentina's abandonment of the float). And here's another relevant piece of information: between 1998 and 2010 the Argentinian price level rose by 143%, while in Chile the price level rose over the same period by 48%.<br /><br />So why use USD as the measure of comparison? I do this since it gives the most convenient yardstick evaluation (euros would do equally well) of the relative external values of the two economies. This is important, since Argentina apparently high growth levels have been also associated with high inflation levels, which have been constantly compensated for by devaluing the peso. In fact Bank of America Merrill Lynch currency strategist - and former IMF economist - Thanos Vamvakidis makes an essentially similar point (although with different conclusions) <a href="http://ftalphaville.ft.com/blog/2011/05/12/567256/devaluation-the-great-greek-damp-squib/">in a research note covered recently by FT Alphaville's Tracy Alloway</a>:<br /><br /><blockquote>"In our view, ...(the results of our study).... point to the conclusion that exchange rate devaluations do not lead to permanent competitiveness improvements in rigid economies, such as in the Eurozone periphery. In this context, tail risk scenarios about EUR exit are misplaced. Structural reforms are the best bet to improve the periphery’s growth prospects, within or outside monetary union".</blockquote><br />Does this whole debate sound familiar to anyone? Anyone remember when Italians were paying themselves in million lira notes? In fact, it was precisely to break the Southern European countries from the high inflation, high interest rates, periodic devaluation dynamic that the Euro was thought to be such a good idea in the first place. It hasn't worked as planned, but that doesn't mean that the most traditional and the most simplistic solutions are necessarily going to be the best ones.<br /><br />On the other hand, does this mean we should then go on to dismiss the coming out of the euro option out of hand for Greece? Evidently not. Let's look at another comparison, this time Argentina and Turkey.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-bs9-IoCUyNWhm2pMWwQTHE797rWAacea8Pkl9L1FQuIDjcMJD-svJH6JiaOZJpQBQjC9S8EVPLbgJMcg83aVxFRAJsMtiy-ji54a-KAPtsoe9CMRMKzqq_Z_m8rs1e-j7hkpoYC5Wq0D/s1600/Argentina+and+Turkey.png"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 215px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-bs9-IoCUyNWhm2pMWwQTHE797rWAacea8Pkl9L1FQuIDjcMJD-svJH6JiaOZJpQBQjC9S8EVPLbgJMcg83aVxFRAJsMtiy-ji54a-KAPtsoe9CMRMKzqq_Z_m8rs1e-j7hkpoYC5Wq0D/s400/Argentina+and+Turkey.png" border="0" alt="" /></a><br /><br />Now in 1998 Turkey had a dollar GDP of $269 billion, and by 2010 this had become $742 billion. That is it had nearly tripled. Yet Turkey's dollar GDP dropped sharply in 2001 following a substantial devaluation of the Lira. Conclusion, competitive devaluations are sometimes useful, so what makes the difference?<br /><br />Well Paul Krugman got near to it, <a href="http://krugman.blogs.nytimes.com/2011/05/10/greek-out/">when he said in his article on Weisenbrot's proposal</a>:<br /><br /><blockquote>"Greece, as a relatively poor country with a history of shaky governance, has a lot to gain from being a citizen in good standing of the European project — concrete things like aid from cohesion funds, hard-to-quantity but probably important things like the stabilizing effect, economically and politically, of being part of a grand democratic alliance".</blockquote><br /><br />We can sum the essence of all this up in a couple of phrases "institutional quality" and "structural reforms". Or put another way, Turkey devalued as part of an IMF programme (it was actually recommended, in the days before the heavy hand of the EU took management control at the IMF), while Argentina broke the peg and devalued in order to get out of one. Turkey was not only able to benefit from the reform pressure instigated by the IMF (the stick), but also by the promise of EU membership under certain conditions (the carrot). Indeed, curiously, EU cultural reservations about Turkish membership have probably lead to far stricter reform hurdles than were either applied to the current members in the South or the East, and Turkey is undoubtedly the great beneficiary of this strictness.<br /><br />Which brings us to the main point: should Greece leave or not leave the Euro? Well, let's go back to something Krugman said in another blog post (<a href="http://krugman.blogs.nytimes.com/2010/04/28/how-reversible-is-the-euro/">How Reversible Is The Euro</a>):<br /><br /><blockquote>"Think of it this way: the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling."</blockquote><br /><br />or <a href="http://krugman.blogs.nytimes.com/2011/05/10/greek-out/">as he argues in his latest post</a>:<br /><br /><blockquote>"That said, Weisbrot is right in saying that the program for Greece is not working; it’s not even close to working. At the very least there must be a debt restructuring that actually reduces the debt burden rather than simply stretching it out. And the longer this situation remains unresolved, the less hope I have that Greece will be able to stay in the euro, even if it wants to".</blockquote><br /><br />The present situation is unworkable, and unsustainable, not only because the accumulated debts are unpayable by Greece alone, but also because the tiny size of the manufacturing industry Greece has ended up with and the general lack of international competitiveness of the Greek economy make an export-lead growth process with the present state of relative prices virtually impossible. There are solutions to both these problems consistent with remaining within the Eurone and without default - issuing Eurobonds to accept part of the Greek debt and enforcing a substantial internal devaluation to restore external competitiveness, for example - but since the adoption of these two strategies is virtually unthinkable given the current mindsets in Brussels, Frankfurt, Berlin and Madrid then we are more or less guaranteed to find ourselves facing some kind of Greek default, and given that the programme as it stands isn't working (this is where the situation so resembles pre-default Argentina as the extent of the fiscal correction means the economic contraction feeds on itself given that exports cannot expand fast enough to counteract the decline in government spending and domestic consumption), it would be strongly advisable to accompany this default with some sort of devaluation.<br /><br />Put another way, if the most valid argument against going back to the Drachma always was that this would imply default, now that default is coming, why not allow Greece to devalue? As Krugman says, the issue isn't whether Greece would openly decide to exit the euro, the issue is what happens if the markets force this solution on Greek and European leaders against their will? Given the programme isn't working, the likelihood of this kind of event occurring in the next 2 or 3 years is far from being negligible, so why not be proactive rather than always relegating ourselves to being reactive? What matters is whether Greece becomes Turkey (oh, what a historical irony) or Argentina. If the powers that be can agree on an ordered restructuring of Greek debt, and a controlled exit from the Eurozone, then Greece has some possibilities of turning the situation round. If exit is forced on Greece in order to escape the clutches of both the EU and the IMF then the move will be, as I suggest in my title, simply the last exit to nowhere. And especially in a historic context of ageing populations and rapidly rising elderly dependency ratios, ratios which will only rise further if thousands of young people exit Greece in the search for work elsewhere, as young Argentinians did in 2002/3. That's another difference most people who make this comparison don't mention: when Argentina devalued the country still had a fertility rate which was slightly above replacement level. Greece has just had more than 30 years with a total fertility rate in the region of 1.3. So while Argentina could look forward to years of demographic dividend and rapid "catch up" growth, if things go wrong Greece can only look forward to an ever older population and ongoing social and economic decline<br /><br />The tragi-comic events surrounding the fate of IMF Director General Dominique Strauss Kahn may well mean that we are about to see significant changes in that organisation. It is to be hoped that, if this is the case, such changes will also involve a rethink of the IMF's role in Europe's crisis, and in particular of the objectives and means of implementation of the Greek programme, with the Fund moving towards a less-eurocentric and more balanced position, one which would be in the collective interest of the community of citizens of the wide variety of countries the institution represents.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-55137905343052164232011-05-15T04:01:00.000-07:002011-05-15T04:03:12.846-07:00The Great Greek And Spanish GDP Mystery - One HypothesisMany an economic eyebrow must have been raised last Friday when Europe's first quarter GDP data was released, and people discovered that the Greek economy had suddenly surged forward, rising by 0.8% over the level it had attained in the last three months of 2010 (or at a 3.2% annual rate, or faster than the US). Since almost everyone with knowledge of the situation is forecasting a further contraction in the economy this year, the result may have been thought to be a surprising one.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg26hhEq8OCCYMD-fNxZZGPe_UUrfM105bqzulBzWpqGmxyBaV8ANoa2XT2MqNiS2WSGExmKTLzGxgxTdLJw-UCTRiArbLFtCyJ9ofaSocp6RrtB5EaS8-oL-Itn7wYS4JMOd0XBnhur_PU/s1600/Greece+GDP+Q-o-Q.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg26hhEq8OCCYMD-fNxZZGPe_UUrfM105bqzulBzWpqGmxyBaV8ANoa2XT2MqNiS2WSGExmKTLzGxgxTdLJw-UCTRiArbLFtCyJ9ofaSocp6RrtB5EaS8-oL-Itn7wYS4JMOd0XBnhur_PU/s400/Greece+GDP+Q-o-Q.png" border="0" alt="" /></a><br /><br />Well, there is no need to call in Sherlock homes just yet, or even the strong-arm boys from Eurostat, since I think I may have worked out what happened to Greek GDP in Q1, or at least I have a good working hypothesis. In the process we will also examine why it was that, against all prognoses, and against a colossal amount of anecdotal evidence that the Spanish economy is falling back towards recession, Spanish GDP actually accelerated.<br /><br />But first, a brief intro to Econ 101 macro. It is important to grasp the fact that GDP isn't the be all and end all of economic analysis, and certainly doesn't give us a complete measure of economic activity. Indeed there are many economic processes which may be of interest to economists - levels of indebtedness, for example, which are simply not captured by the measure, since GDP is what it is: a measure of domestic value added, according to the following formula:<br /><br />GDP = Consumer Demand + Investment Demand + Government Spending + Net Trade (change in exports minus change in imports) + Net Change in Inventories<br /><br />Now, in general we know that the first three items on the list are falling in Greece. even if there does seem to have been some slight improvement in retail sales during the quarter, after a very steep fall in the autumn.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj68_flpi1JLIVpakhU6go-kyNS0gOIL80OnOK9iT8nwoAB8T6gu5ItzV9eGvVvT2c0nO0aGMXV5gfW_A6ehPc5ENtyKrrw-yqKFLp2dGkJtxeRxbnA6s6v303g0cPqV34S4LcYSBaDkntQ/s1600/Greece+retail+sales.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj68_flpi1JLIVpakhU6go-kyNS0gOIL80OnOK9iT8nwoAB8T6gu5ItzV9eGvVvT2c0nO0aGMXV5gfW_A6ehPc5ENtyKrrw-yqKFLp2dGkJtxeRxbnA6s6v303g0cPqV34S4LcYSBaDkntQ/s400/Greece+retail+sales.png" border="0" alt="" /></a><br /><br />But what about the net trade component? Well, before going further it is important to consider is how this calculation works. Basically net trade can improve <strong>either</strong> by the rate of export growth accelerating, <strong>or</strong> by the rate of import growth decelerating. Now in Greece we know that exports have improved, but Greek exports are proportionally so small, and form such a limited part of total economic activity, how can they possibly pull the economy upwards in this way (causing a 0.8% q-o-q increase in GDP)? Well, looking at the chart for imports it can be seen that just as exports have been accelerating, imports have been decelerating, so the combined impact might be quite large (please note we don't yet have the March data).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2e1YVi5ZJe2S-4IwlfLkjsyVy7dlAST2BZkPHK0gNv8UIS1VtMjaJBLSFhnUtdn672dK9A4yGuLPmPdC67mP6Z5Ua9DXRLcOee9ou6sL_b27mOxnO7Cf3tqk8bxvWfaNoxXk_rBoA8lJH/s1600/Greece+Imports.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2e1YVi5ZJe2S-4IwlfLkjsyVy7dlAST2BZkPHK0gNv8UIS1VtMjaJBLSFhnUtdn672dK9A4yGuLPmPdC67mP6Z5Ua9DXRLcOee9ou6sL_b27mOxnO7Cf3tqk8bxvWfaNoxXk_rBoA8lJH/s400/Greece+Imports.png" border="0" alt="" /></a><br /><br />This impression that it was as much a drop in imports as a rise in exports that was behind the sharp quarterly rise in GDP is further reinforced if we look at the year on year performance of the two variables. In recent months Greek imports are sharply <strong>down</strong> y-o-y (despite the surge in energy prices) while exports are <strong>up</strong>.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEierU6SfS_GxXryhE2Cw1MEh8A8-xUmVrtERgbq7edrxhcpoWGNgDJjUituGgHpxI5-QdFHSKqVPnQqE5dPiarNDhyphenhyphen5FSpwL-yX6WqoIPrydCW6vBHyGneWO8L178TshgdLoV7GK9Kmh09U/s1600/Greece+Imports+year+on+year.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEierU6SfS_GxXryhE2Cw1MEh8A8-xUmVrtERgbq7edrxhcpoWGNgDJjUituGgHpxI5-QdFHSKqVPnQqE5dPiarNDhyphenhyphen5FSpwL-yX6WqoIPrydCW6vBHyGneWO8L178TshgdLoV7GK9Kmh09U/s400/Greece+Imports+year+on+year.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1r3n5XXIFBRFL__PcPkL8gLgYnWaZvzHWqB4x7aoEmIUS0zhAxSNLtzqALSGkKrUSXJma2RX-5XRzTt4yzaeWhPISHfB2v56Zp8IYHT_z6M3rLaD1Q0rluh6HyBMF0TrqAObK8KTGFlZz/s1600/Greece+Exports+year+on+year.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1r3n5XXIFBRFL__PcPkL8gLgYnWaZvzHWqB4x7aoEmIUS0zhAxSNLtzqALSGkKrUSXJma2RX-5XRzTt4yzaeWhPISHfB2v56Zp8IYHT_z6M3rLaD1Q0rluh6HyBMF0TrqAObK8KTGFlZz/s400/Greece+Exports+year+on+year.png" border="0" alt="" /></a><br /><br />So GDP rose, but what about does this tell us about living standards? Well, this is just the point. Since the fall in imports reflects a fall in demand, it implies a fall in living standards,and this is the strange thing about what GDP measures and what it doesn't measure. GDP can rise sharply, even when unemployment is rising, and people are getting poorer. This is largely because one of the things GDP doesn't measure is the evolution of what some call the "financial balances" (for more explanation of this idea see the pioneering work of the Canadian economist Rob Parenteau (<a href="http://www.nakedcapitalism.com/2010/03/parenteau-on-fiscal-correctness-and-animal-sacrifices-leading-the-piigs-to-slaughter-part-1.html">here in somewhat polemical form</a>, and <a href="http://neweconomicperspectives.blogspot.com/2009/07/employing-krugmans-cross-farewell-mr.html">here as a more technical explanation</a>).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrrpks9OaAoTKd0WTaJTxHAT2E2uYvVKp89oTDA9sjtxJ4x1ASFUsK-nh10ywFD_ICur6FnHjJW5JH-8IbdUswzzuL4LdcDIsXub7x90ZQhqLaGpyw5Lm1fY3vQ9Oe-mDs8kMxC7uj32Dg/s1600/Greece+current+account+monthly.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrrpks9OaAoTKd0WTaJTxHAT2E2uYvVKp89oTDA9sjtxJ4x1ASFUsK-nh10ywFD_ICur6FnHjJW5JH-8IbdUswzzuL4LdcDIsXub7x90ZQhqLaGpyw5Lm1fY3vQ9Oe-mDs8kMxC7uj32Dg/s400/Greece+current+account+monthly.png" border="0" alt="" /></a><br /><br />In countries running an ongoing trade and current account deficit, the rise in living standards which comes from an increasing excess of imports over exports figures in national accounts as an <strong>output negative</strong> (apart from the transport and retail outlet activity which are a spin-off), and the counter party to all that "living beyond our means" feel-good added credit-driven purchasing power really only shows up as a negative item on the financial side of the accounts, as money borrowed from the exterior, money which is used to finance the deficit. It is a negative item, because all that potential capacity to spend is being diverted away from national activity to external activity. So while you pay for the products consumed (through debt) others get the long term benefit of your spending. Which is why it is such a bad idea to run sizeable current account deficits over any great length of time, since they are financed by credit, and credit is only a way of transferring demand from the future to the present, which means you will feel richer now, and poorer in the future, and this is exactly what is happening to Greece. It is also why the only way to put the situation straight is to export more, and run a trade and current account surplus, since then the value of your net external debt falls. So the correction is necessary and inevitable, although the curious thin is that while it is taking place, and while exports are rising and imports and living standards falling GDP rises, even though people feel much worse off.<br /><br />Obviously, having an economy appearing to accelerate like this is a bit counter intuitive. Evidently it is not the same as having a devaluation-induced import-reduction with demand remaining equal, and more productive activity taking place inside the country as relative prices result in steady import substitution, but then demand deflation policies have these peculiarities attached. Maybe we could think of the type of correction Greece is engaged in as less future demand being brought forward to today, under the hope that the subsequent path of the economy will eventually be on a higher level than it otherwise would have been. Pay now, live later.<br /><br />In the Greek case, since private sector borrowing is at a total standstill, and public sector deficit borrowing is being steadily reduced, the current account deficit is being forced to close, with the consequence that since exports can't rise much (due to competitiveness issues, and their low base) imports will need to fall while unemployment will probably continue to rise.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjE7t83z82JNvktOqRak32KVudV2m1PlZMWhVwYyvynC7_rr4on_jasR_B7yz77776vQEu-eZ0HwOeUAZ46Bg8m5KYRk3v20-ZUWzyB-tUghTglcIvIFtWEz-47eRHGRS1qY_X9IcYp8c7R/s1600/Greece+Bank+Lending+To+Households.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjE7t83z82JNvktOqRak32KVudV2m1PlZMWhVwYyvynC7_rr4on_jasR_B7yz77776vQEu-eZ0HwOeUAZ46Bg8m5KYRk3v20-ZUWzyB-tUghTglcIvIFtWEz-47eRHGRS1qY_X9IcYp8c7R/s400/Greece+Bank+Lending+To+Households.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhuvrtRqjseFbDECoQzaZffCADQTKrpTsVWweWiSd-L4SLyzePSTXSFqWhBrvX1h03xfuT3j43eY9ZSsDzc4KxhyphenhyphenB_zm268il3LQPsVF4n1GsXaSbBI7JbUSLk3po1-pqR24n4aarWPHjV5/s1600/Greece+Bank+Lending+to+Corporates.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhuvrtRqjseFbDECoQzaZffCADQTKrpTsVWweWiSd-L4SLyzePSTXSFqWhBrvX1h03xfuT3j43eY9ZSsDzc4KxhyphenhyphenB_zm268il3LQPsVF4n1GsXaSbBI7JbUSLk3po1-pqR24n4aarWPHjV5/s400/Greece+Bank+Lending+to+Corporates.png" border="0" alt="" /></a><br /><br />If this analysis of what has been going on in Greece is correct, then it can also help us understand the latest set of Spanish GDP numbers a bit better. According to the latest data, in the first quarter of this year Spain's GDP rose by 0.3% over Q4 2010 and by 0.8% over the year earlier quarter. This surprised many analysts since the Bank of Spain has previously estimated growth to be around 0.2%, and a number of 0.1% was often anticipated.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhm5RQk7DpujSJuQH-pWh08MpGNHLN5UDniHvEqFVvvxmpXtILgYzV75w863MD1m2-fRx1vNwGe8DaVPHEIqADGbhGQ1Aa-hlFeAIbLMu0sE_rLDrWoJPNJI9X9TqbtNpO1TJmXpcbp_OM-/s1600/gdp++two.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhm5RQk7DpujSJuQH-pWh08MpGNHLN5UDniHvEqFVvvxmpXtILgYzV75w863MD1m2-fRx1vNwGe8DaVPHEIqADGbhGQ1Aa-hlFeAIbLMu0sE_rLDrWoJPNJI9X9TqbtNpO1TJmXpcbp_OM-/s400/gdp++two.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYDFBrBKtP1upLd_GrIv3FKfPtaA-7zl4F8GtIXnFLzguZPStFI4xtQtij_9pejnTVYS9_0nvnRTs7DKX2m2LqzJwAfHHCsQxHmqTSwEftGbM7Z2Yl7W5Rr3rzi1sPRzKVFkbi-orogODF/s1600/gdp+one.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYDFBrBKtP1upLd_GrIv3FKfPtaA-7zl4F8GtIXnFLzguZPStFI4xtQtij_9pejnTVYS9_0nvnRTs7DKX2m2LqzJwAfHHCsQxHmqTSwEftGbM7Z2Yl7W5Rr3rzi1sPRzKVFkbi-orogODF/s400/gdp+one.png" border="0" alt="" /></a><br /><br />In theory the Q1 performance marks an acceleration over the 0.2% quarterly rise registered in the last quarter of 2010. Such an acceleration seems odd, since all the recent data, industrial output, retail sales, unemployment has been negative, and doubly so since the government is in the process of a very sharp (3.2%) fiscal adjustment process.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl69zA9gssyQv6FzYlTKEJFLLdHTMvL8opMnEJeDy7yqe_heGixwBeFBUc86CpXhoiiLqtYb_DVpgC5PUo6zB7wYlUqm0_rUBBh3ei5V4KP2WINvfrQJZ37_FtcnwmgzZcMUcKZTcvgt7e/s1600/industrial+output.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 210px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl69zA9gssyQv6FzYlTKEJFLLdHTMvL8opMnEJeDy7yqe_heGixwBeFBUc86CpXhoiiLqtYb_DVpgC5PUo6zB7wYlUqm0_rUBBh3ei5V4KP2WINvfrQJZ37_FtcnwmgzZcMUcKZTcvgt7e/s400/industrial+output.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpkGhkIgICDQmZjMzCHWkpAMf1TpFZbQWc_d4DdmIIvVO2kciipQ7VE0TmXMzuzhXecM8KhPXzIJX7IOjjFgwODof0EZrdMh6yGItAizatCYOttX2DF4t644vvjfevpczuC6yB8_cGhEn3/s1600/retail+sales.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpkGhkIgICDQmZjMzCHWkpAMf1TpFZbQWc_d4DdmIIvVO2kciipQ7VE0TmXMzuzhXecM8KhPXzIJX7IOjjFgwODof0EZrdMh6yGItAizatCYOttX2DF4t644vvjfevpczuC6yB8_cGhEn3/s400/retail+sales.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgA8iffvnWL0muYGt8_rAnTd0R2uXHZ5hdrtw5AAUlvq4MzLq_rz9Q18e7VFjSIvIKX7X0QWsopU2ZX8k-r5gVcN3MlGtAx8fhhaAVEat05cfHQ46kGlSmWWQ9CNefITZ-ZGlCpbegQZqRy/s1600/unemployment+one.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgA8iffvnWL0muYGt8_rAnTd0R2uXHZ5hdrtw5AAUlvq4MzLq_rz9Q18e7VFjSIvIKX7X0QWsopU2ZX8k-r5gVcN3MlGtAx8fhhaAVEat05cfHQ46kGlSmWWQ9CNefITZ-ZGlCpbegQZqRy/s400/unemployment+one.png" border="0" alt="" /></a><br /><br />Yet, if we come to look at the relative import/export performance, we will see a milder version of the same phenomenon. It seems exports rose and imports fell in the first quarter, creating a very special kind of "win-win" situation.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuGIuVCBsBE5cXeDpk3-SFJ3btLxmK-6VVXNDhtCSicL_ZWkU1tMYUAop-_WUHYKfuw6Rgl9NDLEnu6AAFikVYX-QHtw1cBEcXJQkE-VPK79mCTV9ERbouhyDWTbv-J24wpZxXP5bceFF5/s1600/WTO+Imports.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuGIuVCBsBE5cXeDpk3-SFJ3btLxmK-6VVXNDhtCSicL_ZWkU1tMYUAop-_WUHYKfuw6Rgl9NDLEnu6AAFikVYX-QHtw1cBEcXJQkE-VPK79mCTV9ERbouhyDWTbv-J24wpZxXP5bceFF5/s400/WTO+Imports.png" border="0" alt="" /></a><br /><br />This is a much milder version of the Greek story, but possibly similar processes are at work in both cases, as Spain's previously large current account deficit is also being steadily forced to close.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEimcSAkuc9UVoEK7G0Y-F_gcuqCP-oQR14TfM6QuOr8oBE4FwnrFKpDHcKdxcbzTGTPXid2hek2eZCoLxMZNl62gzz_q2sJBsrQA-iEegC14atKxiPM3o1FPASA92Hw8c_9Z1PjLg4EAxID/s1600/current+account+balance.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEimcSAkuc9UVoEK7G0Y-F_gcuqCP-oQR14TfM6QuOr8oBE4FwnrFKpDHcKdxcbzTGTPXid2hek2eZCoLxMZNl62gzz_q2sJBsrQA-iEegC14atKxiPM3o1FPASA92Hw8c_9Z1PjLg4EAxID/s400/current+account+balance.png" border="0" alt="" /></a><br /><br />On the other hand, in Spain's case other factors might be at work, like <a href="http://www.economist.com/node/18621761">overspending before this month's regional and local elections</a>. In any event, I am describing all the above as a hypothesis because we still don't have either the March trade data or the detailed GDP data. When we have access to both of these we will have a better idea of just how valid this hypothesis of mine actually is. At the end of the day, one swallow doesn't make a summer, and one month's GDP surprise is simply a drop in the ocean in relation to the major challenges which face these economies in the quarters and years ahead.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-65354802024254008952010-11-28T10:22:00.000-08:002010-11-29T00:18:26.067-08:00Greece Is Almost Certainly "On Track" - But Towards Which Destination Is It Headed?"There is a difficulty that is widely recognized that the amount [of debt] to be repaid is high in 2014 and 2015," Giorgios Papaconstantinou (the Greek Finance Minister).<br /><br />"We are confident that Greece will be able to return to the markets. But whether it will be able to return to the markets on a scale that allows Greece to pay off its European partners and the IMF, that is a question."..."We have a number of options. If paying off the €110 billion loan proves to be a question, we stand ready to exercise some of those options" - Poul Thomsen, head of the IMF team in the ECB-EU-IMF troika delegation.<br /><br />"In the rushed last-minute deal to forestall certain bankruptcy, everyone missed one very important fact. That the memorandum created an unrealistic and immense borrowing squeeze on the feckless Greek state for the next five years."<br />Nick Skrekas - Refusing Greek Loan Extensions Defies Financial Reality, Wall Street Journal<br /><br /><strong>Get On The Right Track Baby!</strong><br /><br />According to the latest IMF-EU report Greece’s reform programme remians “broadly on track” even if the international lenders do acknowledge that this years fiscal deficit target will now not be met and that a fresh round of structural measures is needed if the country is to generate a sustained recovery. My difficulty here must be with my understanding of the English lexemes "remains" and "sustainable", since for something to remain on track it should have been running along it previously (rather than never having gotten on it), and for something - in this case a recovery - to be sustained, it first needs to get started, and with an economy looking set to contract by nearly 4% this year, and the IMF forecasting a further shrinkage of 2.6% next year, many Greeks could be forgiven for thinking that talk of recovery at this point is, at the very least, premature. A more useful question might be "what kind of medicine is this that we are being given", and "what are the realistic chances that it actually works". Unfortunately, in the weird and wonderful world of Macro Economics, witch doctors are not in short supply.<br /><br />As the representatives of the so-called `troika`mission (the IMF, the ECB, and the EU) told the assembled journalists in last Tuesday's press conference “The programme has reached a critical juncture." Critical certainly (as in, in danger of going critical - just look at the 1,000 basis point spread between Greek and German 10 year bond yields, or the 4% contraction in GDP we look set to see this year), but the question we might really like to ask ourselves is what are the chances of the patient surviving the operation in one piece?<br /><br />The statement came at the end of a 10-day mission visit to Athens to review the extent to which the country was complying with the terms of the country’s €110bn bail-out package and take a decision on whether or not to authorise the release of the third tranche of the agreed loan.<br /><br />In the event the decision was a foregone conclusion, with the rekindling of the European Sovereign Debt Crisis as a background, and the very survival of the common currency in the longer term in question, this was no time to tell the markets the tranche was not being forwarded. But still, the expression "on track" continues to fall somewhat short of expectation with the lingered issues like the recent upward revision of the Greek deficit numbers (up to 15.4% for 2009), the failure to increase revenue as much as anticipated, and the need for a further round of “belt tightening” measures in 2011 to try to attain the agreed objective of a 7.4% deficit as a backdrop. The upward revision in the deficit numbers only added to all the doubts many economists have about the long term payability of the Greek debt, which the IMF now expect to peak at around 145% of GDP in 2013, although again, many analysts put the number much higher.<br /><br />Independent analyst Philip Ammerman who is based in Greece, and whose expectations about the evolution of Greek debt have proved to be reasonably realistic, <a href="http://www.philip-atticus.com/2010/11/return-of-bond-vigilantes-and-financial.html">now expects debt to GDP to come in much higher than anticipated in 2010</a>, due largely to 10 billion euros in debt from the train company OSE being added to the total and downward revisions in 2009 GDP from the Greek statistics office.<br /><br />The key to payability is of course a resumption of economic growth, which at the present time looks even more distant than ever. The IMF is arguing for another round of structural reforms – like opening up “closed-shop” professions, or simplifying administrative procedures and modernising collective wage bargaining, and while many of these are necessary, none of these are sufficiently “short sharp shock” like to restart the economy, and in general don’t target the main issue which is how to restore competitiveness to the country’s struggling export sector.<br /><br /><strong>Just One More Moment In Time!</strong><br /><br />Doubts about how Greece was going to start financing its debts in the market after the expiry of the loan programme in 2013 had only been adding to market nervousness in recent days, since in addition to the fact that loan repayments to the EU and the IMF would need to start in 2014. Most critical are the first two years, when the bulk of the debt to the EU and IMF falls due. Under current repayment schedules, In fact, as things stand now, Greece's gross borrowing needs for 2014 and 2015 (when most of the EU-IMF debt falls due) will balloon to over 70 billion euros a year from around 55 billion euros a year in 2011-2013. This represents having to finance about 40% of GDP each year. Not an easy task. The difficulty presented by this looming repayment mountain lead the FT’s John Dizard to speculate that the Greek parliament might be tempted to go for the rapid passage of a law allowing for the application of “aggregate collective action” on bondholders – using the reasoning that, since the money being borrowed at the moment is basically being used to pay off existing bondholders (who are relatively easy to haircut) while the new lenders (the IMF and the EU) are (at least on paper) not. As John says, “Greece is exchanging outstanding debt that is legally and logistically easy to restructure on favourable terms with debt that is difficult or impossible to restructure. It’s as if they were borrowing from a Mafia loan shark to repay an advance from their grandmother”.<br /><br />What a (retroactive) aggregate collective action clause would mean is that if a specific fraction, say 80 per cent or 90 per cent, of existing Greek bondholders agree to a restructuring that lowers the net present value of Greek debt by, say, half, then the remaining “holdout” bondholders would be forced into accepting the same terms. It is the consideration that the Greek Parliament might be tempted to go down just such a road that possibly lies <a href="http://uk.reuters.com/article/idUKTRE6AQ1LR20101127">behind this weekends Reuters report</a> that The EU and the IMF could extend the period in which Greece must repay its bailout loans by five years, to make it easier for it to service its debt. According hot the agency Poul Thomsen, the IMF official in charge of the Greek bailout, stated in an interview with the Greek newspaper Realnews "We have the possibility to extend the repayment period ... from about six years to around 11," This follows earlier reported statements from Mr Thomsen the the IMF “could provide part of the funding on a longer repayment period, or give a follow-up loan.” Indeed the announcement of the Irish Bailout details seems to suggest there has been a general change of position here, since the Irish loan is initially to be for seven and a half years (which certainly does suggest we are all trying hard to kick the can further and further down the road), while - in what you might think was a token nod in the direction of John Dizard's argument, aggregate collective action clauses are now to be written into all bond agreements after 2013. It will be interesting to see how the existing bondholders themselves respond to this proposal when the markets open tomorrow (Monday) morning. <br /><br />So now we know that in fact Greece is likely to be able to extend its dependence on the IMF all the way through to 2020, the only really major question facing us all is: just how small will the Greek economy have become by the time we reach that point.<br /><br />To start to answer that question, let’s take a look at some of the macro economic realities which lie behind the “impressive start” the Mr Thomsen tells us the Greek economy has made.<br /><br /><strong>Austerity Measures Provoke Sharp Economic Contraction</strong><br /><br />The IMF-EU-ECB austerity measures have - predictably - generated a sharp contraction in Greek GDP, with falling industrial output, falling investment, falling incomes, falling retail sales, and rising inflation and unemployment. The big issue dividing Macro Economists at this point is whether countries forming part of a currency union which have a competitiveness problem are best served by their fiscal difficulties being addressed first. <br /><br />Arguably countries which do not have the luxury of implementing a swift and decisive devaluation to restore their competitiveness would be best served by receiving fiscal support from other part of the monetary unionion to soften the blow as they implement a comprehensive programme of internal devaluation to reduce their price and wage levels. That is to say the current approach has the issue back to front, and will undoubtedly lead the countries concerned into even more problems as slashing government spending at a time when no other sector is able to grow is only likely to create a vicious spiral which leads nowhere except towards eventual and inevitable default. To date Greek GDP has fallen some 6.8% from its highest point in Q1 2008, yet far from bottoming out, the contraction seems to be accelerating under the hammer blows of ever stronger fiscal adjustments, and the downard slump still has a long way to go.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQDgVj49xUdNhYJz0TSb-reZWRHsapZrypbM3okn1eE61-DoI1FWaC6pc6xDG9S86egsaWgxaDVQeMvSpYbjv-GG3FUm6qjK0yIaptjqj4SUAxJndUYoTyg9rGtTWVaDYC_xYOkvfHkb0/s1600/Greek+GDP+Constant+Prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQDgVj49xUdNhYJz0TSb-reZWRHsapZrypbM3okn1eE61-DoI1FWaC6pc6xDG9S86egsaWgxaDVQeMvSpYbjv-GG3FUm6qjK0yIaptjqj4SUAxJndUYoTyg9rGtTWVaDYC_xYOkvfHkb0/s400/Greek+GDP+Constant+Prices.png" alt="" id="BLOGGER_PHOTO_ID_5544678335935228658" border="0" /></a><br /><br />The Greek economy contracted by 1.1% quarter-on-quarter in the third quarter of 2010, making for the eighth consecutive quarter of contraction. And evidently there are still have several more quarters of GDP contraction lying out there in front of us.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMWr864V7CMx3zfE-yy6MXVqLWiKTCxr7PcSrtrRm43IrQoRNSi2SJTWpDRA_moONHV54dkm1WXkUuskK3SEkyRQzWmdBtYJOG46oh_ynsIWeScuBn-IkqXvwVcvjG0Et2iXFEV1yXNxA/s1600/Greece+Q-o-Q.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMWr864V7CMx3zfE-yy6MXVqLWiKTCxr7PcSrtrRm43IrQoRNSi2SJTWpDRA_moONHV54dkm1WXkUuskK3SEkyRQzWmdBtYJOG46oh_ynsIWeScuBn-IkqXvwVcvjG0Et2iXFEV1yXNxA/s400/Greece+Q-o-Q.png" alt="" id="BLOGGER_PHOTO_ID_5544680785375978674" border="0" /></a><br /><br />Year on year the Greek economy was down by 4.5% on the third quarter of 2009. This is the fastest rate of interannual contraction so far. Far from slowing the contraction seems to be accelerating at this point.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhefPWg_FP_vOlPzlFcPgZLX4EQ7uslQMOjDfPbjQIFrrbZGtdJY7jtByK0-4AnHC2slXoebKlsn0npjLLUovV1mYHa04BLJHB4ACiK6cD8IhzbRWYcZfTxsKHH82uBeidMSxFZGxlI_J8/s1600/Greece+GDP+YoY.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhefPWg_FP_vOlPzlFcPgZLX4EQ7uslQMOjDfPbjQIFrrbZGtdJY7jtByK0-4AnHC2slXoebKlsn0npjLLUovV1mYHa04BLJHB4ACiK6cD8IhzbRWYcZfTxsKHH82uBeidMSxFZGxlI_J8/s400/Greece+GDP+YoY.png" alt="" id="BLOGGER_PHOTO_ID_5544681289425090834" border="0" /></a><br /><br /><br /><strong>Domestic Consumption In Full Retreat</strong><br /><br /><br />Looking at the chart below, it is clear that Greece enjoyed quite a consumption boom in the first years of the Euro's existence, a boom which is in some ways reminiscent of those other booms in Ireland and Spain, and a boom which came roundly to an end when the credit markets started to shut down. As in other countries, the government stepped in with borrowing to try to keep the boom going, with the major difference that deficitfinance went to levels well beyond those seen in other European countries in 2009, as did the efforts the Greek government went to to try to cover its tracks. <br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFR-WY_adMMPla07Y2zDGeUKMZb5twKsCO5n9aHjZHJHc61A4BCbDuyNLfVeMkRl3eUxI6AKZpKiy2EiSuSDFH7NDLFRmrMPXHHDS_lvq3Fof4oW3OQtofk-qRCXZeTd3ca3I2qaAuVoE/s1600/Greece+Private+Consumption+Volume.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFR-WY_adMMPla07Y2zDGeUKMZb5twKsCO5n9aHjZHJHc61A4BCbDuyNLfVeMkRl3eUxI6AKZpKiy2EiSuSDFH7NDLFRmrMPXHHDS_lvq3Fof4oW3OQtofk-qRCXZeTd3ca3I2qaAuVoE/s400/Greece+Private+Consumption+Volume.png" alt="" id="BLOGGER_PHOTO_ID_5544683396679037234" border="0" /></a><br /><br />One of the clearest indications that the party is now well and truly over is the way in which the level of new car registrations is slumping.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfSc6eEphOO9t06wXP2L7ePBdpQ2mJ_xJjdPxvTSxvw2vFLe6sPSgcHwXd3CKXMW9Gs5BhiowwHCPFGnXreQ1Vt7n5eeO2Ur6DdmYaGdeLvkpCzL1RHgf6T6zPyHRur7bNG4a86Ap8O34/s1600/Greece+car+registrations.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 245px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfSc6eEphOO9t06wXP2L7ePBdpQ2mJ_xJjdPxvTSxvw2vFLe6sPSgcHwXd3CKXMW9Gs5BhiowwHCPFGnXreQ1Vt7n5eeO2Ur6DdmYaGdeLvkpCzL1RHgf6T6zPyHRur7bNG4a86Ap8O34/s400/Greece+car+registrations.png" alt="" id="BLOGGER_PHOTO_ID_5544684641473197282" border="0" /></a><br /><br />Retail sales have now fallen by something over 15%.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsMklKtUHZMMaFikQmVpYV76Os3hSMyMg9Lxq3v4EcEuXlwZJ13ZLjGNrTJP2tsq7fq0HwOYjtqWiAWZoGy9QNpMQhdc9kbJpuNBcf22Mf1x1plTPFnNgIKVV1WIXnbExNQ2_SuF1EyAc/s1600/Greece+retail+sales.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsMklKtUHZMMaFikQmVpYV76Os3hSMyMg9Lxq3v4EcEuXlwZJ13ZLjGNrTJP2tsq7fq0HwOYjtqWiAWZoGy9QNpMQhdc9kbJpuNBcf22Mf1x1plTPFnNgIKVV1WIXnbExNQ2_SuF1EyAc/s400/Greece+retail+sales.png" alt="" id="BLOGGER_PHOTO_ID_5544704385026931794" border="0" /></a><br /><br /><br /><strong>And With It The End Of The Credit Boom</strong><br /><br />The Greek consumption boom came to an end, just as it did in Spain and Ireland, when the credit crunch started to bite in 2008. Pre-crisis household borrowing was increasing at the rate of around 20%, the interannual rate of change has now fallen more or less to zero, and will stay there for some time to come. Since in a mature modern economy aggregate demand (whatever you do in the way of supply side reforms) can only grow in a sustained way as a result of either credit expansion or exports, export growth is going to have to give the Greek economy what little demand growth it can eventually get.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_70aMnaw75aBDJx0Y-70O7ec4sBrnIT6Rh1bmiz5Oa-E-Nf46mtgIvA9VjoKt4JVjU_JlHrdILGTenw-2ix_Kv6AtROCe15eeWKEyYrKlQ7YjxnPhMLvtURKAqc4jLVfD5GLc5HtV29A/s1600/Greece+Bank+Lending+To+Households.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_70aMnaw75aBDJx0Y-70O7ec4sBrnIT6Rh1bmiz5Oa-E-Nf46mtgIvA9VjoKt4JVjU_JlHrdILGTenw-2ix_Kv6AtROCe15eeWKEyYrKlQ7YjxnPhMLvtURKAqc4jLVfD5GLc5HtV29A/s400/Greece+Bank+Lending+To+Households.png" alt="" id="BLOGGER_PHOTO_ID_5544704670182330306" border="0" /></a><br /><br />Along with the general stagnation in household credit, lending for mortgage borrowing has also ground to a sharp halt.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPOTICmn0drIXNphuT1ZM3Qk6oTG-qRASnHXyCrbsWWnFvoFQXHmd61GHTL8uvj1nybhaX2NYCfULszzS_jWfrafqP7SfQqCwClgX5-jV8h9tDtWUiBQ7e6C2PWq-FCbwvmxRLHO35qaE/s1600/Greece+Bank+Lending+For+House+Purchases.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPOTICmn0drIXNphuT1ZM3Qk6oTG-qRASnHXyCrbsWWnFvoFQXHmd61GHTL8uvj1nybhaX2NYCfULszzS_jWfrafqP7SfQqCwClgX5-jV8h9tDtWUiBQ7e6C2PWq-FCbwvmxRLHO35qaE/s400/Greece+Bank+Lending+For+House+Purchases.png" alt="" id="BLOGGER_PHOTO_ID_5544705994968668930" border="0" /></a><br /><br />And credit to companies has also become pretty tight if we look at the next chart.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhxqkX7afpZzlGK8fzo1D4FVItfu8s1gU8dqjHPY3BG5MKfy-irNpbgyCvgBamAxDCNQxNEidWIKo3L359SAnw_fzcXZnJ4b5LI97XrYNQmggHyqW6EvNHR2YznU_74Xq45mWcJ85gFgfc/s1600/Greece+Bank+Lending+to+Corporates.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhxqkX7afpZzlGK8fzo1D4FVItfu8s1gU8dqjHPY3BG5MKfy-irNpbgyCvgBamAxDCNQxNEidWIKo3L359SAnw_fzcXZnJ4b5LI97XrYNQmggHyqW6EvNHR2YznU_74Xq45mWcJ85gFgfc/s400/Greece+Bank+Lending+to+Corporates.png" alt="" id="BLOGGER_PHOTO_ID_5544718496639146338" border="0" /></a><br /><br />Asin many other heavily indebted countries (the US, the UK, Spain) the only sector which is still able to leverage itself is the public one, or at least which was still able to drive demand by leveraging itself, but now, with the IMF EU adjustment programme, increases in government borrowing are also going to suddenly come to an end, with the evident consequencethat the economy goes into reverse gear. I can't help feeling that people aren't using enough emotional intelligence here. Obviously people are outraged by the level of fiscal fraud that was going on in Greece. But outrage and demogogic press headlines seldom form the basis of sound policy. Arguably the competitiveness issue is more important at this point than the fiscal deficit one, since the position is asymmetric - solving the competitiveness issue will automatically open the door to solving the fiscal deficit one, while addressing the fiscal deficit does not necessarily resolve the competitiveness problem, and does not return the country to growth - only a strong supply side dose of ideology can lead you to (mistakenly) think that.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuKMhoUxkU_hOtyvPx4_jaorU5snLaV3IpzAsV-JVPib-IbFJwBFBWrQDi7cTvkPDB9ePgLSHgUj5IpHxHos5vct4zr-P_xvSOC0duMflZV9XfMbz0r_-bY3bGddTK8tx-rX7H91Fas-8/s1600/Greece+Bank+lending+to+government.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuKMhoUxkU_hOtyvPx4_jaorU5snLaV3IpzAsV-JVPib-IbFJwBFBWrQDi7cTvkPDB9ePgLSHgUj5IpHxHos5vct4zr-P_xvSOC0duMflZV9XfMbz0r_-bY3bGddTK8tx-rX7H91Fas-8/s400/Greece+Bank+lending+to+government.png" alt="" id="BLOGGER_PHOTO_ID_5544718706531654962" border="0" /></a><br /><br /><strong>The Best Way Not To Restore Competitiveness: Raise VAT</strong><br /><br /><br />In fact, the fiscal adjustment programme contains two components, reducing spending, and increasing taxes. Of these the most damaging measure as far as growth and competitiveness goes is without doubt the decision to raise VAT by 5%. Not only (as we shall see) does this increase not raise the extra money anticipated (in an economy which is increasingly export dependent the tax base for a consumption tax weakens by-the-quarter in relative terms), it also sharply raises the domestic inflation rate, effectively ADDING to the competitiveness problem. I would say this obsession of the IMF with raising VAT in these economies which are effectively unable to devalue is just plain daft, frankly. And it doesn't impress me how many times respected micro economists describe raising VAT as the most benign of measures: all this does is convince me that they don't really have an adequate understanding of how economies work from a macro point of view, and especially not export dependent economies.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSEt7CKc-z10dKwYjYszCL36U6KysfGeFEkxL8PCl6KdTyUczZ1G1eMpEJNqPkiYqY6l4CDE3BTZ4C_zV4mU5k57NySIDgN71QbQkkwQ3YI73t7PRoNTgxMNITN6d1grlZzWm11NXYH4A/s1600/CPI+YoY.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 215px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSEt7CKc-z10dKwYjYszCL36U6KysfGeFEkxL8PCl6KdTyUczZ1G1eMpEJNqPkiYqY6l4CDE3BTZ4C_zV4mU5k57NySIDgN71QbQkkwQ3YI73t7PRoNTgxMNITN6d1grlZzWm11NXYH4A/s400/CPI+YoY.png" alt="" id="BLOGGER_PHOTO_ID_5544720200422583378" border="0" /></a><br /><br />As we can see in the chart below, the VAT rise not only adds to the consumer price index, it also affects producer prices, and even export sector producer prices, which are sharply up.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcsM354S5QFnpzm-hB3NpW8AzKHprlt9aSagn5vjXzL2bsYi1X6hx3RULmXMAXY3uD4dgyy3f4WT-XJeaCjr4kf878vFzRMzgoYNS4i8kHQqIqubVxjoW4PbkddBh_rgI4dYdjdGTBJ50/s1600/Greece+Export+Producer+Prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcsM354S5QFnpzm-hB3NpW8AzKHprlt9aSagn5vjXzL2bsYi1X6hx3RULmXMAXY3uD4dgyy3f4WT-XJeaCjr4kf878vFzRMzgoYNS4i8kHQqIqubVxjoW4PbkddBh_rgI4dYdjdGTBJ50/s400/Greece+Export+Producer+Prices.png" alt="" id="BLOGGER_PHOTO_ID_5544721585398101938" border="0" /></a><br /><br />I would say that policymakers have fallen into two "Econ 101 simpleton" type errors here. The first is to think that since part of the objective is to raise nominal GDP to reduce debt to GDP, and since GDP is falling, raising the price level might help (I would call this the "fools gold" discovery), and the second is to imagine that since exports don't attract VAT, the impact is relatively benign, without stopping to think the the VAT hike also acts on inputs, and especially in an economy which suffers from chronic price and wage rigidity issues like the Greek one.<br /><br />If a first year student had sent me these kind of arguments in a term essay, aside form awarding a "fail", I think would recommend to the person that they would perhaps be better off studying another topic, physics maybe, since the demonstrated aptitude for applied macro economics would be very low indeed. Could it be that bondholders who normally understand quite a lot more than many imagine about how economies work are also noticing this, hence their growing nervousness.<br /><br />The incredible result of the application of this very short sighted policy is that in addition to the fact that Greece started out with a serious competitiveness issue with its most competitive EuroArea peers, like Germany.....<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRGwz26M3anxu64QzIvKDOvOyzmNHhb8zQliIfbFCMZVbu2vdUsOHymavwYlCEVWKtNbcRB-0I25HWXhr21GaKuk0UcHkLU7gpm6G6-_Iz88WHIm11Sod1d_4Jwru2W_jTAkfvFeS2J00/s1600/Greece+and+Germany+REER.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRGwz26M3anxu64QzIvKDOvOyzmNHhb8zQliIfbFCMZVbu2vdUsOHymavwYlCEVWKtNbcRB-0I25HWXhr21GaKuk0UcHkLU7gpm6G6-_Iz88WHIm11Sod1d_4Jwru2W_jTAkfvFeS2J00/s400/Greece+and+Germany+REER.png" alt="" id="BLOGGER_PHOTO_ID_5544725901858640738" border="0" /></a><br /><br />it has even hadits virtual currency revalued against the EuroArea average since entering the IMF sponsored programme, which is the exact opposite of what we need to see.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhiaHf2_zzTBBZbNSsgGtfPSu5-U6gyAlmpA8_6v0PLA0HDIWjzes075pvt1dvpTuMuliq4qAbYTFRlUrXG8sdU6TJMOUGbzB2PFC0eVuywTeFoU0oHkk8CWEIRDe38kvwCJu-uSFI5IOw/s1600/Greece+REER+Quarterly.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhiaHf2_zzTBBZbNSsgGtfPSu5-U6gyAlmpA8_6v0PLA0HDIWjzes075pvt1dvpTuMuliq4qAbYTFRlUrXG8sdU6TJMOUGbzB2PFC0eVuywTeFoU0oHkk8CWEIRDe38kvwCJu-uSFI5IOw/s400/Greece+REER+Quarterly.png" alt="" id="BLOGGER_PHOTO_ID_5544726236425444242" border="0" /></a><br /><br /><br /><strong>Export Lethargy Feeds The Industrial Output Slump</strong><br /><br />As a result we are seeing no evidence of a Germany-type resurgence in export activity.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEioi5SxAfwFVIRHCcFC1SKUXIcylEZtmlF4uSy-9pBO3Nv-6NeX65_uPIpT_7Yvk6I3zIcCFodRThB1atXQkCv9_yimvldz1GF8umEEjFiuVV_DhDi6Jojklfl-lVLpws7QWCQ8NEtMQ3Y/s1600/Greece+Exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 225px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEioi5SxAfwFVIRHCcFC1SKUXIcylEZtmlF4uSy-9pBO3Nv-6NeX65_uPIpT_7Yvk6I3zIcCFodRThB1atXQkCv9_yimvldz1GF8umEEjFiuVV_DhDi6Jojklfl-lVLpws7QWCQ8NEtMQ3Y/s400/Greece+Exports.png" alt="" id="BLOGGER_PHOTO_ID_5544726433263690194" border="0" /></a><br /><br />And in fact even though the trade deficit has reduced somewhat, it still remains a trade deficit.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIGU2Hdtu3ACiJlgrc84bot7mzzuKapDNLWJu0Arcoq6CGNLMOuG_np5mzI00INyvoNLazE59FhQx2vclvP6k_s-DJveMxuVp3TFz2I68ndDDYsiQ_ouJBFbauvR4K7T9apGz6o7jVLUo/s1600/Greece+Trade+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIGU2Hdtu3ACiJlgrc84bot7mzzuKapDNLWJu0Arcoq6CGNLMOuG_np5mzI00INyvoNLazE59FhQx2vclvP6k_s-DJveMxuVp3TFz2I68ndDDYsiQ_ouJBFbauvR4K7T9apGz6o7jVLUo/s400/Greece+Trade+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5544726702204392146" border="0" /></a><br /><br />Given the fact that domestic demand is falling, while exports stagnate, Greece's industrial sector is still in a sharp and continuing contraction.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPSb1lHff0ohvjj0Irea_w7LTJcOH6qVSw3cs7ebrTAddj7QSD8P4DSk6JLN-XWy4PoG5KOLpmd3QQLlfIBzOxeLFlS1-_AIkokohAxEAUbkQ-an93uN9h1CvEgCwiCWRQ3bIOtuRuOHY/s1600/Greece+Industrial+Output.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 234px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPSb1lHff0ohvjj0Irea_w7LTJcOH6qVSw3cs7ebrTAddj7QSD8P4DSk6JLN-XWy4PoG5KOLpmd3QQLlfIBzOxeLFlS1-_AIkokohAxEAUbkQ-an93uN9h1CvEgCwiCWRQ3bIOtuRuOHY/s400/Greece+Industrial+Output.png" alt="" id="BLOGGER_PHOTO_ID_5544726981237665458" border="0" /></a><br /><br />A contraction which continued and even accelerated slightly in October, according to the most recent PMI reading.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNgaZ4yQmQrgMIYZKLGjZYw2UNPPYYnUG8dHf0Dhy8ugN8E0Ih_Ht_bhQKvgURncyjyng6tB_DMyuYYS1RvvxEJGFrHOPjo6JNdJ3YY0WLPqaCruHVMSH973elZZCSkjsD_9h7hwO4fdc/s1600/Greece.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNgaZ4yQmQrgMIYZKLGjZYw2UNPPYYnUG8dHf0Dhy8ugN8E0Ih_Ht_bhQKvgURncyjyng6tB_DMyuYYS1RvvxEJGFrHOPjo6JNdJ3YY0WLPqaCruHVMSH973elZZCSkjsD_9h7hwO4fdc/s400/Greece.png" alt="" id="BLOGGER_PHOTO_ID_5544727210231710754" border="0" /></a><br /><br />Construction activity is in "freefall", as can be seen from the drop in cement output.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiopMd4jMfkRKT36YF6Mjz_xalcx4H260yiZ5QE-hQESp6-9_BhCYC5QNXiXvUi6b3bZ7ZGFnwDK3fooGiplFttyCis_WH11VYpVBed__ONzFzdWycX52wX7ZQxFhVnXVm6cNME8P3dnxs/s1600/Greece+Cement+Output.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiopMd4jMfkRKT36YF6Mjz_xalcx4H260yiZ5QE-hQESp6-9_BhCYC5QNXiXvUi6b3bZ7ZGFnwDK3fooGiplFttyCis_WH11VYpVBed__ONzFzdWycX52wX7ZQxFhVnXVm6cNME8P3dnxs/s400/Greece+Cement+Output.png" alt="" id="BLOGGER_PHOTO_ID_5544727476851733410" border="0" /></a><br /><br />and the decline will surely continue, as new building permits continue to fall.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEia2s6C6BLLNHGYxeZfAql2BoyHtzg41Auxh_DSuyOeuNZRlhO-GNae_i78oeyL8Mor0tPg7u4y41RPlVQVvTnBka9qADP_i06a-brqWlbtzABpGZNRpOsKzB88MP3w_7HPpdQQEEX9GoQ/s1600/Greece+Building+Permits.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEia2s6C6BLLNHGYxeZfAql2BoyHtzg41Auxh_DSuyOeuNZRlhO-GNae_i78oeyL8Mor0tPg7u4y41RPlVQVvTnBka9qADP_i06a-brqWlbtzABpGZNRpOsKzB88MP3w_7HPpdQQEEX9GoQ/s400/Greece+Building+Permits.png" alt="" id="BLOGGER_PHOTO_ID_5544727766146151298" border="0" /></a><br /><br />And private construction activity continues to drop.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZieHJ2TfowokQb0qjbjBDnTYBdnV6j-Ck7NqSEcLv_1NapdZIorQJ4sferu0kgP9qdjQWzBuWRjdfc6T7uMlZvNKxReOQ-VWYSEWST7sH3n4ysg31iCy9hNDN5b91ROceMDKlOs2-hkE/s1600/Greece+Private+Construction+Output.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 253px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZieHJ2TfowokQb0qjbjBDnTYBdnV6j-Ck7NqSEcLv_1NapdZIorQJ4sferu0kgP9qdjQWzBuWRjdfc6T7uMlZvNKxReOQ-VWYSEWST7sH3n4ysg31iCy9hNDN5b91ROceMDKlOs2-hkE/s400/Greece+Private+Construction+Output.png" alt="" id="BLOGGER_PHOTO_ID_5544728010084982562" border="0" /></a><br /><br /><br />The net result of the economic contraction and a credit crunch is, of course, that while other consumer prices rise, house prices are now falling, giving us just one more reason why Greeks are starting to feel a lot less wealthy than they used to feel. Evidently, to kick start the economy again the fall in land and property prices needs to be brought to a halt. This is where the traditional devaluation strategy helped a lot, since you could stop the fall in nominal prices at a stroke, but the Greeks are helpless in this case, and it is rather alarming to find that there is no discussion of this key issue at the policy level, and just talk about how structural reforms will put everything right.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtUcX0Ql6pueRR5-_piyGWOTkszx0vxcmfxs2HpYqDWQ3TN86EmUGd3yYOxP5ZuW1GWXBMnl6ouY7TxpFVlMAYpp7ilZ-Gbr0AdTlK-8zPPPuvXd1GwZcaV5e132HzL_EV06UVZXxDA_M/s1600/Greece+House+Price+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtUcX0Ql6pueRR5-_piyGWOTkszx0vxcmfxs2HpYqDWQ3TN86EmUGd3yYOxP5ZuW1GWXBMnl6ouY7TxpFVlMAYpp7ilZ-Gbr0AdTlK-8zPPPuvXd1GwZcaV5e132HzL_EV06UVZXxDA_M/s400/Greece+House+Price+Index.png" alt="" id="BLOGGER_PHOTO_ID_5544728288754199954" border="0" /></a><br /><br /><br /><strong>Employment Falls And Unemployment Surges</strong><br /><br />The man and woman power is there to rebuild the economy, as ageing hasn't yet reached the point where the labour force will start to shrink. Indeed at this point it is still rising.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2buaJYw-CxhgsdK6KCfeteysXKQLrV1PGmb8AUEWUpxEJXeAB28SJQHwjZEkOxnWqgNouJrOmLujtKxCVFI5MQ5AfcFcT1jB6KsHJaTFdsPMPM3oFOYDEKvG_viLc3_8lI5fr_GaBPXs/s1600/Greece+Labour+Force.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2buaJYw-CxhgsdK6KCfeteysXKQLrV1PGmb8AUEWUpxEJXeAB28SJQHwjZEkOxnWqgNouJrOmLujtKxCVFI5MQ5AfcFcT1jB6KsHJaTFdsPMPM3oFOYDEKvG_viLc3_8lI5fr_GaBPXs/s400/Greece+Labour+Force.png" alt="" id="BLOGGER_PHOTO_ID_5544729409252427906" border="0" /></a><br /><br />But, of course, employment is now falling.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaNWzX8-8PrsFEIi68bQ8aglXbieYCnyTDcCX91Orhq5Pjzc4JBm3jyNEFUttM9TEtzG502f6q1FvDU0Unkb13FDtVy4PLbbqnyVhxvNcfj27gftruQSerfWh7jx6tbpgcQNXpt3M_wO4/s1600/Greece+Total+Employed.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaNWzX8-8PrsFEIi68bQ8aglXbieYCnyTDcCX91Orhq5Pjzc4JBm3jyNEFUttM9TEtzG502f6q1FvDU0Unkb13FDtVy4PLbbqnyVhxvNcfj27gftruQSerfWh7jx6tbpgcQNXpt3M_wO4/s400/Greece+Total+Employed.png" alt="" id="BLOGGER_PHOTO_ID_5544729688834707074" border="0" /></a><br /><br />And thus, logically, unemployment is rising, and is currently something over 12%.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheGcHY2nfSVJCVjhaTwVIXscosUuA1UEl8fu1ES86HVb9jV9zaUakiaKX0AEbbX8K1ousFmKIphTVZ-Z2wOWeeCqm83fN0hM7TX2bm8vVjYnqLuJoWAXolQot4UtTucqoF5qXY7Y3G4Xc/s1600/Greece+Unemployment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheGcHY2nfSVJCVjhaTwVIXscosUuA1UEl8fu1ES86HVb9jV9zaUakiaKX0AEbbX8K1ousFmKIphTVZ-Z2wOWeeCqm83fN0hM7TX2bm8vVjYnqLuJoWAXolQot4UtTucqoF5qXY7Y3G4Xc/s400/Greece+Unemployment.png" alt="" id="BLOGGER_PHOTO_ID_5544729908547363346" border="0" /></a><br /><br /><strong>And With The Fall In Employment Revenue Comes Under Pressure</strong><br /><br />And with the rise in unemployment, there is a fall in incomes, and thus income tax revenue is falling, putting yet more pressure on the deficit.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_CkV3PfFWhyBPgHptILkGDovdojgn0Oyjmj5xmKTySeSsNogPMm59-Xab89kxfwCmrB2qJV2uNzEWaQWwyL2VFlb6Wt1fdDo53lH7oP_jmZhyV3WGj2Ip227WdTFUINyu69ggfGGeAJ4/s1600/Greece+Personal+Income+Tax+Revenues.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_CkV3PfFWhyBPgHptILkGDovdojgn0Oyjmj5xmKTySeSsNogPMm59-Xab89kxfwCmrB2qJV2uNzEWaQWwyL2VFlb6Wt1fdDo53lH7oP_jmZhyV3WGj2Ip227WdTFUINyu69ggfGGeAJ4/s400/Greece+Personal+Income+Tax+Revenues.png" alt="" id="BLOGGER_PHOTO_ID_5544730438090989698" border="0" /></a><br /><br />At the same time, and despite a 5% increase in VAT rates, returns on the tax are also not rising as hoped.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDm7Bse17mQUbJ-kQBiGI5s_d6RAuvQU6ghC3xP2g8cx_FViaPLTnnQUhpauWxSoz2K30zvFxRdWuc0TAT6E-CKuimpwHk5E9Q3Dns0JNOAXGxWjkuHSUJCqpgbF-Ky85DBG5pR-tSPYc/s1600/greece+VAT+returns.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDm7Bse17mQUbJ-kQBiGI5s_d6RAuvQU6ghC3xP2g8cx_FViaPLTnnQUhpauWxSoz2K30zvFxRdWuc0TAT6E-CKuimpwHk5E9Q3Dns0JNOAXGxWjkuHSUJCqpgbF-Ky85DBG5pR-tSPYc/s400/greece+VAT+returns.png" alt="" id="BLOGGER_PHOTO_ID_5544730692625080130" border="0" /></a><br /><br /><br /><strong>A Contraction Which Feeds On Itself? </strong><br /><br />The Greek fiscal deficit is now falling, but after the huge upward revision in the 2009 figure, getting it down towards this years 9.4% target is a more or less Herculean task, which will involve far more fiscal effort than was previously anticipated, and with the fiscal effort more economic contraction. In addition, the finance ministry recently reported that while Greece's central-government deficit narrowed by 30% in the first 10 months of this year, this still fell short of the targeted narrowing of 32% due to lower than anticipated revenue returns.<br /><br />Finance ministry data show that the Greek central government took in 41.0 billion euros in revenue in the first 10 months of 2010, just 3.7% more than it did in the same period of 2009. The deficit-reduction plan hammered out with the EU and the IMF in May called for 13.7% growth in such revenues for 2010 as a whole. This implies that to meet the target, Greece must receive 14.1 euros billion in November and December, which is highly improbable given that to date this year the Greek government has only once had monthly revenue above €5 billion, and that was in January.<br /><br />On the spending side things have gone better, and targets are being met. Indeed over the summer the Greek government put forward a revised plan that compensates for the lower revenue with deeper spending cuts. But even meeting the lowered target of €52.7 billion would require a 30% jump over last year's revenue for the last two months of the year, and this is well nigh impossible.<br /><br />As a result of the revenue shortfalls and the revision in the 2009 deficit, Greece still looks to be well short of the 7.8% of GDP deficit originally aimed for. Current estimates are for a shortfall this year of something like 9.4% of GDP. In order to try to soothe market fears in this unsettled environment the Greek government last week unveiled a further austerity plan for 2011 involving an addition 5 billion euros in cuts, with the objective of cutting public deficit to 7.4% of GDP by the end of next year. Apart from the fiscal effort involved the new budget will almost certainly involve a stronger economic contraction than previously anticipated - and indeed the Greek government have already revised their forecast to 3% from the previous expectation of a 2.6% shrinkage.<br /><br />The problem is, that Greece is in danger of a counterproductive downward spiral here, since the revenue shortfall is at least partially the result of the existing budget austerity, which has simply helped to squeeze an already weak economy. The expected sharp contractions in GDP this year and next, will weighing heavily on revenue from income and sales taxes. Cuts to public-sector paychecks that went into affect this summer, for instance, have certainly helped contribute to a fall of about 10% in retail sales in August and September, and continuing unemployment rising above 12% will only add to the banking sectors bad debt problems.<br /><br /><br /><strong>You Need To Attack The Competitiveness Issue, And Not Just The Fiscal Deficit One</strong><br /><br />In my opinion the IMF are making a fundamental mistake in relying almost exclusively on structural reforms. "It has to come through structural reforms," Mr. Thomsen said, adding that he expected those reforms to be discussed at the next visit by the delegation early next year. "It cannot come through higher tax rates, that's not good for the economy, and it cannot come from more wage cuts because that is not fair."<br /><br />The are right that more taxes and less salaries without corresponding price reductions don't solve the problem, but Greece needs to do something radical (like a sharp internal devaluation) to restore competitiveness rapidly. Pushing the issues out to 2020 is no solution, and it is hard to imagine Greek civil society will accept the levels of unemployment and social dislocation that are being produced for such a lengthy period of time.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlQrtPwVVyf_JwdmTNz7rWfda26XNT4D6KttFE4mYsMctd9rBRh6b3CunkDp5TZhGk27h4ifK8pOXkvOL2VqjX_wCsBzgGd7InFLkUhJQy5pTEU6Mpr8cFhUNR7IxCCcDImUF9a7df50U/s1600/Greece+Fiscal+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlQrtPwVVyf_JwdmTNz7rWfda26XNT4D6KttFE4mYsMctd9rBRh6b3CunkDp5TZhGk27h4ifK8pOXkvOL2VqjX_wCsBzgGd7InFLkUhJQy5pTEU6Mpr8cFhUNR7IxCCcDImUF9a7df50U/s400/Greece+Fiscal+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5544730914777754530" border="0" /></a><br /><br />Estimates of the future path of Greek debt vary a lot, and their is considerable uncertainty involved in any estimate. The IMF currently forecast that the debt will peak at just under 145% of GDP in 2013, but I think we can regard that as an estimate at the lower end of the range.<br /><br />Despite the fact that George Papandreou's government has been widely praised for enforcing draconian austerity measures, the country still has the largest debt-to-GDP ratio in the EU, which involves a debt mountain of something like 330 billion euros - only 110 billion of which will be funded by the EU-IMF rescue programme. That is to say, private sector bondholders will still have something like (at least) 220 billion euros of exposure to Greek debt come 2013.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgWRYaEzuWPmyDd29o73yoqzJaoVmToTvzqsZ2-4O6T7QJNNq-KfrBskx3OOkcr8WKsNCCpF7bIopY_NOKivOvWBlIsMfrTI_7GEdJy5xohLaARi3eEXxtaX3m5KArPqf9iE6K39J5rsA0/s1600/Greece+debt+to+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 207px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgWRYaEzuWPmyDd29o73yoqzJaoVmToTvzqsZ2-4O6T7QJNNq-KfrBskx3OOkcr8WKsNCCpF7bIopY_NOKivOvWBlIsMfrTI_7GEdJy5xohLaARi3eEXxtaX3m5KArPqf9iE6K39J5rsA0/s400/Greece+debt+to+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5544731182534448530" border="0" /></a><br /><br />Greece's whopping current account deficit has reduced to some extent since the 2008 15% of GDP high, but the level is still quite large.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhdBQ1QaZFmxpNI8ZCt_1DCNomdNyDMW3RAoNv-OZTI0qqO_vMvUioIXuRuZPfB_2Omlf5ivekUcgo31L0QVO3u75lOfOkQrgkmeagsROXI8OqdLexxIQYecKcDQCEjqiMgwsXnWBEzCc/s1600/Greece+current+account+monthly.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhdBQ1QaZFmxpNI8ZCt_1DCNomdNyDMW3RAoNv-OZTI0qqO_vMvUioIXuRuZPfB_2Omlf5ivekUcgo31L0QVO3u75lOfOkQrgkmeagsROXI8OqdLexxIQYecKcDQCEjqiMgwsXnWBEzCc/s400/Greece+current+account+monthly.png" alt="" id="BLOGGER_PHOTO_ID_5544731408566187282" border="0" /></a><br /><br />More importantly the IMF do not forsee Greece running a current account surplus at least before 2015. Indeed they imagine that Greece will still have a current account deficit of 4% of GDP come 2015. Which means that far from paying down their external debt, Greek indebtedness (absent restructuring) will continue to rise over the whole period. According to Greek central bank data, the country had a net external investment position of 199 billion euros in 2009, or put another way, net external debt was something like 110% of GDP.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhf3cMft1o0T5X0aPEii5bhhOCBGfeHSxE4IxW4SzPrhB0hd-2bzk_Kt1fjhsBW6JhHiOyRKGRRJDsqnHgoE7gGbdCxOZNFfUuEFEkq4TeKfGfFIcm2F9rR-qKU1DQpoFjL0hGMV_YV5hI/s1600/Greece+Current+Account+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhf3cMft1o0T5X0aPEii5bhhOCBGfeHSxE4IxW4SzPrhB0hd-2bzk_Kt1fjhsBW6JhHiOyRKGRRJDsqnHgoE7gGbdCxOZNFfUuEFEkq4TeKfGfFIcm2F9rR-qKU1DQpoFjL0hGMV_YV5hI/s400/Greece+Current+Account+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5544731607311958258" border="0" /></a><br /><br />At the end of last week, risk premiums on 10-year Greek bonds over their German equivalents were still timidly nosing above 1,000 basis points, a level many consider to be the market signal that default is likely. And this despite the International Monetary Fund having announced the same day that the Greek reform programme is “broadly on track”.<br /><br />And then there is the return to the financial markets issue. Finance Minister George Papaconstantinou has repeatedly said the country would return to bond markets when the time was right sometime in 2011. This looks increasingly like wishful thinking, especially since the 2009 deficit revision by Eurostat, while the less than anticipated revenue performance means that Greece has already missed its first fiscal consolidation target. Such a lapse may convince inspectors from the EU and the IMF, but it is unlikely to cut too much ice with ultra conservative fixed income market participants.<br /><br />And, as Nick Skrekas points out in the Wall Street Journal, the numbers simply don’t add up. Greece has to raise €84 billion to repay interest and principle over the next three years, even assuming the force of the economic contraction doesn't mean even more missed deficit targets . Add to that an additional €70 billion for each of 2014 and 2015 in repayment of EU-IMF loans, and the calculation equals an unavoidable default, which is what the markets are signalling with there 1,000 to the sky is the limit spread on Greek 10 year bonds over bunds.<br /><br />Even in the pre-crisis days, Greece couldn’t realistically raise more than about €50 billion a year from markets that trusted it. And market participants know the ‘troika’ is being unrealistic in its expectations. Lack of conviction in the bond markets that Greece can survive without a default is creating a vicious cycle that keeps prospective borrowing costs elevated and thus makes eventual repayment even more unlikely. And round and round and round and round we go.<br /><br />In this sense the troika’s earlier inflexibility over the repayment postponement issue has been entirely self-defeating. The delay in letting the markets know that extension was a possibility is rumored to have been in part due to the German government's worries about what the reaction inside Germany would be to the news. Evidently borrowers are going to be able to kick the can a lot harder and a lot further down the road than previously imagined. Indeed only today Ireland is seemingly to get money over a nine year term, which makes it hard to see how exactly the European Financial Stability Facility can be wound up in 2013 as previously planned - indeed the way things are shaping up it looks like 2013 could be the year when it really gets going.<br /><br />Which, as John Dizzard notes in the Financial Times, would seem to create a new potential moral hazard problem, which is that if the funds in the pot are going to be limited, and if potential costs going forward are likely to be high, then we could see a rush to get in (before the funds are all used) with few in any hurry at all to leave. Giving Spain the prospect of 350 billion euros (or thereabouts) over seven and a half years mights seem very tempting, but it is unlikely that those in Rome would be happy to pay rather than join the queue standing next to the soup pot.<br /><br />So, what this all boils down to is, that along with the EU and IMF we can be in no doubt: the reform programme evidently is on track. The only issue which seems to divide everyone - and especially those office-bound Fund employees from their more financially savvy market-participant peers - concerns the exact name of the station towards which the train in question is heading.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-46100576609662333222010-10-16T13:54:00.000-07:002010-10-16T14:06:07.473-07:00An Unusual But Interesting Argument Which May Help To Understand Why QE2 Is Now Almost InevitableFor reasons which aren't worth going into now, I'm reading through a recent report by Deutsche Bank Global Markets Research entitled "From The Golden To The Grey Age" this afternoon. The report (all 100 pages of it, many thanks to researchers Jim Reid and Nick Burns who produced the thing) looks at the extent to which a variety of macro indicators - like GDP growth, inflation rate, equity yields, etc - may have been influenced by demographic forces over the last 100 years or so. It is certainly one of the most systematic reports of its kind I have seen, and well worth losing a Saturday afternoon to read.<br /><br />But in the middle, there is an argument which caught my eye, and I thought it worth reproducing. Basically the starting point is this chart, which if you haven't seen by now (or something like it) I'm not sure where exactly you've been during the last 2 or 3 years.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzzzFKZha3BWXr7_9cWrCOuKKDmBLfUlagE61WC5-64JqeZ2XBmg3pYoPIIjM5z3rXBlsRJCBs-uc0dEI8OjDw6T5px5HBLlQutYheg5A9bNEB26eleJ_JNO0xm0X092bhyeJ27JxzpSCn/s1600/US+Debt+To+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzzzFKZha3BWXr7_9cWrCOuKKDmBLfUlagE61WC5-64JqeZ2XBmg3pYoPIIjM5z3rXBlsRJCBs-uc0dEI8OjDw6T5px5HBLlQutYheg5A9bNEB26eleJ_JNO0xm0X092bhyeJ27JxzpSCn/s400/US+Debt+To+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5528677402697495202" border="0" /></a><br /><br />Obviously, just the most cursory of glances at the thing should lead even the most untrained of eyes to get the point that what is going on around us is not some passing phenomenon, and that there are deep structural factors at work.<br /><br />As our Deutsche Bank researchers put it:<br /><blockquote>As can be seen (from the above chart) there was a step change in the US economy’s indebtedness from the early 1980s onwards and then an additional one in the late 1990s/early 2000s. A similar picture is apparent across most of the Western World.<br /><br />Basically from the early 1980s to the onset of the Global Financial Crisis the economy added on more debt every year and business cycles were extended as a result. Indeed the Fed and Central Banks around the world were afforded the luxury of operating in a secular falling inflation regime (globalisation) that allowed them to cut rates, further allowing the accumulation of debt, every time the economy may have naturally been rolling over into a normal recession consistent with those seen through history. This debt accumulation undoubtedly helped smooth the business cycle and contributed to the period being known as the ‘Great Moderation’. This period came to a spectacular end with the onset of the crisis and it is possible that going forward we will revert to seeing business/credit cycles more like they were prior to the ‘Great Moderation’.</blockquote><br />Now here comes the clever part. Our researchers then go on to take a look at the the average and median length of the 33 business cycles the US economy has seen since 1854. For the overall period they found the average cycle from peak to peak (or trough to trough) lasted 56 months (or 4.7 years). However, the averages are boosted by an occasional elongated "superbusiness cycle", and thus the median length is a much smaller 44 months (3.7 years). As they comment, such numbers must look very strange to those who have only ever analysed business cycles over the last 25-30 years. Within these 33 cycles the contraction period lasted 18 months on average or 14 months in terms of median length. This equated to the economy being in recession 31% or 32% of the time depending on whether you look at the averages or the median numbers. Taking just the period before the “Great Moderation” the average US cycle lasted 5 months less at 51 months (or 4.3 years) with the median at 42 months (3.5 years). Over this period the US economy was in recession 35% and 36% of the time respectively depending on whether you look at averages or the median.<br /><br />Now we used to think that all of that was behind us, but then we used to think that the "Great Moderation" had gotten things under control, and not simply temporarily extended the cycle length by facilitating long-term-unsustainable levels of indebtedness. So in fact, given that, as they say some sort of cycle or other has been with us since at least biblical time, what we might now expect are more "normal" cycles (in historical terms), which put a little better means shorter ones with more frequent recessions.<br /><blockquote><br />"Given all we know about the ‘debt supercycle’, it is likely that the onset of the Global Financial Crisis ended the “Great Moderation” period. Unless we find a way of continually adding more debt at an aggregate level in the Developed World it is likely that we will see much more macro volatility and more frequent business cycles going forward. Given the fact that Developed World Government balance sheets are under pressure, and given that interest rates around the Western World are close to zero, the post-crisis ability to fine tune the business cycle is extremely limited. We may need to put an immense amount of faith in the experimental force of Quantitative Easing to deliver economic stability. This will be an experiment with little empirical evidence as to how it will turn out. For now the base case must be that we revert more towards business cycles more consistent with the long-term historical data".</blockquote><br /><br />So then our authors do their calculations concerning the average length of US cycles since 1854 in order to make a rough estimate of when the next few US downturns will start, as illustrated in the following chart.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXygBZ9qb_5PG9M0rehHSdlv1X9WoTviaCIe65m-EC4ZWnuWCXYQjq35ixEkpklXsKA8cpq4OSj4_DOdMcxa7DQdNhwJLJNzUZiuN6-tL2PBNKxv3YW12uTzK3ODvTcaCx7OoA3mEk9syX/s1600/US+Recession+Estimates.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 126px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXygBZ9qb_5PG9M0rehHSdlv1X9WoTviaCIe65m-EC4ZWnuWCXYQjq35ixEkpklXsKA8cpq4OSj4_DOdMcxa7DQdNhwJLJNzUZiuN6-tL2PBNKxv3YW12uTzK3ODvTcaCx7OoA3mEk9syX/s400/US+Recession+Estimates.png" alt="" id="BLOGGER_PHOTO_ID_5528682403043621618" border="0" /></a><br /><br />Now, without dwelling on the gory details, if we look at the spread between the upside, median, and downside cases, we could pretty rapidly come to the conclusion that the next US recession has a high probability of starting sometime between next summer, and the summer of 2012 - which, as you will appreciate, isn't that far away. I am also pretty damn sure that Ben Bernanke and his colleagues over at the Federal Reserve appreciate this point only too well, and hence their imminent decision on more easing, since a recession hitting the US anytime from next summer will really come like a jug of very icy water on that very fragile US labour market, not to mention the ugly way in which it might interact with the US political cycle.<br /><br />I think the mistake many analysts are making at this point is basing themselves on some sort of assumption like, "if the recession was deep and long, then surely the recovery should be just as pronounced and equally long", but, as the DeutscheBank authors bring to our attention, business cycles just don't work like that.<br /><br />Now, why I think this is an interesting argument is that the starting point for looking at the recovery is rather different from the norm, in that instead of peering assiduously at the latest leading indicator reading, they do a structural thought experiment, and work backwards from the result. Now, one thing I'm sure Ben Bernanke isn't is stupid, so it does just occur to me that either he, or someone on is team, is well able to carry out a similar kind of reasoning process.<br /><br /><br /><span style="font-weight: bold;">Watch Out, Here Comes The QE2</span><br /><br />In fact, it would be an understatement to say that the forthcoming QE2 launch is causing a great deal of excitement in the financial markets. As the news reverberates around the world, it seems more like people are getting themselves ready for some kind of "second coming". Right in the front line of course are the Europeans and the Japanese, and the yen hit yet another 15 year high (this time of 81.11 to the dollar) during the week, while the euro was up at 1.4122 at one point. Greeks, where are you! Can't you engineer another crisis? We need help from someone or we will all capsize in the backwash created by this great ocean liner as it passes.<br /><br />But joking aside, a weaker USD is going to be both the natural and the intended consequence of the coming bout of additional QE by the Fed, and it will have a strong collateral effect on the already weaked and export dependent economies of the EuroArea and Japan.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiclp48hKzUu8_EcwTS74TFjXcOQLReCRCwMpbXLDr2MF1thLI2WjOPomfyNLGaebFWuhEB0NjE5Jp31hQY5duSs9O4KKtDD_xG8ase5pWR-eTdI8POJlxVRcijXtg08AK2F0vqBeFw9VCv/s1600/Weak+USD.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 197px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiclp48hKzUu8_EcwTS74TFjXcOQLReCRCwMpbXLDr2MF1thLI2WjOPomfyNLGaebFWuhEB0NjE5Jp31hQY5duSs9O4KKtDD_xG8ase5pWR-eTdI8POJlxVRcijXtg08AK2F0vqBeFw9VCv/s400/Weak+USD.png" alt="" id="BLOGGER_PHOTO_ID_5528688392067775666" border="0" /></a><br /><br />With this prospect as the background, it should not come as a surprise that talk of currency wars and competitive devaluations is rising by the day. Japan only last week threatened "resolute action" against China and South Korea, Thailand has placed a 15% tax on bond purchases by non resident investors, and central banks from Brazil to India are either intervening to try and keep their currency from rising too fast, or threatening to do so.<br /><br />And the seriousness of the situation should not be underestimated. Many have expressed disappointment that the recent IMF meeting couldn't reach agreement, and hope the forthcoming G20 can do so. But really what kind of agreement can there be at this point, if the real problem is the existence of the ongoing imbalances, and the inability or unwillingness of the Japan's, Germany's and China's of this world to run deficits to add some demand to the global pool. Push to shove time has come, I fear, and if this reading is right then it is no exaggeration to say that a protracted and rigourously implemented round of QE2 in the United States could put so much pressure on the euro that the common currency would be put in danger of shattering under the pressure. Japan is already heading back into recession, as the yen is pushed to ever higher levels, and Germany, where the economy has been slowing since its June high, could easily follow Japan into recession as the fourth quarter advances.<br /><br />Indeed, I think we can begin to discern the initial impact of the QE2 induced surge in the value of the euro in the August goods trade data. The EuroArea 16 have been running a small external trade surplus in recent months, and to some extent the surplus has bolstered the region's growth. It is this surplus that is now threatened by the arrival of the QE2. The first flashing red light should have been the news that German exports were down for the second month running in August, but now we learn from Eurostat that the Euro Area ran a trade deficit during the month.<br /><br /><blockquote>"The first estimate for the euro area1 (EA16) trade balance with the rest of the world in August 2010 gave a 4.3 bn euro deficit, compared with -2.8 bn in August 2009. The July 20102 balance was +6.2 bn, compared with +11.9 bn in July 2009. In August 2010 compared with July 2010, seasonally adjusted exports rose by 1.0% and imports by 1.8%".</blockquote><br /><br />Basically the eurozone countries had been managing to run a timid trade surplus (see chart below, which is a three month moving average to try and iron out some of the seasonal fluctuation) and this had been underpinning growth to some extent. Now this surplus is disappearing, and with it, in all probability, the growth. Maybe we won't get a fully fledged "double dip" in the short term, but surely we will see a renewed recession (and deepening pain) on the periphery and at the very least a marked slowdown in the core.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSf9Nv6KIhMqO5MjoSgiWqAB4L1VhXASVgpblMGgEgr7sM0JAu4B1SJqwtT2HMULU8ZmzLOTRMVbb3kldvZXPZi0oEl1sXhjGta-MDVCAJPRuQ0r5jZ0MlwcVtIMxHgQm_H7eL8_qxC2F1/s1600/EuroArea+Trade+Balance.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSf9Nv6KIhMqO5MjoSgiWqAB4L1VhXASVgpblMGgEgr7sM0JAu4B1SJqwtT2HMULU8ZmzLOTRMVbb3kldvZXPZi0oEl1sXhjGta-MDVCAJPRuQ0r5jZ0MlwcVtIMxHgQm_H7eL8_qxC2F1/s400/EuroArea+Trade+Balance.png" alt="" id="BLOGGER_PHOTO_ID_5528690838317438802" border="0" /></a><br /><br />In fact the current situation is extraordinarily preoccupying. We are now in the fourth year of the present crisis (however you choose to term it, the second great depression, the very long recession, or whatever) and there seems to be no sustainable solution in sight. The underlying problems which gave birth to the crisis are excessive debt (both private and public) and large global imbalances between lender and borrower countries, and neither of these issues has so far been resolved, nor are there proposals on the table which look capable of resolving them.<br /><br />And unemployment in the United States (which is currently at 9.6%, and may reach 10% by the end of the year) is causing enormous problems for the Obama administration. The US labour market and welfare system are simply not designed to run with these levels of unemployment for any length of time. In Japan the unemployment rate is 5.1%, and in Germany it is under 8%. So people in Washington, not unreasonably ask themselves why the US should shoulder so much extra unemployment and run a current account deficit just to maintain the Bretton Woods system and the reserve currency status of the US Dollar.<br /><br />My feeling is that the US administration have decided to reduce the unemployment rate, and close the current account deficit, and that the only way to achieve this is to force the value of the dollar down. That way it will be US factories rather than German or Japanese ones that are humming to the sound of the new orders which come in from all that flourishing emerging market demand.<br /><br />I think it is as simple and as difficult as that.<br /><br />The problems created by the way the crisis has been addressed now exist on a number of levels. In emerging economies like Brazil, India, Turkey and Thailand, ultra low interest rates in the developed world are creating large inward fund flows which are making the implementation of domestic monetary policy extremely difficult, and creating sizeable distortions in their economies.<br /><br />At the same time, a number of developed economies like Spain, the United States, the United Kingdom became completely distorted during the years preceding the crisis. Their private sectors got heavily into debt, their industrial sectors became too small, and basically the only sustainable way out for them is to run current account surpluses to burn down some of the accumulated external debt. Traditionally the solution to this kind of problem would be to induce a devaluation in the respective currencies to restore competitiveness, but in the midst of an effectively global crisis doing this is very difficult, and only serves to produce all sorts of tensions. As Krugman once said, "to which planet are we all going to export".<br /><br />At the same time, two of the world's largest economies - Germany and Japan - have very old populations, which effectively means (to cut a long story short) they suffer from weak domestic demand, and need (need, not feel like) to generate significant export surpluses to get GDP growth and meet their commitments to their elderly population. The very existence of these surpluses also produces tensions, and demands for them to be reduced. But this is just not possible for them, and Japan is the clearest case. For several years Japan benefited from having near zero interest rates and becoming the centre of the so-called global "carry trade", which drove down the currency to puzzling low levels, and made exporting much easier. Large Japanese companies were even expanding domestic production and building new factories in Japan during this period (a development <a href="http://japanjapan.blogspot.com/2007/06/toyota-and-honda-increasing-factory.html">which had Brad Setser scratching his head at the time</a>, trying to work out how the yen could have become so cheap).<br /><br />Then the crisis broke out, the Federal Reserve took interest rates near to zero, and the United States became the centre of the carry trade. The result is that every time the Fed threatens to do more Quantitative Easing the yen hits new 15 year highs, even while the dollar continues its decline, with the result that Toyota are having a change of heart, and are now <a href="http://www.reuters.com/article/idUSTOE69F00420101016">thinking of closing a plant in Japan to move it to Mexico</a>. The present situation is just not sustainable for Japan, which is basically being driven back into what could turn out to be quite a deep recession.<br /><br /><br />Unfortunately I think there is no obvious and simple solution to these problems. As we saw in the 1930s, once you fall into a debt trap, it can take quite a long time to come out again. You need sustained GDP growth and moderate inflation to reduce the burden of the debt, and at the present time in the developed world we are likely to get neither. In the longer term, the only way to handle the presence of some large economies which structurally need surpluses is to find others who are capable of running deficits, but this is a complex problem, since as we have seen in the US case, if the deficit is too large, and runs for too long, the end result is very undesireable. Basically the key has to lie in reducing the wealth imbalance which exists between the developed and the developing world, but this is likely to prove to be a rather painful adjustment process for citizens in the planet's richer countries, so policy makers are somewhat relectuntant to accept its inevitability.<br /><br /><br />Basically, the structural difficulty we face is that all four major currencies need to lose value - the yen, the US dollar, the pound sterling and the euro - and of course this basically is impossible without a major restructuring of what has become known as Bretton Woods II. The currencies which need to rise are basically the yuan, the rupee, the real, the Turkish lira etc. But any such collective revaluation to be sustainable will need to be tied to a major expansion in the productive capacity of the economies which lie behind those currencies.<br /><br /><br />In fact, the failure to find solutions is increasingly leading to calls for protectionism and protectionist measures. The steady disintegration of consensus into what some are calling a "currency war" is, as I said above, another sign of this pressure. On one level, the move to protectionism would be the worst of all worlds, so I really hope we will not see this, but if collective solutions are not found, then I think we need to understand that national politicians will come under unabating pressure from their citizens to take just these kind of measures. The likely consequence of them succumbing to this pressure, which I hope we will avoid, would be another deep recession, possibly significantly deeper than the one we have just experienced. And, not least of the worries, the future of the euro is in the balance at the present time.<br /><br />The structural imbalances which we see at the global level, between say China and the United States, also exist inside the eurozone, between Germany and the economies on the periphery (Ireland, Portugal, Spain, Italy, Greece). These latter countries failed to take advantage of the opportunities offered by the common currency to carry out the kinds of structural reform needed to raise their long run growth potential, and instead they simply used to cheap money available to get themselves hopelessly in debt. At the same time the crisis has revealed significant weaknesses in the institutional structures which lie behind the monetary union, weaknesses which go way beyond the ability of some members to fail to play by the rules when it comes to their fiscal deficits. Steps are now being taken in a night-and-day non-stop effort to try to put the necessary mechanisms in place, but it is a race against the clock, and it is not at all guaranteed that the attempt will be succesful, especially if the volume of liquidity about to hit the global financial system drives the euro onwards and upwards beyond supportable limits.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-84824653969930375952010-09-27T03:16:00.000-07:002010-09-27T22:41:59.250-07:00And Then There Were NoneAccording to Spanish Prime Minister José Luis Rodríguez Zapatero <a href="http://online.wsj.com/article/SB10001424052748704129204575506182829904198.html">speaking in an interview with the Wall Street Journal last Tuesday</a> the European sovereign debt crisis is over. "I believe that the debt crisis affecting Spain, and the euro zone in general, has passed," Mr. Zapatero said.<br /><br />This is excellent news, but it comes with just one proviso, and that is that despite all such reassurances most financial market participants seem to be far from convinced that he is right. True Spain recently raised nearly €4bn in a successful government bond sale, with <a href="http://www.reuters.com/article/idUSLDE68F11Q20100916">some observers suggesting</a> the sale constituted but one more sign that what is still the eurozone’s fourth-largest economy had finally broken free from the group of “peripheral” European economies who have severe economic problems and whose debt is viewed by investors as especially risky.<br /><br />In fact Spain managed to sell €2.7bn of 10-year bonds and almost €1.3bn of 30-year bonds while at the same time bringing yields down noticeably from their earlier highs - to 4.144 percent in the case of the 10-year issue ( from 4.864 percent in June), and to 5.077 percent for the 30 year issue (from 5.908 percent in June). But, at the same time, in the background the extra yield that investors demand to hold Spanish 10-year bonds over German bunds has been steadily creeping back up again, and as of last Friday (24 September) it stood at 183 basis points, below the 220 level being asked in June but still more than double what it was at this point last year.<br /><br />Yet, despite all those nice words we hear from him, one of the things that is worrying investors right now is the real depth of Mr Zapatero’s commitment to reducing the deficit as planned, especially after he <a href="http://spaineconomy.blogspot.com/2010/08/how-many-times-can-one-driver-fall.html">unexpectedly stated on August 10 that in his opinion some of the planned infrastructure spending cuts could be reversed</a>, while on September 10 he reiterated the point, saying that lower borrowing costs may enable the government to "ease up" on some of the projected spending cuts. In fact the extra yield offered on Spanish debt has risen 33 basis points over the period since he started to mention the possibility.<br /><br />On top of which <a href="http://spaineconomy.blogspot.com/2010/09/spains-economy-enters-contraction-mode.html">all the short term indicators we have been seeing</a> suggest that the Spanish economy started to contract again in the third quarter.<br /><br /><strong>Spreads Rising Across The Periphery</strong><br /><br />Of course it isn't only Spanish bond yields which have been sneaking back up of late. Greek 10-year bonds as compared with equivalent German bunds still offer around 950 basis points (or 9.5 percent) of additional yield, only around 20 points below the all time record they hit on May 7, at the height of the Sovereign Debt Crisis<br /><br />Indeed spreads on government bonds all along Europe's periphery have been rising steadily back towards (and even in some cases beyond) their May levels in recent weeks. Most notably the last week has seen both the Irish and Portuguese government 10-year bond yields surge to euro era records levels, in a way which could lead us to ask whether, rather than Spain snuggling back into the main group the big picture story at this point might not be that it is Irish and Portuguese sovereign debt that is being prised apart from the rest.<br /><br />So rather than being over, what the debt crisis now may be entering is a new stage, where one sovereign bond after another is being chisled out and sent off to join their Greek counterpart in the isolation ward. Actually, in this sense the present European Sovereign Debt situation does rather resemble the plot of the well known Agatha Christie detective novel "<a href="http://en.wikipedia.org/wiki/And_Then_There_Were_None">And Then There Were None</a>". As told by M. Christie a group of ten people, all of whom have in one way or another been previously complicit in an earlier death, are somehow tricked into travelling together for what was intended to be a short stay on a secluded island. Once there, and even though the guests are apparently the only people on the island, they are - somehow, and one after another - systematically murdered. So, in a way which may eventually come to foreshadow scenes from the forthcoming meetings of the European Financial Stability Facility management board, each morning one guest less shows up for breakfast. One by one, and little by little, each participant becomes mysteriously overcome by a seemingly inexplicable bout of some fatal variant of what could be termed "systemic instability syndrome".<br /><br />As I say, Irish and Portuguese yield spreads are significantly wider than they were May 7, the last trading day before Greece finally agreed to go for their €110 billion bailout package and the European Central Bank announced the initiation of its ongoing program of purchasing EuroArea government bonds in the secondary markets.<br /><br />And despite holding what was considered to be a "succesful" bond auction at the start of last week Irish 10-year bond yields, shot up`once more during the remainder of the week, hitting a new record high of 6.34 per cent (see Bloomberg chart below), while yield spreads over benchmark 10 year German Bunds spiked to 416bp, euro era another record. At the same time Ireland 5 year CDS shot up to 461 bps, which meant the cost of insuring Irish debt was $461,000 for $10m of debt annually over five years.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiok0BttZqw7rJPweq54MWSXSJMEZpsEeAt4zpZnwSytjVrz5X5D-J3u26qiIrETOVoy0LuUkT28WuyElwEcMr7vh00YmaUrGoy72EY1wfaVSppnMPnwfqNTcTN1PCgLqta73TPgOh0rmH/s1600/Ireland+10+yr+bond+yield..png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 285px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiok0BttZqw7rJPweq54MWSXSJMEZpsEeAt4zpZnwSytjVrz5X5D-J3u26qiIrETOVoy0LuUkT28WuyElwEcMr7vh00YmaUrGoy72EY1wfaVSppnMPnwfqNTcTN1PCgLqta73TPgOh0rmH/s400/Ireland+10+yr+bond+yield..png" alt="" id="BLOGGER_PHOTO_ID_5521252317757702562" border="0" /></a><br /><br />At the same time yields on Portuguese 10-year bonds over comparable German bonds hit a record of near 4.25 percentage points Friday, while the Portuguese debt agency paid a euro era record of 6.24 percent to holders of its 10-year bonds and 4.69 per cent to holders of the four year-bonds in its own bond auction this week. In last equivalent auction, Portugal had paid 5.32 percent on 10-year bonds and 3.62 percent on four-year bonds. Portugal’s budget gap widened in the first eight months of the year, indicating the government may struggle to rein in the euro-region’s fourth-largest deficit as its borrowing costs surged to a record.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR3uXoJkKalTGakGLn8hB1AQoFWWsDGbdlFwbKiPY4HvX40JqBjpuIQpyQeyXQcst9p9FwTaswu040kN2iizsZkdO5E_y6x2S5RGAwluciTsuj9Z_rzU_3vgWOLR9tXwULPzy1fwU6tDGu/s1600/Portugal+10+Year+Yields.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 285px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR3uXoJkKalTGakGLn8hB1AQoFWWsDGbdlFwbKiPY4HvX40JqBjpuIQpyQeyXQcst9p9FwTaswu040kN2iizsZkdO5E_y6x2S5RGAwluciTsuj9Z_rzU_3vgWOLR9tXwULPzy1fwU6tDGu/s400/Portugal+10+Year+Yields.png" alt="" id="BLOGGER_PHOTO_ID_5521252423861155058" border="0" /></a><br /><br /><strong>Portugal and Ireland "Decoupling"?</strong><br /><br /><br />In each case the issue is different, since in the Irish case it was a sharp and unexpected contraction in the economy which became the major concern while in Portugal's case it was an apparent inability to reach the political agreement necessary to get the budget deficit under control.<br /><br />Data out during the week for second-quarter gross domestic product showed the Irish economy has never really left recession, since GDP contracted by 1.2% compared to the first three months of the year, following a downwardly revised 2.2% expansion in the first quarter. Irish GDP has now contracted on a quarterly basis for 9 out of the past 10 quarters, and there is no evident end in sight.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDXJ7EUtu0TiHDc387MAN1XuPBADlQirdeQFiY9QZQ2C4fn0gLNZGX7AXQMr1OQVn3vz_yGzpi8tK_rxH0ZZ_yCdwoFTxkjBC0QuwzAMLp7saovXJ51IKB43KlF4TRwAYKqxmS9G0Ng3K8/s1600/Ireland+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 208px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDXJ7EUtu0TiHDc387MAN1XuPBADlQirdeQFiY9QZQ2C4fn0gLNZGX7AXQMr1OQVn3vz_yGzpi8tK_rxH0ZZ_yCdwoFTxkjBC0QuwzAMLp7saovXJ51IKB43KlF4TRwAYKqxmS9G0Ng3K8/s400/Ireland+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5521257372882034962" border="0" /></a><br /><br />In addition Ireland’s central bank governor Patrick Honohan saw fit to give a rather ill-timed press conference (unless he objective really was to force the country's government into the arms of the EFSF) where he urged the government to implement even deeper fiscal cuts to restore balance to the budget in what seems at this point to be a virtually unrealisable bid to regain investor confidence. All of which left many observers wondering just what the country can do in the present situation, since the budget is evidently deteriorating due to the severity of the economic contraction, and further cuts in spending by anyone (households, companies, government) are only likely to feed the contraction even more, in their turn making even more cuts necessary. <br /><br />Obviously Ireland is rapidly approaching a situation where it cannot move the situation forward based on its own resources. This feeling is only added to by the persistent rumours that subordinated bond holders to Anglo Irish bank may well not get re-imbursed in full. These rumours have found some confirmation in a report which appeared in the Irish Examiner suggesting that the Irish Finance Minister Brian Lenihan had given a strong hint that the riskiest lenders to nationalized Anglo Irish Bank may not get all their money back. <br /><br />Mr Lenihan apparently explained to the paper that the bank guarantee program which will be extended once it runs out at the end of September may only cover deposits and not subordinated debt. <a href="http://www.ft.com/cms/s/0/7189814a-bd04-11df-954b-00144feab49a.html">And if the interpretation put on events by the FTs John Dizard's is correct</a> Mr Lenihan's delay in clarifying the situation is due to the fact that the Irish government is awaiting an EU Commission ruling on exactly this issue. His most recent official statement on the topic was that the Aglo Irish wind-up plan “is being prepared for submission to the [European] Commission for approval”. <br /><br />At the same time the EU’s Competition Commissioner, Joaquin Almunia, issued a statement that “a number of important aspects need to be clarified, and a new notification received, before the Commission is in a position to finalise its assessment and to take a decision”. Which Dizard interprets as meaning that while Anglo Irish might propose a buy-back of its subordinated bonds, and that buy-back might be included in an Irish government proposal, Brussels might, in the end, not approve the plan. Since this would effectively the first time in the current crisis that a significant group of investors did not have their losses underwritten (apart, of course, from the rather unfortunate Lehman incident), decision makers may be rather apprehensive, since no one really knows how the financial markets would react. Yet speculation some such decision will be taken remains rife, as witnessed by <a href="http://www.guardian.co.uk/business/2010/sep/27/anglo-irish-downgrade">the decision by Moody's rating agency to downgrade Allied Irish ratings</a>. Moody's cut Anglo Irish's senior bonds by three notches to Baa3, the last level before junk, but the markets' main focus was on the deep, six-notch cut in the bank's subordinated debt, to Caa1, which indicates that bondholders will be forced to pay for some of the expected bailout.<br /><br /><strong>Deficit Worries In Portugal</strong><br /><br />In the Portuguese case it is the budget deficit issue which is unsettling the markets, with the spread widening sharply following the revelation that far from the deficit being reduced is was actually increasing. According to the latest data from the Finance Ministry the central government’s shortfall during the first eight months of the year rose to 9.19 billion euros from 8.74 billion euros over the equivalent period in 2009. Previously the 2010 deficit had been almost exactly tracking the 2009 one (see chart from Societe Generale below).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5J1mKv0_1x9ZgB__W6FEXqQn1Ea2ySYvFEpIBLEpESyTG52B2QEtIwRvuLz-DDr8TURWpEBH7cgERUP_m6jTuzUrpZOrUBkj0iBLfzfqvA71TElBJO6NaOEIn8kI0AAuCv07FEbGoR7VV/s1600/Portugal+Fiscal+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 264px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5J1mKv0_1x9ZgB__W6FEXqQn1Ea2ySYvFEpIBLEpESyTG52B2QEtIwRvuLz-DDr8TURWpEBH7cgERUP_m6jTuzUrpZOrUBkj0iBLfzfqvA71TElBJO6NaOEIn8kI0AAuCv07FEbGoR7VV/s400/Portugal+Fiscal+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5521252507026418018" border="0" /></a><br /><br />Portugal’s borrowing costs surged to record levels on the news, and while the spread subsequently eased back to 388 basis points, the level is still close to the zone in which Greek bonds were trading in April just before the EU offered the country emergency loans to avoid default (see Greek 10 year spread chart below).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcCyFsTLKzPtpWu-iFaBouIzVQiM2oKNWjju8odGyINa6a2Y4djT2i_JoEY1DgBAU5OTa5g9zB_Kv4z7d7kWtnwfCibLgamQlwuwtoSJMCi6gqcJ64xwXsEYY4C4-p4RGG3ccAZ2u7QLNV/s1600/Greek+10+year+bond+spread.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 306px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcCyFsTLKzPtpWu-iFaBouIzVQiM2oKNWjju8odGyINa6a2Y4djT2i_JoEY1DgBAU5OTa5g9zB_Kv4z7d7kWtnwfCibLgamQlwuwtoSJMCi6gqcJ64xwXsEYY4C4-p4RGG3ccAZ2u7QLNV/s400/Greek+10+year+bond+spread.png" alt="" id="BLOGGER_PHOTO_ID_5521473217655445570" border="0" /></a><br /><br /><br />What this means is that this year's overall public deficit could well come in at around 9 percent of gross domestic product unless there is a radical change in policy during the last few months of the year.<br /><br />According to its commitments to the EU Stability Programme, the Portuguese government should be aiming to reduce the overall deficit to 7.3 percent of GDP in 2010 from last year’s 9.3 percent. The government has pledged to reach the target, with Finance Minister Fernando Teixeira dos Santos saying that the country “can’t afford” not to, but so far there is little evidence that it will be able to do so, and especially with all the political bickering that is now going on in the background.<br /><br />In all these cases, including the Greek and Spanish ones, this issue is not simply one of stimulus versus austerity (always a false polarity when it comes to the situation on the Euro periphery). The real issue is how to restore growth to highly-indebted and structurally-distorted economies, since without growth the debt to GDP ratios will not come down, and the burden of the debt will not be reduced. <br /><br />So more borrowing is not what these countries need right now (other than to aid short term liquidity). What the countries involved all need is more exports and larger industrial sectors, and no one seems to be very clear how they are to achieve them. Simply running a double digit deficit to generate less that 1% (in the best of cases) GDP growth is not exactly a "wise" use of resources. Evidently using deficit spending to cushion programmes which would lead to a surge in exports would make sense, but in no case is this really being done, and all the emphasis is simply going on what may turn out to be a rather fruitless and self-defeating programme of achieving fiscal rectitude.<br /><br />The result is that the peripheral countries are one by one being steadily "decoupled", with Portugal and Ireland now moving up towards Greece, as the following two charts from Citi Research clearly show.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0Ov0yMRb-YJ_yrW6aSHrBHVWLGcMj9CC5KE7N6RbEDa2ulMjz8u8ktKiHUCA9tdVFn-zRBD3Gixq5lQe-QQXLG0boO7O7h4lyKvLPO5-krYPVQuNmqVFB7tCbg33FWeLiPJbmVWF5PONK/s1600/peripheral+spreads.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 281px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0Ov0yMRb-YJ_yrW6aSHrBHVWLGcMj9CC5KE7N6RbEDa2ulMjz8u8ktKiHUCA9tdVFn-zRBD3Gixq5lQe-QQXLG0boO7O7h4lyKvLPO5-krYPVQuNmqVFB7tCbg33FWeLiPJbmVWF5PONK/s400/peripheral+spreads.png" alt="" id="BLOGGER_PHOTO_ID_5521252954840031442" border="0" /></a><br /><br />For quite a long time the Irish and Portuguese spreads simply moved in harmony with the Greek ones, widening as the Greek spread surged upwards. But now it is Greek debt which can be adversly affected by sentiment over the situation in Ireland or Portugal, and not the other way round, and meanwhile the other two countries slowly but surely are moving on up there to join their Greek counterparts as the second of the two charts (which show the recent relative movements in Greek and Irish spreads) seems to demonstrate.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHs4b05X_T8_guEYv3MiaS9AVoIqvYVwSC94Zuv5ByptS3Ch57oE5MZeoXWZvJykmvCu6aKyuSORqsJalNUMma9YfGEpV842yx7GnKOzbkRDX3NXXuLYMj0ooz9YfdlJ5aw2raU_KR6lZ5/s1600/Ireland+and+Greece.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 318px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHs4b05X_T8_guEYv3MiaS9AVoIqvYVwSC94Zuv5ByptS3Ch57oE5MZeoXWZvJykmvCu6aKyuSORqsJalNUMma9YfGEpV842yx7GnKOzbkRDX3NXXuLYMj0ooz9YfdlJ5aw2raU_KR6lZ5/s400/Ireland+and+Greece.png" alt="" id="BLOGGER_PHOTO_ID_5521252813332773810" border="0" /></a><br /><br /><br /><strong>Vigourous Action Needed</strong><br /><br />Naturally the ongoing deterioration in the situation requires bold and far reaching action from the Commission and the ECB. Obviously we should expect to see renewed activity on the part of the ECB, buying an increasing number of eurozone periphery government bonds. Their activity on this front has been increasing of late, but weekly bond purchases are still well below 1 billion euros a week level seen at the height of the crisis in May and June. Evidently we will see calls for more of these purchases in the days and weeks to come, but what is striking at the present time is just how ineffective they have been in containing the damage.<br /><br />The ECB’s bond buying program is effectively the second pillar in the EU crisis containment mechanism established in May. The other one is the Luxembourg-based 440 billion-euro European Financial Stability Facility, headed by former European Commission official Klaus Regling. Mr Regling has also been actively campaigning to calm markets in recent days. "It would be preferable if we didn't even have to intervene," he told the German magazine Der Spiegel in an interview, "In fact, I believe that's the most likely scenario." His hope then is that the very existence of his organization will bring calm to investors and deter speculators. "If that's the case, we'll close up shop here on June 30, 2013," he said.<br /><br /><br />Morgan Stanley’s Chief Global Economist, Joachim Fels remains pretty unconvinced by all of this. “Strains,” he wrote in a recent research report, have now reached a point where "one or several governments" may soon have to resort to the rescue mechanism. "Neither the European sovereign debt crisis nor the banking sector crisis has been resolved and both continue to mutually reinforce each other," he said, adding that the EU's stress tests for banks had manifestly failed to restore the necessary confidence. Fels's conjecture didn't need that long to get some confirmation, since <a href="http://www.businessinsider.com/the-ecb-was-this-close-to-activating-emergency-crisis-mechanism-for-ireland-last-week-2010-9">according to the German newspaper Handelsblatt</a> the ECB was last week actively considering recommending that Ireland avail itself of the fund. The Central Bank declined to comment on the story, and <a href="http://www.moneycontrol.com/news/world-news/ecb-mulled-activating-rescue-aid-for-ireland-press_487239.html">simply pointed out </a>that any decision on the matter was a question for national governments, which is formally correct (and obvious) but doesn't mean that they wouldn't in fact have recommend such a move if asked. <br /><br />So, like former US Treasury Secretary Hank Paulson before them, Europe’s leaders, having armed their bazooka may soon need to fire it. Indeed Mr Regling’s optimism that his organization may quietly disappear from the scene is not generally shared by investors, who as we are seeing seem to be continuously pricing in an ever greater likelihood of intervention.<br /><br />Meantime, <a href="http://www.ft.com/cms/s/0/ff448198-c992-11df-b3d6-00144feab49a.html">according to a report in the Financial Times over the weekend</a>, Europe's leaders are once more at odds among themselves about just how much carrot and how much stick the various national governments need to get their economies back into line. Predictably it is Paris talking about carrots, and Berlin who is talking about sticks.<br /><br />But all this talk of what to do about those countries who in the future fail to stick to the new set of rules which are apparently being prepared monumentally misses the point: what we need are some policies which help the most affected economies get out of the mess they have found themselves in following the way the monetary and fiscal policy rules were implemented last time round.<br /><br />According to one popular analogy currently circulating , the EuroArea countries could be likened to a group of 16 Alpine climbers scaling the Matterhorn who find themselves tightly roped together in appalling weather conditions. One of the climbers - Greece – has lost his footing and slipped over the edge of a dangerous precipice. As things stand, the other 15 can easily take the strain of holding him dangling there, however uncomfortable it may be for them, but they cannot quite manage to pull their colleague back up again. So, as the day advances, others, wearied by all the effort required, start themselves to slide. First it is Ireland who moves closest to the edge, getting nearer and nearer to the abysss with each passing moment. And just behind Ireland comes Portugal, while some way further back Spain lies Spain, busily consoling itself that it is in no way as badly off as the others who have already lost there footing. But if Spain cannot hold out, and all four finally go over, each dragged down by the weight of those who preceded them, then this will leave some 12 countries supporting four, something that the May bailout package only anticipated as a worst-case scenario. In the event that this is finally what happens, Mr Reglin will certainly find that the quiet life has come to an end for him, and that he has plenty of work to do, as will Mr Trichet’s successor at the ECB. In the meantime all the rest of us can do is wait and hope, firm in the knowledge that having come this far, we can only go forward, since there is no easy way back down to the point from which we started. But for heavens sake, the only thing we don't need while we sit here biting our nails is to be told by someone who manifestly has no idea what he is talking about that the danger has already past, even as we slide, inch by inch, onwards and downwards towards the chasm that gapes beneath.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-29241024857551676392010-05-18T00:31:00.000-07:002010-05-18T00:36:15.187-07:00Much Ado About (Some Of) The Wrong ThingsGerman Finance Minister Wolfgang Schaeuble <a href="http://news.yahoo.com/s/ap/20100517/ap_on_bi_ge/eu_europe_financial_crisis;_ylt=AiSs.JwVNYh2UsC2ef3FOg2yBhIF;_ylu=X3oDMTJyc3RmMGgwBGFzc2V0A2FwLzIwMTAwNTE3L2V1X2V1cm9wZV9maW5hbmNpYWxfY3Jpc2lzBGNwb3MDMgRwb3MDNARzZWMDeW5fdG9wX3N0b3J5BHNsawNnZXJtYW55cHVzaGU-">told reporters in Brussels yesterday</a> (Monday) that getting their deficits down was "the only task that everyone has to fulfill for himself and for the common good." Meanwhile, over in New York, <a href="http://krugman.blogs.nytimes.com/2010/05/17/et-tu-wolfgang/">Paul Krugman was busy writing on his blog</a> that "the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue" - which is, according to Krugman, that "wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany". So at one extreme the Eurozone's problems are seen as being almost exclusively fiscal ones, while at the other the principal problem is thought to be one of restoring lost competitiveness. <br /><br />The difference in perceptions couldn't be clearer at this point, now could it?<br /><br />And if all of this is causing so much confusion among reasonably well informed economic observers, then what chance is the layperson likely to have? As it happens, reading through <a href="http://ftalphaville.ft.com/blog/2010/05/15/232281/el-erian-on-the-difficult-choices-still-facing-europe/">this piece by PIMCO's Mohamed El-Erian</a> this morning a number of thoughts started to come together in my head. Essentially what we have on our hands are a number of distinct (yet inter-related) problems, but few studies seem to go to the trouble to differentiate these analytically, and the end result is often a hotch-potch, which given the seriousness of the European situation is an outcome which is a long long way from being satisfactory.<br /><br />One point that is often not stressed hard enough and long enough is that the backdrop to this whole debt issue is the underlying problem of rapidly rising elderly-dependency ratios (and increasing population median ages) across the entire developed-economy world. Normally this implies the imminent arrival of a wave of heavily underaccounted-for-liabilities which will simply increase the pressure on the underlying structural (rather than cyclical) deficits in the worst affected economies. The strange thing is that this development had in principle been long foreseen, and indeed formed part of the underlying raison d'être for drawing the 3% deficit/60% debt Maastricht line-in-the-sand. The other part was, of course, an attempt to stop spendthrift governments being spendthrift. As is now abundantly clear, in neither case can the Maastricht package be said to have worked, but the unfortunate historical accident is that we have come to realise this in the midst of the worst global economic crisis in over half a century (indeed arguably the second worst one ever, and - disturbingly - it is still far from being over).<br /><br />So one part of the sovereign debt concerns which are currently so preoccupying the financial markets is associated with the containability of state debt in the context of ageing societies, and this issue is further complicated by the fact that different developed societies are ageing at different rates. This underlying uneveness is leading some people to draw some surprising conclusions. For example, <a href="http://www.ft.com/cms/s/0/8647e414-6106-11df-9bf0-00144feab49a.html">according to a Financial Times/Harris opinion poll published this morning</a>, the French turn out to be the most nervous of developed economy citizens when it comes to thinking about the sustainability of their country’s public finances. <br /><br />Some 53 per cent of those polled in France thought it was likely that their government would be unable to meet its financial commitments within 10 years, while only 27 per cent thought this outcome was unlikely. Americans were only slightly less worried, with 46 per cent saying default was likely, against 33 per cent who saw it as unlikely. Curiously, only a third of the British people polled thought a government default was likely in the next 10 years, and I say curiously since on many counts the UK economic position is far more critical than the French one is. In fact, I am inclined to think that the British here are being reasonably realistic, while the French and the Americans are not, and I say this for one simple reason: all these countries have had substantial immigration in recent years, while the fertility levels in each case are quite near population replacement level. And this means that their population pyramids are much more stable, and if what is worrying you is rising elderly dependency ratios, then this is important. Let's put it this way, if you assume (a big assumption I know) that underlying GDP growth rates are similar, and that the level of pension entitlement is the same, then the more rapidly the elderly dependency ratio rises the greater the pressure on deficits and accumulated debt.<br /><br />On the other hand, the Spanish respondents were remarkably more positive about their situation, with only about 35 per cent of Spaniards questioned saying they considered default to be a likely eventuality over the next decade. Which is strange, not because I have any special insight into whether or not Spain will default, but Spain's problems are clearly worse than any of the other three aforementioned countries (in part, as Krugman stresses because they lack some key economic policy tools which could help them correct the distortions in their economy) and, even more to the point, Spain's citizens are showing very little appetite at this point for making the changes which will be needed to stave off the worst case scenario. <br /><br />Without reform in the labour market, and in the health and pension systems, France's finances are just as capable as going careering off a cliff as anyone else's, but the French do have a little more time, and this, at the end of the day, could be critical. Also the French (like the Swedes) have done their homework in one department - the demographic one - so their population pyramid is inherently much more stable than the Spanish one. Indeed the Spanish government clearly indicated last week just how little they understand the importance of this question, since rather than facing up to the wrath of the Spanish pensioners (who of course vote) by cutting back on pension payments, they took the easy route (since babies don't vote, and those who never get to be born even less so) and slashed the so called "baby cheque" (which may well not be the best of pro natality policy tools, but still). Basically cutting the baby cheque instead of cutting back on pensions has to be the next best thing to slitting your own throat, just to see what happens. Societies need to invest in their future, not in their past, and having children is an investment, indeed in the age of the predominance of human capital it is one of the most important ones there is.<br /><br />Basically this whole area (of the impact of ageing populations on GDP growth performance and with this the consequent debt dynamics) remains largely underexplored by most mainstream analysts, but for now I will simply state that those "doctors" who wish to offer cures for our collective ills yet fail to mention the underlying dynamics of the demographic transition all our societies are passing through (even in a footnote) have missed one very important dimension of the overall picture, and their analyses and remedies are likely to be correspondingly deficient as a result. The musings of Mohamed El-Erian, interesting as they are, would fall into this category, since I fear he is missing the biggest part of the big picture. <br /><br />Secondly, there is the issue of the financial rescue which has been carried out during the crisis itself. Something strange seems to have happened to the discourse over the last three years, since a problem which originated in the financial sector has now metamorphised into a fiscal crisis for almost all modern democratic states. Indeed, such is the sense of panic being generated out there on this issue that I am already starting to see articles from investor circles asking whether or not democracy is compatible with fiscal rectitude. This is rather putting the cart before the horse, I feel.<br /><br />So having identified an underlying structural issue with government spending in the previous (demographic) argument, we should not fail to notice the fact that another significant part of rising state indebtedness comes from having recently bailed out a significant chunk of the private sector. Look at Latvia for example, and the Parex bank bailout, as the extreme case, since government debt to GDP was something like 12% before the crisis, while it is now heading up to near 80%, or Ireland, where debt was around 35% of GDP before the crisis but will probably rise above 70% this year. <br /><br />In fact, a rather weird circle has been created. The private sector (possibly as a result of the absence of adequate public vigilance) got itself into a huge mess of its own making. Governments all over the globe (understandably and correctly) rushed in to put the fire out, and in the process transferred the problem over to their own balance sheets. But what is most interesting to note about what happened next is how, given that the crisis itself means there are few positive investment outlets in the first world, the money generated by the bailouts is increasingly being used to encircle those very governments who initially made them. Basically a massive moral hazard conundrum has been created, as markets leverage a discourse which pressures governments for fiscal rectitude (which is contractionary - given the depth of the crisis - as far as aggregate demand is concerned), in the process creating the need for yet more bailouts, and so on (the possibility of ultimate Greek default being perhaps the clearest example here).<br /><br />Actually, while the initial "fire prevention" intervention was evidently necessary, people may have been mislead into thinking that action, in and of itself, would do the trick (<a href="http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/default.htm">see Bernanke's speech on Milton Friedman's 90th birthday</a> - with its this time we got it right theme - also see note at the foot of this post) due to a slightly faulty diagnosis of what happened during the great crash. There was, of course, a bank run: but this was by no means the whole picture, and in any event doesn't explain why the whole global economic system took so long to recover, even back then in the 1930s. <br /><br />So something decisive needs to be done to break the circle which currently binds us, although at this point I am not exactly sure what. If we could agree that Mohamed El-Erian's most striking insight is that: "Industrial countries are running out of balance sheets that can be levered safely in order to minimize the disruptive impact of past excesses. ... The balance sheets that are left -which reside essentially in central banks - are not made (and, I would argue, should not be forced) to assume permanent ownership of dubious assets." then the logic would seem to be that the dubious assets need to be put back where they belong - on the balance sheets of the private sector in general (including households) and the likes of AIG, Goldman Sachs, UBS, and naturally PIMCO.<br /><br />But we should be clear: any such move to do this would also be significantly growth "unfriendly" across the first world.<br /><br />And thirdly, and certainly not least importantly, as Paul Krugman is constantly pointing out, here in Europe we have an additional complicating factor: the euro experiment. Whatever the pros and cons of all the various arguments here, one thing seems evident: under the existing set-up the 16 economies are not converging. Exactly why this is would take us into areas which lie far beyond the objectives of this short post, but I would say that, personally, I feel the different demographic trajectories of the countries concerned must form part of the picture. As Angela Merkel is stressing, even in the best of cases (the euro holds) the bailouts which are being prepared can only buy time in which to carry out the much needed adjustments, which in countries like Spain/Portugal/Ireland are as much to do with restoring competitiveness to an extremely distorted private sector as they are to do with applying fiscal correction measures.<br /><br />As far as I can see, measures like collectively financing state debt via EU bonds and bilateral loans - plus operating some variant of Quantitative Easing at the ECB (if this can all credibly be made to stick, and the vicious circle meltdown mentioned in the second point be avoided) - could temporarily stabilise the patient while the much needed surgical intervention is carried out. But my guess is that one by-product of doing things this way would be that a lot of the toxic stuff would then work its way onto the ECB balance sheet. Thus, instead of recapitalising Spanish Cajas, what we would then be collectively into would be recapitalising the central bank, which would be just another form of fiscal sharing through the back door (with the result that, following a good Brussels tradition, what you can't explain to people directly and from centre stage, you explain to them in footnotes and in the small print). The latest data from the ECB (see <a href="http://ftalphaville.ft.com/blog/2010/05/17/233371/the-ecbs-e16-5bn-bond-buying-in-context/">this useful post from FT Alphaville</a>), suggest that the bank is not only busy buying peripheral bonds, it is also buying private paper from countries like Spain and Portugal (although there is no breakdown available on this point).<br /><br />The measures which need to be applied on Europe's periphery are all more or less obvious at the micro level - labour market reform, pension reform, reform of the public administration - but (and assuming we have at most three years to see all this though before the respective populations get very, very restless), on the macro economic side it is very doubtful such measures will have the impact which is expected for them in terms of restoring competitiveness and growth, and fiscal order can only be restored by restoring competitiveness and growth.<br /><br />Given this I can see only two plausible alternatives:<br /><br />a) Either the peripheral economies undertake a sizeable internal devaluation (say 20%, but this is just a rule of thumb estimate). The snag here is that at the present time most EU policymakers remain unconvinced that we need a shift of this magnitude. Yet there is surprisingly little detailed study of how the economies concerned are going to get back to growth without this price correction. Indeed the EU Commission itself has strongly pointed out that the rates of domestic private consumption growth being assumed for these economies by the respective national governments in their Stability Programme estimates are highly optimistic. What would be nice would be for someone to set up a small model to try to examine just how much ongoing growth in the combined goods and services trade surplus countries like Spain now need to achieve to get positive growth in headline GDP under a variety of different assumptions, including low or negative inflation, stagnant domestic consumption and reduced fiscal spending. <br /><br />This should enable people to calculate just how much of a drop in unit costs (from a combination of productivity growth and price adjustment) you need to have to get the kind of surplus you need given the relevant elasticities (etc). In particular one of the problems I see in basing too much hope on using productivity improvements to do the heavy lifting in the correction is that while you can surely get significant efficiencies at the micro level (though not by a long way enough to do the whole job), you can in fact only achieve the result in the short term by slowing a recovery in the labour market (since you will be going for more output with less people), which means aggregate productivity (say GDP per capita as a proxy) doesn't improve that much, given that there is a huge fiscal burden and continuing stress on the financial sector as a result of all those long term unemployed. Alternatively we have another possibility;<br /><br />b) Germany (and possibly one or two other smaller economies) temporarily leaves the eurozone and revalues.<br /><br />Now, since option (a) looks very, very difficult to implement (especially since virtually no one apart from people like me and Krugman apparently wants to even hear of it),to which problem we could add the fact that German politicians are having increasing difficulties convincing their citizens that the "qualitative transformation" of the ECB is what is really in their best interests, then on a purely pragmatic level (b) may well end up being what happens in the end (and we had better just hope any eventual German exit is only temporary).<br /><br />Having Germany temporarily separate from the Eurozone would, in fact, have a number of evident advantages. The first of these would be that citizens in the South would not need to see their wages slashed, while those in Germany would not be asked to pay for bailouts via their tax bill, or lead to blame Greeks or Spaniards for having their hospitals closed or their pensions reduced: ie it would all be politically much easier to handle at this point. <br /><br />Evidentally German banks would have to swallow a write-down, as loans paid back in Euros would not be worth the same in (new)marks, but 70% of something (say) is better than zero or 20%, and the big plus would be that as the Euro devalued sharply the peripheral economies could rapidly return to growth, and government finances could be quickly turned round as exports grew, tourists returned, and (in addition) many of those coastal properties that currently stand empty could be sold. At the end of the day, what would be left would be a private sector, and not a public sector, problem, and it was (in part) the private sector who got us all into this mess (wasn't it?).<br /><br />Indeed this solution does to some extent coincide with what could be termed the new economic reality, since economic growth in emerging markets mean that these are fast becoming key trading targets for German industry, as consumption in Southern and Eastern Europe looks to be increasingly "maxed out". In fact, according to the recent March trade report from the German Federal Statistics Office, the rate of interannual growth in exports to ex-EU "third" countries (34.7%, as compared with 15.1% for the euro area) was significant, while the volume of trade (34.2 billion euros as opposed to 35.2 billion euros for the Euro Area) is roughly comparable, and indeed at this rate countries outside the EU will soon replace the Eurozone group as destinations for German exports.<br /><br />I say I hope this move (if undertaken) would be temporary, since I think in the mid term the German economy is neither so strong, nor the peripheral countries so weak, as many commentators assume. But being out of the zone would give the Germans the opportunity to see this for themselves. <br /><br />The important point to emphasise, I feel, is what we now need is an orderly and credible solution to our problems. Simply standing back and watching things deteriorate, and keeping our fingers crossed that what won't work will, is not going to produce an orderly outcome. Au contraire! Even those precious exports we are winning as a result of the falling Euro are being put in doubt, try these headlines from Bloomberg: <a href="http://www.bloomberg.com/apps/news?pid=20601083&sid=a.KrzDuK604o">Mexico’s Peso Falls Third Day on European Fiscal Deficits</a>, <a href="http://www.bloomberg.com/apps/news?pid=20601083&sid=aM7RZ3B2Y_No">Yuan Appreciation Unlikely This Year Due to Europe Debt Crisis</a>, <a href="http://www.bloomberg.com/apps/news?pid=20601013&sid=aZb9ClY7dNIM">Emerging-Market Stocks Drop Most in Six Days</a>, <a href="http://www.bloomberg.com/apps/news?pid=20601013&sid=a.gDJRrrtLkU">Russian Stocks Slide Most in Week on Oil, Europe Debt Concern</a>. And this is just a quick selection. <br /><br />The problem is that any gain to exports outside the EU can be offset by falling risk sentiment as the currency slide continues, and markets which were previously being funded lose the ability to attract money. What we need are some serious measures which can turn the tide, and restore confidence that we are applying measures which will work.<br /><br />Actually, the argument I am presenting here was first put to me by a young Barcelona IT engineer - David González - and you can <a href="http://www.spamfinanciero.com/2010/04/carta-abierta-los-lideres-europeos.html">find his argument in this blog post</a> (below the Spanish introduction). As David says:<br /><br /><blockquote>In conclusion, at the moment the EMU lacks the necessary economic long term policies to become a stable monetary zone. Obviously, we lack the free currency exchange rate needed in any free trade zone, which would work as an automatic stabilizer between different countries. But we also don’t have enough automatic stabilizers (only the exception of cohesion funds) needed in any monetary zone. First we need to recover the balance, and then we have to make sure it is a stable balance implementing measures that keep it. Otherwise the EU construction process will fail, and the hopes it has bring to so many people and countries will be forgotten. The implications this failure would have for democracy and peace in Europe should not be underestimated. </blockquote><br /><br /><br />Or as Krugman puts it: "If the euro isn’t workable without highly flexible nominal wages, well, it isn’t workable". It's a sad conclusion, but that would seem to be where we are at this point. Basically, it is obvious that any road forward is now fraught with difficulty, but a situation where none other than <a href="http://www.nydailynews.com/money/2010/05/14/2010-05-14_deutsche_bank_ceo_josef_ackerman_seriously_doubts_greeces_ablity_to_repay_its_de.html">the head of Deutsche Bank is saying that in all probability Greece will not be able to pay</a>, and where an <a href="http://www.bloomberg.com/apps/news?pid=20601085&sid=anhdsVLozruI">ECB which badly needs to operate a policy of Quantitative Easing but is at desperate pains to try to show that it isn't</a>, is evidently not sustainable for long. Money has been put on offer, and the financial markets are now chafing at the bit to try to force it up and onto the table as quickly as possible. July promises to be another sweltering month here in Spain. Maybe it's time for a rethink.<br /><br />*****************************************************************<br /> <br /><br /><strong>Note</strong>: At the end of his "<a href="http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/default.htm">On Milton Friedman's Ninetieth Birthday</a>" speech Ben Bernanke arrived at what now looks like a rather hasty conclusion: - "Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again". In fact, what is at issue here is a question of causality, whether the real economy problems are ultimately caused by the absence of a "stable monetary background", or whether in fact, the demand shock unleashed by the unwinding of a highly leveraged economic boom may not be the main factor in preventing the recovery of a "stable monetary background", as we have already seen in the Japanese case. The critical question facing all developed economies in addressing their fiscal sustainability problems is where the aggregate demand is going to come from to make the adjustment both viable and socially palatable.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-12582280978159575912010-05-02T02:40:00.000-07:002010-05-02T02:42:12.899-07:00What A Difference A Day Made!According to a once famous statement by the British Prime Minister Harold Wilson, a week is often a long time in politics. But when it comes to financial market crises we seem to follow a pattern more reminiscent of a line from the Dinah Washington version of an old María Méndez Grever song: "What a difference a day made". The day in this case was last Wednesday, at least for those of us here in Spain, since it was on Wednesday that the ratings agency Standard & Poor's downgraded Spanish Sovereign debt to AA from AA+. As a result the cost of insuring such debt using credit default swaps (CDS) surged at one point to a record 211 basis points according to CMA DataVision prices. Contracts on Greece and Portugal also rose sharply, with Greece climbing 42 basis points to hit 865.5, while Portugal jumped 20 to 406.<br /><br />Standard & Poor's justified their Spain downward revision by referring to their medium-term macroeconomic projections. In particular the agency cited heavy private sector indebtedness (of around 178% of GDP), an inflexible labor market (they expect unemployment to remain around 21% throughout 2010, but then continue at a very high level for half a decade or so), the country's fairly low export capacity (Spain's exports only amount to around 25% of GDP) and the general lack of external price competitiveness. All these factors they feel are likely to mean that Spain will have low growth between at least now and 2016, a factor which will make the combined burden of private and public indebtedness much harder to service.<br /><br /> And despite the fact that Spanish Deputy Finance Minister Jose Manuel Campa stepped forward to say he was “surprised” by the move, arguing they are based on overly pessimistic growth forecasts, the fact is it is very hard to disagree with the S&P conclusions, as investors across the globe well understand. Even the EU Commission recently responded to Spain’s Stability Programme by stating that the growth forecast it contained was far too optimistic, and the IMF are even more pessimistic than the Commission.<br /><br />In fact, it now seems that the present Spanish government seems to be becoming more and more isolated from Spain's financial and corporate establishment with every passing day. As Victor Mallet <a href="http://www.ft.com/cms/s/0/4ed291e0-547d-11df-8bef-00144feab49a.html">points out in today's Financial Times</a>, "it cannot be often that academic economists use pictures of Omaha Beach, site of the bloodiest fighting in the 1944 Normandy D-Day landings, to illustrate their conclusions about one of the world’s medium-sized industrial economies", but this is precisely what the prestigous Barcelona-based Esade business school's latest economic bulletin did in their “H-Hour for the Spanish economy” editorial. “The diagnosis is very serious,” they said. “This is a highly indebted country with a damaged income-generating mechanism.” <br /><br />Now even if one does not entirely go along with the whole analysis they offer of the roots and remedies for Spain's malaise, there can be no doubt that they now take the situation very seriously, even if one could lament that they did not begin to do so starting in August 2007, when the wholesale money markets first closed their doors to the increasingly toxic products that were being issued from within the Spanish banking system. The warning signs were already there, and were plain to see, although, unfortunately few inside Spain were able to do so. As a result, nearly three critical years have been lost, dithering around, large quantities of public money have been wasted, and what was a private sector external indebtedness problem has now been transformed, little by little, into a fiscal crisis of the state.<br /><br />If the Spanish economy is really to be put straight, and not simply go straigh back and recidivise (after whoever it is who will do the "bailing out" finally does it), then surely one major priority during the coming national soul-searching process must be for public opinion leaders to find the ability and the courage to speak openly and clearly about the Spanish economy's "inner secrets", and the strength of character needed to publicly recognise problems in order to be seen to address them in a proactive and not a reactive fashion - to be out there in front of the curve, and not constantly trailing behind it. Put another way, it's high time Spain's bank and financial analyst community finally came out of the closet. <br /><br />And if that all important international investor confidence is to be once more regained then it is important that those in the Economy Ministry are seen to be aware of the problems they face, and not simply reduced to the role of "marketing department" for a government which finds itself in ever deeper difficulty, caught between the rock of its own voters, and the hard place of the international financial markets. If you don't like having rating agency downgrades, then do something to avoid them before they inevitably come. But what was it <a href="http://www.elpais.com/articulo/espana/Zapatero/ve/indicios/economia/mejora/elpepuesp/20100428elpepunac_1/Tes">Mr Zapatero was saying only yesterday</a>, oh yes, he personally can see "signs" the Spain's economy Spain is at long last "improving", that the "worst is now behind us", or as Miguel-Anxo Murado so ironically puts it <a href="http://www.guardian.co.uk/commentisfree/2010/may/01/spain-economy-greece-crisis">in the Guardian's Comment Is Free</a>: "all repeat after me, "Spain is not Greece"". I'm not sure who it is the Spanish Prime Minister currently has interpreting the signs for him - it is certainly not Perdro Solbes, or David Vergara, or Jordi Sevilla, or indeed Carlos Solchaga - but it seems far more likely to me to be one of Spain's renowned Gypsy palm-readers than any reputable and internationally recognised macro economist. <br /><br />In fact, as I have often stressed (and <a href="http://www.nytimes.com/2010/04/30/opinion/30krugman.html">as Paul Krugman makes plain yet again here</a>) Spain's problem is not essentially a fiscal one. Spain's problem is one of very high levels of corporate and household debt, and how Spain's banking system is going to support these during the long economic downturn and the ultra-high unemployment the country now faces, especially as a growing number of unemployed steadily lose their entitlement to unemployment benefit. The problem is not only that unemployment is currently running at 20%, but that benefits only last two years (plus an emergency six month flat rate 426 euro monthly payment extension), while many forecasts are now showing unemployment in the 16% to 20% range in 2013 or 2014. Just how are all these people going to continue to pay all those mortgages?<br /><br />So it is not simply that "public sector borrowing is aggravating external debt and leading Spain towards high-risk territory". This is happening, as Spain's most high profile and most strategic export increasingly becomes government and bank paper, but this is the aggravating factor, and not the root cause. The principal reason why Spanish debt is steadily moving into high risk territory is the continuing state of denial to be found among the Spanish decision making elite, and the absence of any credible plan that is up to the magnitude of the challenge ahead. Confidence has now become the main problem, but not the confidence of those consumers who rationally decide to keep their money in the bank (to earn those very attractive 4 percent interest rates those banks who now anticipate having difficulty funding themselves in the wholesale money markets are offering) rather than going out and spending it. <br /><br />The real issue is to be found in the confidence (or lack of it) those who Spain and its banks owe money to that the country (as a whole and not just the government) is going to be able to pay it all back. And in this context the sea change in mentality that Victor Mallet describes - assuming it is maintained - will be crucial. Those of us with rather longer memories - ones that stretch back to January for example - may wonder whether, once the immediate pressure is off, all that new found national resolve may not simply drift back into the mists from which it emerged, as has happened only too often in the past. Maybe the simplest and quickest way to help everyone feel comfortable that this was not going to happen would be to call in the IMF now, not becuase a bailout loan is needed yet, but as David Cameron is suggesting in the UK case, <a href="http://www.financialadvice.co.uk/news/tax/88508-should-the-imf-be-called-in-to-audit-uk-plc-accounts.html">to carry out a "no holes barred" policy audit</a>, so that everything which should be transparent actually is.<br /><br /><strong>Who Really Likes Having A Dose Of Ebola</strong><br /><br /><br />Of course the problems which became all too apparent on Wednesday went well beyond Spain. Along with the CDS prices, bond spreads widened all across the European periphery - with Spanish, Greek, Portuguese, Italian, and Irish yields all widening in tandem. Yields on Greece's two-year bonds briefly even hit an incredible 21%, following Standard & Poor's downgrade of the country's sovereign debt to junk status the day before. <br /><br />All of this and more finally forced the EU’s hand, and officials had to go rushing to the microphone to reassure investors that Greece would soon be able to access an aid package, with German Chancellor Angela Merkel going so far as to state that talks about providing aid should now be accelerated. <br /><br />Then the numbers started to be filtered out, and evidently they were much larger than many had been expecting. According to press reports IMF chief Dominique Strauss-Kahn told German policymakers that Greece might need EUR120-130bn over three years, a number which the German press quickly calculated would mean that the German contribution might then go up to EUR25bn.<br /><br />Certainly, at the point of writing we still don’t know what the exact number will be - and it is not even sure they have decided yet - but the reality is that once the EUR120-130bn number is out there from an authoritative source, it will be hard not to hit it, if not exceed it.<br /><br />Then followed the announcement that IMF staff have reached an agreement with the Greek authorities on a 3-year program that will include draconian fiscal cuts (of the order of 10pc of GDP) and a series of structural measures aimed at driving nominal wages lower, reforming the pension system and building better institutions. Thus, the message this weekend to investors is: stop worrying about Greece for the next three years; you can continue to speculate in the secondary market, but the Greek government will be fine. And debt restructuring with the private sector now seems to be off the table for, at least for as long as the Greek government stick with the conditions – which will obviously be the aspect to watch carefully going forward. And even if there is an eventual default, the main counterparty will be other European governments (and the taxpayers who back them) and not private bondholders. <br /><br />On the other hand, Europe’s institutions have, at a stroke, opened themselves up to a large slice of what is known as “moral hazard”, since the implicit message is : what we are doing for Greece we'll do for any other Euro-zone country, if needed. So from this moment on, we are all in up to our necks, if not beyond.<br /><br />This "historic moment" point-of-no-return dimension did not escaped the notice of Dominique Strauss-Kahn either, since following his meeting with German politicians he was at pains to stress the potential contagion affect lack of backing Greece to the hilt would have had on the euro and the rest of Europe in the days to come. “I don't want to hide behind a rosy picture. It's not easy,” he said. All this “ can also have consequences far away. We have to face a difficult situation. We are confident we can fix it... But if we don't fix it in Greece, it may have a lot of consequences on the EU.”<br /><br />Highly respected US economist and Harvard University Professor Martin Feldstein went even further, saying that in his opinion Greece will eventually default on its bonds and he feared other euro-area nations may follow, most probably Portugal. “Greece is going to default despite all the talk, despite the liquidity package,” he said. Portugal's name is mentioned frequently these days, since although the government deficit and debt levels are lower in Portugal than in Greece and the Portuguese government has much more fiscal credibility than its Greek counterpart, when you add private sector debt to the public part the number is not far short of 300% of GDP, and in fact the underlying problems are very similar to those which are to be found in Greece.<br /><br />But it isn’t only in the South the the EU has to worry, since probems in the East continue to fester. The Hungarian forint had a fairly hard time of it over the past few days, and had a two-day intraday loss 3.6 percent on Tuesday and Wednesday, its biggest such fall since March last year. At the same time the cost of credit default swaps on Hungarian debt rose 23.5 basis points to 240. The drop followed revelations from Hungary’s incoming Prime Minister Viktor Orban that the country’s underlying fiscal deficit had in fact been rather higher than the previous government had acknowledged. So contagion may now be also moving Eastwards, meaning that EU institutions may now increasingly face a battle on two fronts, since the wobbling won’t simply stop with Hungary, there is Latvia, Bulgaria and Romania to also think about (just to name the first three that come to mind).<br /><br />As Angel Gurria, OECD Secretary General, said this week: “This is like Ebola. When you realise you have it you have to cut your leg off in order to survive...... it is contaminating all the spreads and distorting all the risk assessment measures. It is also threatening the stability of the entire financial system.”Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-31960875914689917772010-04-23T08:54:00.000-07:002010-04-23T09:22:22.627-07:00The Greek Tragedy ContinuesThe future of the Eurozone is decidedly hanging in the balance at the moment. <a href="http://fistfulofeuros.net/afoe/economics-country-briefings/do-i-see-movement-in-the-greek-trenches/">As I said earlier in the week</a>, the problem isn’t a simple question economics anymore: everything now is all about credibility, about who does what, and when, and how everyone else reacts. As the crisis trundles on and on, news that Greek bond spreads have hit ever higher post European Monetary Union records has become such a regular event that the process now seems almost a monotonous one. However, what happened on what we could now call this week’s Greek “Black Thursday” certainly marked a new, and more worrying milestone in the ever evolving crisis. The news this morning that Greece has demanded the activation of the EU-IMF loan - news <a href="http://ftalphaville.ft.com/blog/2010/04/23/210766/first-thoughts-on-greek-aid-activation/">which apparently took even the EU Commission itself by surprise it seems</a> - only adds to the general sense of confusion that abounds.<br /><br />The problem we are presented with is not only that Greek 10-year bond yields reached 8.83 per cent, their highest levels since 1998, or that the cost of insuring Greek government debt against default hit a record high of 616 basis points. The really disturbing development was that spreads on government bonds all around Europe’s periphery – including countries like Hungary and Bulgaria - widened sharply, raising heightened concerns that Greek contagion may move from being a mere possibility to becoming a reality. And the cost of protecting peripheral eurozone borrowers against default also hit record levels, with Spain and Portugal touching record highs for their Credit Default Swap prices.<br /><br />The surge in Greek bonds followed news that Eurostat, the European Union’s statistical service, had revised its estimate of the country’s 2009 deficit to 13.6 per cent of gross domestic product from 12.7 per cent, and the announcement that Moody’s Ratings Agency had downgraded Greek sovereging debt to A3 from A2.<br /><br />Markets are obviously nervous at the moment, and understandably so, with two issues in the forefront of their minds. In the first place the real level of commitment of core Europe, and especially Germany, to supporting the periphery through several years of difficult and painful structural adjustment is far from clear. On the other, the ability of political leaders in Greece and other affected countries to carry their citizens with them through the sacrifices which will be required to maintain the monetary system intact continues to remain in doubt.<br /><br />German voters are notably uneasy about lending money to Greece, and a sizeable majority of them are against any form of aid. Reticence on the part of Angela Merkel’s coalition partner also makes obtaining parliamentary backing for the loan difficult, and the FDP senior spokesman on financial questions, Frank Schaeffler, stated bluntly this week that either Greece needed to intensify its austerity plan or it should leave the Euro. <br /><br />Most observers, however, consider a Greek withdrawal to be only a remote possibility, given that any return to the Drachma would make the country’s debts even less payable. In fact the threat to the integrity of the currency union comes from an altogether different quarter. What is in now increasingly in doubt is the ability of Germany’s political leadership to carry voters with them should either Greece decide to default while continuing with Euro membership, or should other member countries be forced to apply for loans.<br /><br />At the same time, some sort of Greek default is now no longer simply a theoretical possibility among many others, indeed talk of the inevitability of some form of debt restructuring (albeit voluntary) grows with every passing day. Erik Nielsen European Economist with Goldman Sachs said this week he is expecting Greece to offer some sort of “voluntary debt-restructuring” to creditors over coming months, while JP Morgan issued a research note saying that while such restructuring may not be imminent, the move would make sense given that Greece could be seen as “the sovereign analogue of a ‘bad’ company with a bad capital structure”. <br /><br />Restructuring is simply a polite word for default, with the difference that it is normally carried out by agreement. The most likely form of restructuring in the present context would be debt rescheduling, whereby short and medium-term debt is converted into a long-term version, as happened with the so-called “Brady bonds” devised by the US Treasury to resolve the debt difficulties of a number of Latin American countries in the late 1980s. <br /><br />One indication that the ground may be being prepared for some kind of restructuring can be found in the decision reported by German Deputy Finance Minister Joerg that any aid to Greece would come in the form of pooled loans from the euro-zone countries and not through the purchase of Greek bonds. Plans to purchase bonds are “off the table,” he said. This procedure implies that government loans would be strongly guaranteed, while private bond holders would really pay the price for the Greek “rescue”.<br /><br />At the same time voices are now being raised asking whether it would not be a better idea for Germany, rather than financing more and more loans, simply to put its losses down to experience and go back to the Deutsche mark? According to Joaquin Fels, Chief Global Economist at Morgan Stanley, the Greek rescue measures could “set a bad precedent for other euro- area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time,” in this case “countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union.”<br /><br /><br />Evidently such statements can be read as bargaining postures, attempts to get politicians and voters in the South of Europe to focus their minds on the problem in hand, but they can also be read as warnings of what could happen if they do not. At the present time the situation is extraordinarily confused. Greek Prime Minister George Papandreou's formal request for financial financial support seems to have taken almost everyone completely by surprise although it shouldn't have, since as I reported in my earlier post the Greek Finance Minister George Papaconstantinou had previously warned that his country could call on loan backup from the EU and the IMF even while talks with the 20 strong EU, ECB and IMF mission were continuing. Actual details of the level of financial support which will be offered remain scant at this point. <a href="http://www.reuters.com/article/idUSWBT01384420100423">According to G20 sources who spoke to Reuters</a>, the Greek government have only asked at this point for a first tranche downpayment, to give them working capital to keep going while the talks continue (think of the JP Morgan distressed company talks with the receiver analogy). What is quite striking, however, is how the government let things come to this pass before striking the decisive agreement - evidently they could not hold out till after the German regional elections, and that is another worrying sign. When all is said and done, one thing is obvious, the forthcoming loan will clearly have some kind of super-senior status (which means it would be payable before ALL other creditors - German voters would settle for nothing less), and this implies that it is likely to be existing bondholders, and not EU national governments, who are going to be invited invited to pay for the Greek bailout. How they will react to this realisation is what remains to be seen in the days and weeks to come.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-66472058038084497332010-04-20T06:38:00.000-07:002010-04-20T06:47:48.453-07:00Do I See Movement In The Greek Trenches?This isn't about economics anymore, this is now about who does what, and when, and how everyone else reacts.<br /><br />Certainly the news that Greek bonds hit another post-EMU record high yesterday can hardly be said to have come as a surprise. 10-year bond yields reached 7.76 per cent at one point and closed up 26 basis points on the day. This morning Greece comfortably sold 1.5 billion euros worth of 3 month Treasury Bills - in the end they sold 1.95 billion euros of them - but <a href="http://www.businessweek.com/news/2010-04-20/greece-s-3-month-treasury-bill-yield-doubles-on-default-concern.html">the yield on the bonds more than doubled to 3.65 percent</a>, from 1.67 percent for a sale of similar debt on January 19. And the the extra yield investors demand to hold Greek 10-year bonds instead of German bunds, the euro-region’s benchmark government securities, rose again today - to as much as 472 basis points - the most since Bloomberg records began in 1998. The average spread over the past 10 years has been 61 basis points. Greek two-year notes also fell, pushing the yield 23 basis points higher to 7.51 percent.<br /><br />On the other hand, <a href="http://online.wsj.com/article/SB10001424052748704671904575193492072402292.html?mod=WSJ_WSJ_US_World">Bundesbank President Axel Weber was out there yesterday telling a group of German lawmakers</a> that Greece was going to need <strong>more</strong>, not less money.<br /><br /><blockquote>Greece may require financial assistance of as much as €80 billion ($107.92 billion) to escape its debt crisis and avoid default, Bundesbank President Axel Weber told a group of German lawmakers Monday, according to a person familiar with the matter.<br /><br />The estimate, considerably more than the €45 billion that European countries and the International Monetary Fund are currently prepared to extend Greece this year if it needs a bailout, suggests that a rescue of the country may come in several stages and reach beyond 2010.</blockquote><br /><br />Why, I ask myself, is a conservative, and normally discreet, figure like Axel Weber out there stressing precisely this point at this moment in time, when German voters are notably nervous about any sort of aid to Greece, reticence on the part of Angela Merkel's coalition partner makes a parliamentary debate on a loan difficult, and <a href="http://www.businessweek.com/news/2010-04-16/greece-may-spur-german-rethink-morgan-stanley-says-update1-.html">voices are even being raised</a> about whether it would not be a better idea for Germany simply to put the losses down to experience and go back to the Deutsche mark?<br /><blockquote>Germany might consider exiting Europe’s current monetary union to create a smaller bloc as the Greek crisis threatens to turn the euro area into a region of “fiscal profligacy,” Morgan Stanley said.<br /><br />Greek rescue measures “set a bad precedent for other euro- area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time,” said Joachim Fels, co-chief global economist at Morgan Stanley in London, in an April 14 note. “If so, countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union.”</blockquote><br /><br />All these statements can be read as bargaining postures, attempts to get people in the South of Europe to focus their minds on the problem in hand, but they can also be read as warnings of what could happen if they do not.<br /><br />Certainly, nothing at this point is very clear. Especially, <a href="http://www.ft.com/cms/s/0/4c7c6d3e-4bdc-11df-a217-00144feab49a.html">as the FT reminds us this morning</a>, when we live in a world where the unthinkable has finally become thinkable. So we could now ask ourselves whether the financial markets are not in fact, and before our very eyes, gearing themselves up for an event which many had not previously been factored into the realms of the possible: Greek debt restructuring.<br /><blockquote>Even as Greek bail-out discussions continue – talks between representatives of the European Commission, European Central Bank and IMF were delayed on Monday by the volcanic ash cloud – market watchers are starting to question whether, in the long term, Greece can avoid a restructuring of its debts or even an outright default.<br /><br />“Investors and analysts are now running the numbers to see what a haircut to Greek bonds would be,” says Steven Major, global head of fixed income research at HSBC. “One way to do this is to compare restructurings for emerging market sovereigns. Based on the defaults over the last 12 years the average long-term recovery rate is close to 70 per cent. Ultra-long Greek bonds currently trade at a price below this.”</blockquote><br /><br />The Financial Times also reports that the IMF is likely to raise the question of debt restructuring at their forcoming meetings with the Greek finance ministry - you know, the ones that have been delayed by the symbolic intervention of all that volcanic ash. According to the FT source it is not likely to be a detailed discussion “just a pointed reminder of the debt forecast”. <br /><blockquote>The IMF has already told the finance ministry informally that Greece’s debt will reach 150 per cent of GDP by 2014, according to this person. Greece’s debt to GDP level – 113 per cent in 2009 – is already the highest in the eurozone. The IMF calculates that Greece will need to find €120bn ($162bn) over the next three years.</blockquote><br /><br />Of course, the term "debt restructuring" does sound a lot better than default, and the expression does cover a wide range of possible outcomes, running from unilaterally changing the terms of the bonds one the one hand, to voluntary renegotiation to ease refinancing pressure at the other.<br /><br />One proposal which has been advanced (<a href="http://www.ft.com/cms/s/0/da5b9516-4b1f-11df-a7ff-00144feab49a.html">most recently by Wolfgang Munchau</a>) is for recourse to some form of Brady bond:<br /><blockquote>Restructuring is a form of default, except that it is by agreement. It could imply a haircut – an agreed reduction in the value of the outstanding cashflows for bond holders. The Brady bonds of the late 1980s, named after Nicholas Brady, a former US Treasury secretary, worked on a similar principle. An alternative to restructuring would be a debt rescheduling, whereby short and medium-term debt is converted into long-term debt. This would push the significant debt rollover costs to well beyond the adjustment period.</blockquote><br /><br />Brady bonds were initially issued to ease the debt difficulties of a number of Latin American countries in the late 1980s (and they are modeled on the earlier Japanese par bonds - you can <a href="http://en.wikipedia.org/wiki/Brady_Bonds">read more about them in wikipedia here</a>). The essential idea in the Greek case would be that current debt instruments would need to be swapped for some longer term bond with a lower than market rate coupon (or implied interest rate). <br /><br />Of course, as Munchau points out, in order to get the existing bondholders to trade their debt on a voluntary basis, they would have to be put under some sort of pressure:<br /><blockquote>One way to force the debate would be to attach super-senior status to the EU loan to Greece. I understand this is still an unresolved issue. Super-senior means this loan would be repaid before existing debt. Should Greece ever get into a liquidity squeeze, bondholders would be put in a back seat. In such a situation, they might prefer rescheduling.</blockquote><br /><br />Which makes this <a href="http://english.capital.gr/news.asp?id=948906">little detail about the form of the EU loan</a> rather more interesting than it might seem at first sight:<br /><blockquote>Any aid to Greece would come in the form of pooled loans from the euro-zone countries and not the purchase of Greek bonds, German Deputy Finance Minister Joerg Asmussen said Tuesday.<br /><br />He also said that Greece will be an issue at the meetings of finance ministers and central bankers from the Group of Seven leading industrial nations and the Group of 20 industrial and developing nations this weekend in Washington.<br /><br />"Of course, Greece will be an issue," Asmussen told reporters Wednesday. He also said that "if financial aid for Greece will be given, then the pursued path will be to provide pooled loans." Germany would provide its share of such loans through the state-owned KfW Banking Group and the loans would be guaranteed by the government.<br /><br />Plans to purchase bonds "is off the table," he said. The advantage of providing pooled loans is that there can be stricter conditions to paying out such loans, such as demanding the implementation of fiscal reforms. </blockquote><br /><br />So we could imagine that the forthcoming loan would have super-senior status (German voters would settle for nothing less), and, if this interpretation is correct, it will be existing bondholders, and not the EU governments, who will be being invited to "bail Greece out". Well, maybe we won't have to wait too much longer to find out, since <a href="http://news.smh.com.au/breaking-news-world/greece-may-use-eu-loan-by-next-month-finance-minister-20100420-srlg.html">the Greek Finance Minister George Papaconstantinou stated today</a> that the country could call on loan backup from the EU and the IMF by as early as next month depending on loan conditions and the progress of talks with the EU, ECB and IMF joint mission, which is composed of around 20 people according to reports. Plenty to talk about, and plenty of people to do the talking. Too many, perhaps?Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-90381396299775629102010-04-11T05:02:00.000-07:002010-04-11T05:18:51.597-07:00Angela CallingAngela Merkel is a Chemist. In her doctoral thesis - entitled "Untersuchung des Mechanismus von Zerfallsreaktionen mit einfachem Bindungsbruch und Berechnung ihrer Geschwindigkeitskonstanten auf der Grundlage quantenchemischer und statistischer Methoden" - she demonstrated herself to be a thoroughgoing expert when it comes to analysing the speed of disintegration of chemical compounds once the bonds which hold them together are weakened. Unfortunately she is now having to apply all this acquired expertise and know-how in a determined attempt to avoid the break up and falling apart, not of a highly complex chemical substance, but of an even more complex economic and political one, and the bonds which are the focus of all her attention right now are not chemical, but financial and social.<br /><br />The problems we in Europe all now face together ("wir teilen ein gemeinsames schicksal" in M. Trichet's words) have not arrived just "suddenly one springtime" as it were, indeed they come from afar. Right from the very begining it has been no easy matter for German society to achieve the consensus necessary to accept the idea of participating in a common currency, the Bundesbank has long maintained its by now well-known reservations, while not a few have been the voices expressing the view that having so many diverse countries all sharing the same monetary unit would inevitably create a structure which was too unwieldy to be manageable, and too weak to hold together when the real storm weather came. What was needed, it was argued, was a two, not a one, speed Europe.<br /><br />Unfortunately, all these simmering issues have once more resurfaced during the last week, over the tricky question of what to do about Greek financing needs, and Germany's economic and political leadership now seem to be locked in an intense debate about exactly which path to take. Meanwhile Greek bond spreads simply work their way onwards and upwards, while capital flight from Greek bank deposits has forced the banks themselves to go rushing to the government for a further 18.000 million euros in funding just to keep them alive.<br /><br />The current issue came to a head last Monday afternoon, following <a href="http://www.ft.com/cms/s/0/e1370d50-409a-11df-94c2-00144feabdc0.html">a brief report on the Financial Times website</a> stating that progress with the decision on any Greek rescue plan was effectively deadlocked due to the inability of the Germany to agree with her other European partners the precise rate of interest to be charged on any loan to be provided. Ironically it is this single issue which is currently bringing European decision making to a dead halt, and creating a level of uncertainty and debate of such intensity that, if it is not resolved decisively, could bring the very future of the Euro into question. And it is not a trivial matter, since the rate charged will become a precedent, which other, larger, countries can refer to later.<br /><br />Essentially the problem is this. According to the US economists Carmen Reinhardt a Ken Rogoff (in a widely quoted paper <a href="http://terpconnect.umd.edu/~creinhar/Papers/RR%20Debt%20and%20Growth-01-18%20NBER.pdf">Growth In A Time Of Debt</a>) a potential tipping point exists once government debt breaches the 100% of GDP level in the aftermath of a financial crisis. After this point the impact of additional state spending is, paradoxically, to effectively reduce growth (given the weight of interest repayments, and the additional risk price charged for lending, and the impact of more government debt on investor confidence) and indeed far from helping a country to recover, further borrowing may mean the economy actually shrinks rather than grows. <br /><br />Let's take an example. Imagine Greece has debt at the 100% of GDP level (in fact it is somewhat over 115%), and the price investors charge for buying the bonds is around 6% (or more or less 3% more than the German government has to pay to sell equivalemt debt). Now let's also imagine that Greece has zero inflation and zero growth (they are in the midst of a massive correction which will last some years, so these are reasonable, and indeed possibly even optimistic assumptions). Then Greece will need to produce what is know as a "primary surplus" (or difference between current spending and current income) of around 6% just to stand still, and not see its level of gross indebtedness increase. But Greece, in 2009, had a primary deficit of some 7% of GDP.That is to say, simply to not get more in debt Greece has to withdraw something like 13% of GDP in demand from the economy, and this is massive, which is why all the experts anticipate a sharp contraction in the Greek economy over the next 3 or 4 years, and why rather than looking to domestic demand the Greeks will need to look to exports for support (The US economist Charles Calomiris has <a href="http://www.economics21.org/commentary/painful-arithmetic-greek-debt-default">an excellent detailed explanation of all this here</a>, while <a href="http://baselinescenario.com/2010/04/06/greece-and-the-fatal-flaw-in-an-imf-rescue/">Peter Boone and Simon Johnson dig even deeper here</a>) .<br /><br />Which is where the European Union comes in. Basically, if Greece has to pay such a high interest rate differential to support such a large debt there is every likelihood she will not be able to continue to finance herself, and default will become inevitable. You can only demand so much effort from the reformed alchoholic before they are driven back to drinking in frustration. On the other hand the EU could help by making the interest rates charged cheaper, but unfortunately there is a 1993 decision of the German constitutional court which makes it effectively illegal for the German government to participate in such a subsidised loan. The IMF can help, they are reportedly willing to make a loan of up to 10 billion euros at very favourable rates, but there are limits to how far they can go, since they cannot justify favouring comparatively rich Europeans when they deny such funding to poorer countries in the third world.<br /><br />And the quantity Greece actually needs is massive. Initial reports spoke of a total loan of around 25 billion, but this is surely not enough. At least 50 billion will be needed, and some estimates put the number much higher (see <a href="http://baselinescenario.com/2010/04/06/greece-and-the-fatal-flaw-in-an-imf-rescue/">Peter Boone and Simon Johnson again</a>). And remember, we are not talking about fancy theories here, all of this is all simple arithmetic: either Greece gets a large, cheap loan, or she will default. They will have no alternative. So European decision making is gridlocked, while on Thursday Greece's 10 year bond interest rate differential hit record post-EMU highs of 4,63%, and the ineterest being charged was not 6% but near to 8% at one point.<br /><br />Naturally, if Greece were to do the "honourable thing", and leave the Eurozone and default, "all would be light". But they won't, and there is no good reason why they should do so. Now, <a href="http://www.nytimes.com/2010/03/29/opinion/29Starbatty.html">enter Professor Starbatty of Tübingen University</a>. He has another proposal. Not Greece, but Germany should leave the Eurozone, and go back to the Mark. And before you start to laugh, you should bear in mind that he is very serious in his proposal, and many Germans agree with him. Indeed so seriously does Angela Merkel take the possibility that any cheap loan to Germany will encourage supporters of Professor Starbatty to go to the Constitutional Court and ask for a ruling that German participation in the common currency is illegal that she has frozen the whole Greek bailout process. <br /><br />And it is not clear, at this stage what the view of the <a href="http://www.news.com.au/business/breaking-news/germany-wary-of-greece-bailout/story-e6frfkur-1225851696299">Bundesbank</a> is. According to German press reports, <a href="http://blogs.ft.com/money-supply/2010/04/08/bundesbank-mumblings/">accepted by the bank itself</a>, the Bank is currently considering an internal report on the rescue loan proposal which states "This agreement of the heads of government, which according to our knowledge has been reached without any consultations from central banks, implies <strong>risks to stability that should not be underestimated</strong>," (my emphasis).<br /><br />And before anyone complains that the Germans are too dependent on exports to the South of Europe to do anything which makes selling these more difficult, please consider that domestic demand growth in all four Southern European members of the Eurozone is expected to be extremely weak over the next decade, while growth in emerging markets like India, China, Brazil and Indonesia is predicted to be massive. The markets are moving, so why not move with them?<br /><br />Of course, none of this means that the Eurozone, like one of those chemical compounds Angela used to study, is about to fly apart. But we should not underestimate the stresses the currency union faces at this point. As former IMF chief economist Ken Rogoff pointed out in the Financial Times this week, "if investors gather with enough sustained force, and if the central bank lacks sufficient resilience and resources, they can blow out a fixed exchange rate regime that might otherwise have lasted quite a while longer." What the countries in the South of Europe need to give the Germans right now are not arguments about how they would be foolish for them to leave, but arguments about what they themselves are prepared to do to make it more attractive for them to stay. The German giving machine is all done, and the Germans themselves are now more than tired of being continually told they need to pay, pay and pay again for events that now took place over half a century ago. Calling, Berlin, calling Berlin, hello, hello, is anybody there?Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-58361387709681864822010-03-26T03:41:00.000-07:002010-03-26T03:43:10.137-07:00From A Greek Debt Crisis To A Eurozone Structural One?When we look back five years from now, will we see this week as marking a turning point in the short, but far from uneventful, ten year history of Europe’s common currency? Certainly <a href="http://online.wsj.com/article/SB20001424052748704094104575143340013234692.html">recent comments by the deputy governor of the People's Bank of China</a> have made evident what was already implicit: the dependence of EU sovereign debt on sentiment in global markets, especially in Asia and the Americas. Simon Derrick, chief currency strategist at Bank of New York Mellon even went so far as to say the trauma of recent days might well signal the point that we <a href="http://www.ft.com/cms/s/0/510dce5e-385b-11df-aabd-00144feabdc0.html">stop talking about a “Greek debt crisis” and start talking about a “Eurozone structural crisis”</a> . And while Herman Van Rompuy, president of the European Council, was telling us on the one hand that the eurozone will never let Greece fail, <a href="http://www.ft.com/cms/s/0/83f555a8-3757-11df-9176-00144feabdc0.html">Jane Foley, research director at Forex.com busied herself explaining</a>, on the other, that any involvement of the International Monetary Fund in helping Greece to stabilise its fiscal position only heightens the risk that the country might one day end up leaving the eurozone. So just where are we at this point?<br /><br />Basically it is important to recognise that the current crisis has placed the spotlight on the severe institutional weaknesses which lie underpin the common currency, and it is just these weaknesses which are leading so many commentators to now ask themselves whether it might not have been easier to implement political union in Europe before embarking on such an ambitious monetary experiment.<br /><br />These weaknesses became even more clear on Thursday when Jean Claude Trichet went very public in making clear that <a href="http://www.bloomberg.com/apps/news?pid=20601092&sid=a7aIwbYvgErc">he personally is totally opposed to IMF participation in any Greece "rescue"</a>. “If the IMF or any other authority exercises any responsibility instead of the eurogroup, instead of the governments, this would clearly be very, very bad,” he said on France’s Public Senat television. And this on the same day as Angela Merkel and Nicolas Sarkozy were publicly celebrating the triumph of the "Franco-German" entente. Clearly there are still many rivers left to cross before we can say we have reached the other side in this particular structural crisis.<br /><br />Basically the issues facing Greece are now not primarily fiscal ones. The issue is how to get growth back into the economy fast enough to stop deflation and the economic contraction taking away all the good work acheived through fiscal cutbacks, and how to finance Greek borrowing at a rate of interest which stops the level of indebtedness spiralling upwards out of control.<br /><br />The <a href="http://www.economist.com/business-finance/displaystory.cfm?story_id=15772801&source=hptextfeature">Economist magazine have done their own calculation on this</a>, and they estimate that a loan of €75 billion rather than the currently rumoured €25 billion will be needed and that the country is likely to need five years (rather than three) to get its deficit down below 3% of GDP. They also assume that Greek GDP will be 5% below its current level by 2014. Obviously the output you get in these sort of calculations rather depend on the expectations you put in, but these are not unrealistic expectations.<br /><br />As I explain in <a href="http://fistfulofeuros.net/afoe/economics-and-demography/the-debt-snowball-problem/">this post on the debt snowball problem</a>, only two things really matter at this stage, the rate of change in nominal Greek GDP (that is non price adjusted) and the rate of interest charged on the sovereign debt. As regards nominal GDP, the Economist assume a 5% contraction in 2010. This may seem rather steep, but it does include an anticipated fall in prices as well as a drop in GDP. My own calculations suggest a drop in real GDP of about two percent, rather than the somewhat higher numbers others are talking about. I suggest this number is more realistic given the degree to which the trade deficit is likely to correct, and the net trade impact on headline GDP numbers. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrcJpKxcNHG4bbcJFPCevmGj6LrCZ9JISKBShH-AfEid_A-o4-nA73UjIeZI23AyVAOE0KZWen_E5tYiHe3OQVvPxGpW089SnibQNtCjP0XILBSMGodpC2MXFPu6xMQMdioztAZQQSuJAh/s1600/Greece+Goods+Trade+Deficit.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrcJpKxcNHG4bbcJFPCevmGj6LrCZ9JISKBShH-AfEid_A-o4-nA73UjIeZI23AyVAOE0KZWen_E5tYiHe3OQVvPxGpW089SnibQNtCjP0XILBSMGodpC2MXFPu6xMQMdioztAZQQSuJAh/s400/Greece+Goods+Trade+Deficit.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5452889043966980370" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq31-n7b0PyZfJU-a3-R-HbUDmByfGgzWxIzsNh_5u4ikNd9IPPJRLHUzrNIPtTvvMJYmVUfHNMvX0JK2KsR-j49BTGXM2k55yXm-CGbI6wFY7tdnl8JASv0B7MKS1sAggRbN5h8hflW2d/s1600/Greece+Exports.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq31-n7b0PyZfJU-a3-R-HbUDmByfGgzWxIzsNh_5u4ikNd9IPPJRLHUzrNIPtTvvMJYmVUfHNMvX0JK2KsR-j49BTGXM2k55yXm-CGbI6wFY7tdnl8JASv0B7MKS1sAggRbN5h8hflW2d/s400/Greece+Exports.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5452888960074483906" /></a><br /><br />As far as prices goes, I think a one percent fall in the CPI is a reasonable guess at this stage. If you look at the chart below you will see that interannual Greek inflation is still well above the EU 16 average, but prices have now been falling since November, and even though we shouldn't neglect the impact of tax and public sector tariff increases, prices will almost certainly be down in December 2010 over January. The big difficulty is estimating by how much.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvIQN_yxXkEBzZFFt6nvyT5H0NEkPHSJWFS0G9CCcaKWRoNpWokuNW_UJCJ9VP7bE17qXYKwGqLCW7bG5y8ES4bufqZD_sWVIDTsohjgz9otrXTOE7NMl4xT21ih_aMBP-R9I5YXKu_BTy/s1600/CPI+YoY.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 215px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvIQN_yxXkEBzZFFt6nvyT5H0NEkPHSJWFS0G9CCcaKWRoNpWokuNW_UJCJ9VP7bE17qXYKwGqLCW7bG5y8ES4bufqZD_sWVIDTsohjgz9otrXTOE7NMl4xT21ih_aMBP-R9I5YXKu_BTy/s400/CPI+YoY.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5452883668475259778" /></a><br /><br />One of the key issues facing Greece at the moment, with large parts of its outsanding debt needing to be refinanced, is just what rate of interest (or extra spread) will have to be paid on any loan (<a href="http://fistfulofeuros.net/afoe/economics-and-demography/why-not-unravel-the-imf-too-while-were-at-it/">I deal with this question in this post</a>). This is almost a key question, since it can become a "life or death" issue in determining whether or not the country will be forced into default. But here both the EU and the IMF have a problem, since if the Euro Group countries make a loan at a level near to the the current price charged for German debt (which is what should happen if we argue Greek debt carries no additional risk since we are all guaranteeing it), then other countries who are currently paying more (Spain, Ireland, Portugal, Austria etc) may ask why they also could not have such favourable treatment. On the other hand, asking the IMF to make a cheaper loan causes problems, since it could be seen as subsidising Europe in sorting out its problems, and this might not be easily understood in Emerging Economies where there are evidently many more needy cases than Greece's to think about.<br /><br />The bottom line is that there is no easy answer here, and Europe is struggling to convince the rest of the world that it has both the will and the instruments to effectively tackle the problem of maintaining a single currency in a diverse group of countries. <a href="http://www.straitstimes.com/BreakingNews/Money/Story/STIStory_506860.html">Herman Van Rompuy said on Friday there was no danger of Portugal being sucked into the same sort of debt whirlpool as Greece</a>, and that Portugal would not be the next country to be sent over to Washington in search of a helping technical hand from the IMF. Which raises the question: if it won't be Portugal, who will it be?Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-82534164108200449432010-03-24T05:56:00.000-07:002010-03-24T06:00:28.303-07:00Why Not Unravel The IMF Too While We're At It?If you're really good at making a pigs ear of things, why not join the EU? Of course, this is not meant as a piece of solid advice, rather it is a cry of frustration at being impotently forced to watch so many things done so badly, each in turn, and one after the other. Southern Europe's problem is essentially a competitiveness problem, and not a fiscal one, and if many states have been having growing difficulty with their negative fiscal balances, this is a symptom of the problem, and not its cause. Even in the worst of cases - countries like Greece and Portugal - the rising recourse to fiscal outlays has been a response to lack of "healthy" growth, and the root cause of this continuing difficulty in generating real growth has been the underlying lack of competitiveness, and the inability to export your way out of trouble once the burden of debt starts to rise, so simply pruning the fiscal side isn't going to cure the problem, and by now that simple point should be obvious, I would have thought.<br /><br />Naturally a lot of financial markets attention has been focusing recently on whether or not the Euro is about to unravel. Even the ever-so-prudent Ralph Atkins <a href="http://www.ft.com/cms/s/0/b95fe7f8-36b7-11df-b810-00144feabdc0.html">winds up his mamoth "Defiant Berlin" review</a> with a quote from Jörg Krämer, chief economist at Commerzbank in Frankfurt who says the next few years may see the eurozone becoming more of a “transfer union”, one in which better performing countries have to help out weaker members. “That" - he argues - "could mean Germany says, ‘we are no longer willing to support the weaker parts of the EU’, while the Greeks say that they are not prepared to have policy dictated by the Germans," Thus: “The risk cannot be totally excluded of a eurozone break-up within 10 to 15 years – and this is a consequence of widening eurozone divergences.” To which Atkins adds "If that risk rose, Europe would be facing a very different ballgame". You bet it would!<br /><br />To some extent I cannot help feeling that a congenital inability to take bite-the-bullet type decisions is resulting in an ongoing process of passing the buck ever onwards and upwards. The latest exemple here is the issue of IMF involvement in the Greek adjustment process. Now, as with any issue, there are good reasons and there are bad reasons why IMF involvemnet might be considered desireable. Among the good reasons are the vast experience and technical expertise of the fund, or the fact that representatives of the IMF might find it easier to say "no", given that the underlying sovereignty issues are not exactly identical when posed in terms of the IMF as they are in terms of the EU.<br /><br />But among the bad reasons would be the idea that the IMF could fund any eventual Greek loan more cheaply. As far as I can see, a lot of the EU interest in having an IMF loan to Greece stems from the need to make the rate of interest applied cheap enough to bring the spread down. This is an important concern, since it is not obvious why a country which is making its best effort to put things straight should need to be paying an exorbitant charge for the money it borrows while it does this. Earlier this week European Central Bank President Jean-Claude Trichet <a href="http://www.businessweek.com/news/2010-03-23/greek-impasse-deepens-as-trichet-rejects-loan-subsidy-update2-.html">spoke out strongly against offering the kind of low-interest loans for which the Greek government has been pressing</a> - “There shouldn’t be any subsidy element, no concessionary element” in any eventual loan to Greece, he told members of the Economic and Monetary Affairs Committee of the European Parliament. And maybe this is the only reasonable position the ECB can take (given its Charter), but evidently the Eurogroup of countries are not bound by the same constraints and they themselves could do this (via recourse to Group-backed EuroGroup bonds, or whatever), which raises the obvious question: why don't they?<br /><br />Well, one of the reasons lying behind all the reluctance we are currently seeing may not be the issue of the German constitution, or even the question of changes to the Lisbon Treaty, or any of the major issues of principal which arise and would require lengthy and onerous debate. Maybe the question is a much more simple one: perhaps Europe's leaders are simply worried that if they make a cheap loan to Greece, then Spain, Portugal, Ireland, Italy, Austria, Slovenia and Slovakia may all soon argue they also need one.<br /><br />My view is that this is an issue where the EU itself needs to bite the bullet, and make large changes, ones which lead, as Wolfgang Munchau has been arguing, to much closer political union. If we need the IMF in Greece, and I think we do, it is for its proven capacity to implement programmes, and its extensive technical resources, NOT for the money.<br /><br />Indeed the Indian economist Subroto Roy just raised a very important issue in this regard on my Facebook. If IMF funds are used to bailout Greece, wouldn't that be a bit like the poor pampering the rich. Shouldn't IMF money be being used for other things? Shouldn't the IMF have other priorities? Evidently stabilising Europe is important, but shouldn't the EU be doing that (and not just as a matter of pride, as a matter of international solidarity)? As Roy asks, what happens if...<br /><br />"the US, Britain, ANZ and everyone else in the IMF who is not in the Eurozone.... (decide to)... legitimately ask why the effective subsidy of Greece by its Eurozone partners should be transferred to the rest of the world ... (after all) .... the Europeans have enough clout in the IMF to, say, insist some of their own IMF-directed resources be directed towards Greece specifically, which would spell the unravelling of the IMF if it became a general habit."<br /><br />Exactly.<br /><br />On a slightly different, but somewhat related topic, I basically agree with a lot of what Martin Wolf wrote in his <a href="http://www.ft.com/cms/s/0/924b4cc0-36b7-11df-b810-00144feabdc0.html">Excessive Virtue piece in the FT yesterday</a>. As Martin points out, in saying "nein" to those who suggest that its economy should become a little less competitive what the German government is effectively saying is that the eurozone must become some kind of greater Germany - a huge export machine which generates a massive surplus with the rest of the world, a surplus which enables all those highly indebted member countries to pay down their debts. But, as Wolf argues, this policy would have profoundly negative implications for the entire world economy.<br /><br />He cites the German secretary of state Ulrich Wilhelm, who, in a letter to the FT, argues that:<br /><br /><blockquote> “The key to correcting imbalances in the eurozone and restoring fiscal stability lies in raising the competitiveness of Europe as a whole. The more countries with current account deficits are able to increase their competitiveness, the easier they will find it to decrease their public and foreign trade deficits. A less stability-oriented policy in Germany would damage the eurozone as a whole.”</blockquote><br />This worries Wolf, who argues that Mr Wilhelm is inviting everybody to join a zero-sum world of beggar-my-neighbour policies in which every country tries to grab market share from the rest (strange how all of this sounds very similar to the way things wound up back in the 1930's, now isn't it?). As he suggests, at a time of generalised global weakness, this is a self-defeating recommendation for both the eurozone and the world. If we take a look at Japanese exports, which after an initial surge, <a href="http://www.ft.com/cms/s/0/9e38ad40-36f1-11df-bc0f-00144feabdc0.html">are basically now near enough to being stationary</a>, it is obvious that deficient aggregate demand in Europe is now part of the problem:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhU0iy3mzFs7Ci4NKiPeIgdOCqVXdYCEnJNsbDWUAPRTKTH6RHmnFoAzPp0RV5di9m2PEA3ZsuwF5SL4r_cUb8aE94vA5Otu6q1BAkrtvEo-u6c98MBG9F9xrr5zfqQcAxoPUbZs2Gv0aA/s1600/japan+exports+EU.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 257px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhU0iy3mzFs7Ci4NKiPeIgdOCqVXdYCEnJNsbDWUAPRTKTH6RHmnFoAzPp0RV5di9m2PEA3ZsuwF5SL4r_cUb8aE94vA5Otu6q1BAkrtvEo-u6c98MBG9F9xrr5zfqQcAxoPUbZs2Gv0aA/s400/japan+exports+EU.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5452168943690419810" /></a><br /><br />And obviously with all the fiscal pruning and "good housekeeping" we are now about to see, this problem is set to get worse, not better. Being well apprised of the problem Wolf then goes on to put forward an alternative:<br /><blockquote>"An alternative solution might be to help the world absorb larger export surpluses from the eurozone, the US, Japan and the UK. True, no sustainable exit from the present quagmire can be envisaged without increased net capital flows into emerging countries. It also seems evident that this is where the world’s surplus savings ought to end up. But it is going to take time and much reform to make this happen."</blockquote><br />Really, I entirely agree, but a quantum leap in thinking is necessary here. If the books are to balance - and if we want growth and pensions in the OECD then they have to - what we need to do is help cheaper finance reach those countries with capacities to grow and absorb others exports, while the EU takes on in-house responsibility for sorting out the financing (but not necessarily the disciplining) of its own members. That is, if cheap loans need to be provided to anybody it is to those in need in the Emerging Countries, and not to Europeans who have happily spent their own way into difficulty.<br /><br />In fact, <a href="http://fistfulofeuros.net/afoe/economics-and-demography/ten-new-year-questions-for-paul-krugman/">in my New Year questions to Paul Krugman</a> I raised some sort of similar point, but unfortunately his response was not exactly positive.<br /><br />E.H.: One of the standard pieces of economic observation about countries recovering from financial crises is that their recoveries are export driven. This has now almost attained the status of a stylised fact. But as you starkly ask, at a time when the financial crisis is generalised across all developed economies - whether because those who borrowed the money now have difficulty paying back, or those who leant it now struggle to recover the money owed them - to which new planet are we all going to export? Maybe we don’t need to look so far afield. Many developing economies badly need cheap and responsible credit lines, and access to state-of-the-art technologies. Do you think there is room for some sort of New Marshall Plan initiative, to generate a win-win dynamic for all of us?<br /><br />P.K.: Um, no. Not realistically as a political matter. We’ll be lucky if we can get the surplus developing countries to spend on themselves. My guess is that our best hope for recovery lies in environmental investment: taking on climate change could, in terms of the macroeconomic impact, be the functional equivalent of a major new technology.<br /><br />So the solution to our problems is not politically realistic. And meantime we keep trying to play around with policies which simply won't work. It is now pretty clear to me at least just how so much valuable time was lost back in the 1930s, thrashing around playing with solutions which didn't, and wouldn't, work. As Krugman himself likes to say, "history has a habit of repeating itself, the first time as tragedy, and the second time as yet another tragedy".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-35067605503580295692010-03-16T03:26:00.000-07:002010-03-16T03:31:35.563-07:00Waiting For Something To Turn Up: Europe's Looming Pensions-based Sovereign Debt CrisisAs Irwin Stelzer argued <a href="http://online.wsj.com/article/SB10001424052748703915204575103310374127910.html">in a recent opinion article in the Wall Street Journal</a>, Spain’s Prime Minister José Luis Rodríguez Zapatero seems to be an admirer of Charles Dickens's character Mr. Micawber. When asked what he plans to do about Spain’s 11.4% fiscal deficit, first he promises to extend the retirement age, only to later tell us the measure may not be necessary. Then he promises a public-sector wage freeze, only to have his Economy Minister, Elena Salgado, say he really doesn't mean exactly what he seems to say. And in any event, we shouldn’t worry too much, since given that Spain is a serious country, somehow or other the fiscal deficit will be cut to 3% by 2013, even though most serious analysts consider the economic growth numbers on which the budget plans are based to have their origins more in the dreams of an Alice long lost in Wonderland than in any kind of sobre analysis of real possibilities. "We do have a plan," deputy prime minister, Maria Teresa Fernandez de la Vega assures us, but to many that plan now seems to be little better than hoping, like the proverbial Mr. Micawber, that "something will turn up."<br /><br />The lastest to draw attention, to the problematic nature of this "wait and see" approach - and to the gaping hole which is now yawning in Spain’s national balance sheet - is the credit ratings agency Fitch, who only last week warned that many Western governments now face unsustainable debt dynamics following measures taken to address the financial crisis.<br /><br />The agency singled out Britain, France and Spain as being in special and urgent need of outlining plans to strengthen their public finances if they don’t want to risk losing their current highly prized AAA ranking.<br /><br />This strong and direct warning <a href="http://www.marketwatch.com/story/fitch-says-uk-fiscal-consolidation-too-slow-2010-03-09?reflink=MW_news_stmp">was issued by Brian Coulton, Head of Global Economics at Fitch</a>, who said "High-grade sovereign governments need to articulate more credible and stronger fiscal consolidation plans during the course of 2010 to underpin confidence in the sustainability of public finances over the medium-term and their commitment to low and stable inflation. The UK, Spain and France in particular must outline more credible fiscal consolidation programmes over the coming year given the pace of fiscal deterioration and the budgetary challenges they face in stabilising public debt."<br /><br />Yet, while criticising Portugal's gradual approach to fiscal consolidation as a matter of "concern" Fitch senior director Paul Rawkins also argued that the Spanish govenment had acted swiftly in announcing plans to consolidate public finances. Nonetheless he did still warn that the economic risks facing Spain remain very high, especially since the pace of decline in tax revenues is dramatic enough to be preoccupying, while continuing “labour market inflexibilities could well prolong the economic adjustment”.<br /><br />The current problem facing Spain (and other similarly affected countries) has its roots in two quite distinct sources. In the first place measures taken to counteract the impact of the financial crisis have been inadequate and have simply produced large short term deficits. However to this short term liquidity and adjustment problem must now be added the further dimension of longer term impacts on public finances which have their origins lie in ageing populations, and the effect on economic growth of having older and smaller working-age populations.<br /><br /><br />Regarding the first, as Willem Buiter, now chief economist at Citi has pointed out, more than 40 per cent of global GDP is currently being produced in countries (overwhelmingly advanced economies) running fiscal deficits of 10 per cent of GDP or more. Over most of the last 30 years, this level fluctuated in the 0-5 per cent range and was dominated by debt form emerging economies. So the crisis marks a watershed, from which there will likely be no turning back, and in many ways could not have come at a worse moment for those countries who still have to undertake substantial pension reform to put their nation finances on a solid footing when faced with the unprecedented ageing which lies ahead.<br /><br />Indeed, to take the Greek case, while the short term fiscal deficit has been the focus of most of the press attention, the longer term problem associated with the funding of Greek pensions far outweighs issues associated with the falsifying of national accounts in the early years of this century. A recent report by the European Commission found that Greek spending on pensions and health care for its ageing population, if left unchecked, would soar from just over 20 percent of GDP today to around 37 percent of G.D.P. by 2060. And Greece is simply an early warning indicator of troubles to yet to come, in larger countries like Germany, France, Spain and Italy who have all relied for decades on pay as you go type state-financed pension schemes. Now, governments across Europe are being pressed to re-examine their commitments to providing generous pensions over extended retirements because fiscal issues associated with the downturn have suddenly pushed at least part of these previously hidden costs up to the surface.<br /><br />In fact, unfunded pension liabilities far outweigh the high levels of official sovereign debt. According to research by Jagadeesh Gokhale, an economist at the Cato Institute in Washington, bringing Greece’s pension obligations onto its balance sheet would show that the government’s debt is in reality equal to something like 875 percent of its gross domestic product. That would be the highest debt level in the 16-nation euro zone, and far above Greece’s official debt level of 113 percent. Other countries have obscured their total obligations as well. In France, where the official debt level is 76 percent of economic output, total debt rises to 549 percent once all of its current pension promises are taken into account. Similarly, in Germany, the current debt level of 69 percent would soar to 418 percent. Of course, these numbers are arguable, and may well be in the excessively high range, but the fact still remains: outstanding and unfunded liabilities are huge, and would have been difficult to honour even without the present crisis. As it is, we are now in danger of spending the seedcorn which could have been harvested later on down the road.<br /><br />Public opinion has yet to assimilate the seriousness of the issues involved here. As Pimco Chief Executive <a href="http://www.ft.com/cms/s/0/c8655bdc-2c78-11df-be45-00144feabdc0.html">Mohamed El-Erian said in a recent FT Opinion article</a>, the importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood. With time, this issue will prove to be highly consequential. The latest Fitch report is simply another warning shot. The sooner we all recognise the, the greater the probability of our being able to stay ahead of the disruptions this adjustment to reality will cause. It is time to stop simply waiting around to see what is going to turn up, since if we do continue like this we won’t like what we eventually find.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-45246459490700249502010-03-15T13:44:00.000-07:002010-03-15T13:47:07.594-07:00Serious Problems Emerge For The F-UK-De Group Of CountriesWell, I for one can't help thinking that it's now well time we all stopped getting carried away with the use of so many acronyms. Not only may one man's meat easily prove to be another's poison, it may even be that for some the entire meal will be so distasteful as to prove totally indigestable. And so it is with the latest set of proposals to appear on that diagnostic lab bench which has been hastily erected in the search for that magic "cure all" for the eurozone's many ills. <br /><br />Daniel Gros, in a well meaning, but I feel fatally flawed, move to get us all away from talking about some of the members of our own community as if they were PIGS, has decided to tell us that they are not pigs at all, <a href="http://www.ceps.be/book/adjustment-difficulties-gipsy-club">they are merely GIPSYs</a>. Of course, depending on which way you look at it, such forms of reference could be taken as a compliment ("you sure do eat like a pig"), or not, but stopping to think for a moment about the kind of controversy which has been provoked by the arrival of large numbers of Roma in Italy, perhaps telling the countries which lie on Europe's periphery that the best way to conceptualise them is as a bunch of "gitanos" is not the best way to get reasoned debate going. Nor is it necessarily the best way to do this to tell the members of core Europe that they as things stand they are essentially F-UK-De. But there it is. That's just how things are these days.<a name='more'></a><br /><br /><strong>A Fiscal Adjustment Alone Won't Work</strong><br /><br />Now, taking us back a bit nearer to that harsh and horrid reality, Daniel does in fact, in his ill-named Working Paper "<a href="http://www.ceps.be/book/adjustment-difficulties-gipsy-club">Adjustment Difficulties in the GIPSY Club</a>", actually get to the heart of some very important matters, and really I thoroughly recommend everyone to read it from start to finish. The core of Daniel's argument is, I feel, the extraordinarly obvious point that the kind of fiscal adjustment currently being proposed for some of the peripheral countries is going to have one, and only one immediate consequence: these countries are going to be sent off to the outer darkness of very, very (see his numbers) sharp GDP contractions, and these contractions run the risk of preciptating pre-Argentina 2000 type situations in one after another of the countries involved, since the contractions in nominal GDP are so large that they effectively take away with the one hand what was given (in the form of sacrfice) with the other, and will lead to a seemingly endless spiral of increases in the debt-to-GDP ratios, which will in turn lead to ever deeper short-term fiscal cuts, and ever stronger contractions, etc, etc.<br /><br />As Daniel argues, the only way to restore competitiveness, and avoid the dreaded Argentine spiral is to carry out some form of internal devaluation:<br /><br /><blockquote>"What can Greece do to escape the ‘Argentine’ vicious circle of higher risk premia and a worsening economic outlook? The only way to minimise the cost of the external and fiscal adjustments that are required to... make the situation sustainable is to make Greece more competitive and thus stimulate exports."<br /><br />"This can be achieved only by an across-the-board reduction of wages (or rather labour costs) in the private sector of between 10 and 20%. Cuts in wages of this order of magnitude will encounter fierce popular resistance. They could come about either at the end of an extremely painful process when unemployment has reached peaks never seen before or they could come much earlier as the result of an overarching national agreement in which the government, opposition parties and the social partners agree on what is needed in the light of present circumstances. Greece thus needs a concerted effort at the national level not just a government that pushes austerity measures through Parliament."</blockquote><br /><br /><br /><br /><strong>So Why Are The Other F-UK-De?</strong><br /><br />The problem is, conceptualising this situation as one group of fiscally derilict countries having to be controlled by another group of upright and competitive ones does not give us a complete picture of the mess we are all in, as Gideon Rachman eloquently argues in his <a href="http://blogs.ft.com/rachmanblog/2010/03/wolfgang-schaubles-torture-chamber/">Dr Schäuble's Torture Chamber post</a>:<br /><br /><blockquote>Behind the careful bureaucratic language, Schauble makes some amazing claims and proposals. Here are just a few.<br /><br />“All eurozone members must return to adherence to the stability and growth pact as rapidly as possible.” This is just hypocrisy. I was living in Brussels when the pact was gutted the first time - because Germany and France were unable to keep within the 3% deficit limit.<br /><br />Schauble also seems keen to resurrect the main feature that made the stability and growth pact lack credibility in the first place: the notion that countries that are running out of money need to be shocked back onto the path of virtue and prudence by being fined - a move that would obviously worsen their financial plight. </blockquote><br /><br />Basically, as Rachman argues, we all need to calm down a bit here, and get things rather more in persective. In the first place the Eurozone's economies - as I keep arguing day in and day out - are all roped together via the system of current account deficits and surpluses. <br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg8rYKHQs3Nzw9Hv6vSEZA06GFrTFCDkc-BpnJey5tUX6U0tV57ftcSS0eLHrCjH4EnAdncCdPows3YbJZJkgJrrUuRAfqelMo5M78pirv65jc7qqoWOD4uptX8OZEWQBelC0zeRh44Wu0y/s1600-h/Current+Account+Balances.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 239px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5448422279047477522" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg8rYKHQs3Nzw9Hv6vSEZA06GFrTFCDkc-BpnJey5tUX6U0tV57ftcSS0eLHrCjH4EnAdncCdPows3YbJZJkgJrrUuRAfqelMo5M78pirv65jc7qqoWOD4uptX8OZEWQBelC0zeRh44Wu0y/s400/Current+Account+Balances.png" /></a><br /><br />This is a point <a href="http://www.ft.com/cms/s/0/225bbcc4-2f82-11df-9153-00144feabdc0.html">France’s finance minister Christine Lagarde draws attention to in an interview in this morning's Financial Times</a>. As M. Lagarde says:<br /><blockquote>“[Could] those with surpluses do a little something? It takes two to tango,” she said in an interview with the Financial Times. “It cannot just be about enforcing deficit principles.”<br /><br />“Clearly Germany has done an awfully good job in the last 10 years or so, improving competitiveness, putting very high pressure on its labour costs. When you look at unit labour costs to Germany, they have done a tremendous job in that respect. I’m not sure it is a sustainable model for the long term and for the whole of the group. Clearly we need better convergence.”</blockquote><br /><br />Well, let's leave aside today the issue of whether or not convergence is a realitistic (or even a possible) objective for Europe's economies given the large demographic mis-matches between countries, but still, Lagarde is on to something. What we don't have is a situation where on the one hand we have everything for the best in the best of all possible worlds, while on the other we have a group of slouchers and forgers. This kind of thing makes for nice headlines, but it is far from corresponding to reality.<br /><br />Another reason the F-UK-De group are in trouble if the GIPSYs wander off to the outer darkness, is that they will have issues to resolve in their banking systems, as the chart below reveals. German banks may have little exposure to Greek debt, but their exposure to Spain and Ireland is enormous.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcoZAUaYigkzbjUi-akGqIWP7kA0UOQPeawaT_FHXgc0Uo09NZP2vSQXpcMYqX9Xxms98ZI4WPZZt3XJt_TOl-N-ChQudbs9mqI-FvpDkpd947Ja18Eruw0ka5D1Yr6RjJ-s3-p_RN6yV9/s1600-h/Europe's+Exposure+to+Peripheral+Banks.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 285px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5443266481047228082" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcoZAUaYigkzbjUi-akGqIWP7kA0UOQPeawaT_FHXgc0Uo09NZP2vSQXpcMYqX9Xxms98ZI4WPZZt3XJt_TOl-N-ChQudbs9mqI-FvpDkpd947Ja18Eruw0ka5D1Yr6RjJ-s3-p_RN6yV9/s400/Europe's+Exposure+to+Peripheral+Banks.png" /></a><br /><br />In fact, the massive exposure of German and French banks to Portugal, Ireland, Greece and Spain offers part of the explanation as to why Europe’s biggest economies have been steadily moving to rescue their southern neighbors in recent days, according to a recent report from Societe General entitled “Shotgun Greek Wedding.” According to the report banks in Germany and France alone have a combined exposure of $119 billion to Greece and $909 billion to the four countries, according to data from the Bank for International Settlements. Overall, European banks have $253 billion in Greece and $2.1 trillion in the four countries collectively referred to as the "PIGS".<br /><br /><blockquote>“The exposure is enormous,” said Klaus Baader, co-chief European economist at Societe Generale in London. “The crisis in Greece isn’t Greece’s problem alone but a concrete problem for Europe’s whole banking sector. That explains the interest of finance ministers in stabilizing the situation.”</blockquote><br /><br /><strong>Defining Moment?</strong><br /><br />Gideon Rachman admitted that this one felt like a significant moment to him, and I am inclined to agree. We have two proposals on the table, and neither of them will work. In the first place simply treating the problem on Europe's perifery as an essentially fiscal one will not return these countries to competitiveness, and will simply precipitate GDP contractions, and deflationary spirals, that will lead inexorably towards failure, defualt, and possibly exit from the Eurozone (which, in fact, Herr Schläuble seems to feel would be an acceptable outcome to all this). <br /><br />On the other hand, A Germany (or a Japan) which is not able to maintain a substantial external surplus (which is the only way a country with their kind of demographic profile can attain headline GDP growth, since internal demand is long gone as a "driver") since without a surplus and without GDP growth the implicit liabilities of ageing populations (via health and pension commitments) will become unpayable, leading to default (or a huge slashing of public welfare commitments) in these countries too.<br /><br />Wolfgang Munchau also seems to think it is decision time. As he argues in his Op-ed in today's FT, "<a href="http://www.ft.com/cms/s/0/3afdea12-2fd3-11df-9153-00144feabdc0.html">Shrink the eurozone, or create a fiscal union</a>". I know which side I am on. As Joaquín Almunia once argued, <a href="http://edwardhughtoo.blogspot.com/2009/03/almunia-syllogism.html">people would need to be crazy to leave the Eurozone</a>. So let's get on with it, and go climb that hill which lies out there in front of us.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2015165562401949306.post-81638232332374502672010-02-14T05:34:00.000-08:002010-02-14T05:37:37.188-08:00Just What Is The Real Level Of Government Debt In Europe?<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaskBizpLmj2y6njibIEcpKfP6JTF6s27yI1UqoMeCVVH8EqoF-l_bEK76XMleFpNmEPCdjpeTGB3AER9HoV0bMVgMlUqlAFmM44hknyDIvIgABYG4JiPAro1q0CCrEviOuIOMFr0Vo3vy/s1600-h/Botin.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 267px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaskBizpLmj2y6njibIEcpKfP6JTF6s27yI1UqoMeCVVH8EqoF-l_bEK76XMleFpNmEPCdjpeTGB3AER9HoV0bMVgMlUqlAFmM44hknyDIvIgABYG4JiPAro1q0CCrEviOuIOMFr0Vo3vy/s400/Botin.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5438085487868523106" /></a><br /><br />“If you don’t fully understand an instrument, don’t buy it.”<br /><br />To the above advice from Emilio Botín, Executive Chairman of Spain’s Grupo Santander, I would simply add one small rider: Don’t sell it either, especially if you are a national government trying to structure your country’s debt.<br /><br />In <a href="http://www.nytimes.com/2010/02/14/business/global/14debt.html?pagewanted=1">a fascinating article in today's New York Times</a>, journalists Louise Story, Landon Thomas and Nelson Schwartz begin to recount the mirky story of just how the major US investment banks have been able to earn considerable sums of money effectively helping European governments to disguise their growing mountain of public debt.<br /><blockquote>Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts. <br /><br />As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels. <br /><br />Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.</blockquote><br /><br />In fact, concerns about what it is exactly Goldman Sachs have been up to in Greece are not new, and the Financial Times have been pusuing this story for some time, in particular in connection with the investment bank's <a href="http://www.ft.com/cms/s/0/53bbbd40-0c42-11df-8b81-00144feabdc0.html">ill fated attempt to persuade the Chinese to buy Greek government debt</a> (and <a href="http://ftalphaville.ft.com/blog/2010/02/09/145201/goldmans-trojan-greek-currency-swap/">here</a>, and <a href="http://www.zerohedge.com/article/ever-increasing-parallels-between-aig-and-greece-and-cds-puppetmaster-behind-it-all">here</a>). Nor is the fact that the Greek government resorted to sophistocated financial instruments to cover its tracks exactly breaking news, since I (among others) have been writing about this topic since the middle of January - <a href="http://greekeconomy.blogspot.com/2010/01/does-anyone-really-know-size-of-greek.html">Does Anyone Really Know The Size Of The Greek 2009 Deficit?</a> - following the arrival in my inbox of a leaked copy of the report the Greek Finance Minister sent to the EU Commission detailing the issues. <br /><br />What is new in today's report from the NYT team is the extent to which they identify the problem as a much more general one, involving more banks and more countries, since "Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere". I very strongly suggest that our NYT stalwarts take a long hard look at what has been going on in Spain, and especially at the Autonomous Community level.<br /><br />So the question naturally arises, just how much in debt are our governments, really? As the NYT team point out, Eurostat has long been grappling with this matter, and as far back as 2002 they found themselves forced to change their accounting rules, in order to try to enforce the disclosure of many off-balance sheet entities that had previously escaped detection by the EU, since up to that point the transactions involved had been classified as asset "sales", often of public buildings and the like. Following advice paid for from the best of investment banks many European governments simply responded to the rule change by reformulating their suspect deals as loans rather than outright sales. As we say in Spain "hecha la ley, hecha la trampa" (or in English, when you close one loophole you open another). According to the NYT authors:<br /><br />"As recently as 2008, Eurostat.... reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”"<br /><br />So just what is all the fuss about. Well, in plain and simple terms it is about an accounting item known as "receivables". Now, <a href="http://en.wikipedia.org/wiki/Accounts_receivable">according to the Wikipedia entry</a>:<br /><br /><blockquote>"Accounts receivable (A/R) is one of a series of accounting transactions dealing with the billing of a customers for goods and services received by the customers. In most business entities this is typically done by generating an invoice and mailing or electronically delivering it to the customer, who in turn must pay it within an established timeframe called credit or payment terms."</blockquote><br /><br />However, as <a href="http://en.wikipedia.org/wiki/Factoring_(finance)">we can learn from another Wikpedia entry</a>, often the use of "accounts receivable" constitutes a form of factoring, and this is where the problems Eurostat are concerned about actually start:<br /><br /><blockquote>Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.</blockquote><br /><br />But how does all this work in practice? Well, the World Wide Web is a wonderful thing, since you have so much information near to hand, at just the twitch of a fingertip. <a href="http://www.john-laing.co.uk/pfi_ppp/948.htm">Here is a useful description of what are known as PPI/PFI schemes</a>, from UK building contractor John Laing:<br /><blockquote>A Public Private Partnership (PPP) is an umbrella term for Government schemes involving the private business sector in public sector projects. <br /><br />The Private Finance Initiative (PFI) is a form of PPP developed by the Government in which the public and private sectors join to design, build or refurbish, finance and operate (DBFO) new or improved facilities and services to the general public. Under the most common form of PFI, a private sector provider like John Laing will, <strong>through a Special Purpose Company (SPC)</strong>, hold a DBFO contract for facilities such as hospitals, schools, and roads according to specifications provided by public sector departments. Over a typical period of 25-30 years, <strong>the private sector provider is paid an agreed monthly (or unitary) fee by the relevant public body</strong> (such as a Local Council or a Health Trust) for the use of the asset(s), which at that time is owned by the PFI provider. This and other income enables the repayment of the senior debt over the concession length. (Senior debt is the major source of funding, typically 90% of the required capital, provided by banks or bond finance). Asset ownership usually returns to the public body at the end of the concession. In this manner, <strong>improvements to public services can be made without upfront public sector funds</strong>; and while under contract, the risks associated with such huge capital commitments are shared between parties, allocated appropriately to those best able to manage each one.</blockquote><br /><br />And for those still in the dark, <a href="http://en.wikipedia.org/wiki/Private_finance_initiative">Wikipedia just one more time comes to the rescue</a>:<br /><br /><blockquote>The private finance initiative (PFI) is a method to provide financial support for "public-private partnerships" (PPPs) between the public and private sectors. Developed initially by the Australian and United Kingdom governments, PFI has now also been adopted (under various guises) in Canada, the Czech Republic, Finland, France, India, Ireland, Israel, Japan, Malaysia, the Netherlands, Norway, Portugal, Singapore, and the United States (amongst others) as part of a wider program for privatization and deregulation driven by corporations, national governments, and international bodies such as the World Trade Organization, International Monetary Fund, and World Bank.<br /><br />PFI contracts are currently off-balance-sheet, meaning that they do not show up as part of the national debt as measured by government statistics such as the Public Sector Borrowing Requirement (PSBR). The technical reason for this is that the government authority taking out the PFI contract pays a single charge (the 'Unitary Charge') for both the initial capital spend and the on-going maintenance and operation costs. This means that the entire contract is classed as revenue spending rather than capital spending. As a result neither the capital spend nor the long-term revenue obligation appears on the government's balance sheet. Were the total PFI liability to be shown on the UK balance sheet it would greatly increase the UK national debt.</blockquote><br /><br />And here are two more examples of what is involved which were brought to light by a quick Google. First of all, the case of Italian health payments. Now according to analysts Patrizio Messina and Alessia Denaro, <a href="http://www.orrick.com/fileupload/753.pdf">in this report I found online from Financial Consultants Orrick</a>:<br /><br /><blockquote>In the last years many structured finance transactions (either securitisation transactions or asset finance transactions) have been structured in relation to the so called healthcare receivables.The reasons are several. On one side, the providers of healthcare goods and services usually are not paid in time by the relevant healthcare authorities and therefore, in order to gain liquidity, usually assign their receivables toward the healthcare authorities. On the other side, due to the recent legislation that provides for very high interest rates on late payments, the debtors as well as banks and other investors have had the same and opposite interest on carrying out different kind of transactions. In this brief article we will analyse, after a quick description of the Italian healthcare system, some of the different structures that have been used in relation to transactions concerning healthcare receivables and, in particular, we will focus on transactions concerning the so called “raw receivables”, which are lately increasing in the Italian market practice, by analysing the legal means through which it is possible to ascertain/recover such receivables.</blockquote><br /><br />This system thus has two advantages (apart from the fact that it effectively hides debt). In the first place the healthcare providers gain liquidity in order to continue to run hospitals, pay doctors, etc, while those who effectively intermediate the transaction earn very high interest rates for their efforts, interest payments which have to be deducted from next years health care provision, and so on. <br /> <br />As the Orrick report points out, Italy’s national healthcare service (servizio sanitarionazionale, “nhs”) is regulated by the legislative decree of December 30, 1992, no. 502 (“decree 502/92”).The reform introduced by decree 502/92, as amended from time to time, provides for a three-tier system for the healthcare service, as outlined below: State level The central government provides a national legislation limited to very general features of the NHS and decides the funds to be allocated to the single regions according to specific criteria (density of population, etc.) for the NHS. <br /><br />As the Orrick analysts note: "the Healthcare Authorities usually pay the relevant Providers with a certain delay".<br /><blockquote>Usually, when healthcare funds are allocated, in the national provisional budget, the central government underestimates the amount of healthcare expenditure. Since the central government does not provide regions with enough funds, regions are not able to provide enough funds to Healthcare Authorities, and payments to the Providers are delayed. Since the Providers need liquidity, they usually assign their receivables toward the Healthcare Authorities. To deal with all the above issues, Italian market practice has been developing an alternative system of financing through securitisation and asset finance transactions of Healthcare Receivables.</blockquote><br /><br />As the analysts finally conclude:<br /><br /><blockquote>Despite of the risks concerning the judicial proceedings, Italian market players are still very interested on carrying on securitisation transaction on this kind of asset, <strong>principally because Legislative Decree no. 231/02 provides for very high interest rates on late payments</strong> (equal to the interest rate applied by ECB plus 7%) - my emphasis</blockquote><br /><br />Another technique Eurostat have identified as a means of concealing debt relates to the recording of military equipment expenditure, <a href="http://www.defense-aerospace.com/article-view/feature/67285/bureaucrat's-delight:-eu-rules-on-military-leases.html">as described in this report I found dating from 2006</a>. At the time Eurostat were worried about the growing provision of military equipment under leasing agreements. Basically they decided that such provision was debt accumulable.<br /><blockquote>Eurostat has decided that leases of military equipment organised by the private sector should be considered as financial leases, and not as operating leases. This supposes recording an acquisition of equipment by the government and the incurrence of a government liability to the lessor. Thus there is an impact on government deficit and debt at the time that the equipment is put at the disposal of the military authorities, and not at the time of payments on the lease. Those payments are then assimilated as debt servicing, with a part recorded as interest and the remainder as a financial transaction.</blockquote><br /><br />However, a loophole was found in the case of long term equipment purchases:<br /><br /><br /><blockquote><br />Military equipment contracts often involve the gradual delivery over many years of a number of the same or similar pieces of equipment, such as aircraft or armoured vehicles, or including significant service components, such as training. Moreover, in the case of complex systems, it is frequently the case that some completion tasks need to be performed for the equipment to be operational at full potential capacity. Some military programmes are based on the combination of several kinds of equipment that may be completed in different periods, so that the expenditure may be spread over several fiscal years before the system, globally considered, becomes fully operational. <br /><br />In cases of long-term contracts where deliveries of identical items are staged over a long period of time, or where payments cover the provision of both goods and services, government expenditure should be recorded at the time of the actual delivery of each independent part of the equipment, or of the provision of service. </blockquote><br /><br />Payment for such items are only to be classifed as debt at the time of registering the actual delivery, which may explain why, if my information is correct, the Greek military as of last December were still officially "testing" two submarines which had been provided by German contractors, since final delivery had still to be formally registered, and the debt accounted.<br /><br />A lot of information about the kind of things which were going on before the 2006 rule change can be found <a href="http://www.europlace.net/paris06/p9-charlotte_lavit_d_hautefort.pdf">in this online presentation from Europlace Financial Forum</a>. Here are some examples of private/public sector cooperation in Italy.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifo05JYS42wsTTeQNbPk4yS3LCqR9hHbs9OSzQElV0LX_fSnldf1DvgcgmWo3feptMnNCqf-2XrYKX0aDt_wsoMohMdEQM28MfAZ-UXqTI0xd8zEOMniE__bnjgS7iLId62GzMvLNZpgdm/s1600-h/Italy+receivables.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 300px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5438045860714137330" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifo05JYS42wsTTeQNbPk4yS3LCqR9hHbs9OSzQElV0LX_fSnldf1DvgcgmWo3feptMnNCqf-2XrYKX0aDt_wsoMohMdEQM28MfAZ-UXqTI0xd8zEOMniE__bnjgS7iLId62GzMvLNZpgdm/s400/Italy+receivables.png" /></a><br /> <br />And here's a chart showing a list of advantages and possible applications:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSKuh8AkWdv4k3fu7Xvk6WkDPVKQnbfMIuGOXvq_8QNLdt6d-nn7ODwKDS852DGASXxhJ_VKyc41SJCjmgpSGgM1xbiXvndruWDGB1t5fqrHrSr-2dZYmaUxxm7KlQwly-RA_1y-fXYdQZ/s1600-h/Receivable+projects.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 298px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSKuh8AkWdv4k3fu7Xvk6WkDPVKQnbfMIuGOXvq_8QNLdt6d-nn7ODwKDS852DGASXxhJ_VKyc41SJCjmgpSGgM1xbiXvndruWDGB1t5fqrHrSr-2dZYmaUxxm7KlQwly-RA_1y-fXYdQZ/s400/Receivable+projects.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5438046932968852178" /></a><br /><br />Now, at the end of the day, you may ask "what is wrong with all of this"? Well quite simply, like Residential Mortgage Backed Securities these are instruments that work while they work, and cause a lot of additional headaches when they don't. I can think of three reasons why debt aquired in this way in the past may now be problematic.<br /><br />a) they assume a certain level of headline GDP growth to furnish revenue growth to the public agencies committed to making the payments. Following the crisis these previous levels of assumed growth are now unlikely to be realised.<br />b) they assume growing workforces and working age populations, but both these, as we know, are now likely to start declining in many European countries.<br />c) they assume unchanging dependency ratios between active and dependent populations, but these assumptions, as we also already know, are no longer valid, as our population pyramids steadily invert.<br /><br />Given all this, a very real danger exists that what were previously considered as obscure securitisation instruments, so obscure that few politicians really understood their implications, and few citizens actually knew of their existence, can suddenly find themselves converted into little better than a glorified Ponzi scheme.<br /><br />And if you want one very concrete example of how unsustainable debt accumulation can lead to problems, you could try reading <a href="http://www.laverdad.es/murcia/v/20100214/region/indigencia-municipal-20100214.html">this report in the Spanish newspaper La Verdad</a> (Spanish, but Google translate if you are interested), where they recount the problems being faced by many Spanish local authorities who are now running out of money, in this case it the village of San Javier they have until the 24 February to pay a debt of 350,000 euros, or the electricity will simply be cut off! The article also details how many other municipalities are having increasing difficulty in paying their employees. And this is just in one region (Murcia), but the problem is much more general, as Spain's heavily overindebted local authorities and autonomous communities steadily grind to a halt.Unknownnoreply@blogger.com0