The Greek finance minister European tour of charm has some reasonable ideas in terms of financial engineering. Unfortunately, adjustment is about operational restructuring and only when this has been agreed should the financial engineering solution be designed. I will explain why through two stories.
First the micro story: imagine that Greece is a large corporation running three different businesses. The first business has a good customer basis (e.g. healthcare) but low profits because of over manning. The second has a very long payback period (e.g. infrastructure) and will only turn a profit after a decade. The third is a loss making business (e.g. corporate welfare) with a bleak outlook in terms of future returns. Overall, the company is heavily indebted and runs at a small profit or loss.
Let us consider three restructuring options: a) close down business 3, sell business 2 and use proceeds to refinance business 1; b) refinance existing debt, declare a wage cut for all businesses, stop any further investments in business 2 and reorganize business 3; and c) draw some idealistic reorganization plans and try to convince the creditors that it can only repay them by investing more in the three businesses.
Restructuring plan a) is what a private sector company might do. It would not be the most efficient, because it would not solve the over manning and would jeopardise its service quality and client base. It would continue a lousy business but generating enough cash to keep the creditors happy.
Plan b) is what one may call a restructuring a la Troika. It would ease the financial pressure in the short term but would not improve any of the businesses. Business 3 would still run at a loss and businesses 2 and 1 would deteriorate in both quality and customer base.
Plan c) we may call it a wishful thinking Syriza plan. If “romantic” creditors bought it, they would only throw good money after bad money. The promised growth, even if it happens, will not be enough or sustainable and will only last as long credit keeps flowing in.
Now for the macro story. Of course, if restructuring was done along private sector lines (option 1) the company will not need to worry much about what would happen to businesses 3 and 2, since business 1 was small in relation to the rest of the economy. However, this a fundamental difference in relation to Greece. The country as a whole could not ignore the macro consequences of plan 1, because aggregate demand would reduce significantly causing economic decline instead of growth with a consequent rise in unemployment. So, what could the central bank and budgetary authorities do to minimize such effects?
If they had their own currency (which Greece no longer has), they could devalue it to ensure that real (not nominal) wages would decline making the country as a whole more competitive and hope that the unemployed would quickly get a new job in the export oriented industries. This could be supplemented by printing money, retraining and many other supply side measures. Whether this was enough is not relevant because Greece wants to remain in the Euro and the ECB cannot manage the Euro to meet the needs of Greece. Moreover, Greece is indeed the heavily indebted company and would need extra credit to finance such measures, credit that she no longer may create and has difficulty to obtain in the financial markets.
As expected, see my 2011 post, plan b) has already failed with dramatic declines in GDP and employment. Plan c) could ease the current social disaster in the short run but would make the current imbalances much worse, by compounding over manning across all businesses, perpetuating loss making businesses and government mismanagement.
So, which macro policies can be implemented to emulate a better private sector restructuring plan compatible with economic growth? Basically by providing extra funding and refinancing based on strict conditionality to impose a modified private restructuring plan.
These modifications should involve a mandatory reduction of over manning in the surviving businesses 1 and 2. All redundant workers should be paid a temporary unemployment benefit plus grants to promote labour mobility and the creation of self-employment businesses. The business sector 2 should be capitalized and progressively privatized to maintain a minimum level of investment on a selective basis (only for projects with a short payback period or export orientation). Internal devaluation should be achieved by longer working hours paid in non-negotiable long term government bonds. The fiscal and welfare systems should be entirely revamped and simplified to eradicate tax evasion, free riding and corruption.
As long as conditionality forces the Greeks to use their well-known creativity in the right direction, instead of accounting and fiscal tricks, they will come up with many other ideas and we do not need to enter into further details here.
What Greece, Europe and its creditors cannot afford is to let the Greeks deviate from following a private sector type of restructuring. Without such conditionality, any moratoria, debt swaps, special funds and other types of financial engineering are a waste of money.
Otherwise, everyone risks being caught into a loose-loose dispute between Syriza’s loony left agenda and the Troika’s austerity fairy tale that self-flagellation creates by itself an invigorated economy.
Showing posts with label Greece. Show all posts
Showing posts with label Greece. Show all posts
Wednesday, 4 February 2015
Tuesday, 27 January 2015
More on Greece: Krugman’s utopia or folly?
Nobel Laureate Paul Krugman’s case for reducing Greece’s debt service so that she no longer needs to run a large budget surplus is the following: “Suppose that the multiplier is 1.3 — which is what IMF estimates seem to suggest — and that Greece can collect 40 percent of a rise in GDP in revenue (roughly matching its average revenue/GDP). Then an additional billion euros in spending should generate around 0.5 billion euros in revenue, reducing the primary surplus by only 0.5 billion euros”.
However, his back-of-the-envelope calculation is based on an unfounded optimism about the public spending multiplier. I know that he knows that the multiplier effects of spending (public or private) are reduced through import and saving leakages. But, what he (and other optimists) usually miss is that such leakages are extremely dependent on the confidence about the spending policies being implemented.
For instance, if Greek politicians are not credible the multiplier could suddenly reduce to 0.5 and the primary surplus would be reduced by 0.8 billion euros. Or, even worse, if the ruling party is seen as revolutionary, as is the case with Syriza, the leakages may even turn the multiplier into negative values (e.g. -0.5), in which case the primary surplus reduction would be 1.2 billion euros and the current surplus would quickly vanish and destroy any lenders’ willingness to refinance the current debt level ad aeternum.
Indeed, without their own currency, capital controls and the possibility of imposing trade barriers, the leakage through imports is inevitable. Likewise the fear of the radical Syriza policies will accelerate capital flight which is a form of “hoarding”. Moreover, an unexperienced left wing political coalition is usually the most fertile ground for corruption and mismanagement which again act as a form of “hoarding”. In a country already plagued by a culture of corruption, a change towards a “loony left” will only exacerbate the problem.
In conclusion, Krugman’s call to give more importance to debt flows than debt stocks is not a folly, but in Greece’s circumstances it is certainly utopia. So the European countries should only agree to more public spending if Syriza passes a test of political responsibility and can be tied up to a properly designed adjustment program (not the ones implemented in the past by the Troika).
However, his back-of-the-envelope calculation is based on an unfounded optimism about the public spending multiplier. I know that he knows that the multiplier effects of spending (public or private) are reduced through import and saving leakages. But, what he (and other optimists) usually miss is that such leakages are extremely dependent on the confidence about the spending policies being implemented.
For instance, if Greek politicians are not credible the multiplier could suddenly reduce to 0.5 and the primary surplus would be reduced by 0.8 billion euros. Or, even worse, if the ruling party is seen as revolutionary, as is the case with Syriza, the leakages may even turn the multiplier into negative values (e.g. -0.5), in which case the primary surplus reduction would be 1.2 billion euros and the current surplus would quickly vanish and destroy any lenders’ willingness to refinance the current debt level ad aeternum.
Indeed, without their own currency, capital controls and the possibility of imposing trade barriers, the leakage through imports is inevitable. Likewise the fear of the radical Syriza policies will accelerate capital flight which is a form of “hoarding”. Moreover, an unexperienced left wing political coalition is usually the most fertile ground for corruption and mismanagement which again act as a form of “hoarding”. In a country already plagued by a culture of corruption, a change towards a “loony left” will only exacerbate the problem.
In conclusion, Krugman’s call to give more importance to debt flows than debt stocks is not a folly, but in Greece’s circumstances it is certainly utopia. So the European countries should only agree to more public spending if Syriza passes a test of political responsibility and can be tied up to a properly designed adjustment program (not the ones implemented in the past by the Troika).
Monday, 26 January 2015
The lesser evil for Greece and Europe
By electing the Syriza party, the Greeks in despair have turned what was an untenable situation into a nightmare scenario, perhaps hoping to force some kind of way out from the present situation.
What are in fact the Greek options? Using my academic hat I will put them bluntly and leave to others the task of dressing them in politically correct language. The options are basically three.
The first is that once in power, Tsipras and other radical leaders in the coalition will become realists and will not rock the boat. The second is that he will try to implement his political and economic agenda and will end up in mayhem and forced out of the Euro, or, in a worst case scenario, exit the EU and fall back into dictatorship. The third option is that he will declare a moratorium or some other form of debt default and will end up being bailed out again by the Troika.
There are several international experiences we may use as an analogy for each scenario.
The “get real” hypothesis has two versions: a) the FT hope that Tsipras becomes a Lula da Silva rather than a Hugo Chaves; and, b) Krugman’s (socialist) wishful thinking that the sudden abandonment of austerity will revive the Greek economy and the political mess will disappear. Both are very unlikely. The first, because the ideological base of Tsipras is fundamentally different from that of the Lula’s party in Brazil and the financial situation is much worse in Greece. The second ignores that the moderate socialist left has been almost wiped out of the political map and replaced by radicals without previous government experience.
The “mayhem and Euro exit” scenario is the most dangerous for Greece and Europe, if one judges from historical precedents such as the Cuban revolution or the rise of Nazism in Germany. One should not forget that it was economic anarchy, national humiliation, anti-Semitism and the fear of communism that led the Germans to vote Hitler into power. The fact that Syriza has chosen as coalition partner a nationalistic anti-Semite party and left-wing leaders in Southern Europe are increasingly endorsing anti-Semitism under the guise of pro-Palestinian support, creates an environment favorable to the Greek Golden Dawn neo-Nazi party which came third in the election.
The “new debt restructuring and new bailout” is the lesser of the three evils. In practice it means that the Troika needs to develop a new financing mechanism to lend Greece the money they need to repay their debt. This way of preventing a formal write-off of loans from international financial institutions, which enjoy preferred creditor status, has been used by the World Bank through AID lending and by the IMF through the HIPC/MDRI and PRGT Initiatives. Two countries with recently overdue repayments to the IMF were Zimbabwe and Argentina. Both with left-leaning, populist leaders who decided to challenge the international lenders. The results have been years of economic decline and rampant corruption. So, Greece, a country already rigged by alarming levels of corruption, might follow their path. However, for the good of Greece, one should hope that Tsipras will be more like Cristina Kirchner than Robert Mugabe.
To close this rather bleak outlook, I must address the question on whether there are no solutions for the Greek problem. Yes, there are. And I have written about some of them in other posts (e.g. here and here) in 2011, at the start of the Southern European crisis.
However, I do not foresee a possibility that someone will endorse them before the Greek electorates gets disillusioned with the new utopia, votes for more reliable politicians and the EU leaders reconsider their austerity bias. I hope that time will prove me wrong.
What are in fact the Greek options? Using my academic hat I will put them bluntly and leave to others the task of dressing them in politically correct language. The options are basically three.
The first is that once in power, Tsipras and other radical leaders in the coalition will become realists and will not rock the boat. The second is that he will try to implement his political and economic agenda and will end up in mayhem and forced out of the Euro, or, in a worst case scenario, exit the EU and fall back into dictatorship. The third option is that he will declare a moratorium or some other form of debt default and will end up being bailed out again by the Troika.
There are several international experiences we may use as an analogy for each scenario.
The “get real” hypothesis has two versions: a) the FT hope that Tsipras becomes a Lula da Silva rather than a Hugo Chaves; and, b) Krugman’s (socialist) wishful thinking that the sudden abandonment of austerity will revive the Greek economy and the political mess will disappear. Both are very unlikely. The first, because the ideological base of Tsipras is fundamentally different from that of the Lula’s party in Brazil and the financial situation is much worse in Greece. The second ignores that the moderate socialist left has been almost wiped out of the political map and replaced by radicals without previous government experience.
The “mayhem and Euro exit” scenario is the most dangerous for Greece and Europe, if one judges from historical precedents such as the Cuban revolution or the rise of Nazism in Germany. One should not forget that it was economic anarchy, national humiliation, anti-Semitism and the fear of communism that led the Germans to vote Hitler into power. The fact that Syriza has chosen as coalition partner a nationalistic anti-Semite party and left-wing leaders in Southern Europe are increasingly endorsing anti-Semitism under the guise of pro-Palestinian support, creates an environment favorable to the Greek Golden Dawn neo-Nazi party which came third in the election.
The “new debt restructuring and new bailout” is the lesser of the three evils. In practice it means that the Troika needs to develop a new financing mechanism to lend Greece the money they need to repay their debt. This way of preventing a formal write-off of loans from international financial institutions, which enjoy preferred creditor status, has been used by the World Bank through AID lending and by the IMF through the HIPC/MDRI and PRGT Initiatives. Two countries with recently overdue repayments to the IMF were Zimbabwe and Argentina. Both with left-leaning, populist leaders who decided to challenge the international lenders. The results have been years of economic decline and rampant corruption. So, Greece, a country already rigged by alarming levels of corruption, might follow their path. However, for the good of Greece, one should hope that Tsipras will be more like Cristina Kirchner than Robert Mugabe.
To close this rather bleak outlook, I must address the question on whether there are no solutions for the Greek problem. Yes, there are. And I have written about some of them in other posts (e.g. here and here) in 2011, at the start of the Southern European crisis.
However, I do not foresee a possibility that someone will endorse them before the Greek electorates gets disillusioned with the new utopia, votes for more reliable politicians and the EU leaders reconsider their austerity bias. I hope that time will prove me wrong.
Saturday, 3 November 2012
Why the IMF therapy is not working in Portugal
The IMF repeats in Portugal the ostrich policy of not recognizing what is fundamentally wrong with its adjustment approach in the Euro Area. In its 5th review of the Portuguese program it states that “authorities have made good progress in reducing macroeconomic imbalances … But after a strong start, the program has entered a more challenging phase … a large and durable fiscal gap has emerged due to a shift in the composition of output from domestic demand to less-taxed net-exports”.
Despite the initial Portuguese external disequilibrium being milder than the Greek or Irish, I anticipated that the program was likely to fail because it had been undertaken reluctantly, too late, with too little and it was too soft. Moreover, its management was weak, incompetent and erratic partly because the Troika was desperate to have a success story and it had in Portugal a Finance Minister – Victor Gaspar – that was seen as one of their men. So, all tough measures (e.g. reducing the number of municipalities and monopolistic rents) were abandoned or reversed. For instance, fiscal consolidation which was to be implemented by 2/3 of expenditure cuts and 1/3 of revenue measures failed completely with the expenditure hardly slowing down and the revenue collapsing.
By now the IMF had to agree to extend its program for one more year and to grant some waivers, while it is already busy working on another package that will inevitably result on more time and more money. This will only raise the Portuguese external debt to new heights without any visible improvement in its economic growth.
Just as a reminder, note that the Greek debt path under IMF management, which started in May 2010 with a general government debt equivalent to 115% of GDP and was supposed to peak in 2012 at 149%, at the start of the second IMF bailout in June 2012 had already reached 165% and is expected to peak at 171% in 2014. For comparison, in Greece the total net external debt rose from 87 to 107% of GDP between 2009 and 2012 while in Portugal (external debt, excluding FDI and reserves) rose only from 98 to 99% of GDP. However, the portion owed by the government increased from 64 to 95% of GDP, degenerating into a sovereign debt crisis.
In a recent post we called the current IMF (Troika) adjustment program for Portugal a pyrrhic victory because, when compared to previous programs, it had doubled the cost of external adjustment in terms of output loss. We identified as the main culprit a weak foreign trade multiplier. So, the key question is why isn´t the trade multiplier working now as it did in past programs? As we calculated the multiplier effect by assuming a constant income elasticity of demand for imports the explanation must be accounted for by a sluggish international economic growth and or changes in relative prices (terms of trade).
In fact, the growth of the world economy accounts for a small portion of the reduced multiplier effect, since the OECD was growing at 6% during the first two programs but recently it has been growing at only 4.3%. So, the majority (71%) of the blame for the smaller multiplier effect lies in a weak export performance because of lower price elasticities and adverse changes in the terms of trade. Since recent estimates show that the export price elasticity remains low (0.42) and statistically is not significantly different from zero, the core explanation must lie in the terms of trade.
The Portuguese terms of trade did not deteriorate enough to drive a higher level of economic activity because of an irresponsible fiscal policy of indirect tax increases that caused a futile destruction of businesses in the non-tradable goods sector and the failure to confront the powerful lobbies in the energy and transport sectors that hamper the tradable goods sector. This trend in the terms of trade is clearly visible in the following chart.
The persistence of domestic inflationary forces despite an increase of 3.5 percentage points in the unemployment rate which reached 15.5% can only be the result of market rigidities compounded by fiscal mistakes.
The program of fiscal consolidation was not only inefficient, but foolish and poorly sequenced. Instead of targeting the preservation or a small rise in revenue, through the broadening of the tax base and selective competitive tax cuts, combined with substantial cuts in subsidies and other wasteful forms of spending it did the reverse. In terms of sequencing, instead of beginning with spending cuts, followed by a broadening of the income tax base and cuts in corporate taxes it did the reverse. It raised indirect taxes first at the expense of external competitiveness and is now promising a massive increase in income and corporate taxes for 2013 to be followed by spending cuts in 2014, thus perpetuating unnecessarily the current recession for at least another two years.
In conclusion, the program left untouched all the cancers blocking the growth of the Portuguese economy listed in this blog long ago as being: irresponsible recourse to PPP financing, large rent-seeking privatized monopolies, extensive subsidization of energy, environment, technological and other self-serving mafias, too many, too inefficient and too indebted State enterprises for the exclusive benefit of their managers, unions and bankers, a financial sector who suckles on public financing, the uncontrollable spending of the health and social security sectors, the destruction of a professionally independent public service, dysfunctional fiscal and judicial systems and generalized recourse to off-budget operations and creative accounting. Indeed, it made things worse through mismanagement. So, without changing course, Portugal is condemned to more than a decade of slow growth and unbearable indebtedness and sooner or later it will have to default or ask for debt forgiveness for the first time since 1892.
As a Portuguese I am saddened to see my beloved country ravaged by an incompetent government in collusion with useless international organizations at the mercy of an unholy alliance of heartless Teutonic European mandarins, predatory Chinese and Angolan dictators and dubious Latin American business interests. This is the end result of 80 years of state capitalism in Portugal.
Despite the initial Portuguese external disequilibrium being milder than the Greek or Irish, I anticipated that the program was likely to fail because it had been undertaken reluctantly, too late, with too little and it was too soft. Moreover, its management was weak, incompetent and erratic partly because the Troika was desperate to have a success story and it had in Portugal a Finance Minister – Victor Gaspar – that was seen as one of their men. So, all tough measures (e.g. reducing the number of municipalities and monopolistic rents) were abandoned or reversed. For instance, fiscal consolidation which was to be implemented by 2/3 of expenditure cuts and 1/3 of revenue measures failed completely with the expenditure hardly slowing down and the revenue collapsing.
By now the IMF had to agree to extend its program for one more year and to grant some waivers, while it is already busy working on another package that will inevitably result on more time and more money. This will only raise the Portuguese external debt to new heights without any visible improvement in its economic growth.
Just as a reminder, note that the Greek debt path under IMF management, which started in May 2010 with a general government debt equivalent to 115% of GDP and was supposed to peak in 2012 at 149%, at the start of the second IMF bailout in June 2012 had already reached 165% and is expected to peak at 171% in 2014. For comparison, in Greece the total net external debt rose from 87 to 107% of GDP between 2009 and 2012 while in Portugal (external debt, excluding FDI and reserves) rose only from 98 to 99% of GDP. However, the portion owed by the government increased from 64 to 95% of GDP, degenerating into a sovereign debt crisis.
In a recent post we called the current IMF (Troika) adjustment program for Portugal a pyrrhic victory because, when compared to previous programs, it had doubled the cost of external adjustment in terms of output loss. We identified as the main culprit a weak foreign trade multiplier. So, the key question is why isn´t the trade multiplier working now as it did in past programs? As we calculated the multiplier effect by assuming a constant income elasticity of demand for imports the explanation must be accounted for by a sluggish international economic growth and or changes in relative prices (terms of trade).
In fact, the growth of the world economy accounts for a small portion of the reduced multiplier effect, since the OECD was growing at 6% during the first two programs but recently it has been growing at only 4.3%. So, the majority (71%) of the blame for the smaller multiplier effect lies in a weak export performance because of lower price elasticities and adverse changes in the terms of trade. Since recent estimates show that the export price elasticity remains low (0.42) and statistically is not significantly different from zero, the core explanation must lie in the terms of trade.
The Portuguese terms of trade did not deteriorate enough to drive a higher level of economic activity because of an irresponsible fiscal policy of indirect tax increases that caused a futile destruction of businesses in the non-tradable goods sector and the failure to confront the powerful lobbies in the energy and transport sectors that hamper the tradable goods sector. This trend in the terms of trade is clearly visible in the following chart.
The persistence of domestic inflationary forces despite an increase of 3.5 percentage points in the unemployment rate which reached 15.5% can only be the result of market rigidities compounded by fiscal mistakes.
The program of fiscal consolidation was not only inefficient, but foolish and poorly sequenced. Instead of targeting the preservation or a small rise in revenue, through the broadening of the tax base and selective competitive tax cuts, combined with substantial cuts in subsidies and other wasteful forms of spending it did the reverse. In terms of sequencing, instead of beginning with spending cuts, followed by a broadening of the income tax base and cuts in corporate taxes it did the reverse. It raised indirect taxes first at the expense of external competitiveness and is now promising a massive increase in income and corporate taxes for 2013 to be followed by spending cuts in 2014, thus perpetuating unnecessarily the current recession for at least another two years.
In conclusion, the program left untouched all the cancers blocking the growth of the Portuguese economy listed in this blog long ago as being: irresponsible recourse to PPP financing, large rent-seeking privatized monopolies, extensive subsidization of energy, environment, technological and other self-serving mafias, too many, too inefficient and too indebted State enterprises for the exclusive benefit of their managers, unions and bankers, a financial sector who suckles on public financing, the uncontrollable spending of the health and social security sectors, the destruction of a professionally independent public service, dysfunctional fiscal and judicial systems and generalized recourse to off-budget operations and creative accounting. Indeed, it made things worse through mismanagement. So, without changing course, Portugal is condemned to more than a decade of slow growth and unbearable indebtedness and sooner or later it will have to default or ask for debt forgiveness for the first time since 1892.
As a Portuguese I am saddened to see my beloved country ravaged by an incompetent government in collusion with useless international organizations at the mercy of an unholy alliance of heartless Teutonic European mandarins, predatory Chinese and Angolan dictators and dubious Latin American business interests. This is the end result of 80 years of state capitalism in Portugal.
Friday, 4 November 2011
Democracy and the Euro-Greek Tragicomedy
It appears that Aristotle defined tragicomedy as a serious action with a happy ending. So can we write the recent tragedy of the Greek bailout and the ongoing comic infighting of the Greek politicians as a prelude to a plot with a happy ending?
Last night’s refusal to agree on a Greek government of national salvation might lead to either new elections or a referendum on the bailout program. This should be the democratic way to solve the current deadlock. The people should be given the last word; even if the results leave the nation divided in two almost identical camps the winning camp has the mandate to carry out his policies. That is the foundation of democracy and it is preferable to forcing the Greeks to accept the undemocratic tutelage of the shameful duo Merkel-Sarkozy.
Now, let’s imagine that the camp opposing the current bailout wins and decides to declare a unilateral default on the Icelandic-style, but decides to keep the Euro. This is the scenario feared by the “very serious people in pin stripes” and some economists who fear the contagion of a disorderly bail-out.
What can Mr. Juncker, Draghi and Barroso do about it? According to Mr. Barroso the Lisbon Treaty does not have any legal mechanism to expel a Euro-zone member. Mr. Draghi’s interpretation of the European Central Bank remit is that it does not include any responsibility as lender of last resort for any member country. Mr. Junker’s Eurogroup meeting of the Finance Ministers of the Eurozone countries was institutionalized by the Lisbon treaty without any power over its members. So, let us image also that they decide to do nothing.
Would this mean the end of the Eurozone? In principle no! For instance, in the Dollarzone (USA) when a local government defaults on its Muni-bonds the Federal Bonds barely move. Yes, I know, the USA has a Federal budget. However, its interstate transfers are not enough to justify the decoupling between the Munis and the Treasuries. What is different is that the FED (the US central bank) has an implicit remit to bailout the major banks whose failure would represent a systemic risk as it has shown in the crisis of 2008.
This is a key weakness of the current ECB thinking. Should the markets attack the other highly leveraged countries to an extent that would bankrupt some of their major banks in those countries the ECB might feel restrained in continuing to lend to such countries.
Indeed, as illustrated by its continuing purchase of low quality securities, the ECB does not need to have an explicit lender of last resort mandate enshrined in the European Union treaty. Nor does it need to take massive losses on its ABS holdings, as has been propagated by the German Press. For instance, it can simply print money to finance an off-balance sheet vehicle to park such securities and ask the EFSF and the Governments rescued to share on its capitalization.
So here is a script for a happy ending to the Greek tragicomedy:
1) Greece reasserts its firm commitment to remain in the Euro;
2) Greece defaults on its debts and goes to the London and Paris clubs for a restructuring deal with better terms than those currently on offer;
3) To support the debt restructuring program Greece applies to the IMF for a new extended facility;
4) Meanwhile the ECB extends an unlimited liquidity line to one or two of the best Greek banks to keep the financial system afloat, subject to Greece agreeing to points 1-3;
5) The ECB announces that it will provide such lines to any other member who needs them;
6) To kill any doubts about its own strength the ECB will begin selling its low quality assets to special purpose vehicles;
7) Faced with such determination the markets will begin pricing the sovereign debt spreads of the various Eurozone members in accordance with their respective risk profile; and
8) After the successful implementation of programs 2 and 3, Greece regains market access within three years.
Here is the lesson from such tragicomedy. One should never give up on the ability of democracy to find a solution. It may be convoluted; it may take some time, but it will be better than a dictatorial solution under a veil of technocracy or to a shameful begging for help from a mixed bag of world leaders gathering in the G20 group.
Last night’s refusal to agree on a Greek government of national salvation might lead to either new elections or a referendum on the bailout program. This should be the democratic way to solve the current deadlock. The people should be given the last word; even if the results leave the nation divided in two almost identical camps the winning camp has the mandate to carry out his policies. That is the foundation of democracy and it is preferable to forcing the Greeks to accept the undemocratic tutelage of the shameful duo Merkel-Sarkozy.
Now, let’s imagine that the camp opposing the current bailout wins and decides to declare a unilateral default on the Icelandic-style, but decides to keep the Euro. This is the scenario feared by the “very serious people in pin stripes” and some economists who fear the contagion of a disorderly bail-out.
What can Mr. Juncker, Draghi and Barroso do about it? According to Mr. Barroso the Lisbon Treaty does not have any legal mechanism to expel a Euro-zone member. Mr. Draghi’s interpretation of the European Central Bank remit is that it does not include any responsibility as lender of last resort for any member country. Mr. Junker’s Eurogroup meeting of the Finance Ministers of the Eurozone countries was institutionalized by the Lisbon treaty without any power over its members. So, let us image also that they decide to do nothing.
Would this mean the end of the Eurozone? In principle no! For instance, in the Dollarzone (USA) when a local government defaults on its Muni-bonds the Federal Bonds barely move. Yes, I know, the USA has a Federal budget. However, its interstate transfers are not enough to justify the decoupling between the Munis and the Treasuries. What is different is that the FED (the US central bank) has an implicit remit to bailout the major banks whose failure would represent a systemic risk as it has shown in the crisis of 2008.
This is a key weakness of the current ECB thinking. Should the markets attack the other highly leveraged countries to an extent that would bankrupt some of their major banks in those countries the ECB might feel restrained in continuing to lend to such countries.
Indeed, as illustrated by its continuing purchase of low quality securities, the ECB does not need to have an explicit lender of last resort mandate enshrined in the European Union treaty. Nor does it need to take massive losses on its ABS holdings, as has been propagated by the German Press. For instance, it can simply print money to finance an off-balance sheet vehicle to park such securities and ask the EFSF and the Governments rescued to share on its capitalization.
So here is a script for a happy ending to the Greek tragicomedy:
1) Greece reasserts its firm commitment to remain in the Euro;
2) Greece defaults on its debts and goes to the London and Paris clubs for a restructuring deal with better terms than those currently on offer;
3) To support the debt restructuring program Greece applies to the IMF for a new extended facility;
4) Meanwhile the ECB extends an unlimited liquidity line to one or two of the best Greek banks to keep the financial system afloat, subject to Greece agreeing to points 1-3;
5) The ECB announces that it will provide such lines to any other member who needs them;
6) To kill any doubts about its own strength the ECB will begin selling its low quality assets to special purpose vehicles;
7) Faced with such determination the markets will begin pricing the sovereign debt spreads of the various Eurozone members in accordance with their respective risk profile; and
8) After the successful implementation of programs 2 and 3, Greece regains market access within three years.
Here is the lesson from such tragicomedy. One should never give up on the ability of democracy to find a solution. It may be convoluted; it may take some time, but it will be better than a dictatorial solution under a veil of technocracy or to a shameful begging for help from a mixed bag of world leaders gathering in the G20 group.
Friday, 28 October 2011
Shameful European Leaders
In today’s news: “AP - The chief of Europe's bailout fund visited Beijing on Friday to discuss possible terms for a bond sale aimed at raising money from China and other non-European investors”.
After months of protracted squabbling over how to solve the Greek problem, all that Sarkozy and Merkel could come up with was a convoluted scheme that involves begging support from one of the remaining communist dictatorships – China.
To realize how outrageous their incapacity was, one must recall that the haircut or debt forgiveness that Greece, Ireland and Portugal needed at the start of the crisis was about 140 billion Euros, that is, the equivalent to the European Union budget for one year.
To understand how shameful it is to rely on the support of a non-democratic country, it is important to remember that China does not have a fully convertible currency, ranks 7 and 6 respectively in terms of political rights and civil liberties in the Freedom House index (a classification worse that of Iran and Rwanda) and according to Amnesty International is by far the country with the worst record in terms of executions which remain a state secret (again worse than Iran).
This is a dark episode in the history of European integration, and a shaking foundation for the future of the Euro as a currency.
After months of protracted squabbling over how to solve the Greek problem, all that Sarkozy and Merkel could come up with was a convoluted scheme that involves begging support from one of the remaining communist dictatorships – China.
To realize how outrageous their incapacity was, one must recall that the haircut or debt forgiveness that Greece, Ireland and Portugal needed at the start of the crisis was about 140 billion Euros, that is, the equivalent to the European Union budget for one year.
To understand how shameful it is to rely on the support of a non-democratic country, it is important to remember that China does not have a fully convertible currency, ranks 7 and 6 respectively in terms of political rights and civil liberties in the Freedom House index (a classification worse that of Iran and Rwanda) and according to Amnesty International is by far the country with the worst record in terms of executions which remain a state secret (again worse than Iran).
This is a dark episode in the history of European integration, and a shaking foundation for the future of the Euro as a currency.
Friday, 22 July 2011
Bond swap plan is for Greece and Greece only, but it won’t be enough.
The FT just published a few details of the bond swap agreement in the new bailout for Greece. The swap agreement is only for Greece, and “All other euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature”.
The only interesting feature of the agreement is the voluntary exchange of bonds maturing before 2019 by 15 and 30 year bonds, paying 5.9 and 6.8%, as a compensation for the banks accepting a 21% “haircut” on the value of the existing bonds. IIF, the Banker’s designer of the plan, estimates a participation rate of 90%.
The Greek government will have to use the new funding to buy European AAA bonds to post as collateral for the new bonds. The cover ratio was not specified, but if it is close to one the “haircut” will be meaningless. Even at 50% and with a take up rate of 90% the effect of the effective haircut would be only “9.45%”.
As been amply demonstrated in last few years the Greek problem is not one of liquidity but of solvency. We and many other observers have estimated that to get out of insolvency Greece needs a debt pardon of about 50%.
All the other measures announced to support Greece are not enough to fill the gap between these 50% and the expected “haircut” of 9.45%. So, it is only a matter of time before Greece needs another bailout, probably as early as 2013.
The only interesting feature of the agreement is the voluntary exchange of bonds maturing before 2019 by 15 and 30 year bonds, paying 5.9 and 6.8%, as a compensation for the banks accepting a 21% “haircut” on the value of the existing bonds. IIF, the Banker’s designer of the plan, estimates a participation rate of 90%.
The Greek government will have to use the new funding to buy European AAA bonds to post as collateral for the new bonds. The cover ratio was not specified, but if it is close to one the “haircut” will be meaningless. Even at 50% and with a take up rate of 90% the effect of the effective haircut would be only “9.45%”.
As been amply demonstrated in last few years the Greek problem is not one of liquidity but of solvency. We and many other observers have estimated that to get out of insolvency Greece needs a debt pardon of about 50%.
All the other measures announced to support Greece are not enough to fill the gap between these 50% and the expected “haircut” of 9.45%. So, it is only a matter of time before Greece needs another bailout, probably as early as 2013.
Friday, 7 January 2011
Why the IMF therapy is not working in Greece
The main role of IMF-sponsored adjustment programs is to facilitate a normal access of the borrowing countries to external markets. With the CDSs on Greek debt at 11% (above those of Venezuela) and yields on 10-year debt higher than they were before the IMF program (see chart above) the failure of the program is unquestionable.
One of the reasons why markets do not believe that Greece will be able to avoid defaulting, is probably due to the fact that the IMF approach can only use one of the three tools of their standard treatment - fiscal and budgetary policy. With Greece being a member of the Euro-zone, the other two - monetary and exchange rate policy are not available unless Greece is forced out of the Euro.
Unfortunately, the IMF has no experience of dealing with balance of payment adjustments within monetary unions. Moreover, even in relation to budgetary policy, the IMF does not realize that Greece (like Portugal and Spain) has an economic system based on state capitalism. Thus, unless they starve the Greeks (in a Ceausescu experiment) it will not be possible to achieve an external balance without destroying the state capitalism system, which the Greeks are not willing to do.
Thus the only three alternatives for Greece (and to Portugal, who is trying to mimic an IMF program without the IMF) are: a) to force a significant hair-cut on its bond-holders, b) to receive a major grant from other EU countries, or c) a mix of both. None of these is a pleasant solution but there is no other way out.
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