“You are both gentlemen…or something” – debating Greece with Lorcan Roche Kelly

This week I spoke at Camp Alphaville in London. It was good fun. Among other things I had great fun arguing with my good friend Lorcan Roche Kelly about Greece. As usual Lorcan and I do not agree on anytihing.

See the “fight” here.

And if you want to see Lorcan and I arguing last year at Camp Alphaville about the ECB (Lorcan claims he won that argument…) see here.

PS FT Alphaville’s Cardiff Garcia orchestrated the whole thing.

PSS see also my earlier post How the RECOVERY will look like when Greece leaves the euro.

Hypermind prediction: Nearly 50% probability of Grexit in 2015

Have a look at the latest numbers from Hypermind’s prediction market on the likelihood of Greece leaving the euro in 2015.

Grexit probability

In my view this likely is also the kind of probability that the rest of the financial markets put on Grexit in 2015 and given the relatively calm reaction in the European markets to recent developments then this a fairly good indication that we would not face an European financial armageddon if Greece were to leave the euro area.

In this regard it is also worthwhile noticing that Hypermind also runs a prediction market for euro zone GDP growth in 2015 and if anything the expectations for GDP growth have inched up slightly recently (to around 1.5% around 1.4% a month ago). Said in another way there seems to be little correlation between the increased likelihood of Grexit and euro zone growth expectations.

HT Maxime Cartan

The race to default…is it time for ‘Puerto Ricixt’?

It has been characteristic about the Great Recession that so relatively few countries have defaulted given the scale of the financial distress and the slump in economic activity. But it now seems to be changing. Greece this weekend moved dramatically closer to a sovereign default and the Ukrainian government has signaled that it could effectively default in July.

And now this from the commonwealth of Puerto Rico (from the New York Times):

Puerto Rico’s governor, saying he needs to pull the island out of a “death spiral,” has concluded that the commonwealth cannot pay its roughly $72 billion in debts, an admission that will probably have wide-reaching financial repercussions.

The governor, Alejandro García Padilla, and senior members of his staff said in an interview last week that they would probably seek significant concessions from as many as all of the island’s creditors, which could include deferring some debt payments for as long as five years or extending the timetable for repayment.

“The debt is not payable,” Mr. García Padilla said. “There is no other option. I would love to have an easier option. This is not politics, this is math.”

…Puerto Rico’s bonds have a face value roughly eight times that of Detroit’s bonds. Its call for debt relief on such a vast scale could raise borrowing costs for other local governments as investors become more wary of lending.

Perhaps more important, much of Puerto Rico’s debt is widely held by individual investors on the United States mainland, in mutual funds or other investment accounts, and they may not be aware of it.

Puerto Rico, as a commonwealth, does not have the option of bankruptcy. A default on its debts would most likely leave the island, its creditors and its residents in a legal and financial limbo that, like the debt crisis in Greece, could take years to sort out.

Still, Mr. García Padilla said that his government could not continue to borrow money to address budget deficits while asking its residents, already struggling with high rates of poverty and crime, to shoulder most of the burden through tax increases and pension cuts.

He said creditors must now “share the sacrifices” that he has imposed on the island’s residents.

…With some creditors, the restructuring process is already underway. Late last week, Puerto Rico officials and creditors of the island’s electric power authority were close to a deal that would avoid a default on a $416 million payment due on Wednesday.

…“My administration is doing everything not to default,” Mr. García Padilla said. “But we have to make the economy grow,” he added. “If not, we will be in a death spiral.”

A proposed debt exchange, where creditors would replace their current debt with new bonds with terms more favorable to Puerto Rico, signals a significant shift for Mr. García Padilla, a member of the Popular Democratic Party, who was elected in 2012.

…He said that when he took office, he tried to balance the fiscal situation through austerity measures and fresh borrowing. But he saw that the island was caught in a vicious circle where it borrowed to balance the budget, raised the debt and had an even bigger budget deficit the next year.

…“There is no U.S. precedent for anything of this scale or scope,” according to the report, one of whose writers was Anne O. Krueger, a former chief economist at the World Bank and currently a research professor at the School of Advanced International Studies at Johns Hopkins University.

…Some officials and advisers say Congress needs to go further and permit Puerto Rico’s central government to file for bankruptcy — or risk chaos.

It is hard to miss the similarities between Puerto Rico and Greece, while Greece is a independent country Puerto Rico is a commonwealth within the USA, but both share the fact that they are part of a bigger currency union.

So if we wanted to formulate a theory of default we might want to bring in two elements – an in-optimal currency union (and too tight monetary policy for some members of the union) and serious moral hazard problems due to the perceived high likelihood of a bail-out by the big brother – the US government in the case of Puerto Rico and the European taxpayers in the case of Greece.

PS Ukraine and Venezuela are also on the path to default, but that I believe are quite different stories.

PPS What do we call it if Puerto Rico gives up the US dollar? Puerto Ricixt?

We need a mechanism for sovereign debt crisis resolution

In the future I will be writing a weekly column for the Danish business daily Børsen. The first column appears in today’s edition of the newspaper (you can read the article in Danish here). International news outlets and newspapers interested a syndication deal on my new weekly column are welcome to contact me (lacsen@gmail.com).

On this occasion I here share the English translation of the article:

We need a mechanism for sovereign debt crisis resolution

Recently nearly all the news flow in the financial media has been about the risk of a Greek sovereign default. But Greece is not the only country, which is currently in serious risk of a default. The same is the case for Ukraine, Venezuela and Puerto Rico. Thus, if we are unlucky, we might get 3-4 sovereign defaults within the next 1-2 months.

It is quite obvious that a possible Greek or Ukrainian sovereign default is something that contributes to the uncertainty surrounding especially the European economy and it is clear that this is contributing to increasing volatility in global financial markets.

The main source of uncertainty in relation to sovereign default is uncertainty about when it happens and what creditors that will be affected.

If we compare a sovereign default with a company or a bank going bankrupt, then it is the case that we in most developed economies in the world have relatively clear rules on how a possible bankruptcy should be handled in legal terms.

It is usually the case that a company in financial trouble under certain conditions can go into receivership, while trying to see if the company can be rescued. And if this rescue attempt fails then there will be quite clear rules about what creditors are first in line when the estate is made up.

Such mechanisms mostly ensure that an orderly and controlled restructuring or liquidation of the company can take place and at the same time ensure the greatest possible transparency about who will bear any losses.

Unfortunately we don’t have similar rules and mechanisms when it comes to sovereign defaults. As a result even a minor risk of a possible sovereign default creates unnecessary volatility in the global financial markets.

This, however, need not be the case and one may wonder why we in the EU hardly have discussed the possibility of organizing a mechanism within the EU, or at least within the euro area, which can ensure a more transparent and proper handling of threatening sovereign defaults.

In 2010, the four economists – including the former chief economist of the World Bank Anne Krueger – put forward a concrete proposal for “A European mechanism for sovereign debt crisis resolution”. The plan for example included a proposal for a special European court to oversee the process of debt negotiations and debt restructuring. Such a court and clear rules on debt restructuring would greatly help to make the handling of the sovereign debt crises much less politicized than it is today.

Unfortunately, the proposal has not received much attention among European decision-maker, and one can only fantasize about how much easier the handling of the Greek debt crisis would have been if we had such rules and mechanism for orderly debt restructuring in place in recent years.

Companies go bankrupt. And so does governments. We therefore urgently need to set up institutions and mechanisms to handle sovereign defaults.

Remember the “Corralito”? Lessons on Greece and Argentina from the New York Times

This is from the New York Times today:

Greece will keep its banks closed on Monday and place restrictions on the withdrawal and transfer of money, Prime Minister Alexis Tsipras said in a televised address on Sunday night, as Athens tries to avert a financial collapse.

The government’s decision to close banks temporarily and impose other so-called capital controls — and to keep the stock market closed on Monday — came hours after the European Central Bank said it would not expand an emergency loan program that has been propping up Greek banks in recent weeks while the government was trying to reach a new debt deal with international creditors.

The debt negotiations broke down over the weekend after Mr. Tsipras said he would let the Greek people decide whether to accept the creditors’ latest offer. That referendum vote is to be held next Sunday, after the current bailout program will have expired.

And this is from the New York Times on December 2 2001:

The government (of Argentina) has limited cash withdrawals from banks and taken a step toward adopting the dollar as Argentina’s currency, as part of a desperate effort to avert a run on banks and a chaotic devaluation.

The measures, announced late Saturday, were another sign that Argentina is on the brink of a default on its $132 billion in public sector debt. It has already cut the interest payments it makes on $45 billion in bonds in recent days.

A month later we had street rioting, banking sector collapse, a sovereign default and a major devaluation – not to mention the collapse of government and a very busy rotating door at the presidential palace!

Will Greece be luckier in the coming month? Let’s hope so.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

How the RECOVERY will look like when Greece leaves the euro

Most indications are that Greece this weekend effectively has been pushed over edge by the collective failures of Greek and European policy makers. The combined forces of an European monetary straitjacket, the lack of a coherent European sovereign debt crisis resolution mechanism and weak Greek institutional structures and a lot of badwill on both sides of the issue in the end did it.

And we are now facing bank run, possible banking sector collapse, the likely introduction of capital controls, a Greek sovereign default and potentially also a Greek exit from the euro area.

So there is no doubt that the future looks very bleak for the Greek economy, but there are also good arguments that all this actually might mark the beginning of a Greek economic recovery in the same way the Argentine default and devaluation in January 2002 was the beginning of a sharp recovery in Argentine growth in from 2002 to 2007.

Argentina in 2001-2, Greece today 

it is no coincidence that I mention the example of Argentine. Hence, I have long argued that the present Greek crisis is very similar to the Argentine crisis of the late 1990s and early 2000s. Both countries have been suffering under the combined pressures of a monetary regime that creates strong deflationary pressures and a weak domestic political system.

We can essentially think of this as both a demand and a supply problem. With the monetary system causing a collapse in aggregate demand and weak institutional structures at the same time causing a negative supply shock as well as creating downward rigidities to wages and prices.

In the late 1990s the Argentine’s currency board set-up created serious deflationary pressures and a drop in nominal GDP, which caused a rise in Argentine debt ratios. There was a simple “solution” to this problem – Argentina should give up the currency board and devalue. That happened in early 2002.

Even though the contraction in the Argentine economy continued in the first couple of quarters after the devaluation growth soon picked up and in fact Argentine real GDP growth in the period 2003-2007 averaging nearly 8.5% per year. Obviously we should not forget that GDP dropped 10% in 2002, but that was essentially the impact of the banking crisis that played out ahead of the devaluation rather than a result of the devaluation.

I think that we very well could be in for a very similar development in Greece if the country indeed leaves the euro area. Obviously we are now in the midst of an extremely chaotic political and economic situation and what could become a full scale banking crisis and a disorderly sovereign default. The bank run we effective already have seen on its own constitutes a massive monetary tightening – due to the drop in the money-multiplier – and that on its own is going to have a strongly negative impact on the Greek economy in the coming quarters.

However, Grexit will also remove the monetary straitjacket, which has had caused an enormous amount of economic hardship in Greece since 2008. The removal of this straitjacket will cause a significant easing of Greek monetary conditions, which in my view very likely will cause a sharp rise in nominal GDP in Greece in the coming years. The graph below shows the development in Argentine M2 and nominal GDP on the back of the Argentine devaluation in 2002.

I think we might very well see a similar development in Greece on the back of Grexit and given the price and wage rigidities in the Greek economy we are likely to see a sharp recovery in Greek real GDP growth – after the initial deep recession, but my guess is that Grexit will be the beginning of the end of this recession.

The graph below shows the development in real GDP in Argentina eight years ahead of the default and the devaluation in 2002 and in eight years following the initial collapse. The graph also includes Greek real GDP. “Year zero” is 2001 for Argentina and 2014 for Greece.

Argentina Greece RGDP

The recovery will not primarily be about exports

Hence, I believe there is good reason to think that a potential Grexit will be the beginning of a sharp recovery in Greek growth – following the initial sharp contraction. However, I would like to stress that contrary to the common-held view such recovery will not be about Greece becoming more “competitive” due to the drop in value of the “New Drachma” (I easily see a 70-80% devaluation following Grexit).

Rather we are likely to see a sharp recovery in domestic demand as a likely sharp rise in inflation expectations will cause a sharp increase in money velocity. This combined with the expected increase in the money supply will cause a significant easing of Greek monetary conditions, which likely will spur a strong recovery in Greek growth.

This is exactly what happened in Argentina. This is from Mark Weisbrot and Luis Sandoval’s 2007-paper on “Argentina’s economic recovery”:

“However, relatively little of Argentina’s growth over the last five years (2002-2007) is a result of exports or of the favorable prices of Argentina’s exports on world markets. This must be emphasized because the contrary is widely believed, and this mistaken assumption has often been used to dismiss the success or importance of the recovery, or to cast it as an unsustainable “commodity export boom…

During this period (The first six months following the devaluation in 2002) exports grew at a 6.7 percent annual rate and accounted for 71.3 percent of GDP growth. Imports dropped by more than 28 percent and therefore accounted for 167.8 percent of GDP growth during this period. Thus net exports (exports minus imports) accounted for 239.1 percent of GDP growth during the first six months of the recovery. This was countered mainly by declining consumption, with private consumption falling at a 5.0 percent annual rate.

But exports did not play a major role in the rest of the recovery after the first six months. The next phase of the recovery, from the third quarter of 2002 to the second quarter of 2004, was driven by private consumption and investment, with investment growing at a 41.1 percent annual rate during this period. Growth during the third phase of the recovery – the three years ending with the second half of this year – was also driven mainly by private consumption and investment… However, in this phase exports did contribute more than in the previous period, accounting for about 16.2 percent of growth; although imports grew faster, resulting in a negative contribution for net exports. Over the entire recovery through the first half of this year, exports accounted for about 13.6 percent of economic growth, and net exports (exports minus imports) contributed a negative 10.9 percent.

The economy reached its pre-recession level of real GDP in the first quarter of 2005. As of the second quarter this year, GDP was 20.8 percent higher than this previous peak. Since the beginning of the recovery, real (inflation-adjusted) GDP has grown by 50.9 percent, averaging 8.2 percent annually. All this is worth noting partly because Argentina’s rapid expansion is still sometimes dismissed as little more than a rebound from a deep recession.

So you better get ready for the stories in the media following a potential Grexit that this will be “good for Greek tourism” and “feta exports”, but if you study monetary history you will know that this will only be part of a the story and looking ahead over the coming five years it is much more likely that the story will be a sharp recovery in Greek domestic demand.

But don’t forget Greece’s quasi-Constitutional problems

Concluding, I am probably more optimistic that a potential Grexit will cause a recovery (after the initial contraction) in the Greek economy than most economists who tend to stress Greece’s structural problems. That, however, does not mean that I don’t think Greece has structural problems. In fact I believe the Greece has very serious structural problems and I will even go so far as to say that Greece’s deep structural problems are a result of fundamental constitutional problems.

Hence, at the core of the problems that have dominated the Greek economic development for decades (if not centuries!) is a flawed political system. Therefore, if Greece wants to avoid ending up as present-day Argentina – where the initial positive effects of monetary easing has been “replaced” by overly easy monetary policy and large political uncertainties – then there is a need for fundamental constitutional reform to reduce the role of government in the Greek economy and constrain the unhealthy relationship between economic and political interests.

So yes, monetary easing can solve the demand problems in the Greek economy (I think that actually was under way prior to Syriza winning the parliament elections), but monetary easing will not do anything about Greece’s structural and constitutional problems.

Finally, on a personal note I must say I have a very deep sympathy for the economic and social suffering of the Greek population and I full well understand their justified frustration they have with European and Greek policy makers who so utterly have failed in the past seven years. I equally understand the frustration of German, Danish and Slovak tax payers who directly or indirectly over the past seven years have been asked to pick up the bill for numerous badly designed bailout packages. They have done very little good to Europe or Greece.

But I mostly hope that we would give up the national stereotyping and instead study the fundamental economic and monetary issues. The Greek crisis is not about the Greeks being “lazy” (in fact Greeks work a lot more than the Germans…) or corrupt, but it is about the serious monetary policy failures of the ECB and a generally badly designed monetary policy framework in Europe combined with the failures of the Greek political establishment.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

The end game or a new beginning for Greece? We have seen all this before

Ever since I started my blog in 2011 Greece has been on the verge of banking crisis, sovereign default and euro exit. It now looks as if we might get all of that very soon and very quickly.

This is from CNBC today:

Talks fell apart between the Greek government and its creditors, and European officials said Athens’ bailout program will expire on Tuesday.

Euro zone finance ministers met to try and thrash out a reforms-for-rescue deal for Greece after the country’s prime minister threw a curveball of a referendum on the deal late Friday night. During Saturday’s meeting, the finance ministers rejected Greece’s request for a one-month bailout extension, meaning that Athens could soon face very serious economic issues.

“It’s not a question to see what might happen on Monday. In terms of a crisis (for Greece), the crisis has commenced,” Irish Finance Minister Michael Noonan said after the day’s second meeting.

Greece is due to pay the International Monetary Fund 1.5 billion euros Monday and without a deal this weekend risks missing that payment.

I can’t say I am surprised we are here now – maybe I am surprised that it has taken this long – but the rest is unfortunately not that surprising to anybody who has studied economic and monetary history. We have seen all this before.

I wrote about that already back in 2011:

The events that we are seeing in Greece these days are undoubtedly events that economic historians will study for many years to come. But the similarities to historical crises are striking. I have already in previous posts reminded my readers of the stark similarities with the European – especially the German – debt crisis in 1931. However, one can undoubtedly also learn a lot from studying the Argentine crisis of 2001-2002 and the eventual Argentine default in 2002.

What this crises have in common is the combination of rigid monetary regimes (the gold standard, a currency board and the euro), serious fiscal austerity measures that ultimately leads to the downfall of the government and an international society that is desperately trying to solve the problem, but ultimately see domestic political events makes a rescue impossible – whether it was the Hoover administration and BIS in 1931, the IMF in 2001 or the EU (Germany/France) in 2011. The historical similarities are truly scary.

I have no clue how things will play out in Greece, but Germany 1931 and Argentina 2001 does not give much hope for optimism, but we can at least prepare ourselves for how things might play out by studying history.

I can recommend having a look at this timeline for how the Argentine crisis played out. You can start on page 3 – the Autumn of 2001. This is more or less where we are in Greece today.

I wrote that back in 2011. It has been four more years of economic and social pain for the Greek population so you got to ask yourself – just how bad can the alternative be?

And finally a – highly speculative – note: If we in fact get Grexit then my forecast is that we will have a couple of quarters of negative GDP growth (as a result of the bank run we already have seen), but then Greece will see the mother of all recoveries as the New Drachma plummets (likely 70-80%).

This will be the positive result of ending the monetary strangulation of the Greek economy. However, structurally and politically it is hard to be positive – and hence Greece will then again within the next decade face another crisis likely in the form of weak growth and this time around high inflation as public finance problems will likely remain unsolved. At least this is how it played out in Argentina…

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Guest post: Europe’s problem is not a Greek drama but a medieval Calvinist morality play (by Mikio Kumada)

I have asked my friend Mikio Kumada to write a guest post on blog on a topic he knows very well – the Greek crisis. While I do not agree with everything Mikio writes (I do agree with most of it) I think it is extremely important to get a broader and more insightful perspective on the Greek crisis (and the euro crisis) than the standard “Calvinist” version.

Good luck.

Lars Christensen

Guest post: Europe’s problem is not a Greek drama but a medieval Calvinist morality play

by Mikio Kumada

The crisis that Greece has found itself in over the past five years has been invariably labelled as a “Greek tragedy” by the media around the world – which is both wrong and misleading. More importantly, it is very unhelpful when it comes to finding a way out for Greece and for Europe as a whole.

The reality is that, if one wishes to use catchy cultural labels, it would be more appropriate to call it a medieval European morality play of the Calvinist sort – and a rather bad one at that, too. Bad, because it harks back to notions of good and evil that perpetuate mistakes and delay a solution to the actual problem.

In this “Calvinist” play, the Europeans are telling Greece:

“We understand that your house is on fire, but you cannot use our stand-by fire extinguishers and fire engines, because you’ve been a bad boy/bad girl, and you have to repent for your sins first. You can use the extinguishers in the rooms in which our property is stored, but for the rest, use this bucket of water instead, which we so generously provide to you.”

What you say if your house was on fire, and your “friends” gave the above “advice” and “help”?

Do not get me wrong: Greece was predominantly responsible for the fact that its house was so easily inflammable, and that that it was ill-prepared to cope with the disaster. But it is only to a smaller part responsible that the fire is still raging.

Furthermore, over the past five years, Greece has done its best to put out the fire with the water bucket, and to “repent”, as recommended – i.e. it has implemented a wide range of difficult reforms and cuts (Prof. Karl Whelan of University College Dublin provides a good account here). Even Greece’s new government is willing to compromise to a considerable degree.

That said, let me move straight on to what I believe is the most likely scenario of how things will play out in the coming days or weeks – depending on the level of European intransigence ability to admit mistakes and lose a little bit of face, for the sake of avoiding an even greater calamity.

In spite of what I may have appeared to suggest above, I believe Europeans in general and Northern Europeans in particular are emotionally capable of soul-searching and intellectually perfectly endowed for reflection and pragmatism, to use a very Greek term. Thus, realistic, practical solutions will ultimately prevail in this whole affair.

Consequently, I still think there will not be a “Grexit” – not this week, not this quarter, not next year, or in any other year. What is most likely (though of course not certain) to happen, is the following:

  • There will be an extension of the current (revised and softened) program for something like 3 to 6 months.
  • In order to achieve this, the Europe will find a way to move Greece’s current liabilities versus the IMF and the ECB to the ESM, without actually having to spend a single “new” penny. The funds required for this purpose are available – in the form of the unused 10 billion euros from the Greek bank recapitalization fund, the roughly 2 billion euros in ECB profits from its older purchases of the Greek bonds, and by allowing Athens to borrow a couple of billion more from its own banks (the issuance limit of T-bills is subject to approval by the ECB). This will also allow the Europeans to get the IMF off their backs for now.
  • This, in turn, should eventually allow Greece to participate in what is the most important determinant factor for Europe’s economic recovery in the near future – the ECB’s first proper quantitative easing program that began in March – before it’s too late.
  • There will be a third financing program for Greece sometime early next year, which will be much smaller in size and more realistic by design than the previous ones. It will probably include a specific European commitment to provide debt relief – in order to get the IMF back on board. Or it will completely “Europeanize” the problem.
  • Under these conditions, it will be possible for Greece to produce nominal GDP growth – which is the mother of all debt sustainability miracles, as it is the basis of all household income, corporate profit, and tax revenue.

I should add that international political considerations regarding the IMF form an important part and driver of the above scenario. Point 2) would calm the US-led IMF, for now, as it would avoid a global loss of face for Europe, if an EU member is allowed to default vs. the fund.

Needless to say, such an event would weaken Europe’s global standing in the organization, and beyond. No matter how much Northern Europe would like to detach itself from it, Greece is a European affair.

Here, it is useful to remember that we live in an era in which the Bretton Woods organizations will soon be competing, to say the least, with similar international institutions-in-the-making, led by China and the BRICs. This is no small matter.

Europe’s huge combined share aside, the IMF’s two largest shareholders are the US and Japan, which, by the way, stands behind the Eurozone bailout loans with some 90 billion US dollars.

And while Germany, and others, could try to squarely place the blame on Athens, but hardly anyone would really buy that. The rest of the world would see this as a European failure, especially since the IMF was (reportedly) pressured by the Europeans to bend its rules to lend to Greece. Allies and friends such as the US/UK and Japan will have a harder time siding with Europe, and the emerging economies will see as proof that Europe’s role in the IMF is not just oversized, but also very costly, to say the least.

The problem of the “Calvinist” approach to the Greek crisis also plays a role on this level.

After all, practically all major countries outside Northern Europe are less moralistic and more pragmatic when it comes to debt problems. One example can be found in the fact that the US, UK and Japan were quicker in intellectually accepting QE, without concerning themselves too much about whether this represented inappropriate / immoral “stealth government financing” (I believe QE is simply a perfectly legitimate, useful and important tool of monetary policy). Another example can be found in a side-quip by a Chinese economist I overheard in Hong Kong, who described Beijing’s ongoing (vaguely veiled) bailout of its highly indebted provinces as being akin to Europe’s bailout of Greece – “just without the austerity”.

To make a long story short, I do believe that Europe will overcome the limitations imposed by the simplistic application of culture-specific morality in internationally relevant policy affairs – especially when the tools and means to overcome its problem are clearly available.

And if there is any “Greek drama” involved in this, it could very well prove useful for Europe as a whole, by confronting it with important policy questions – and thus ultimately help it move on to a more workable, and pragmatic, solutions to its problems.

© Copyright (2015) Mikio Kumada

Yanis Varoufakis has a point – the Greek debt crisis is mostly about the collapse of NGDP

The Greek Finance Minister Yanis Varoufakis has a new article for Project Syndicate. He is making a point that Market Monetarists have been making since the outbreak of the euro crisis – it is not really a ‘debt crisis’, but rather a monetary crisis.

This is Varoufakis:

The view that Greece has not achieved sufficient fiscal consolidation is not just false; it is patently absurd. The accompanying figure not only illustrates this; it also succinctly addresses the question of why Greece has not done as well as, say, Spain, Portugal, Ireland, or Cyprus in the years since the 2008 financial crisis. Relative to the rest of the countries on the eurozone periphery, Greece was subjected to at least twice the austerity. There is nothing more to it than that.

Here is his graph:

Now compare that with a graph I had in one of my blog posts back in 2012:

And this is what I wrote then:

The conclusion is very clear. The change in public debt ratios across the euro zone is nearly entirely a result of the development in nominal GDP.

The “bad boys” the so-called PIIGS – Portugal, Ireland, Italy, Greece and Spain (and Slovenia) are those five (six) countries that have seen the most lackluster growth (in fact decline) in NGDP in the euro zone. These countries are obviously also the countries where debt has increased the most and government bond yields have skyrocketed.

This should really not be a surprise to anybody who have taken Macro 101 – public expenditures tend to increase and tax revenues drop in cyclical downturns. So higher budget deficits normally go hand in hand with weaker growth.

The graph interestingly enough also shows that the debt development in Greece really is no different from the debt development in Germany if we take the difference in NGDP growth into account. Greek nominal GDP has dropped by around 10% since 2007 and that pretty much explains the 50%-point increase in public debt since 2007. Greece is smack on the regression line in the graph – and so is Germany. The better debt performance in Germany does not reflect that the German government is more fiscally conservative than the Greek government. Rather it reflects a much better NGDP growth performance. So maybe we should ask the Bundesbank what would have happened to German public debt had NGDP dropped by 10% as in Greece. My guess is that the markets would not be too impressed with German fiscal policy in that scenario. It should of course also be noted that you can argue that the Greek government really has not anything to reduce the level of public debt – if it had than the Greece would be below to the regression line in the graph and it is not.

So yes I agree with Varoufakis that a lot of Greece’s fiscal troubles are a direct consequence of the collapse of Greek GDP. That, however, does not change the fact that Greece needs serious structural reforms – including pension reform, tax reform and privatisation – preferably also in my view serious constitutional reforms and I am not sure that the hard-leftist Syriza government is able or willing to deliver such reforms.

And I am not arguing that the EU and the IMF should let Greece off the hook, but on the other hand I do think that there are ways forward.

In my view the best solution – and there are no easy solutions at this point – is deep structural reforms in Greece combined with a refinancing of Greek government debt so the present debt to the European Stability Mechanism is replaced by newly issued bonds linked to Greek NGDP.

Interestingly enough Varoufakis has also suggested that Greek public debt should be linked to NGDP. This is how I explained the idea recently:

The general idea with NGDP linked bonds is that the servicing of the public debt is linked to the performance of Greek NGDP. This would mean that if growth picked up in Greece then the Greek government would pay of more debt, while is NGDP growth slows then Greece will pay of less debt.

This of course would make Greek public finances much less sensitive to shocks to NGDP and therefore reduce the likelihood that the Greek government would be forced to defaults if growth fails to pick-up. On the other hand German taxpayers should welcome that if there I a pick-up in NGDP growth in Greece then the Greek government would actually pay back its debt faster than under the present debt agreement.

Furthermore, more if public debt servicing is linked to the development in NGDP growth then Greek public finances would become significantly more counter-cyclical rather than pro-cyclical.

NGDP linked bonds is not a solution for all of Greece’s problems – far from it –  but it could help reduce the pain of necessary structural reforms.

So once again I have to say that I to a large extent agree with Varoufakis analysis and some of his policy proposals. That, however, does not mean that I think he has the backing in the Syriza government to implement the serious structural reforms in the Greece that I also think is badly needed.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

“Now the enriched country merely declares it is insolvent and spits on Its victims.”

I can’t help of thinking of events in the 1930s when I see the headlines in the financial media these days. One thing is the geopolitical situation – another thing is the new Greek government’s attempt to negotiate a new debt deal with the EU.

To me it is striking to what extent the economic and political situation in Greece resembles that of Germany in the early 1930s. And similar the position of Germany today – both that of the German media and of the German government is very similar to the French position in the early 1930s.

In 1931 the German economy was in a deep crisis with deflation and ever mounting debt – both public and private. A rigid monetary regime – the gold standard – was strangulating the German economy – while extremist parties on the left and right became increasingly popular among voters. At the same time the position of French government was uncompromising – Germany’s problems is of her own making. The answer was more austerity and there could be no talk of a new debt deal for Germany. Nobody seemed to think there was a monetary solution.

I therefore think we can learn a lot from studying events in the early 1930s if we want to find solutions for the euro zone crisis and it might be particularly suiting for the German newspapers to take a look at what they themselves were writing in early 1930s about the French position and then compare that with what today is written in Greek newspapers about the German position today.

Or compare what the French media was saying about Germany in 1931. Just take a look at this quote:

(The French newspaper) L’Intransigeant describes Germany‘s financial methods as frankly dishonest bankruptcy. “In 1923,” it states, “Germany reduced the national debt to nothing, then borrowed abroad on short terms credit which was invested on long terms, and is thus unable to repay her creditors. Now the enriched country merely declares it is insolvent and spits on Its victims.”

I am pretty sure I could find a similar quote in the Bild Zeitung today about Greece.

I encourage my readers to have a look at the newspaper achieves from 1931 to find similarities with the situation today in regard to the relationship between France and German in 1931 and Germany and Greece today. I will be happy to publish your findings (drop me a mail at lacsen@gmail.com).

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