24 September 2011

Time to get rid of the witch doctor

The reward for brutally enforcing a policy crippling the Greek economy is another €8-billion of emergency fund. It will go in through one door of the state and straight back out through another to the banks. It is Orwellian to call it a Greek rescue package. On each occasion the Government receives its 'bailout' money, the average Greek is left with less in his hands. Greeks are not dancing on the streets with overwhelming joy at being saved (see this Austria report). The relieved faces are elsewhere.

Greek default is inevitable and the longer it takes the more expensive it becomes for everyone. Talks focus on how to minimize the damage to the creditors. The Greek economy is secondary. Most of the Greek population do not believe it is working, is in their interests, or offers any hope. Austerity is so damaging that default comes as a relief. It has become a question of survival.

It is impossible for Greece to repay debts by measures that reduce its ability to pay. The economy will shrink 5.5 percent this year and another 2.5 percent next year (latest IMF report). Targets will be missed again. Greece's public debt was supposed to peak at 160% but now the IMF forecasts 189%.  Nearly a quarter of the working population will be out of work by December. The strains on Government revenues and ability to collect taxes are plain to see.

It simply will not work. Protesters on the streets in Greece have every right to say  'We won't pay!'.

Meanwhile urgent discussions and a complicated poker game is being played in Washington.  A G20 statement said the euro zone would take action to "maximize" the impact of the bailout fund by mid-October, recognizing that default and an substantial 'haircut' on Greek debt is essential.

Venizelos, the Greek Fin. Minister, spoke of “absolute fiscal derailment” and “we continue to generate deficits” True, but  austerity is derailing everything.  There will no engine let alone rails for the Greek economy to run. Austerity and the Third world experience, as World Bank's former Chief Economist testifies, does not work. Is there a such thing as  'growth-friendly fiscal consolidation'. The European Community (?) needed to undertake structural reforms not purely confined only to Greece but to the entire Eurozone structure. Balancing national fiscal consolidation without financing European-wide investment programs, reduces countries to colonies.  Why are such programs so politically unlikely? There was and is no Marshall plan.  Perhaps, the threat of a disorderly default will create the willingness for one.

Austerity is about making everyone miserable so that the accounts can look less miserable. In the end there is no paper left to print the account books on. It is a failure to recognise the causes of the Euro crises. This is an excellent read: http://streetlightblog.blogspot.com/2011/09/what-really-caused-eurozone-crisis-part.html 

Internal devaluation is a broken wand

When it comes to restoring trading balances, there is no substitute for actual devaluation. The inability to deal with cartels, local monopolies and market power makes internal devaluation impossible.  This applies not only to Greece but also to Europe.

Monstrosities, such as the Common Agricultural Policy and Investment projects (that require the borrower to match the same amount of money), favour the big against the small.  Food prices are artificially far too high and local cartels control the markets - here's an example of Greek food price fixing and supermarket cartels. One supermarket even imports Greek products back into the country and sells cheaper than French / German controlled supermarkets. In Northern Greece, those who can, go to the borders to get cheaper petrol, food and clothes. Not surprisingly many businesses are closing down.

Wages and incomes fall and many small private businesses close down. Some stay open by not paying their works for months.  Greece, once full small families businesses, is a country full of empty premises and closed shops. The poor have had enough and so have the middle classes - see 'Greece's Middle Class Revolt against Austerity' Austerity in the name of debt service has become a recipe for revolution.

Yesterday Venizelos said 'we would rather be the government who hit the lower and middle classes than be the government that failed to save the country"  So, one wonders, who is he referring when he says 'save the country'?

Greece will default, but it has to default on its terms not on the creditors. The sooner it defaults the quicker it will get out of its debt spiral.  But how do you get rid of the witch doctor?

There seems to be a democratic problem

More enlightening Venizelos quotes: “we are lucky to be under international control” and “when you depend on the markets, you have to accept the creditor’s point of view”

This may depend on how the Greek Parliament votes next week.  But, if we follow Venizelos' logic, what is the point of having a Greek parliament? Why not close it down, get rid of the pretence and save money? Besides, most European were not allowed to directly vote on the Euro. The European idea it seems is not to let Europeans directly vote on the Europe Idea - but they can vote every year on pop songs.

Yet, without a sense of community and mutual trust (and this must imply a better version of democracy) there can be no European common debt structure (ECB backed Euro bonds) or fiscal union.  Without this there is no hope for a common currency.  It becomes intolerable or unacceptable to one or more of its members and breaks down. A European tragedy of the commons.

Speaking of illusions and virtual reality, make what you think of the following:

Greek Default

Default, and the knock on effects on the other PIIGS economies, could mean that some members, such as Greece or even Germany, leaving the Eurozone.  The Greek government has to prepare for events that unfold.

Greece can restore competitiveness and rebuild its economy.  The problem is going from point A to point B and not forgetting that many legal, economics and democratic reforms are still needed.  

If Greece leaves, then the new drachma would fall and immediately restore competitiveness. It would boost the tourist industry and exporters would be able to sells goods and services aboard more cheaply. Imports would become more expensive and the country's trading deficit will shrink.  There are three difficulties with this story: the ability its citizens and businesses to survive the immediate financial crisis; what happens in Greece's export markets and/or the rest of the Euro zone; and access to capital and funds for investment, growth and economic recovery.  The answers are by no means clear ........

The depreciation (that some say could be as much as 50%) of the new drachma could turn any debts that remained in Euros into a crippling burden. It is this prospect that would create a massive run on the Greek Banking System and, is in one sense, the lock on the euro cell.   But to some extent, with the expectation of default, this has already been happening.

The Greek banking system is already in very bad shape. It is not only having to deal with the holdings of Greek debt but the flight of depositors. As the FT's alphaville scribbles on "a note to the troika – every time you say “lack of progress”, another depositor’s faith that a Greek bank is better than the storage space under a pillow dies."  Many deposits have left the country fearing a default and exit. Again from FT's alphaville 'The humble Greek (and Argentine) depositor'

Banks will have to be re-capitalised, provided with liquidity and socialised. If socialised, backed with public funds, the government will have the option to privatised (sell shares/stock of what it puts in later at a price that gives a profit) when the economy recovers. Businesses, those paying mortgages and Greek depositors will need protecting.  Debts will need to be re-negotiated and/or converted into local currency.  Some compensation scheme, for example a stake/shares in the re-capitalised banks, is needed to cover the loss in value of savings.

The Government will printing the new currency and, if there is no external assistance, pumping in liquidity into the banking system. The period is likely to be inflationary and at some point the brakes need to be put back on.  Here lies a difficult question. Would you trust the present Government to do this and not to use its printing presses postpone essential economic, democratic and legal reforms? I suspect a change to government and political system would be required.

The outcome would be chaotic, but planning is needed anyway to cover for the increasing possibility of a Euro-wide system breakdown. A great deal depends on the political struggle with creditors to force them to accept their losses.

It is in this struggle, that the Greek government still has an important weapon to limit the internal financial damage. Greeks governments bonds were issued and written under Greece law (and not yet roll-overed into English law) which gives the Government enormous power. It can call for much bigger losses on the part of creditor holders than what is currently being suggested. The tables can be reversed. Rather than debtor being coerced into doing whatever the creditor wishes, the ability to inflict large losses on the creditors ought to make them more receptive to the demand of the debtors. Hence individuals and companies usually have their assets seized, but countries don't.

The term 'selective default' ought to be re-defined to mean who the Greek electorate choose to 'selectively default'.  Good and bad creditors and debts should be separated and investigated. The international law on odious debts needs to be tested. Not all creditors (those supplying funds for real investment projects as oppose to bogus ones) ought bear the same costs. Here's the famous documentary (if you haven't seen it) explaining the idea:

Two are a couple of points that should be mentioned while speaking of Argentina.

Argentina suffered a debt crisis after fixing its currency to the US dollar in 1992. It lost its competitiveness, built up a large trading imbalance that could not be indefinitely financed  and a collapse in public finances.  It defaulted and eventually recovered. The crisis occurred when the global economy was in healthy circumstances.  Default in 2001/2002 forced bank to place limits on withdrawals. There were big losses for depositors and banks as their assets and liabilities were re-denominated, each at a different exchange rate. It survived. Look at the following graph (via Krugman – it is not up-side-down:

After a period of decline Argentina grew by 9% in 2003 and, with a surge in global demand for agricultural commodities carried on at around that rate until 2008. It survived the 2008 meltdown better. Economic growth occurred even though it did not have access to international capital markets. Perhaps a mixed blessing as the witch doctors will no longer in charge of its economy. Today it has growth rate near to 10% ( Yes it does have corruption and inflation).  Default, however, required an upheaval to the political system and a change in government.

The Greek situation is not quite the same as the Lehman Brothers collapse that triggered the 2007/8 global financial crisis. That was a shock.  A Greek default would not be a surprise and would not have the same effect on markets.  Financial markets have been trying to anticipate this event ever since the Greek crisis begin at the end of 2009. As everyone is expecting default, and those who can have ran for cover, the financial impact has been partly offset.  The crisis that never seems to end, is being perpetuated by throwing money at a lost cause.  At some point there will be none left to throw. 

Assuming the worst case scenario - default and exit leads to a lock out on all capital markets - there is a ray of hope in the following diagram. At the same, it explodes another myth about Greece (via Bloomberg).

This shows that Greek households (the red section), unlike the Greek state (white), haven't been 'spending above their means' to the extent that Germans have. The Greek State may have been partying but ordinary Greeks haven't.

If Greece defaults then it will lose its creditability and international ability to borrow. But hasn't it already lost it?  This would force Greece to live within its means, which is what the current austerity measures are suppose to be doing. But, possibly for only a few years. Greece still has resources and householders that are potential under-leveraged savers, which can provide a basis for future growth.   

As for the rest of the Euro Zone?

It might not be a bad idea to read 'Modest Proposal' after all. They might discover that it was also about saving the Euro. Remember that Marshall plan?

1 comment:

  1. Every nation should be allowed to be as little competitive as she wants. That is not the problem (not even in a curreny union). The problem begins when less competitive nations want to have the same standard of living as workaholic nations have (particularly in a currency union). That is, in esssence, the nature of the Greek problem. The Greek culture is different from the German culture as regards the achievement of material wealth. Offer a German to fulfill every one of his wishes and he might answer: a top career; a top income; a top standard of living; etc. When Diogenes was asked the same question by Alexander the Great he replied: "Move out of the sun!" There you have it.