I am travelling for most of today and so haven’t much time to write a blog. I am typing this on the train to Sydney airport. The press has been increasingly highlighting the on-going Greece situation. What is important to note is that the neo-liberals are no longer honey-coating the fiscal austerity in terms of “fiscal contraction expansion”. The Greek finance minister is now saying that the Greeks have a choice between disaster and total disaster. Other are juxtaposing sacrifice with chaos. I have noted that in recent months that a lot of commentators have been asserting that an exit would be a disaster – far worse than the current “disaster” of 4 years recession and more to come. But rarely do you read any coherent analysis of what might happen should Greece exit the Eurozone. My view is that while the dislocation would be intense and costly it would, in the longer-term, be less costly than the current alternative – which is persistent recession for the foreseeable future and a savage erosion of real living standards, especially for the next generation. As on commentator put it over the weekend (full quote provided later) – the current austerity approach with “deep structural inequalities and its rigid adherence to a failed economic ideology, protects neither democracy nor human rights. Stiff-necked and punitive, it prefers to eat its children
It is ironic that the fiscal austerity argument is often phrased in terms of needing to take the “crippling” debt burden off the future generations. However, the damage that the bailout packages are doing to those generations is highly significant yet that irony is never noted.
The UK Guardian article (February 12, 2012) – As Greece stares into the abyss, Europe must choose – made this point emphatically:
Six inches from the riot policeman’s shield outside the Greek parliament last Friday, a tall, pale boy was shouting at a man who could have been his uncle: “It’s your generation that brought us to this point, but it’s mine that has to pay for it. You have to take responsibility for what’s happening here.”
Please read my blog – The rising future burden on our kids – for a discussion of why fiscal austerity imposes a heavy burden on the future generations.
The Greek Finance Minister was quoted by Bloomberg (February 13, 2012) as saying in relation to the current political impasses in Athens that:
Today at midnight, before markets open, the Greek Parliament must send a message … We must show that Greeks, when they are called on to choose between the bad and the worst, choose the bad to avoid the worst.
Reinforcing the Finance Minister, the Troika-installed Prime Minister told the Greek people via TV that:
We are looking the Greek people straight in the eye with full knowledge of our historical responsibility … The social costs that come with these measures are contained in comparison to the economic and social catastrophe that will follow if we don’t adopt them … We have to sacrifice a lot so as not to sacrifice everything.
The Prime Minister he replaced obeyed the Troika script by saying:
We must speak honestly and tell Greeks what bankruptcy really means. It means chaos.
It should be noted that bankruptcy only applies to the nation’s status as a user of a foreign currency (Euro) and becomes irrelevant once the nation restores its own currency. As I discuss below, under those terms, it can duly re-denominate all foreign-currency obligations in terms of its new currency and solvency then becomes guaranteed.
It is interesting that there is horror expressed by commentators about the possibility that the Greek government could enforce creditors to accept Drachma instead of Euros, the same horror is not expressed when the Troika propose a PSI arrangement that could carve up to 75 per cent off the value of current Greek bond investments (in Euros).
I will come back to the political assessments later but you note that they are no longer making the mainstream macroeconomic argument that has been justifying the imposition of austerity – that growth is just around the corner once the private sector realises that the deficit cutting will reduce future tax burdens and as a consequence they stop saving and start to spend again.
That nonsense – was always nonsense – and its bald-facedness is now being exposed.The future for Greece under current policy is bleak and the private sector know it.
The Troika (EC/IMF/ECB) operating through the agency of the Finance Ministers Summit initially wanted Greece to impose further – huge – cuts in net public spending in return for the next bailout installment that would see that nation pay up on its impending debt commitments.
The ridiculousness of the whole deal was that the Greeks were expected to achieve certain fiscal targets by this time. The progress of the Greek cutbacks is reviewed every three months by the baleful bureaucrats within the EC and the IMF. What they expected to happen each three months is of some confusion. The indications are that they actually expected the fiscal situation to improve.
But it was always obvious that under current conditions – fiscal austerity would lead to an increasing budget deficit and rising public debt ratio – as aggregate demand continued to contract.
All the real GDP estimates of the Troika have been shown by unfolding events to be over-optimistic. The Greek economy is in a severe downward spiral and has been getting worse for the last 4 years.
The recession is now entirely self-imposed by the Troika and its henchmen/women in the Greek polity.
But it is now well-known that the Finance Ministers acting turned nasty on Greece last week and demanded even harsher cuts including a 22 per cent cut in the nominal money wage (a much larger cut in real terms), drastic cuts in pensions and public sector employment cuts of up to 15,000 workers by 2015.
These additional cutbacks are the equivalent of about 7 per cent of GDP over the next three years and under those circumstances the Greek economy will remain in recession at least over that period.
It is inconceivable that a nation would tolerate 7 or 8 years of enforced recession when it is largely unnecessary.
The Germans have been claiming that even with these latest proposed cuts the public debt ratio will remain above 120 per cent of GDP.
The media is also perpetuating the claim that chaos would follow a Greek-exit from the Eurozone.
The UK Guardian article (February 12, 2012) – There’s talk of an exit – but default would have catastrophic consequences – claimed that the “break-up would bring banking chaos”.
The article said that a “Grexit … would send shockwaves throughout the world economy”.
… default and “re-drachmatisation” would be a costly and chaotic process … in the short term banks across the eurozone might have to be closed to prevent a run on the single currency as investors speculated about which country might be next. A new wave of bank nationalisations would be likely to follow as lenders counted their losses on now worthless Greek debt.
Capital controls would have to be imposed and borders shut to stop money flooding out of Greece. Portugal, Italy and Spain would come under intense pressure from investors wary about the risk of another victim. Banks everywhere, already reluctant to lend, would cut back hard, nervous about their exposure to the bonds of all Europe’s crisis-hit states.
For Greece, a drastic devaluation … could at least provide the hope of an export-led recovery. But unlike Argentina, which defaulted on its debts in 2001 after a wrenching political and economic crisis, Greece has neither the advantage of plentiful natural resources nor a boom in the world economy to ride.
So you get the message – chaos – drastic devaluations etc. No mention of the recent ECB initiatives to provide at virtually zero cost massive long-term funding to European banks.
No mention of the growth that the Greek government could engender immediately if it regained currency-sovereignty.
Further, the implication that capital controls are chaotic would not sit with Malaysia during the Asian crisis. The IMF has also released research showing that capital controls are effective and beneficial.
Please read my blog – Are capital controls the answer? – for more discussion on this point.
Also revealed over the weekend was the secret conversation between the German Finance Minister Wolfgang Schaeuble and his counterpart in Portugal Vitor Gaspar recorded before last Thursday’s Eurogroup meeting of Finance Ministers began. The conversation was recorded by the Portuguese station – TVi24.
This meeting upped-the-ante on Greece by demanding an extra €325 million extra in public spending cuts before this coming Wednesday in order to get the latest bailout.
Further, the bailout money would be sequestered and the Greek government would have to prioritise debt repayments over general government spending. It is estimated that 70 per cent of the bailout money will be prioritised in this way. In other words, there’s not much there for the Greek people.
It is clear that “divide and conquer” strategies are being used as the German indicates to the compliant, almost simpering Portuguese finance minister that Germany would “adjust” the Portuguese bailout conditions as long as the decision to enforce even harsher sanctions on Greece went through.
The conversation went like this (with the segments marked … being inaudible):
Wolfgang Schäuble: … we need an adjustment to the programme, after our substantial decision on Greece … Not to [unclear]. If then there will be a necessity for an adjustment for the … programme, we would be ready to do that.
Vítor Gaspar: That’s much appreciated.
Wolfgang Schäuble: As long as my fellow members of the government … that public opinion in Germany don’t believe that our decisions are serious, because they don’t believe in our decision on Greece.
Vítor Gaspar: We have made quite substantial programme on the European framework.
Wolfgang Schäuble: You have, yes.
Vítor Gaspar: That we have. And now we must work today …
This You Tube video presents an interesting analysis of the body language between Vítor Gaspar and Wolfgang Schäuble – “the petitioner and the petitioned”!
The New York Times article (February 10, 2012) – Amid Efforts to Rescue Greece, a Lack of Trust From Allies – interpreted the exchange as an indication that:
The conversation … illustrated a stark fact as the euro zone’s debt crisis enters its third year: While Portugal, Ireland and other countries may be struggling, Greece has found itself in a category of its own — a nation the rest of Europe no longer trusts.
One hypothesis about the behaviour of the Germans and French (and other northern European leaders) over the last few years in relation to Greece it that they have been buying time. The process of grinding Greece into the ground has allowed the rest of the Eurozone to shore up the dykes!
This point is made by the UK Guardian’s economics editor Larry Elliot in his article (February 10, 2012) – European debt crisis pitches Germany against Greece.
He says that “(t)he Germans want the Greeks out. That is the clear message from the decision by Europe’s finance ministers to reject the offer of a fresh package of austerity measures”,
He considers that the time is now ripe to get rid of the Greeks because the Germans now have the view that “the actions taken by the European Central Bank over the past couple of months have been sufficient to ensure no contagion effects from Greece to the other debt-stricken eurozone members and, just as importantly, to the fragile European banking system”,
I tend to agree with that assessment.
It is probable that what has been taken to be bumbling by the political leadership in the Eurozone has also been a process of buying time while the European banks – assisted by the ECB – have been reducing their exposure to the Greek economy.
In that context, are these claims of chaos justified? I think not unless Greek society is so unstable that it is likely to disintegrate anyway.
The Citibank recently released a Report (I cannot link to it because it is subscription only) which introduced the term Grexit into the lexicon. More importantly, the discussion acknowledges that the financial markets are now openly considering the exit of Greece from the Eurozone.
Citigroup estimated that probability as having risen from 25-30 per cent in November 2011 to 50 per cent within 18 months in February 2012.
So what would happen?
First, it is claimed that the bond markets would stop funding the peripheral EMU nations (Portugal, Spain, Italy) for fear that they would also exit. The reality is that if Greece actually got away with wiping off a substantial portion of its public debt (via the so-called PSI arrangement) it is likely that the other beleaguered nations would demand similar relief.
Would a negative bond market reaction become chaotic? Not in the least. Ask yourself – who has the ultimate power in this situation – the markets or the ECB? The answer is obvious.
The ECB can simply shore up the EMU member states and all the private banks should it choose to do so. Its long-term lending program to the banks and the Securities Markets Program (where it is buying significant quanties of government debt in the secondary markets) is already effectively doing that.
Under those circumstances the bond markets are not in a position of power to dictate to anyone.
The Citigroup analysis supports that assessment:
Policymakers in the EA have the technical ability/capacity to respond to exit fear contagion. The heavy lifting would likely mostly be left to the ECB, but the recent 3- year LTRO has highlighted that policymakers have plenty of ammunition left to respond to non-fundamental contagion and hysteria.
So if the Euro leaders really want to preserve a wider Eurozone – beyond a German-centric Deutschmark-zone – then it has the capacity to do something about it.
My assessment is that the financial markets have already been taking into account the likely exit. Currency flows out of Greek banks have already occurred.
The Citigroup analysis also supports this conclusion:
Direct (and some indirect) exposures to Greece of foreign banks, other investors, and non-financial corporates have been reduced substantially and contingency plans have been made by a likely large number of public and private institutions. This process has been going on for the past 18 months, but by now the reduction in direct exposure to Greece and the extent of contingency planning may well have reduced the direct effects of Grexit to a level that could likely be absorbed by most relevant (non-Greek) institutions without major disruption.
In real terms, the fate of the rest of the Eurozone would not seem to depend much on Greece. Its overall impact on trade for the rest of the EMU is small (nations such as Romania and Bulgaria are more exposed).
The Citigroup analysis says:
Given the limited integration of Greece into regional or global supply chains, the supply effects of Grexit on world output or trade would also likely be minor.
So why then have the Eurozone leaders been talking about keeping Greece in the EMU? The UK Guardian article (February 12, 2012) – As Greece stares into the abyss, Europe must choose – asks the same question and provides a speculative answer:
Why, then, have large sections of the Greek elite clung so hard to the fantasy that a new loan deal can “save” the country? The obvious answer is that default is a black hole and an enormous risk. No one can predict what suffering a default might bring. Another is that the current crop of politicians built their careers in the system that is now unravelling, based on oligarchies, clientelism and corruption; they’ve proved unwilling to make the reforms that might, in a different global climate, have revived both Greece’s economy and its democracy.
The author also points to “deeper … cultural and political” reasons relating to “old splits in Greek society”. The European project diverts the Greeks from their militaristic/authoritarian past.
Thus the elites have seemingly more to lose from a Greek exit than the real Eurozone economy, which would not lose very much at all. The latter’s problem is the ridiculous fiscal austerity being imposed by all EMU governments.
Second, what about the Greek economy?
It is clear that the Greek government would have to default on its Euro-denominated obligations which in the language being used in financial markets would prompt a “credit event”. There is a fear that there are very large CDS payouts linked to such an event but they would not be Greece’s problems and central banks in other nations including the ECB could deal with those as above.
It is often claimed that there would be drawn out contract litigation as a result of the default on euro-denominated contracts. As the Citigroup analysis suggests, this could be overcome by the Greek government passing “a currency law” which would:
… stipulate one or more conversion rates between the old and the new Greek currency (which we will call the ‘New Drachma’)…
Besides one or more rate(s) of conversion, the currency law would likely also specify that the new currency is legal tender for payment and settlement of debt in the ‘relevant country’, i.e. Greece, including for the payment of public and private debt obligations (including bank loans, deposits, and securities) and other contracts, including wage and pension contracts.
Short of a military takeover of the country, a sovereign Greek nation could defy all claims against it outside of the conditions that it sets in terms of its own currency.
The Greek government could defy the rest of the world completely (as in the early days of the Argentinean default) or offer re-denomination in terms of the new currency. Once re-domination was accepted then its so-called “sovereign debt” problem vanishes. It becomes a sovereign currency-issuing nation with debts only denominated in its own currency – which means it could always service those debts.
Should the bond markets decide that they do not want to invest in Greek currency financial assets then the Greek central bank – newly legislated to support the national interest could provide funding to the Greek treasury without any fundamental financial problems.
You will not read of this sort of analysis in the general media because while possible it represents the anathema to the neo-liberals. They would hate it to be understood that a nation had these options available to them.
Its new currency would depreciate – by how much is anyone’s guess. The likelihood is that the depreciation would be sharp and large. But its downward spiral would be finite and reversed as trade flows turned in favour of exports and the real cost of imports rose.
While the Greeks do not have large quantities of natural resources like Argentina did when it defaulted and floated in 2001-02 it still has very desirable assets that are exchange rate sensitive – its tourism capacity. I predict that there would be a boom in that sector virtually immediately and investment funds would flow into it.
The change in the current account would put a floor into the currency fall.
But in the meantime there would be a risk of inflation coming through the current account – as import prices rose in domestic-currency terms. As the currency appreciated again (as the Germans flooded into the sunny Greek islands to escape the Berlin winter) the inflation risk would be attenuated.
The Greek government would be advised to “discount” cost of living adjustments in their pension and wages system in this context. The exchange rate will not fall for very long – it would be a sharp, once-off adjustment.
This means that there is a real income loss to the nation (via the higher import prices) and that must be borne. Attempting to adjust nominal returns within the nation for these losses would create the danger of an inflationary spiral.
But as long as real productive capacity can be brought into use via public spending the danger of hyperinflation is low in these circumstances.
Third, would Greece need to impose capital controls?
The Citigroup analysis suggests:
In our view, it is highly likely that Grexit would be accompanied by the imposition of strict capital controls. True, the Treaty (Art. 63) forbids any restrictions on capital or payment flows between EU member states, but we think that an exiting country, facing massive disruptions in its international capital account transactions would need to impose strict capital and foreign exchange controls following exit if some semblance of financial order is to be maintained.
Malaysia gained major benefits from adopting this strategy in 1997. As noted above, the IMF has demonstrated the conditions under which capital controls, previously eschewed by free market ideologues, can be highly beneficial to a nation making large currency adjustments.
Fourth, none of these adjustments would be easy and costless. But once the nation has its currency sovereignty restored the national government would be able to spend, in a strategic way, to increase domestic production and employment and kick-start the growth process.
It will still have to ensure that its nominal pension system (which is relatively generous by world standards) is capable of being maintained in real terms. That is, it is likely that some structural changes to entitlements will be needed (read: cuts) to ensure that the productive capacity of the economy is in line with the nominal demands on it.
Greece’s inflation history in the past indicates that this sort of policy change will be required. But it would be far better to pursue that course of action within a growth environment supported by its own currency.
Trying to impose harsh structural adjustments when there is a major cyclical event (recession) occurring is very difficult (politically) and highly damaging (economically and socially).
No-one is denying that the Greek economy has structural issues which predicate it to imported inflation. Even with the harsh fiscal austerity which has seen its unemployment rate rise to above 18 per cent with no ceiling in sight, the current account deficit has risen.
Its export base is narrow and it imports a wide variety of consumer goods including food.
But those problems are not going to be solved more quickly by impoverishing the nation. A freely floating exchange rate will be a more effective way of attenuating the imbalances that have emerged between northern and southern Europe with respect to trade.
However, the real bonus that an exit would bring is that the Greek government could unambiguously concentrate on a domestic growth strategy and put an end to its recession.
The last four years have brought the need for some reforms – to the taxation and pension system – into relief. Within a growth context, the Greek government would probably have a better change of brokering these changes with its population than under the current conditions which are fermenting total social breakdown and open rebellion.
The UK Guardian article (February 12, 2012) – As Greece stares into the abyss, Europe must choose – brings home the reality of the fiscal austerity:
When you ask people on the street if they would rather Greece went bankrupt than submit to further measures, many now point out that it is already bankrupt, that public sector workers have gone unpaid for months, that hospitals have no supplies, that the poor are being wrung dry in order to pay the banks. “Let’s get it over with,” a woman who works for the education ministry said to me. “Then we’d know we only had €250 a month and we could start again. This is not the people’s Europe we dreamed of.” The fact that Poul Thomsen of the IMF, the eurozone’s poster boy Mario Monti, the markets and countless economists agree that more austerity will deepen Greece’s depression without making the debt sustainable adds weight to her argument … [and the current fiscal austerity] … with its deep structural inequalities and its rigid adherence to a failed economic ideology, protects neither democracy nor human rights. Stiff-necked and punitive, it prefers to eat its children.
On that sobering note I will finish.
I have to catch a flight now. Note that I will not be able to moderate comments for some hours due to a long flight.
That is enough for today!