Tag Archives: greek default

Greece: A Default is a Better Outcome Than the Deal on Offer

By Marshall Auerback

Pick your poison. In the words of Greek Finance Minister Evangelos Venizelos, the choice facing Greece today in the wake of its deal with the so-called “Troika” (the ECB, IMF, and EU) is “to choose between difficult decisions and decisions even more difficult. We unfortunately have to choose between sacrifice and even greater sacrifices in incomparably more dearly.”  Of course, Venizelos implied that failure to accept the latest offer by the Troika is the lesser of two sacrifices.  And the markets appeared to agree, selling off on news that the deal struck between the two parties was coming unstuck after weeks of building up expectations of an imminent conclusion. 
In our view, the market’s judgment is wrong:   an outright default might ultimately prove the better tonic for both Greece and the euro zone. 

The only questions that remain to be resolved are these: have all of the parties begun preparations to mitigate the ultimate impact of an outright default by Athens?  And will the ECB be sufficiently aggressive in combating the inevitable speculative attacks on the other members of the euro zone periphery, which are almost certain to ensue, once Greece is “resolved” one way or the other.
Within the Troika, the Germans in particular have been the champions of taking the toughest line possible against the Greeks and other “Mediterranean profligates”. But however stubborn Berlin appears to be, the Merkel Administration is certainly not stupid. At this juncture, it seems more rational to view their  ongoing promotion of fiscal austerity as a political smokescreen: In reality, what Germany likely wants to do in the case of Greece is trigger is an involuntary default so that the other PIIGS don’t get the wrong idea and ask for a similarly large haircut on their debts.  They realize the consequences that might follow, as the others gear up for similar treatment.  Far easier were Greece to move toward involuntary default, in the eyes of Berlin.
Politically, of course, the Merkel government can’t actually come out and advocate a Greek default or, indeed, outright expulsion from the euro zone. Far more politically astute to promote fiscal austerity on top of yet more fiscal austerity, (even though that is certainly not winning Mrs. Merkel any popularity points in Greece), until the Greeks themselves scream “Uncle!” and default outright.
It helps domestically as well. According to polls Angela Merkel is now the most popular politician in Germany, which is why she persists with this pernicious narrative that the problems of Greece all stem from fiscal profligacy and laziness, in contrast to the responsible and hard-working German people.
Ultimately, though an involuntary default carries risks for the stability of the euro payments system, a deal, per the terms outlined in the press, is bad for Greece.  And probably even worse for global markets, especially the bond markets.
Either eventuality creates problems but default is probably the less bad option longer term. Let me elaborate:
Greece is a hopelessly uncompetitive economy that probably shouldn’t be in the euro zone. But can you surgically detach Greece if it defaults, without some sort of impact on the entire euro payments system?

And what will the impact be on Greece itself?  The country currently runs a primary budget deficit (excluding interest payments on debt) of around 5% of GDP. Were it to default, Athens would be forced to go cold turkey (“cold Greece”?) until the primary fiscal deficit (now around 5% of GDP) is balanced. Maybe the government could suspend all military expenditures as a first pass? At the very least, they can stop buying German military equipment!
No question, that under a default, a lot of public sector employees will be sacked, pensions will be at risk, and unemployment will almost certainly go higher.  But that is certainly going to occur under the deal now being struck.   Were the country to revert to the drachma, however, they would likely be left with a substantially weaker currency, which could ultimately provide the country with the wherewithal to compete in the global economy. With a super-cheap exchange rate, Greece could become a Mecca for retirement homes, research hospitals, trans-European liberal arts colleges, and maybe low-overhead software startups. Plus, a permanent home for the Olympics. It could live happily ever after, as Florida does, on the pension income of the elderly and the beer money of the young.
This would be the source of the foreign transfers that the private banking sector won’t make anymore. In Greece’s case that credit went to the public sector and a lot of it built useful infrastructure, so it’s not a waste, but the first step is surely to cancel the debts and stop the illusion that they can be paid. And it would end the “death by 1000 cuts” currently being imposed on the Troika, which will serve no useful economic, political or social purpose.
Of course, there will be a slew of defaults and an endless series of court cases, litigation, etc., much as there was when Argentina defaulted in 2001.  But it would force the issue of debt restructuring on the table in a meaningful way and at least provide Greece with light at the end of the tunnel.
To ensure some sort of viability of the drachma, the Greek government would have to find a more credible means of ensuring tax compliance. Most Greeks with money have presumably already moved it beyond the reach of the Greek banking system, so that savings would not be wiped out. As the tide of repossessions begins, many of these oligarchs would likely start to buy back the Greek assets on the cheap, as it is doubtful that the euro banks will want anything to with them.
Beyond that, it would be important for Athens to establish a new tax system that minimises tax evasion, so as to create demand for the new drachma immediately, and mitigate the formation of an extensive parallel transactions currency. After all, it is possible that many Greeks might prefer to use the existing stock of euros in the country and there is very little the EU authorities could do to stop this (much as the US government could not prevent Panama from dollarising its economy). But in order to establish a long-lasting demand for drachmas, two things would have to happen: 
  1. The Greek government would announce that it will begin taxing exclusively in the new currency.
  2. The Greek government would announce that it will make all payments in the new currency. 

Given the country’s history of tax evasion on income tax, a national real estate tax would likely work better than a new income tax.
(See here for more details:)

On the other hand, the challenge for the European Union authorities is to ensure that speculative capital is not unleashed on the next weakest link in the chain – say, Portugal – to ensure that there is an adequate firewall established and to minimise disruptions to the entire euro payments system. It’s unclear to me whether the euro zone authorities have truly thought this aspect through and considered the best means to prevent a major disruption of the EMU payments system. Then again, perhaps this is what the ECB’s new programs are really all about.

On the other hand, I happen to think a rescue of the sort that is now being publicly mooted is worse for both sides. The imposition of yet more fiscal austerity on Greece will exacerbate the debt deflation dynamics which are destroying the country and will provide Greece with ZERO means of servicing even the reduced levels of debt. The country will still remain uncompetitive and depression like conditions will continue, with the ongoing burden of more euro denominated debt servicing.
More dangerous is the risk that comes if there is a “successful” deal: It come with the pending question- ‘if Greece doesn’t have to pay, why do I’- The Irish are asking that question already, and I’m sure the Portuguese and Spanish will soon be asking the same thing. As my friend Warren Mosler has noted: 

Possible immediate consequences of that discussion include a sharp spike in gold, silver, and other commodities in a flight from currency, falling equity and debt valuations, a banking crisis, and a tightening of ‘financial conditions’ in general from portfolio shifting, even as it’s fundamentally highly deflationary. And while it probably won’t last all that long, it will be long enough to seriously shake things up.

Longer term, a Greek default could well provoke the question, “What on earth do governments issue bonds for anyway?” That might well provoke a far more provocative debate on the nature of modern money and the self-imposed legal constraints with which sovereign governments bind themselves in their conduct of fiscal policy. But that’s probably best left to the pages of another blog post!

Core Europe Sitting Pretty in their PIIGS Drawn Chariot

By Marshall Auerback and Warren Mosler

The refusal to countenance a Greek default is now said to be dragging the euro zone toward even greater crisis.  Implicit in this view, of course, is the idea that the current “bailout” proposals are operationally unsustainable and will lead to a broader contagion which will ultimately afflict the pristine credit ratings of core countries such as Germany and France.

Well, we see a very different view emerging:  The “solution” currently on offer – i.e. the talk surrounding the European Financial Stability Fund (EFSF) now includes suggestions of ECB backing.  This makes eminent sense.  Let’s be honest: the EFSF is a political fig-leaf.  If 440 billion euros proves insufficient, as many now contend, the fund would have to be expanded and the money ultimately has to come from the ECB — the only entity that can create new net financial euro denominated assets — which means that Germany need no longer fret about being asked for ongoing lump sums to fund the EFSF in a way that would ultimately damage its triple AAA credit rating.

Despite public protestations to the contrary, it is beginning to look like the elders of the euro zone have begun to embrace the reality that, when push comes to shove, it is the ECB that must write the check, and that it can continue to do so indefinitely.

That means, for example, the ECB can buy sufficient quantities of Greek bonds in the secondary markets to allow Greece to fund itself in the short term markets at reasonable interest rates.  And it gets even better than that for the ECB, as the ECB also substantially enhances its profitability by continuing to buy deeply discounted Greek bonds and using Greece’s income stream to build the ECB’s stated capital.  As long as it continues to buy Greek debt, Greece remains solvent, and the ECB continues to increase its accrual of profits that flow to capital.

The logical conclusion of all of this is ECB ownership of most of Greece’s debt, with austerity measures imposed by the ECB steering the Greek budget to a primary surplus, along with sufficient taxation to keep the ECB’s capital on the rise, and help fund the ECB’s operating budget as well.  Now add to that similar arrangements with Ireland, Portugal, Spain and Italy and it’s Mission Accomplished!

Mission Accomplished?  Are we daring to suggest that the Fathers of the euro zone had exactly this in mind when they signed the Treaty of Maastricht? 

Or, put it another way: it’s all so obvious, so how could they not have this mind?

So let’s take a quick look at the central bank accounting to see if this seemingly outrageous thesis has merit. 

Here is what is actually happening. By design from inception, when the ECB undertakes its bond buying operation, the ECB debt purchases merely shift net financial assets held by the ‘economy’ from Greek government liabilities to ECB liabilities in the form of clearing balances at the ECB.  While the Greek government liabilities shift from ‘the economy’ to the ECB.  Note: this process does not alter any ‘flows’ or ‘net stocks of euros’ in the real economy. 

And so as long as the ECB imposes austerian terms and conditions, their bond buying will not be inflationary.  Inflation from this channel comes from spending.  However, in this case the ECB support comes only with reduced spending via its imposition of fiscal austerity.  And reduced spending means reduced aggregate demand, which therefore means reduced inflation and a stronger currency.  All stated objectives of the ECB.

We would stress that this is NOT our PROPOSED solution to the euro zone crisis (see here and here for our proposals), but it is clearly operationally sustainable, it addresses the solvency issues, and puts the PIIGS before the cart, which at least has the appearance of putting them right where the core nations of the euro zone want them to be.

Additionally, the ECB now officially has stated it will provide unlimited euro liquidity to its banks. This, too, is now widely recognized as non-inflationary.  Nor is it expansionary, as bank assets remain constrained by regulation including capital adequacy and asset eligibility, which is required for them to receive ECB support in the first place.   

To reiterate, it is becoming increasingly clear, crisis by crisis, that with ECB support, the current state of affairs can be operationally sustained.

The problem, then, shifts to political sustainability, which is a horse of a different color.  And here is where the Greeks (and the other PIIGS) paradoxically have the whip hand.  So long as the Greeks continue to accept the austerity, they wind up being burdened by virtue of their funding of the ECB.  The ECB takes in their income payments from the bonds, and the ECB alone ensures that Greece remains solvent.  It’s a great deal for the ECB and the core countries, such as Germany, France and the Netherlands, as it costs the core’s national taxpayers nothing.  And, as least so far, Greece thinks the ECB is doing them a favor by keeping them out of default.  The question remains as to whether the Greeks will continue to suffer from this odd variant of Stockholm (Berlin?) Syndrome.

Perhaps not if some of the more recent proposals make headway.  As an example of what might be in store for Greece, consider the “Eureca Project”, publicly mooted in the French press last week.  In essence, it aims to reduce “Greek debt from 145% to 88% of GDP in one step” without default (so protecting all northern European banks); reduce ECB exposure to Greek debt (that is, force Greece to pay the ECB for the bonds it has purchased in secondary bond markets) and it claims that it will “kick-start the Greek economy and revive growth and job creation” and promote “structural reform.”

So how is it going to do all of that?  Simple: engage in the biggest asset strip in history.  The proposal in essence calls for a non-sovereign entity to take all the public assets – hand them over to a holding company funded by the EU which pays Greece who then pay off all it debtors. End of process – except that if it is implemented, the Greeks could well say “Stuff it.  Let’s default and take our chances.  At least we get to keep our national assets.”  That’s the risk that is being run if the ECB and the economic moralists in Germany take this too far.  If this proposal were accepted, the eurocrats would in fact have a failed nation state on their hands in 3 months time — in the eurozone, not the Mideast or Africa.

By contrast, the current arrangements seem tame in comparison.  They obviate the solvency issue, but even here one wonders how much more can be inflicted on countries such as Greece.  We stress that the current arrangements have OPERATIONAL sustainability, not necessarily POLITICAL sustainability.  The near universally accepted austerity theme is likely to result in continuously elevated unemployment, and a large output gap in general characterized by a lagging standard of living and high personal stress in general. This creates huge systemic risk insofar as it might well make sense for Greece (and others) ultimately to reject this harsh imposition of austerity.  But, so far so good for the core nations, as there appears to be no movement in that directions (except on the streets of Athens, rather than in the Greek Parliament). 

By the ECB continuing to fund Greece, and not allowing Greece to default, but instead to continue to service its debt, the whole dynamic has changed from doing Greece a favor by not allowing Athens to default to disciplining Greece by not allowing the country to default.  And while that’s what the Germans SEEMINGLY haven’t yet figured out, if one is to judge from the current debate, particularly in Germany itself, at the same time they have approved the latest package and are quickly moving in the direction we are suggesting.  Note that Angela Merkel has been most adamant on the particular question of allowing Greece to default or allowing an “orderly restructuring.”  It’s also worth noting that when the ECB funds Greece, that funding facilitates Greek purchases of German goods and services, including military, at no cost to the German taxpayer.  In fact, Germany gets to run larger trade surpluses, which means by accounting identity it is able to run lower government budget deficits, which allows it to feel virtuous and continue its incessant economic moralizing. 

So what’s in it for Germany?  That should be obvious by now:  Germany gets to export to Greece, and to control/impose austerity on Greece, which keeps the euro strong, interest rates in Germany low, and FUNDS the ECB.  All in the name of punishing the Greeks for past sins.  It doesn’t get any better than that for the core nations.  It’s time for the Germans to stop pushing their luck.  Rather, they should embrace the genius of one of the so-called southern profligates, Italy, as they have surely created an operationally sustainable doomsday machine of which Machiavelli himself would be proud. How could this not be the Founding Fathers’ dream come true?