Last week, the German Magazine Der Spiegel carried the story (May 6, 2011) – Greece Considers Exit from Euro Zone. I thought that if the story was true then Greek leadership must finally be coming to their senses. The reality is that the EMU bosses have once again stalled the judgement day and provided some soft relief for an economy that continues to deteriorate. Everyone knows what the problem is – the EMU doesn’t work and without a federal fiscal redistribution mechanism it will never be able to deliver prosperity. Every time an asymmetric demand shock hits the Eurozone, the weaker nations will fail. Trying to impose fiscal rules and austerity onto the EMU monetary system just makes matters worse. Greece should definitely leave the Eurozone. Life will be difficult then but the adjustment mechanisms that would then be available to the government (floating exchange rate and currency monopoly) are more people-friendly (capable of increasing jobs and income) than the way they are currently pursuing the problem (internal devaluation and demand contraction). Europe continues to demonstrate it has no answers worth considering.
The Spiegel story said that “(t)he debt crisis in Greece has taken on a dramatic new twist” and that “sources” told the journalist that the Greek government was considering leaving the Eurozone and reintroducing its own currency. This was ahead of a meeting of EMU Finance Ministers last week.
The economic problems in Greece are becoming more “massive” and civil unrest is growing with “protests against the government being held almost daily”.
The story claimed that the “crisis meeting” last Friday evening was an “alarmed” response to “Athen’s intentions” although if you read the news reports that came out of that meeting you would not have concluded that.
The Spiegel article reports that a secret German Finance Ministry report claims that a new Greek currency would devalue by 50 per cent on the Euro immediately and this would cause Euro-denominated Greek debts to soar.
In other words: Greece would go bankrupt.
Not in its new currency. By leaving the EMU is would declare bankruptcy in terms of the Euro but it could negotiate all loans into the new currency and be fully solvent.
That is the nature of currency sovereignty – a government can never go broke if all liabilities are held in that currency.
Spiegel said that the secret Report also claimed that if Greece went “(i)nternational investors would be forced to consider the possibility that further euro-zone members could withdraw in the future”. Yes, all of them should go – Portugal, Ireland, Greece, Spain – and then the system would collapse as it should.
The Report also noted that the ECB would have to write-down its holdings of Greek state bonds and “Germany would bear the majority of the losses” given its investment in ECB capital.
German neo-liberal economist, Hans Werner Sinn favours a Greek withdrawal. In this article (May 7, 2011) – Top-Ökonom sieht in Euro-Aus für Griechenland kleineres Übel – he said (by way of translation):
If Greece were to leave the Eurozone, it could devalue and become competitive. But of course there would be an immediate bank run. If on the
other hand Greece had a socalled internal devaluation in the required size of 20-30% in the Eurozone by cutting salaries and prices then it would be on the verge of civil war.
In my view, anti-social arrangements like those intrinsic to the design of the Eurozone cannot ultimately suppress individual dissent. As people work out that the Euro monetary system is so anti-people and anti-prosperity and more about meaningless rules (except when Germany and France violate them), there will have to be political changes.
But the rest of the press were not talking about a Greek exit.
The UK Guardian commented on the secret meeting of EU finance ministers in this article (May 9, 2011) – Greece will crash, so build up the buffers.
The Guardian commenting on last year’s €110bn EU bailout for Greece and the fact that Greece has “missed” its deficit reduction targets said:
The obvious conclusion is that the bailout is not working and that Greece’s debts, which are forecast to peak at 160% of GDP, are too high to allow the country’s economy to recover. In that case, eurozone leaders should stop pretending that more budget cuts and more calls for the Greeks to privatise state assets will make the numbers add up eventually. They should instead start talking about ways to reduce Greece’s debts and think about how to contain the knock-on damage to eurozone banks that hold Greek bonds.
It is not Greece’s debts that are making it hard for it to recover. It is the fact that the Greek government has accepted a nonsensical pro-cyclical fiscal austerity approach that stops the economy growing.
Growth is needed to (a) reduce its deficit; and (b) start reducing its public debt ratio.
Without growth, it is little wonder it is missing its austerity targets. The reality must be dawning on the Greek government that despite the rhetoric to the contrary from the Euro-conservatives the budget outcome is not something a national government can control irrespective of whether it issues its own currency or not.
The Guardian concludes that “the market views a Greek default as inevitable eventually” and that the EMU politicians will eventually stop bailing it out.
The author says that urgent policy issue is to ensure the Eurozone banks do not suffer when this happens. Which is the main motivation of the EMU bosses. The only reason they are keen to keep Greece within the EMU and beyond a formal default is that the big French and German banks would go down in flames given their debt exposure to the Greece.
The same day (May 9, 2011), Larry Elliot wrote in the UK Guardian that – Greek crisis lets Osborne peddle myths. Elliot also said that the ” secret meeting involving finance ministers from a selective group of eurozone countries” at the weekend did not consider Greece’s withdrawal from the EMU. Instead it was about “easing the repayment terms on its loans, providing a second bailout and debt restructuring”.
The relevant part of this article for today’s blog was his comparison between the UK and Greece. Elliot said:
To the extent that Britain is like Greece, it is that slower growth is making it harder to get borrowing down. In all other respects, the comparison does not bear scrutiny, not least because the UK is outside the eurozone and thus has the advantage of a floating exchange rate.
First, all national economies – whether their governments are sovereign in their own currency or not – operate in similar ways with respect to the response of production to aggregate demand (spending). Growth in output and employment comes in response to spending. If you cut spending you cut growth.
Spending can come from the private sector (consumption and investment), the external sector (net exports) or the public sector.
The floating exchange rate is a part of the crucial difference between Greece and the UK. But the more fundamental difference is that the UK issues its own currency while Greece is forced to use a foreign currency. To be fully sovereign in its own currency a government has to have a monopoly over its issuance and float it freely on foreign exchange markets.
The latter requirement frees domestic policy from having to defend the exchange rate. Under fixed exchange rates, monetary policy becomes tied to maintaining the parity (by buying and selling local currency in foreign exchange markets to prevent any excess supply or demand occurring). Fiscal policy then cannot push the economy to capacity if the external sector is in deficit. This is because monetary policy would be continually contracting local demand (by buying currency and taking it out of the economy and pushing interest rates up).
The UK will never be like Greece while they maintain their currency sovereignty.
But that is not to say that the austerity strategy will not work badly for the Brits just as it has for Greece. The point is that Britain doesn’t have to impose such austerity. The fake problem – an excessive deficit and rising public debt – is of no consequence to a fully sovereign nation such as Britain.
The deficit is a problem in Greece because it has to be financed through private markets (in lieu of the bailouts of the Eurozone which have effectively short-circuited the Greek government’s dependency on private bond markets, albeit only while the bailouts last and the ECB keeps buying Greek bonds in the secondary markets.
Which brings me to an article today (May 13, 2011) – Every euro-zone crisis is different – written by one Daniel Gros, who is the director of the Centre for European Policy Studies and has a PhD in Economics from Chicago, which I guess, goes a long way to explaining his viewpoint. The CEPS is largely neo-liberal in outlook.
The article is taken from this commentary – Sovereign Debt vs Foreign Debt in the Eurozone.
Gros claims that:
THE present crisis in the euro zone is known around the world as the “euro sovereign-debt crisis”. But the crisis is really about foreign debt, not sovereign debt.
He cites the example of Portugal that has public debt and deficit ratios similar to France but high foreign debt in the private sector (banks and firms). He claims this is why the “risk premium on its public debt increased continuously”. It is a strange argument and unconvincing.
The foreign debt exposure of the private sector in Portugal clearly exposes it to credit risk (default risk). But that is not a sovereign debt default risk. The Portugal government has default risk by virtue of the intrinsic design of the monetary system. All debt is effectively foreign to it because it uses a foreign currency – the Euro.
Gros goes onto to say that Italy and Belgium are not being attacked by bond markets nearly as much as Portugal because “both have very little foreign debt”.
My observation holds – all EMU nations have foreign-currency debt from the perspective of the national government. The most likely reason Italy and Belgium are less under attack from bond markets at present is because they are very large countries and bond traders know that the ECB/EU will never let them default.
Gros suggests that markets are focusing on foreign debt because:
… in a crisis, private debt tends to become public debt. Financial markets thus look at the overall indebtedness of a country. But it matters to whom this debt is owed.
But in saying that if the US absorbed private debts the bond markets would know that there was no risk of default because the US government issues the US dollar. But the markets also know that if a national government in the EMU was stupid enough to take on troubled private debt it would not be risk free anymore than when the private sector held it.
He does, correctly, bring in the fact that “euro-zone states retain their full taxing powers” and says bond markets know that a government can always repay “domestic debt” by increasing taxes. He goes one step further to say:
But the key point remains: as long as a government retains its full taxing powers, it can always service its domestic debt, even without the ability to print money. But this is not the case if the debt is owed to foreigners, because the government cannot tax them.
First, foreign-currency-denominated debt is a problem for any government – whether it issues its own currency or not. For a fully sovereign nation (like the UK, US, Australia), taking on foreign-currency-denominated debt immediately compromises their sovereignty and introduces default risk. The nation has to get sufficient foreign exchange (in the currency that the debt is denominated in) via net exports. If it cannot do that then the debt becomes problematic.
Second, retaining tax powers is only a necessary condition to being able to get enough tax revenue to cover liabilities. The tax base has to be responsible and sufficient to accomplish that. The problem is that the sort of problems that the EMU nations are in have come at a time when the tax base has shrunk dramatically.
Third, trying to exploit a “declining” tax base in a recession is pro-cyclical and is likely to reduce tax revenue even further as the economy shrinks.
Fourth, not having the “ability to print money” – which is Gros’s crude way of expressing currency issuing sovereignty (noting that governments do not “print money” when they spend) – is the crucial reason why the Eurozone nations are facing debt default. That is, ultimately the reason why they need to gain “finance” anyway.
Gros rather strangely says that while it is “foreign debt that constitutes the underlying problem for a sovereign with solvency issues”:
… fiscal adjustment is necessary but insufficient to escape a debt crisis. Fostering domestic savings, and getting citizens to buy bonds of their own government instead of keeping their money abroad, is just as important.
And so he further bypasses the main issue. Pro-cyclical fiscal adjustment makes the problem worse. It is being forced onto nations because they have surrendered their currency sovereignty. EMU nations are not”sovereign with solvency issues” – rather they are like the states in a federal system – a curious one at that which eschews “federal-level” fiscal adjustments to overcome asymmetric demand shocks. That is, they are not sovereign in any monetary sense.
A government can only foster domestic savings if it provides income growth. Austerity undermines both income growth and the private capacity to save.
Further, Greek would be much better off – defaulting on all Euro debt, introducing its own currency, and engendering economic growth – in part, via public works and also via its increased external competitiveness as the “drachma” devalues.
It should also abandon the practice of debt issuance and allow the central bank to pay interest on excess reserves as the means to maintain control over its own short-term interest rate.
Then the bond markets would become irrelevant, people would return to work albeit with lower real incomes (courtesy of the depreciation) and the Greek government could be judged on its own ability to administer sensible fiscal policy (or not).
After nearly a week concentrating on Australian issues (it was Budget week and Labour Force week after all) I thought some international discussion was needed.
Please see all my blogs about the – Eurozone as background for today’s discussion.
The Saturday Quiz will be back sometime tomorrow.
That is all for today!