I suppose I have to write something about the extraordinary deal that emerged out of Brussels yesterday. I tweeted at the time that the “Latest EU Bailout will not end the uncertainty. Greece will not be able to withstand a decade of repressive economic policies”. The ABC National News last night introduced the bailout in terms of “finally resolving the uncertainty” and then proceeded to interview an analyst who outlined why the deal will increase uncertainty. This is the state of confusion among the media commentators who are bullied by the Troika to mouth is the official rhetoric but who must also realise that the projections underpinning the approach are deeply flawed and that the situation in Greece will continue to deteriorate. The reality is that this “deal” only buys some more time. In the meantime, the real situation in Greece will continue to worsen. Standby for the third Greek bailout.
This picture from the Sydney Morning Herald tells it all. Analysis by body language experts would tell us that the IMF boss is using “Dominant body language” and the unelected Greek PM-stooge is adopting subservient positions – (see Changing Minds for more analysis).
Cap-in-hand-Mr-unelected-President do what you are told!
The news items all seemed to stressed that the deal would stave off bankruptcy, which was imminent in a formal sense, at the end of March 2012.
However, nobody should be mislead into believing that this bailout deal is not a formal default.
The terms of the deal are obvious – private debtors will be coerced by the threat of a 100 per cent loss into accepting a 53.5 per cent reduction (the so-called “haircut”) on the face value of their Greek public bond holdings.
That is a €107 billion default.
Further, the creditors will be asked to accept new long-term bonds which have lower returns than originally promised in December. This part of the default will be worth around €100 billion if it all went to plan.
All of this is being driven by the Troika grabbing some imaginary debt sustainability threshold of 120% of GDP out of the air. Where is the formal analysis demonstrates that 120% is fundamentally different to 150% or some other percent?
I wonder what Rogoff and Co. would say, given that the IMF has in the past liberally quoted the equally arbitrary threshold of 80% that Rogoff touts as being the magic number beyond which government bankruptcy is imminent.
Now the world is being led to believe that there will be no bankruptcy problems over the next 8 years for Greece even though its public debt ratio will remain well beyond the 120% threshold.
The arbitrariness of all of this is staggering, given that the whole policy thrust is based upon highly formal macroeconomic models, which clearly deliver no definitive results.
This is pure ideology – the most disgusting kind.
However, the first emphatic point to make is that if this deal goes through then the Greek government has defaulted.
But there is a broader sense in which the Troika rhetoric is poisonous.
On February 12, 2012, the famous Greek composer Mikis Theodorakis wrote an open letter to the international community – THE TRUTH ABOUT GREECE – where he makes the telling point about bankruptcy:
Production has come to a standstill, the unemployment rate has reached 18%, 80.000 shops have closed down, along with thousands of small businesses and hundreds of industries. In total, 432.000 enterprises have shut down. Tens of thousands of young scientists are abandoning the country, which is every day sinking into medieval darkness. Thousands formerly wealthy citizens are scavenging on rubbish heaps and sleeping on the pavement.
In the meantime, we are supposed to be surviving thanks to the magnanimity of our lenders, the Europe of the Banks and the IMF. In reality, every package deal which charges Greece with tens of billions of Euros is repaid in full, while we are burdened with new unbearable interest rates. And since it is necessary to maintain the State, the Hospitals and the Schools, the Troika is burdening the middle and lower economic strata of society with excessive taxes, leading directly to starvation.
The whole letter is worth considering although he, like most observers, fail to understand the nuances of the EMU when compared to a true fiat currency system like that in the UK, Japan, US, Australia etc.
In an interview following the release of the Open Letter – Interview: Theodorakis’ call to arms (February 19, 2012), Mikis Theodorakis was asked whether “disorderly default be better for the middle and poorer classes than the bailout?” – that is, conjecturing whether the latest bailout is, in fact, a better option. He replied:
How can one speak of default in the future tense when we already have absolute bankruptcy – when 423,000 businesses have shut down and the unemployment rate is over 20 percent. Don’t you see the people scouring through garbage and sleeping on sidewalks? Those who led us consciously to bankruptcy – the troika and the government – now claim they want to save us from bankruptcy. It is incredible!
So while the Troika has been massaging the interests of the big banks, they have been using the Greek citizens as fodder. Greece declared itself to be following a path of continuous recession which will last for at least a decade or more (even on optimistic IMF assumptions). Once it took that course of action, it declared itself bankrupt.
Will it work?
Definitely not! When you study the documents and think about the underlying economics of the situation, it doesn’t take long to realise is that the “ifs and buts” that are involved with deal make the highly improbable that it will ease any uncertainty.
Despite all the solemn rhetoric at the official press conference, this Sydney Morning Herald article (February 21, 2012) – Rescue plan won’t prevent Greek default – which came out soon after the deal was announced, captures the outcomes accurately. In relation to the debt ratio parameters mooted at the Summit, the article concludes that:
Either way it is unsustainable. And the new round of even harsher austerity measures agreed upon last week will only serve to make any such forecasts useless.
The austerity measures, by definition, will further weaken the Greek economy which already has been in recession for five years and which showed an alarming drop in the final quarter of last year. And if the GDP continues to shrink, the debt ratio must blow out, ensuring the country will never manage to retain control of its debt situation … So there is no way Greece can avoid default and further negotiations will ensue this year and next.
It’s here that the difference between a stock and a flow must be appreciated. Those who think that this bailout will end the uncertainty fail to appreciate that government spending and revenue are flows – the result of a multitude of transactions between the government and non-government sectors every day.
The outstanding public debt is a stock – the accumulation of the difference between the spending and revenue flows. Every day that spending flows exceeds revenue flows, the stock of public debt rises.
This particular bailout payment might meet the immediate needs – that is the March-end deadline for a large tranche of “current” debt to be repaid. But meanwhile as long as they’re running primary deficits, the stock of debt is continually increasing.
And it is not clear that they can achieve the primary surpluses that the IMF forecast are necessary for the Troika’s plan to be sustainable.
In other words, the bailout is nothing more than a temporary measure, which fails to address the underlying problem – a chronic lack of economic growth.
The confidential 9-page document prepared for the EU by the IMF is no longer confidential – there are now leaked copies circulating. You can download one from HERE.
The Greek Debt Sustainability Analysis aka DSA starts with this:
Since the fifth review, a number of developments have pointed to a need to revise the DSA. The 2011 outturn was worse than expected, both in terms of growth and the fiscal deficit; the macroeconomic outlook has deteriorated significantly, due to events in Europe; the fiscal outlook has deteriorated due to the economy and due to delays in developing fiscal-structural reforms.
The confusion is clear. They recommended harsh austerity, coerced the Greek government into compliance, and the economy went backwards. As I have demonstrated in the past, this is a standard IMF outcome. When they are bullying governments into imposing austerity they always provide optimistic forecasts for real GDP growth and unemployment reductions.
Please read my blog – IMF – the height of hypocrisy but still wrong as usual – for more discussion on this point.
These errors are systematic and reflect the ideological bias of the underlying analytical framework that the IMF uses.
So it was no surprise that the so-called “2001 outturn was worse than expected”. Anyone who understood the basic macroeconomics involved would have predicted the decline in real GDP growth in Greece was going to be worse than the projections that were published in the fifth review.
Then you get the gobbledygook that “the fiscal outlook has deteriorated due to the economy” – yes, the automatic stabilisers – and because of “delays in developing fiscal-structural reforms” – the latter reflects the ideological component of the explanation.
If the Greek government had imposed all of the demands placed upon it by the Troika then the situation would be far worse than it already is.
In that case, the budget deficit and related public debt ratios would have gone in the reverse direction to that desired by the IMF.
The fiscal outlook has “deteriorated” in Greece because of the austerity and the damage that that approach is having on real GDP growth.
Note the inverted comments in the descriptor “deteriorated”. From a Modern Monetary Theory (MMT) perspective, it is unhelpful to think that a larger deficit, per se, is worse than a smaller deficit.
I prefer to distinguish between good and bad deficits. The former occurs when a government makes discretionary net spending choices in line with the saving preferences of the non-government sector, which result in high levels of employment and appropriate levels of real GDP growth.
A bad deficit occurs when the government attempts to reduce the budget deficit at a time when the non-government spending is insufficient to drive an adequate growth rate and the result is a recessionary outcome with the automatic stabilisers pushing the budget balance into further deficit.
However, when we think of the EMU member-nations, and the fact that they are forced to use a foreign currency – the euro – then under certain circumstances a discretionary increase in the budget balance may threaten their solvency.
It is pointed when you see the “Key Macroeconomic and Fiscal Assumptions Underlying Baseline” in IMF documents and the projection of the unemployment rate is excluded.
The 9-page document assumes that real GDP growth will be -4.3 per cent in 2012, 0 in 2013, and then bounce back to 2.3 per cent in 2014.
What will drive this growth?
The IMF claim that:
… the revised package of structural reforms agreed, which will tend to deepen the contraction initially, but will pull forward the recovery (by improving unit labor costs, which through the other structural reforms assumed in the program, translates into increased price competitiveness and higher investment).
So this is the traditional wage-cut approach to recession, which has been a demonstrated failure when it has been applied in the past.
It says that reducing unit labour costs will lower the supply price for firms and output will grow. As Keynes and others were at pains to demonstrate, reducing wages not only impacts on the supply side of the economy but also undermines aggregate demand.
The mainstream approach is to ignore the demand effects from wage cuts. The reasoning is strictly that which is applicable to a single firm. Such a firm might correctly expect a wage cut in its own workforce to have little impact on its revenue and expand employment as a consequence.
But when the wage cut is across the whole economy such reasoning is flawed. This is the so-called fallacy of composition that bedevils most mainstream macroeconomic analysis.
Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.
The situation is even worse in Greece because the austerity programs are savaging other incomes that drive aggregate demand. Firms will not increase output when there is no sustainable growth in demand nor will they expand investment (to build more productive capacity) if the current stock of capital can adequately meet the current (declining) demand for goods and services.
The IMF may reply and argue that the recovery will not come from domestic demand but rather that the lower unit labour costs will improve international competitiveness of the Greek economy and allow for a trade-driven recovery.
However with many of Greece’s trading partners also now plunging back into recession as a consequence of the flawed fiscal austerity being imposed upon them by the Troika, there would appear to be little hope of an export-led recovery.
The IMF, as noted above, always present an optimistic projection to accompany their demands for posterity.
The IMF spend time analysing the “risks” of the strategy and it is here that you realise what a damaging farce is being played out.
They realise that if the budget deficit fails to go quickly into a primary surplus then the debt dynamics conjectured will fail.
They they note that if there are “significant shortfalls in privatization proceeds” is in the public debt levels will rise “appreciably”. In the context of a declining real growth rate, that means the public debt ratio will also rise.
The scale of the fiscal contraction required by the Troika will be extremely damaging to real GDP growth. I predict that a return to primary surplus next year is highly unlikely. It would have to be substantial improvements in the tax base over the next 12 months and was continued deterioration in economic activity is hard to see that occurring.
The IMF notes that point but still assumes the impossible.
Larry Elliot in his Guardian column (February 21, 2012) – €130bn plaster leaves Greece independent in name only – notes in relation to the IMFs growth projections that:
Against a backdrop of wage cuts, spending cuts, pension cuts, collapsing consumer confidence, capital flight and an investment strike, that looks a tad improbable. The IMF admits that there is a risk of a deeper recession; what it doesn’t say is that the risk is exceptionally high.
They also note that the debt trajectory is “sensitive to the degree of participation in the PSI deal” (among other things). They assume that the “creditor participation rate” will “be 95 percent”.
Who is next?
In 1949, US economist James Duesenberry published a book (Income, Saving and the Theory of Consumer Behavior, Cambridge, MA: Harvard University Press) in which he outlined the “Relative Income Hypothesis” as a means of explaining consumption behaviour at the macroeconomic level.
People where considered to assess the satisfaction they acquired from consumption spending not from the absolute level of consumption but rather the level relative to average consumption. While most mainstream economists ignore the findings from other social sciences such as psychology and sociology (thinking the neo-classical economic model to be self-contained), it is clear that humans are status-seeking and function in groups.
While Duesenberry was trying to solve an anomaly between cross-sectional evidence and time-series evidence regarding consumption behaviour, his point is that there is a “demonstration effect” operating that determines consumption spending (and saving). People watch the consumption of their neighbours and social groups they aspire to be part of. This is in colloquial terms referred to as “keeping up with the Jones'”.
In crude terms, if your next door neighbour buys a new car, then irrespective of whether you can truly afford such a vehicle in terms of your own income, there will be pressure to follow suit.
So if Greece is allowed to write off 53.5 per cent of its debt, why wouldn’t we expect to see Italy, Spain, Ireland, Portugal and the rest of the nations lining up to do the same. Why will the populations in those countries not demand their governments seek similar deals – given that all of them are going down the same damaging austerity route?
The cradle of democracy no more
Another extraordinary aspect of the “deal” is that the Greeks will have to accept foreign “inspectors” permanently moving into the key economic and social policy ministries in Athens.
In the official wording we read that European monitors will have “an enhanced and permanent presence on the ground in Greece”.
In his Open Letter, Mikis Theodorakis writes:
Imagine that with this Memorandum we concede to foreigners our National Independence and our National Property. That is, our harbours, airports, road networks, electricity, water supply, subterranean and underwater wealth, etc., etc. Add to that our historical monuments, like the Acropolis, Delphi, Olympia, Epidaurus and such sites, since we have waived all our legal defences.
Further, the “deal” requires the Greek government to establish an “escrow account” which will be supervised by the Troika and, in which, the bailout funds will be deposited. The foreign creditors will have a priority drawing on this account.
So the bailout will provide no extra capacity for the Greek government to service the needs of its own economy and citizens. The Greek government is even being forced to change its constitution to guarantee priority in its spending to debt servicing.
While the introduction of the euro so the Greeks abandoned their currency sovereignty, the latest demands from the troika amount to a final and undignified loss of national independence. How long the Greek people will tolerate this undignified loss is the question.
If the Euro bosses think that this will end the confusion then as Larry Elliot from the UK Guardian wrote (February 21, 2012) – €130bn plaster leaves Greece independent in name only:
… whatever eurozone finance ministers were smoking in their all-night marathon talks it must have been something strong.
Under the conditions being imposed upon the Greek economy, revenue flows to the Greek government will likely continue to decline and the public debt dynamics move contrary to the assumptions in the IMF’s DSA.
Meanwhile, the punishment of the Greek population will continue into the distant future.
In a few months time, we’ll be talking about a third Greek bailout. In the interim, the unemployment rate will continue to rise along with increased destruction of productive capacity and rising poverty levels. In the official documents accompanying the next bailout summit, the IMF will blithely inform us that the outturns for 2012 were worse than expected and an even harsher austerity trajectory will be required.
That is enough for today!