Tag Archives: greek economy

While the video is narrated in Italian, the message is clear in any language: When everyday people start to realize that austerity is the problem, not the cure, they will resolutely reject it, and begin to reclaim their democracy from those who would financially enslave them.

Anschluss Economics – The Germans Launch A Blitzkrieg on the Greek Debt Negotiations

News stories continue to suggest that Greeceonce again appears on the verge of reaching a deal with its private sectorcreditors on how much of a loss they would be willing to accept on their bondholdings. The latest numbers suggest a 70% write-down. A pretty strikingcomedown for what is supposed to be a “voluntary default” and, hence,not subject to the triggers of a credit default swap on Greek debt.
Naturally, the spin surrounding the proposedagreement is that this is a “one-off” and that other troubledperiphery nations shouldn’t even begin to think of securing a comparable deal.But the inherent tension between securing a write-down on Greek debt which moreclosely mirrors the disaster which is now the Greek economy, and the desire tominimise the potential contagion effect is rearing its ugly head already, andmay help to explain some of Germany’s recent machinations.

Europe’s Non-Solution

By Marshall Auerback

Today is supposedly the day where the problems of the euro zone get resolved once and for all. And when have we heard that before? Truth be told, it’s hard to get excited about any of the “solutions” on offer, because they steadfastly refuse to acknowledge that the eurozone’s problem is fundamentally one of flawed financial architecture. The banking “problems” and corresponding “need” for urgent recapitalization, are simply symptoms of that problem. Offering the “cure” of banking recapitalization for a problem which is ultimately one of national solvency (of which the banking crisis is but a symptom) is akin to offering chemotherapy to solve heart disease. Despite the current “thumbs-up” from the markets, the treatment is likely to exacerbate the disease, rather than represent the cure.

Let’s go back to core principles. We agree that the concern about Portugal, Ireland, Italy, Greece and Spain (PIIGS), indeed ALL other Euronations is justified. But using PIIGS countries as analogues to the US is a result of the failure of deficit critics to understand the differences between the monetary arrangements of sovereign and non-sovereign nations. Greece, Italy, France, and yes, Germany, are all USERS of the euro—not an issuer. In that respect, they are more like California, Massachusetts, indeed, any American state or Canadian province, all of which are users of their respective national government’s dollar.

But the eurozone’s chief policy makers continue to ignore this fundamental point and therefore, steadfastly avoid utilizing the one institution – the European Central Bank – which has the capacity to create unlimited euros, and therefore provides the only credible backstop to markets which continue to query the solvency of individual nation states within the euro zone. The ECB is so loath for everybody to agree on a Greek default, on the grounds that they bear “the loss” even though it is a notional accounting loss that has no bearing on their ability to create euros until the cows come home. By contrast, when you get national governments funding the European Financial Stability Fund (EFSF), then it does ultimately threaten the credit ratings of France and Germany once the markets begin to call their bluff on how far they’re prepared to go to support this political fig-leaf called the EFSF. And because NONE of these countries is sovereign in respect to their currency (they USE the euro, but they don’t ISSUE it), it expands the potential insolvency problem, taking Germany down along with the rest.

The market pressures are most acute today in respect of Greece, but the broader concern is that speculators will eventually look toward the bigger PIIGS, such as Italy, and this is where the issue of the European Financial Stability Fund’s structural weaknesses come into play.

Let’s not get bogged down in numbers. The EFSF could have 440 billion euros behind, 1 trillion, 2 trillion, even 10 trillion euros, but it all comes back to the funding sources. The French are right: it makes no sense to implement this program without the backstop of the ECB, which is the only entity that could make any guarantees credible, by virtue of its ability to create unlimited quantities of euros.

Both the leading policy makers within the euro zone and market participants continue to conflate two distinct, but related issues: that of national solvency and insufficient aggregate demand. Policy makers want the ECB to do both, but in fact, the ECB is only required to deal with the solvency issue. When you do that in a credible way, then you get the capital markets re-opened and you give countries a better chance to fund themselves again via the capital markets. It means you do not actually need several trillion dollars, because you have a credible backstop in place – a central bank that can create literally trillions of euros via keyboard strokes and thereby address the markets’ concerns about national solvency. At this point, the bonds of the various nation states become less distressed and the corresponding need for massive banking recapitalization goes away.

Banking recapitalization is being demanded because the eurozone keeps demanding “voluntary” hair cuts” on Greek debt. But letting Greece default will not end Europe’s crisis and will not allow Germany and other core nations to brush themselves off and move merrily on their way. It becomes a question of whether a bailout now is good for Germany and France but not so good for Greece. Because if Greece is allowed to default, then their debt goes away. Authorities in effect agree substantially to lower their debt and reduce their payments.

How does that help the core countries, such as Germany or France? Indeed, getting France and Germany into the sovereign debt guarantee business via the EFSF (which is what happens if the ECB has no role) ultimately contaminates their own national “balance sheets”, thereby causing the markets to query their solvency as well and extending the contagion effects well beyond the PIIGS. We will have a situation akin to Ireland, whereby a country which had fundamentally solid government finances taken down via ill-considered guarantees to its insolvent banking system. Peripheral EMU is to core EMU as Irish banks once were to Ireland. By getting into the guarantee business, Ireland drove down a policy cul de sac from which it is still trying to extricate itself and smeared itself with correlated risk that required it to seek a bailout.

If the ECB continues to fund Greece via its bond purchases and does not allow them to default, then Greece has to continue to make these payments. But the ECB has this weird idea that somehow continuing their bond buying operation allows Greece (and other “fiscal deviants”) to avoid their “fiscal responsibilities” (i.e. continued fiscal austerity). The reality (however misguided), is that the bond buying operations actually provide the ECB with its leverage to force Greece and others to continue their “reforms”. Bond buying by the ECB changes the whole dynamic from doing Greece a favor to disciplining Greece by not allowing them to default and allowing the ECB to collect a significant income stream from the Greeks in the meantime. The minute Greece defaults, this leverage is lost. And then what is to stop the other “problem children” from demanding the same terms?

What is amazing as one listens to the commentary is the number of people who keep defining this as a banking crisis. Worse is their desire to punish the banks, which were told at the euro’s inception that one national bond was as good as another. The system wouldn’t have functioned (or, rather, its flaws would have become manifest sooner) if the national banks had proceeded on the basis that, say, Italian bonds weren’t as good as German bunds. So now the rules are being re-written and the “irresponsible” bankers are to be punished.

Okay, bankers have been irresponsible in a multitude of areas, many of which have already been documented on this blog. But here they are being punished for the wrong things. This is ultimately a national solvency crisis, not a banking crisis, so how does punishing the bankers and their shareholders help here?

Everybody in Europe, save the Germans, appears to understand this right now. Every time something unconventional is urged on the Germans, they scream “Weimar”. One of the indicators of development – intellectual and national and otherwise is to appreciate history and be able to decompose it into components.

Can’t the Germans make that simple division? I was a speaker at an EU forum two weeks with lots of Euro-types flown in. They kept talking about Weimar as if it was yesterday. Rome fell at one time too!

The other alternative is even less pleasant to contemplate, which is that there might be some Machiavellian genius behind the German position: perhaps their goal is to see the rest of Europe economically deflated into the ground, at which point, they will scoop up the pieces on the cheap, bit by bit. They’ll get their empire, albeit 70 years after Hitler expected when he invaded Poland. It’s Anschluss economics writ large. So Germany’s motives are either misguided, or more sinister than is now apparent.

But let’s deal with the core issue first: no solution can be found until the EMU leaders deal with the solvency issue. After that, everything else falls into place. It won’t restart economic growth, but it gets you out of the fiscal straitjacket because once the markets are persuaded that the individual countries are fundamentally solvent, they will lend again at sensible interest rates, which in turn can help to deal with today’s problem of insufficient aggregate demand.. And it means you don’t have to start worrying about massive haircuts on the debt because the bonds are trading at distressed levels precisely because the markets don’t believe these countries have a credible solution for the problem of national solvency.

The revenue sharing proposal which has been proposed by a number of us (see here and here ) is the most operationally efficient manner to involve the ECB, with a minimum of legal disruption. Additionally, it’s not inflationary, as it mere substitutes national bonds with reserves in the banking system and building banking reserves is not inflationary (see here for more)

Questions have been raised both about the ECB’s ultimate solvency and the legal constraints which govern its mandate. To deal with the solvency issue first: has anyone bothered to ask themselves what the concept of solvency means for a central bank that creates its own money? Bill Mitchell has addressed this many times (see here), but if one takes the 30 seconds required to ponder this question, surely we can understand that the concept of solvency is totally and thoroughly irrelevant to a central bank with a sovereign currency (i.e. not convertible on demand into a fixed quantity of other currencies or a commodity).

The ECB and others who resist its involvement in the salvation of the common currency continue to think and act as if it is a central bank operating under a gold standard. That is insane, and certifiably so.

In regard to the legal requirements:

  • The ECB does not have a statutory minimum capital requirement.
  • It transfers profits to national governments but in times of losses is can only request a capital injection should its capital be depleted.
  • The European Council (which is representative of elected governments) is not compelled to accede to this request.
  • Hence, the ECB is a perfect balance sheet to warehouse risk since its losses need not become fiscal transfer as it can rebuild its profits via seigniorage over a number of yrs. In that sense, its role is analogous to that of the Swiss National Bank effectively warehoused its Swiss banks’ bad paper during the height of the crisis in 2008.

Of course, the ECB would HATE this and the risk is that its losses would limit its willingness to maintain its bond buying program. But it remains the only game in town. The bond buying is precisely what gives them leverage and, paradoxically, preserves the quality of its balance sheet, since the purchases themselves ensure that the distressed bonds of countries such as Greece do not lose value because the ECB prevents them from defaulting. As we have described before, the ECB effectively uses the income of the Greeks (and others) to rebuild its capital base. The minute the EFSF is introduced, along with the notion of haircuts, the ECB loses its leverage and the credit risk contagion shifts to the core countries of the EU, which WILL threaten their AAA ratings.

It also means this whole issue of banking recapitalisation is a big red herring. In reality, banks don’t really need recapitalisation. What most depositors care about is being able to get their deposit money out of their bank, so whether they are solvent or not is not their primary concern. Arguably, all of the US banks were insolvent in 1982, but the FDIC guarantees worked to stabilise the system.

Bank capital is always available at a price. The ‘market process’ is for net interest margins to widen to the point where earnings attract capital. Except this all assumes credit worthiness isn’t an issue.

The problem with current policy is that it is turning both the public and private sector into a ‘credit event’ which will make it extremely difficult for the borrowers to switch lenders.

In the current environment you have a solvency crisis which is feeding into the banking system because a large proportion of their assets are euro denominated government bonds. Going down the path of “voluntary” hair cuts and forced recapitalization will simply set off a massive debt deflation spiral. We will see bank’s fire selling assets left and right – management will not issue equity at these miserably low price to book values. Which in turn will depress economic activity even further, widen the very public deficits which are so exorcising the Eurozone’s policy making elite, and bring us back to Square One. Already the guns are being turned on Italy, now that Greece is on the threshold of being “solved”.

In the words of Italy’s greatest poet: “Lasciate ogne speranza, voi ch’entrate.”*

*Abandon hope all ye who enter here – Dante, ‘The Inferno’

Greece: the ECB’s Daily Floggings will Continue until the Greek Economy Recovers

The European “troika” that has been driving Greece into adeepening depression has just completed an analysis documenting the failure ofits policies.  The analysis hasleaked.  Here are its introductoryparagraphs.

Greece:Debt Sustainability Analysis
October21, 2011

“Since the fourthreview, the situation in Greece has taken a turn for the worse, with the economyincreasingly adjusting through recession and related wage-price channels,rather than through structural reform driven increases in productivity. Theauthorities have also struggled to meet their policy commitments against theseheadwinds. For the purpose of the debt sustainability assessment, a revisedbaseline has been specified, which takes into account the implications of thesedevelopments for future growth and for likely policy outcomes. It has beenextended through 2030 to fully capture long term growth dynamics, and possiblefinancing implications.
The assessment showsthat debt will remain high for the entire forecast horizon. While it woulddecline at a slow rate given heavy official support at low interest rates(through the EFSF [European Financial Stability Facility] asagreed at the July 21 Summit), this trajectory is not robust to a range ofshocks.  Making debt sustainable willrequire an ambitious combination of official support and private sectorinvolvement (PSI). Even with much stronger PSI, large official sector support wouldbe needed for an extended period. In this sense, ultimately sustainabilitydepends on the strength of the official sector commitment to Greece.”

The leakedmemo helps explain why the Troika always lets the periphery twist slowly in thewind even though doing so hurts everyone – if this memo is representative theTroika must be choking to death on its jargon, theoclassical economics dogma,and its propaganda.  In plain English,the memo concludes:
1.  Greece’seconomy is crashing
2.  Ourclaim that the “reforms” we were imposing would cause productivity improvementsthat would drive a robust recovery has proven false
3.  Ourprediction that the Greek economy would improve and allow Greece to repay itsdebts is inoperative
4.  Ournew prediction is that Greek debt will remain dangerously high for the lengthof our prediction (through 2030)
5.   If anything nasty happens to the economyduring the next 20 years Greece will be unable to repay its debt
6.  Onlylong-term bail outs and requiring Greece’s creditors to take substantial lossescan make it possible for Greece to avoid collapse
Those admissions, while striking, are notthe Troika’s most important admission.  Notethat the Troika’s first paragraph contains the remarkable phrase that Greece is“adjusting through recession.”  Apparently,Greece is adjusting to a recession “through recession.”  One assumes that under this framing Greece“adjusted” to World War II through its troops and civilians dying.  What the Troika appears to be trying to sayis that Greek wages are falling as the Greek economy collapses, which causesthe collapse to accelerate.  Thememorandum claimed that the Troika’s initial model was based on experience inother nations that were forced to adopt austerity during a severe recession andexperienced remarkable recoveries, but admits that the model has failed inGreece.  (The reality is that it failedin the other nations as well, but the Troika is having enough trouble admittingthe truth about Greece.) 
The Troika’s new, more pessimisticforecast is that Greece’s recession is mild by the start of 2012 and is over bythe end of 2012.  That is an extremelyoptimistic assumption, not a pessimistic one. The odds are strong that the Troika’s austerity program will causeGreece to descend into a severe recession. If it does, the Troika’s plan blows up immediately.  But the Troika recognizes that it does notrequire a recession to blow up their projections.  Stresstests to this revised baseline illuminate further the problem with sustainability,revealing that the downward debt trajectory would not be robust to shocks.”  If almost anything material goes wrong – overthe next twenty years – the Troika project that the Greek economy would descendinto a debt and deficit death spiral.  The odds that nothing relevant to the Greekeconomy and government will go wrong over the next two decades are tiny.  The Troika is basing its new plan onassumptions that are so rosy that they could populate a large flower garden.
The Troika assumes that Greece will run avery large “primary surplus” in its budget – and maintain it for decades.  The Troika recognizes that this “requiressustained and unwavering commitment to fiscal prudence by the Greek authorities.”  There are two problems with thisassumption.  It is imprudent to run abudgetary surplus during a collapse of private sector demand that is causing asevere recession.  Doing so will make theexisting recession far worse and trying to do so for decades will cause orexacerbate future recessions.  The Troikaassumes the opposite:  “[S]trong growth willbe very hard to achieve unless Greece’s high debt overhang is decisively tackled.Overall, the scenario emphasizes the crucial importance of frontloadinggrowth-enhancing structural reforms for debt sustainability.”  The Troika concedes that it is critical thatGreece promptly achieve substantial growth. The Troika, however, is insisting on austerity – budget surpluses –during a severe recession.  That is apro-cyclical policy that makes the recession worse.  The Troika is counting on magic –“growth-enhancing structural reforms” to overcome the self-destructive natureof their austerity program and produce a prompt, robust recovery from thereception.    
The second problem is that if the Troikabelieves that the Greek government will display a “unwavering commitment” fordecades to actions that are (deservedly) extremely unpopular among theelectorate then it must have been meeting in a an Amsterdam hash house when itwrote this sentence.
Adopting these new myths about Greece’sprompt recovery from recession and maintenance of very large surpluses fordecades allowed the Troika to abandon two prior myths.  The memorandum shows that the Troika hasdropped the fantasy that Greece will soon be able to borrow funds from themarkets without any guarantees from the European Central Bank (ECB).  The new estimate is that it will take adecade before Greece can borrow and that it will not be able to borrowsubstantial funds “until late [in] the second decade.”  Similarly, the Troika finally admits that aGreek default on its existing debt is certain. “Greece’s debt peaks at very high levels and would decline at a very slowrate pointing to the need for further debt relief to ensure sustainability.” 
The Troika has not given up one of theircentral myths even though it is one of the most pernicious myths in the last 80years.  It is one that Keynes (andreality) disproved long ago.  The Troikabelieves that if Greece fell into a deeper recession it would recover more quickly because of the recession.  The “logic” is that severe recessions lead tosharp drops in working class wages, which makes the nation far morecompetitive, which expands its exports, which accelerates Greece’s recovery under the Troika’s new model.    
“Tomodel this it is assumed that through much deeper recession and deflation thecompetitiveness gap is unwound by 2017, instead of during the next decade. The headwindsfrom the deeper recession are assumed to delay the achievement of fiscal andprivatization policy targets by three years.
Asthe economy rapidly shrinks, debt would reach extremely high levels in theshort run at 208 percent of GDP. If Greece could weather the shock toconfidence this could create, the eventual more rapid recovery of the economywould help bring debt back down towards the revised baseline path….”
This passage “explains” the Troika’s useof the phrase “adjusting through recession.” We can now see what a chilling phrase it is and how little empathy theTroika has for human beings who are suffering. “The competitiveness gap” assumes that the Greek working class isseriously overpaid and that as the recession deepens and causes ever greaterunemployment it will cause Greek wages to fall sharply until it reaches thepoint that the Greeks are competitive with places like Portugal.  The Troika propounds the myth that recessionsare self-correcting and that the more severe the recession the “more rapid[the] recovery.” 
Greece is already a nation beset bysevere income inequality and unemployment, and the Troika claims thatincreasing the income inequality and unemployment dramatically is one of thekeys to recovery.  Slashing working classwages and employment in a Great Recession, however, causes private sectordemand to fall sharply.  The underemployedcut their consumption for obvious reasons, but many workers will cutconsumption because they fear that they will lose their jobs.  The result of the Troika’s austerity policiesin Greece has not been a recovery, but a deepening depression, as the Troika’smemorandum admits.  Greece is notrecovering under the Troika’s self-defeating austerity mandates.  The Troika’s policies are analogous todoctors bleeding their patients centuries ago under the delusion that itimproved their health. 
In the same quoted passage, the Troikapresents an additional myth – “deflation” causes nations in severe recessionsto recover.  Deflation does the opposite,for several reasons.  I will explainbriefly only one of these reasons.  Whenprices are falling on major goods for which it is often possible to deferpurchases (e.g., buying a new automobile or refrigerator), consumers may defertheir purchases because deflation means that they can buy those goods at alower price in the future.  One of thefundamental characteristics of severe recessions is grossly inadequate privatesector demand, so deflation exacerbates recessions by reducing private sectordemand.
The Troika’s memorandum has a revealingaside about what the ECB cares about. The context is the presentation of the necessity of Greece’s creditorsagreeing to large reductions in Greece’s debts.
“DeeperPSI,which is now being contemplated, also has a vital role in establishing thesustainability of Greece’s debt.”
That sentence ends with the followingfootnote.
1“The ECB does not agree with the inclusion of these illustrative scenariosconcerning a deeper PSI in this
The ECB has no statutory mission toprotect the interests of Greece’s creditors. Its decision to side with the interests of Greece’s creditors(overwhelmingly European banks, particularly German banks) against theinterests of a member nation makes clear why the ECB poses an enormous dangerto Europe.  The ECB is dominated bytheoclassical economists who glory in their “independence” from democraticinstitutions but are slavish servants of the systemically dangerousinstitutions (SDIs) – the misnamed “too big to fail” banks.